Issue of Debentures: Meaning, Examples and Journal Entries

The issue of debentures allows companies to raise funds by borrowing from the public, offering fixed interest payments and repayment of principal at maturity. Debentures are typically issued at par, premium, or discount and do not affect ownership, as debenture holders are creditors, not shareholders. It’s a popular option for financing without diluting control.

Issuing debentures is a common way for companies to raise capital without diluting ownership. It allows businesses to borrow funds by offering fixed interest payments to debenture holders, with the principal repaid at maturity. This method is crucial for understanding corporate financing strategies. For those looking to delve deeper into such financial concepts, online finance courses provide a structured approach to learning the intricacies of debenture issuance. It will help individuals develop the skills to analyze such financial instruments and their impact on business growth and stability in today’s competitive market.

 

What is Issue of Debentures?

The issue of debentures is a way for companies to raise money from the public without giving up ownership. A debenture is like a loan where the company promises to pay regular interest and return the principal amount after a set period. 

Companies issue debentures when they need funds for expansion, new projects, or debt clearance. Debenture holders are treated as creditors and not owners of the company. They do not have voting rights but enjoy a fixed income. Debentures can be secured or unsecured, depending on whether the company offers any asset as security against the loan.

Journal Entries on Issue of Debentures

Example:

On 1st April 2025, ABC Ltd. issued 1,000 debentures of ₹100 each at par to raise funds for business expansion. The full amount was received on the same day.

Date: 1st April 2025

Bank A/c                      Dr.  ₹1,00,000  

    To Debentures A/c                       ₹1,00,000

(Being 1,000 debentures issued at ₹100 each at par and money received)

Advantages of Issue of Debentures

The issue of debentures is a popular method for companies to raise long-term funds without giving up ownership control. It offers several financial and operational advantages, making it a preferred choice for business expansion, project financing, and working capital needs.

1. Fixed Interest Cost

Debentures come with a fixed rate of interest, which helps companies plan their financial expenses more accurately. Unlike dividends, which can vary, the company knows exactly how much it must pay to debenture holders, ensuring predictable and manageable outflows.

2. No Ownership Dilution

Issuing debentures does not affect the ownership rights of existing shareholders. Debenture holders are treated only as creditors, not part-owners. This means the original shareholders continue to control the company’s decision-making without sharing profits or voting rights.

3. Large Funds Raised

Through debentures, companies can raise significant money in a single issue. This helps them fund large projects, expansions, or clear existing debts without the lengthy and complex process of issuing shares or seeking multiple small loans.

4. Tax Benefit

The interest paid on debentures is considered a business expense and is tax-deductible under income tax laws. This reduces the company’s taxable profits, lowering tax liability and making debenture financing a cost-effective borrowing option.

5. Flexibility

Companies enjoy flexibility when issuing debentures as they can choose between secured, unsecured, redeemable, or convertible types based on their financial strategy. This adaptability makes debentures attractive to companies and investors with different risk and return expectations.

What are the Risk Factors While Investing in Debentures?

1. Credit Risk
   If the company faces financial trouble, it may delay or default on interest payments and principal repayment. Investors must check the company's credit rating before investing.
2. Interest Rate Risk
   Debenture prices are sensitive to market interest rates. If interest rates rise, the value of existing debentures falls, affecting the investor’s returns if they plan to sell before maturity.
3. Liquidity Risk
   Some debentures are not actively traded in the market, making it difficult for investors to quickly sell them without losing value when they need cash.
4. Inflation Risk
   If inflation rises, the fixed interest from debentures may lose real value. This reduces the purchasing power of the returns earned by investors over time.
5. Reinvestment Risk
   If investors receive interest payments regularly, they might not always find opportunities to reinvest that money at the same attractive rate, especially when market rates fall.
6. Call Risk
   Some debentures are callable, meaning the company can repay them early if interest rates drop. This forces investors to reinvest at lower rates, affecting overall earnings.

Accounting Treatment of Issuing of Debentures

When a company issues debentures, it can do so at par, premium, or discount, and similarly, the repayment (redemption) can also be at par or premium. The accounting treatment varies based on these terms.

1. Issue at Par and Redemption at Par

Debentures are issued and redeemed at their face value (example: ₹100 issued and repaid at ₹100).

Journal Entry:

Bank A/c                    Dr.  

    To Debentures A/c

(Being debentures issued at par)

2. Issue at Discount and Redemption at Par

Debentures are issued for less than face value but redeemed at full face value.
 

Journal Entry:

Bank A/c                    Dr.  

Discount on Issue of Debentures A/c   Dr.  

    To Debentures A/c

(Being debentures issued at discount and redeemable at par)

The discount is treated as a loss and shown as an asset, written off over time.

3. Issue at Premium and Redemption at Par

Debentures are issued for more than face value but redeemed at face value.

Journal Entry:

Bank A/c                    Dr.  

    To Debentures A/c  

    To Securities Premium A/c

(Being debentures issued at premium and redeemable at par)

Securities Premium is credited and shown under Reserves and Surplus in the balance sheet.

4. Issue at Par and Redemption at Premium

Debentures are issued at face value but will be redeemed at a higher amount.

Journal Entry:

Bank A/c                    Dr.  

Loss on Issue of Debentures A/c   Dr.  

    To Debentures A/c  

    To Premium on Redemption of Debentures A/c

(Being debentures issued at par and redeemable at premium)

The premium payable on redemption is treated as a loss and written off over time.

5. Issue at Discount and Redemption at Premium

Meaning: Debentures are issued at less than face value and redeemed at more than face value.

Example:
On 1st April 2025, DEF Ltd. issued 800 debentures of ₹100 each at a 5% discount, redeemable at a 10% premium after 5 years.

Journal Entry:

Date: 1st April 2025

Bank A/c                      Dr.  ₹76,000  

Loss on Issue of Debentures A/c   Dr. ₹14,000  

    To Debentures A/c                           ₹80,000  

    To Premium on Redemption of Debentures A/c ₹8,000

(Being 800 debentures issued at 5% discount and redeemable at 10% premium)

Here, Loss on Issue = ₹4,000 (5% of ₹80,000) + ₹8,000 (10% premium) = ₹12,000.

Conclusion

The issue of debentures is a trusted way for companies to raise long-term funds without affecting ownership control. It offers benefits like fixed interest costs and tax advantages but also carries risks for investors. Proper planning, clear terms, and maintaining creditworthiness are essential for companies to use debentures as a financing tool successfully.