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Interest on Debenture

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What is Interest on Debenture?

Business owners often resort to public borrowing to meet capital deficit or for expansion purposes. Now, there are several means through which company owners can generate funds. Notably, the issue of debenture is arguably one of the best ways of generating some money for the company. 


Both debenture holders and company owners tend to benefit through the issue of debentures. To elaborate, the company owners can raise the required amount of capital, while debenture holders generate income in the form of debenture interest.


Before we dive straight into the meaning of debenture interest, we should become familiar with the fundamental concept of debentures first. It would help us to gain a more precise idea of the concept and all its aspects.


What is Debenture?

A debenture is an unsecured debt instrument. Typically, it is a certificate which is issued by a company as an acknowledgement that it owes money to its holder. It is issued to the public through a prospectus which is quite to the issue of shares.


The fact that there is no collateral involved with debentures, their holders are heavily dependent on the reputation and creditworthiness of the issuer.  Like mentioned earlier, the primary purpose of issuing debenture is to raise the required funding or capital for business-oriented reasons. For investors, debentures are deemed to be low-risk investment options that help to generate substantial returns. Debenture can be defined as an unsecured debt unit. It is a certificate that is issued by a company where it states that it owes money to the owner of the debenture. This is issued to the public by a prospectus. There is no collateral included in the debentures and the holders of the debentures are dependent on the reputation of the company that issues the debenture. Debentures are mainly issued so that fundings can be raised or the capital required is obtained for business-related reasons. The investors see debentures as a low-risk investment that can help them to get substantial returns too.  

 

Debenture interest can be defined as the money the owner of the debenture is supposed to earn after they invest money in the debenture of the company. If the company wants collateral security then the owners would not get any interest on the amount they have invested. It is paid at a rate that is fixed on the face value. Interest is a charge on the company that issues a debenture and the interest must be paid irrespective of the status of revenue. According to the Income Tax Act of 1961, the companies that issue debentures have to deduct TDS on interest at a rate of interest specified. In simple terms, interest can be defined as an award where all the holders of the debentures receive the interest for investing in the company’s debentures. The company is the one that pays the interest at a regular period which is previously set by the interest rate in the face value.


Test Your Knowledge: Who are debenture holders?

  1. Company Owner

  2. Creditor

  3. Debtor

  4. Promoter


Types of Debenture

As per the Companies Act, 2013, a company cannot issue debentures that accompany voting rights. Other than that, companies can issue the following debentures –

  1. On the Basis of Security

i. Secured debentures

ii. Unsecured debentures

  1. On the Basis of Convertibility

i. Convertible debentures

ii. Non-convertible debentures

  1. On the Basis of Priority 

i. First mortgage debentures

ii. Second mortgage debentures

  1. On the Basis of Negotiability

i. Bearer debentures

ii. Registered debentures

  1. On the Basis of Permanence 

i. Redeemable debentures

ii. Irredeemable or perpetual debentures


Test Your Knowledge: A debenture whose principal amount is not paid by the issuing company only at the time of liquidation is known as:

  1. Redeemable Debentures

  2. Non-convertible Debentures

  3. Bearer Debentures

  4. Irredeemable Debentures

 

What is Interest in Reserved Debenture?

Debenture interest can be explained as the capital which debenture holders are entitled to earn for investing their money in the said company’s debenture. However, if a company tends to issue debenture as collateral security, the holders would not receive any interest on their investment.


Typically, interest on debentures is paid at a fixed rate on their face value systematically. It must be noted that such an interest is a charge on debenture issuing company’s profit and must be paid to the holders, irrespective of the revenue status.


As per Income Tax Act, 1961, debenture issuing companies are required to deduct TDS on interest on debentures at a specified rate of interest. However, such a tax is imposed only if the payable interest amount exceeds the mentioned limit. The tax thus collected is deposited to the income tax authorities by the denture issuing company.


Test Your Knowledge: Interest paid on debenture is:

  1. Appropriation of Profits

  2. Charge Against Profit

  3. Transferred to General Reserve

  4. Transferred to the Account of Sinking Fund

On that note, let’s check out how debenture interest is treated in the books of accounts.

 

Accounting Treatment of Interest on Debenture

This is how debenture interest is treated in accounting in a different situation.

A. In Case Interest is Due and the Tax on It is ignored – Interest Paid Journal Entry 

Date 

Particulars

Amount (Dr)

Amount (Cr)


Interest payable on debentures A/C

ZZZZ



To Debenture holder A/C


ZZZZ


(Being interest payable)



B. In Case Interest on Debenture is Due and TDS is levied – TDS Payable Journal Entry

Date 

Particulars 

Amount (Dr)

Amount (Cr)


Interest payable on debentures A/c

ZZZZ



To Debenture holders’ A/C


ZZZZ


To TDS Payable A/C 


ZZZZ


(Being interest is paid on debentures and TDS)




C. In Case of Payment of Interest on Debenture – Interest Payable Journal Entry

Date 

Particulars 

Amount (Dr)

Amount (Cr)


Debentures A/c

ZZZZ



To Bank A/C


ZZZZ


(Being interest paid is transferred to a bank)



 

D. In Case of Deposition of TDS – TDS Payable Journal Entry

Date  

Particulars 

Amount (Dr)

Amount (Cr)


TDS Payable A/C

ZZZZ



To Bank A/C


ZZZZ


(Being TDS amount is deposited in bank)



 

E. Transferring Interest to the Statement of Profit and Loss at Year-End

Date 

Particulars 

Amount (Dr)

Amount (Cr)


Profit and Loss Statement

ZZZZ



To Interest payable on debenture A/C


ZZZZ


(Being interest is paid on debentures is transferred P/L Statement)



 

Test Your Knowledge: What is the nature of a debenture application account?

  1. Personal account

  2. Real account

  3. Nominal account

  4. None of these

Task For You: Pass a journal entry for TDS deducted.


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FAQs on Interest on Debenture

1. What are the types of Debenture?

The types of debenture are divided based on different factors and they are given as follows: 

A. Based on Security

a) Secured debentures

b) Unsecured debentures

B. Based on Convertibility

a) Convertible debentures

b) Non-convertible debentures

C. Based on Priority 

a) First mortgage debentures

b) Second mortgage debentures

D. Based on Negotiability

a) Bearer debentures

b)Registered debenture 

E. Based on Permanence 

a)Redeemable debentures

b) Irredeemable or perpetual debentures 

2.  What are Redeemable Debentures?

The most important feature of a debenture is that the amount has to be repaid. Every debenture does not come with a repayment date specifically. But redeemable debentures come with a specific date of repayment. The issuer of the debenture has to repay the amount on a predetermined date to the one from which it borrowed the amount of the holder of the debenture. Due to this, companies can bring in more investors with redeemable debentures. This is due to the assurance that the investors will get paid in future.  

3.  What are Non-Convertible Debentures?

The debentures that are on a fixed income which are usually issued by large companies as a public issue to get a larger and long term capital are called non-convertible debentures or NCD. They also provide a higher rate of interest when compared to convertible debentures. Such debentures cannot be transformed into stocks or equity and they have a fixed date of maturity. The interest can be paid monthly, quarterly and even monthly. They are quite beneficial for investors with a low-risk rate.

4.  What is a Bearer Debenture?

The bearer debentures can be explained as those debentures which are transferred by delivery and can be paid to the bearer of it i.e. the bearer who has the instrument. The records of such debentures are not maintained and transfer registration is also not required. Thus, these are also called unregistered debentures. The bearer debentures holder has to submit coupons for interest payments that are attached physically to the security of the issuing company or bank to receive the payments of interest.

5. How do Irredeemable Debentures Work?

Irredeemable debentures can be defined as the agreement which is made by the borrower and the lender with a good amount of interest rate. When the company becomes insolvent, the debenture makes sure that the lender gets the funds first. This type of debentures gives the lender safety in case the company which borrowed faces monetary difficulties and this denture is also a cost-effective method for the company that borrows.

6. What is the meaning of Interest?

In finance, interest can be defined as a percentage of loan value that borrowers pay to lenders in addition to the principal amount. Typically, it is charged or offered at a fixed rate. Debenture interest is an example of interest. 

7. What is a Debenture?

A debenture is a debt instrument with the help of which issuing companies intend on raising funds or capital.  It is mainly a certificate that serves as a piece of evidence that the company owes money to the debenture holder.