Features and Differences of Secured, Unsecured, and Other Debentures
Debentures are vital instruments in the world of corporate finance and accounting. A debenture is a formal document by which a company borrows money from investors, promising to repay the amount on a future date and to pay fixed interest, usually at set intervals. Debenture holders are considered creditors of the company, not owners, and play a key role in long-term business funding. The rules and classification of debentures are outlined in law, ensuring transparency and providing investors with several options to match different financial goals.
Classification of Debentures: Concepts and Types
Debentures can be classified into several types based on security, tenure, convertibility, registration, and interest rate. These distinctions help both companies and investors select the most appropriate financial instrument. Understanding these categories is fundamental for commerce students and practitioners in accounting and finance.
| Type | Basis | Example |
|---|---|---|
| Secured Debentures | Backed by company assets or property | Debenture with a mortgage charge |
| Unsecured Debentures | No specific asset as collateral | Debenture without asset backing |
| Redeemable Debentures | Repayable at a set time or in instalments | 5-year fixed tenure debenture |
| Irredeemable Debentures | Not due for repayment during company’s lifetime | Perpetual or long-term debenture |
| Convertible Debentures | Can be converted into shares | Convertible debenture after 3 years |
| Non-Convertible Debentures | Cannot be exchanged for shares | Plain debenture, remains as debt |
| Registered Debentures | Issued in the name of a holder, recorded in company books | Transfer requires documentation |
| Bearer Debentures | Transferable by delivery, no record kept | Bearer instrument with coupon |
Key Definitions and Principles
- Debenture: A formal certificate representing company debt, with a promise to pay interest and repay principal.
- Secured Debenture: Backed by company assets; has either a fixed or floating charge.
- Unsecured Debenture: Not backed by any specific asset, relying on company reputation.
- Redeemable Debenture: Must be paid back at a specific time or period.
- Irredeemable Debenture: No fixed repayment period; repaid on liquidation.
- Convertible Debenture: Gives investors the right to convert debt into company shares.
- Non-Convertible Debenture: Remains debt until maturity, with no conversion rights.
- Registered/Bearer Debenture: Determines if transfer of ownership requires formal documentation or simple delivery.
Practical Examples and Problem-Solving Steps
Suppose a company issues ₹5,00,000 of secured, redeemable debentures at 8% for a period of 6 years. The interest is paid annually. To calculate the annual interest payment:
= ₹5,00,000 × 8%
= ₹40,000 per year
If these debentures are “secured,” investors have a claim against specific assets if the company defaults. If they are “convertible,” after a certain period, debenture holders might opt to convert these into shares, increasing their ownership stake.
Step-by-Step Approach to Identify Debenture Type
- Check if debenture is backed by any asset (secured/unsecured).
- Identify tenure details: Reedemable if there is a maturity; irredeemable if not.
- Determine conversion rights: Convertible if exchangeable for shares, non-convertible if not.
- Review registration: Registered if name is recorded; bearer if not.
- Look for interest rate terms: Fixed coupon or zero-coupon (sold at discount).
Key Features and Application in Commerce
- Debentures allow companies to raise funds without diluting ownership.
- Interest on debentures is a legal obligation and tax-deductible.
- Secured debentures attract risk-averse investors due to safety of collateral.
- Convertible debentures appeal to investors seeking future capital gains.
| Merits | Demerits |
|---|---|
| Does not dilute control or ownership of current shareholders | Interest must be paid even if company makes no profit |
| Provides stable, long-term funds for business operations | High debt may increase insolvency risk |
| Creates trust for investors when secured by assets | Fixed financial burden on company’s resources |
Debenture vs Share: Table of Comparison
| Basis | Debenture | Share |
|---|---|---|
| Nature | Debt instrument | Ownership instrument |
| Returns | Fixed interest | Variable dividend |
| Security | May be secured | Not secured |
| Voting Rights | No | Yes |
| Repayment Priority | Priority during liquidation | Paid after debt is cleared |
Practice Questions
- Differentiate between secured and unsecured debentures with examples.
- How does a convertible debenture benefit investors?
- A company issues 2,000 redeemable debentures of ₹1,000 each at 7%. Find the total annual interest outflow.
Next Steps for Deeper Learning
To master all topics on debentures and improve your understanding of Commerce, continue exploring authoritative study materials and solved examples on relevant Vedantu learning resources. Regular practice of classification, problem-solving, and comparative analysis strengthens both theory and application in exams and practical business situations.
FAQs on All Types of Debentures Explained for Commerce Students
1. What are the different types of debentures?
Debentures are classified into several types based on features such as security, repayment, convertibility, and registration.
Major types include:
• Secured and Unsecured Debentures
• Redeemable and Irredeemable (Perpetual) Debentures
• Convertible and Non-Convertible Debentures
• Registered and Bearer Debentures
Each type caters to specific investor and company requirements as per Company Law and accounting standards.
2. What is the difference between secured and unsecured debentures?
Secured debentures are backed by company assets as collateral, giving holders greater security.
Unsecured debentures have no asset backing, so holders are treated as general creditors.
Key Points:
• Secured = asset-backed, lower risk
• Unsecured = no collateral, higher risk
• In liquidation, secured debenture holders get payment before unsecured ones
3. What are redeemable and irredeemable debentures?
Redeemable debentures are repaid by the company on a predetermined date or after a specific period.
Irredeemable debentures (perpetual debentures) do not have a fixed date of repayment and remain outstanding unless the company chooses to pay them back or is liquidated.
Summary Table:
• Redeemable: Fixed repayment date
• Irredeemable: No fixed maturity, perpetual in nature
4. What are convertible and non-convertible debentures?
Convertible debentures can be exchanged for equity shares of the issuing company after a specified period.
Non-convertible debentures (NCDs) cannot be converted to equity and must be redeemed in cash.
Key Differences:
• Convertible: Option for conversion into shares
• Non-convertible: Only repayable in cash, no conversion
5. Are debentures assets or liabilities?
For the issuing company, debentures are liabilities because they represent borrowed funds that must be repaid. For investors, debentures are assets, as they expect to receive regular interest and principal repayment.
6. What are the merits of issuing debentures?
Merits of debentures include:
• Do not dilute company control or ownership
• Offer fixed interest, attracting conservative investors
• Provide long-term financial stability
• Can be secured for lower risk and cost of capital
Debentures are commonly used as a reliable source of debt financing.
7. What is the main difference between a debenture and a share?
Debenture: Represents a loan to the company (debt instrument); does not carry ownership or voting rights.
Share: Represents a part of company ownership; shareholders have voting rights and may get dividends.
Summary Table:
• Debentures: Fixed interest, priority in repayment, no voting rights
• Shares: Variable dividend, residual claim, voting rights
8. What features are common to all types of debentures?
All debentures share these key features:
• They are debt instruments issued by companies
• Debenture holders are creditors
• Fixed interest is usually paid before dividends
• Redemption terms depend on type (redeemable/irredeemable)
9. What is meant by registered and bearer debentures?
Registered debentures are issued in the name of a specific person and can be transferred only by a transfer deed and registration in the company's records.
Bearer debentures are payable to whoever holds them and are transferable by mere delivery.
10. How are debentures shown in company balance sheets?
Debentures appear under the Non-Current Liabilities section in the company balance sheet, usually listed as "Debentures" or "Long-Term Borrowings", alongside details such as security and interest rate as per regulatory norms.
11. What is a debenture in simple words?
A debenture is a long-term loan instrument issued by a company to raise money from the public or investors, promising to pay a fixed rate of interest plus eventual repayment of principal at maturity.
12. Can you give an example of a convertible debenture?
Yes. Example: A company issues a 5-year, 8% convertible debenture. After 3 years, holders can convert each debenture into a predetermined number of equity shares of the company. This offers flexibility and potential ownership benefits to investors.
