As the issue of debentures introduction, it is a debt instrument that organisations issue for investors to raise capital. Therefore, it is mainly an asset class that serves the long-term capital requirements of a company. Besides, it carries an extended period of maturity at a fixed rate of interest payable periodically such as quarterly, semi-annually, or annually.
For instance, let’s assume that a company ABC issues bonds worth Rs.1,000 in the secondary trading market. Therefore, bondholders have a legal claim to Rs.1,000 worth of ABC’s assets. However, in case of debentures, holders lack the legal ownership of ABC’s assets.
It is primarily due to the fact that debentures are not backed by assets. As a result, creditworthiness coupled with the appropriate market rating generate the confidence of
investors in this debt instrument.
What are Debentures?
Moving on to the definition of debentures, it is a category of corporate debt that is not supported by collateral. As a result, the companies that issue debentures do not have to pledge their assets to fulfil their capital requirements. On top of that, the trust of the issuer is an important element in its financial validity in the market.
Apart from business organisations, governments also use debentures to fund their infrastructure initiatives. As these organisations do not pledge their assets during debenture issue, traders can earn higher profits from their transactions. Consequently, debentures are traded in the debt market through a network of investment brokers.
Besides, investors receive debentures in the form of official certification from the issuing organisation. Therefore, these corporations are legally obligated to repay the principal amount invested by an individual after a stipulated period. In addition, the interest that accrues on the principal amount is fixed. Therefore, debentures are an investment avenue that is often referred to as ‘fixed cost bearing capital’.
For example, suppose an investor Mr. Jones purchases a debenture with a face value of Rs.50,000. The rate of interest applicable is 10% per annum for 5 years. Therefore, Mr. Jones will receive a fixed interest payment of Rs.5,000 every year.
However, the issue of debentures showcases a wide range of features that separate it from other categories of security.
Test Your Knowledge
Consider that the face values of two debentures are Rs.100 each. Debenture A is available at a market price of Rs.85. On the other hand, Debenture B has a market price of Rs.120. Figure out which debenture is discounted and which one is a premium.
What are the Features of Debentures?
The most prevailing and prominent features of debentures include the following pointers –
Redeemable and Irredeemable Debentures – These two types of debentures differ on the degree of time involved in the repayment process. First of all, redeemable debentures make sure that issuing corporations fulfil their repayment obligations to holders. Therefore, the investors are eligible to receive the principal amount combined with the interest portion after a pre-determined period of time.
On the other hand, the companies that issue irredeemable debentures have no legal obligation to pay the principal amount to holders. However, they must pay the interest on the face value of the debenture as specified intervals.
Convertibility of Debentures – A specific section of debentures have the tendency to exhibit convertibility in terms of asset class. Therefore, investors can convert their debentures into equity shares after a tenure. This category of debentures has a conversion ratio which specifies the proportion of shares in exchange of the face value of a bond. For instance, Mr. Jones is eligible to get 10 shares for a debenture with a principal value of Rs.1,000. Therefore, the convertibility ratio is 10:1.
Contrarily, non-convertible debentures lack the option to be converted into equity shares at any points of time. Non-convertible debentures usually offer a higher rate of interest than ordinary convertible debentures. Moreover, the issue of debenture in this category is exposed to lower market risk and has an increased liquidity.
Rank During Liquidation – Debentures and bonds both precede shareholders in terms of receiving debt after a company goes bankrupt. For example, consider that a company ABC faces bankruptcy in the debt market. On liquidation of its assets to repay the creditors, debenture holders are at the beginning of the order. Therefore, companies issue first debentures for creditors who want to recover their sum of investment.
However, second debentures imply that the holders case receive their repayment after other debts are taken care of.
Market Value of Debentures – Even though debenture issue is at face value, it so happens that the market price often dips or rises. In case the market price is lower than the face value, the debenture is said to be discounted. However, if the market price exceeds the face value, the debenture is a premium issue.
Therefore, keeping the features in mind will help a student understand the operations of the debt market. However, if you want a detailed insight into the interesting world of issue of debentures, visit the official website of Vedantu today!
FAQs on Issue of Debentures: Process and Examples
1. What is the issue of debentures, and why do companies do it?
The issue of debentures is a process used by companies to raise long-term debt capital. A debenture is a formal document that acknowledges a loan to the company at a fixed rate of interest. Companies issue debentures primarily to fund expansion, projects, or working capital needs without diluting the ownership of existing shareholders, as issuing shares would. Furthermore, the interest paid on debentures is a tax-deductible expense, which can lower the company's overall tax liability.
2. What is the step-by-step process for issuing debentures to the public?
The process for issuing debentures, as per the CBSE Class 12 syllabus, typically involves the following steps:
- Board Resolution: The Board of Directors must pass a resolution authorising the debenture issue.
- Issue of Prospectus: A prospectus is issued to the public, inviting them to subscribe. It contains details about the company and the debenture issue.
- Receiving Applications: Interested investors apply for debentures along with the application money.
- Allotment of Debentures: The company allots debentures to the applicants. Allotment money is then called for.
- Issuance of Certificates: A debenture certificate, which is the official acknowledgement of debt, is issued to the debenture holders within the stipulated time.
3. Can you provide an example of issuing debentures at a premium?
Issuing debentures at a premium means the issue price is higher than the face value (or nominal value). For example, if a company issues a 9% Debenture with a face value of ₹100 at a price of ₹110, it is an issue at a premium of ₹10.
The extra ₹10 received is not part of the debt; it's a capital profit. This amount is credited to a separate account called the 'Securities Premium Reserve Account' and is shown on the liabilities side of the Balance Sheet under 'Reserves and Surplus'.
4. What does it mean to issue debentures for consideration other than cash?
This occurs when a company acquires assets (like machinery or an entire business) and pays the seller (vendor) by issuing debentures instead of money. For example, if ABC Ltd. buys a building worth ₹50,00,000 from a vendor, it can pay by issuing 50,000 debentures of ₹100 each. No cash is exchanged, but the company acquires an asset and creates a liability. This is a common practice explained in detail for accounting purposes and can be done at par, premium, or discount.
5. What are the main types of debentures a company can issue?
Based on the CBSE 2025-26 syllabus, debentures can be classified from different perspectives:
- From a Security Viewpoint:
- Secured Debentures: Backed by a charge on the company's assets.
- Unsecured Debentures: Not backed by any specific asset. - From a Tenure Viewpoint:
- Redeemable Debentures: Repayable after a specific period.
- Irredeemable (Perpetual) Debentures: Not repayable during the company's lifetime. - From a Convertibility Viewpoint:
- Convertible Debentures: Can be converted into equity shares after a certain period.
- Non-Convertible Debentures (NCDs): Cannot be converted into shares.
6. What is the difference between issuing shares and issuing debentures for a company?
The key difference lies in their nature and the relationship they create with the investor.
- Nature of Capital: Shares represent owned capital, making shareholders owners of the company. Debentures represent borrowed capital, making debenture holders creditors of the company.
- Return on Investment: Shareholders receive dividends, which are a portion of the profits and are not guaranteed. Debenture holders receive fixed interest, which is a charge against profit and must be paid regardless of whether the company makes a profit.
- Repayment: Share capital is generally not returned during the company's lifetime, whereas debentures are issued for a specific period and are repaid on maturity.
- Security: Debentures are often secured by a charge on the company's assets, while shares are not. You can find more details in our Class 12 Accountancy Revision Notes.
7. Why would a company issue debentures as collateral security instead of a direct issue?
A company issues debentures as collateral security when it takes a loan from a bank or financial institution. Instead of selling the debentures for cash, the company pledges them as a secondary security for the loan. If the company defaults on the loan repayment, the lender has the right to claim these debentures and become a debenture holder. This is done to provide extra security to the lender and may help the company secure a loan on more favourable terms. No journal entry is required for the issue itself, only a note on the balance sheet, unless the company defaults. For more information, refer to our page on Debentures as Collateral Security.
8. How does the Companies Act, 2013 regulate the issue of debentures?
The Companies Act, 2013, along with SEBI regulations, imposes several conditions to protect investors:
- A company cannot issue debentures with voting rights.
- Every company issuing debentures must create a Debenture Redemption Reserve (DRR) out of its profits to ensure funds are available for repayment upon maturity.
- A Debenture Trustee must be appointed if the company offers debentures to more than 500 people.
- The company must pay interest and redeem the debentures as per the terms of the issue, and failure to do so can lead to penalties.
9. In case of a company's liquidation, who gets paid first: debenture holders or shareholders?
Debenture holders get paid first. During liquidation, there is a clear order of repayment. Debenture holders are creditors of the company and their claims have priority over shareholders. Secured debenture holders are paid first from the sale of the assets they have a charge on. After all external liabilities, including debentures, are settled, preference shareholders are paid. Equity shareholders, being the owners, are the last to be paid, if any funds remain.
10. How is the 'Discount on Issue of Debentures' treated in a company's financial statements?
When debentures are issued at a discount (below their face value), the discount is a capital loss for the company. According to the Companies Act, 2013, this loss should be written off. It is typically written off over the life of the debentures. Each year, a portion of the discount is charged to the Statement of Profit and Loss. Until it is fully written off, the unamortised portion of the 'Discount on Issue of Debentures' is shown on the Asset side of the Balance Sheet under 'Other Non-Current Assets' or 'Other Current Assets'. To understand the calculations, you can explore the topic of issuing debentures at a discount in detail.
