Issue of Debentures

Issue of Debentures as Collateral

Debentures issued as collateral security is secondary or parallel security for the original loan taken by the company. The lender can realize the collateral security in case borrower fails to make the payment of the original loan. In this article, we will learn more about the debentures issued as collateral security and accounting treatment.

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Debentures issued as Collateral Security

Collateral means secondary. Thus, collateral security refers to supporting or secondary security for a loan. In case the borrower fails to pay the original loan amount on the due date, the lender can sell the collateral security to realize the amount of loan.

Usually, the borrower places a particular asset or a group of assets as collateral security. When he fails to pay the loan, these assets are sold and the loan is paid from the sale proceeds.

However, sometimes a company may issue its own debentures as collateral security for a loan. When it pays the loan on the due date, the lender immediately releases the main security and these debentures.

In a case where the company is unable to repay the principal amount and the interest on the loan on the due date, the lender becomes the holder of these debentures.

Thus, he can exercise all the rights of a debenture holder. However, the holder of these debentures is entitled to the interest on the loan but not on the debentures.

Browse more Topics under Issue Of Debentures

Learn more about Features, advantages, and disadvantages of Debentures.

Accounting Treatment

There are the following two methods for recording this kind of debentures:

Method 1

As per this method, the company makes no entry at the time of issuing these debentures. It discloses them by way of a note under the liability secured that issue of debentures and outstanding, under the ‘Notes to Accounts’ of Balance Sheet.

debentures issues as collateral security

Under this method, we pass the following journal entry to record the issue of such debentures:

Date Particulars   Amount (Dr.) Amount (Cr.)
1. Debentures Suspense A/c Dr.  XXX
     To % Debentures A/c Cr.  XXX
(Being issue of … % Debentures as collateral security as per Board’s Resolution no…dated…)

 

In this case, we will show the debentures account on the liabilities side of the Balance Sheet. While we will show the Debentures Suspense A/c on the assets side of the Balance Sheet under Other Non-Current Assets.

At the time of repayment of the loan by the company, it needs to reverse the entry in order to cancel it.

However, Method 1 is more logical and rational from the accounting perspective. Thus, it is advisable to follow method 1.

Solved Example For You

Shah Ltd. takes a loan from State Bank of India of ₹5000000. It gives 12% First Mortgage Debentures of face value ₹100 each of ₹7000000 as collateral security. Show the accounting treatment using both the methods.

Ans.

Method 1

The company will show it in the ‘Notes to Accounts’ of Balance Sheet in the following manner:

Notes to Accounts of Shah Ltd. as at…(includes)

Long-term Borrowings
Secured Loan
State Bank of India 5000000
(Collaterally secured by the issue of ₹7000000 12% First Mortgage Debentures)

 

Method 2

Date Particulars   Amount (Dr.) Amount (Cr.)
Debentures Suspense A/c Dr. 7000000
     To 12% First Mortgage Debentures A/c Cr. 7000000
(Being issue of ₹7000000, 12% First Mortgage Debentures as collateral security as per Board’s Resolution no…dated…)

 

Balance Sheet of Shah Ltd. as at….(Extracts)

  Particulars   Notes No. Amount (₹)
EQUITY AND LIABILITIES
1. Non-current liabilities
Long-term borrowings 12000000
Total 12000000
ASSETS
2. Non-current Assets
Other non-current assets 7000000
3. Current Assets
Cash and cash equivalents 5000000
Total 12000000
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