Introduction of Debentures and Interest on Debentures
Debentures are a type of debt instrument issued by a company or a government to raise capital or funds for its business. It is an acknowledgement given by them for having borrowed a certain amount of money, which it promises to repay at a future date.
The debenture is issued under the company’s seal. It is in the form of a certificate, which is an acknowledgement of indebtedness. It usually specifies a particular period or date for repayment. The debenture contains a contract for repayment of the principal after a fixed period and for payment of interest on debentures at a fixed rate. Also, it generally creates a charge on the undertaking of the company or some parts of its property. Some debentures can be converted to equity shares, while others cannot be.
Issue of Debentures
In general terms, the definition of the word issue is to supply or distribute. But in this context, the meaning of the word ‘issue’ is to give out a certificate with the company’s seal as an acknowledgement of the debt taken by the company. The procedure for issue of debentures by a company is very much like the issue of shares. Another word for issuing can be supplied or giving out something, which may be banknotes or company shares.
Interest on Debentures
In general terms, the definition of the word issue is to supply or distribute. But in this context issuing debentures means to give out a certificate with the company’s seal as an acknowledgement of the debt taken by the company. The procedure for the issue of debentures by a company is very much like the issue of shares. Another word for issuing can be supplied or giving out something, which may be banknotes or company shares.
Terms of Issue
Companies use debentures when they need money for their expansion. The terms of issue of debentures come with a promise to repay at a future date. Debentures are a part of the borrowed capital. Therefore debenture holders are called creditors of the company. At the time of liquidation and repayment, first preferences are given to the denture holders.
There are four different types of debentures. They are (1) Secured and Unsecured (2) Registered and Bearer and (3) Convertible and Non-Convertible. (4) First and Second.
Secured Debentures: These are the debentures where a charge has been established on the properties or assets of the company for the purpose of repayment of the debt.
Unsecured Debentures: These debentures do not have a particular charge on the assets of the company. However, a floating charge may be established by default.
Registered Debentures: These debentures have details of names, addresses, and particulars of holdings of the debenture holders. The said details are filed in a register kept by the company. These debentures can be moved only by a normal transfer deed.
Bearer Debentures: These debentures can be transferred by way of delivery. The company does not have any record of the debenture holders
Convertible Debentures: These debentures are chargeable to equity shares or in any other security either at the choice of the company or of its holder. These debentures are either fully or partly convertible.
Non-Convertible Debentures: These cannot be changed into shares or any other security.
First Debenture: This type is repaid before the other debentures.
Second Debenture: This can be paid only after the First debenture is paid back.
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Ethical Words and Definitions
Words related to ethics or the words associated with ethics in this context would be individualism, value-system, principle etc. There are both advantages and disadvantages in investing in debentures issued by the companies.
Few terms of ethics in business are Honesty, Integrity, Promise-Keeping & Trustworthiness, Loyalty, Law Abiding, etc.
Advantages
If the investor needs fixed income at a lesser risk, they prefer this.
Financing through them is less costly, compared to the cost of preference or equity capital.
The company does not involve its profits in a debenture.
A debenture does not carry voting rights. Financing through them does not dilute the control of equity shareholders on management.
Disadvantages
Every company has a certain borrowing capacity. With the issue of debentures, the capacity of the company to further borrow funds reduces.
Debentures put a burden on the company on its earnings. So there is a greater risk when the earnings of the company fluctuate.
The company has to make provisions for repayment on the specified date, even during the period of financial strain on the company.
FAQs on Issue and Redemption of Debentures: Explained
1. What is meant by the issue and redemption of debentures?
The issue of debentures is the process through which a company raises long-term funds by borrowing money from the public. It is essentially a formal acknowledgement of debt. Redemption of debentures is the repayment of this debt to the debenture holders after a specified period. In simple terms, issue is borrowing money, and redemption is paying it back. You can learn more about this process in our detailed explanation on the Issue and Redemption of Debentures.
2. What are the main types of debentures a company can issue?
As per the CBSE Class 12 syllabus for 2025-26, companies can issue various types of debentures, which are classified based on different criteria:
- From the point of view of Security: Secured and Unsecured Debentures.
- From the point of view of Tenure: Redeemable and Irredeemable (Perpetual) Debentures.
- From the point of view of Convertibility: Convertible and Non-Convertible Debentures.
- From the point of view of Registration: Registered and Bearer Debentures.
Each type offers different features regarding security, repayment, and potential for conversion into equity. Explore the different types of debentures to understand their unique characteristics.
3. Can a company issue debentures for a consideration other than cash? Explain with an example.
Yes, a company can issue debentures for considerations other than cash. This typically happens when a company acquires assets or an entire business and pays the vendor by issuing debentures instead of cash. For example, if 'ABC Ltd.' purchases machinery worth ₹5,00,000 from 'XYZ Ltd.' and issues 5,000 debentures of ₹100 each to XYZ Ltd. as payment, this is an issue of debentures for consideration other than cash.
4. What are the common methods for the redemption of debentures?
Redemption of debentures is the process of repaying the amount to the debenture holders. The primary methods prescribed in the CBSE curriculum are:
- Lump-Sum Payment: The entire amount is paid to the debenture holders at the expiry of a specified period.
- Payment in Instalments by Draw of Lots: A portion of the debentures is redeemed periodically by selecting them through a random draw.
- Purchase in the Open Market: The company can buy its own debentures from the stock market if the terms of issue permit.
- Conversion into Shares or New Debentures: The company can redeem its debentures by converting them into new shares or debentures.
For a deeper dive, read our guide on the methods of debenture redemption.
5. How are debentures different from shares?
The primary difference between debentures and shares lies in their nature:
- Ownership vs. Loan: Shares represent ownership (equity) in a company, making shareholders owners. Debentures represent a loan (debt) to the company, making debenture holders creditors.
- Return: Shareholders receive a dividend, which is an appropriation of profit and is not guaranteed. Debenture holders receive interest, which is a charge against profit and must be paid regardless of whether the company makes a profit.
- Repayment: The amount invested in shares is generally not returned during the company's lifetime, whereas debentures are issued for a fixed term and are repaid on maturity.
6. What is the difference between a Debenture Redemption Reserve (DRR) and a Debenture Redemption Investment (DRI)?
DRR and DRI are both legal requirements to safeguard the interests of debenture holders, but they serve different purposes. Debenture Redemption Reserve (DRR) is a reserve created by appropriating profits to ensure that funds are set aside for redemption. It is not a cash fund but an allocation of profits. In contrast, Debenture Redemption Investment (DRI) requires the company to invest a specified percentage of the value of debentures maturing in a year in designated securities. This ensures that liquid cash is available when the time for redemption arrives. Learn more about the specifics of DRR and DRI here.
7. Why would a company issue debentures as collateral security?
A company issues debentures as collateral security when it takes a loan from a bank or financial institution. These debentures are given as secondary security, in addition to the primary security. If the company defaults on the repayment of the primary loan, the lender can exercise its rights over these debentures. It's a way of providing extra assurance to the lender without an immediate outflow of funds or creation of a primary charge on assets. This is often preferred when the primary security's value is borderline or fluctuates.
8. Is the interest paid on debentures an appropriation of profit or a charge against profit? Explain the importance.
Interest on debentures is a charge against profit, not an appropriation of profit. This is a crucial distinction. As a 'charge', it means the interest must be paid to debenture holders irrespective of whether the company earns a profit or incurs a loss. It is treated as a business expense and is debited to the Profit and Loss Account. An 'appropriation', like dividends to shareholders, is only paid out if the company has sufficient profits. This makes debentures a less risky investment from the investor's perspective. You can explore the accounting treatment of interest on debentures in detail on our page.
9. How do debentures differ from bonds in the Indian context?
While often used interchangeably, there is a technical difference. The primary distinction lies in security. In India, bonds are typically issued by government or public sector undertakings and are generally secured by the assets of the issuer. Debentures are usually issued by private sector companies and can be either secured or unsecured. Therefore, bonds are often perceived as having a lower risk compared to unsecured debentures. For a complete breakdown, see the difference between bonds and debentures.
10. What happens to the 'Discount on Issue of Debentures' account? How is it treated in financial statements?
The 'Discount on Issue of Debentures' is a capital loss for the company. It represents the difference between the face value of the debentures and their lower issue price. This amount is not written off in a single year. Instead, it is amortised (written off) over the life of the debentures. Until it is fully written off, the unamortised portion of the discount is shown on the asset side of the Balance Sheet under the head 'Non-current Assets' (if it is to be written off after 12 months) or 'Other Current Assets' (if it is to be written off within 12 months).
