Accounting for Debt Capital

Debt Capital refers to funds borrowed by a company which must be repaid after a specified period. It is a major source of long term finance for companies. Unlike equity capital, debt capital does not give ownership or voting rights to lenders. Common forms of debt capital include debentures, bonds, and long term loans from banks or financial institutions. Interest on debt capital is a fixed obligation and must be paid regularly, even if the company earns no profit. In corporate accounting, debt capital is shown as a liability in the balance sheet. In India, issue and management of debt capital are regulated by the Companies Act 2013 and SEBI rules.

Types of Debt Capital:

1. Debentures

Debentures are long-term debt instruments issued by a company to the public, acknowledging a loan at a fixed interest rate. They can be secured (backed by a charge on assets) or unsecured, and may be convertible into equity shares or non-convertible. Governed by the Companies Act, 2013, they involve a debenture trustee to protect investors. Interest is payable regardless of profits, and principal is repaid at maturity. They are a major source of debt capital, offering tax benefits (interest is tax-deductible) but increasing financial risk.

2. Bonds

Bonds are similar to debentures but are typically issued by government entities, financial institutions, and large corporations for long-term funding. They are generally secured and have a longer tenure. In India, bonds issued by public sector undertakings (PSUs) and infrastructure companies are common. They offer fixed or floating interest (coupon) payments. While “debenture” is the term commonly used for corporate debt in India, “bond” often implies a higher degree of safety and institutional issuance. The legal framework overlaps significantly with debentures.

3. Term Loans from Financial Institutions

These are loans obtained from banks, NBFCs, or development financial institutions (like SIDBI, IFCI) for a fixed term (medium to long-term). They are used for specific purposes like project financing, expansion, or capital expenditure. They carry a fixed or floating interest rate and are almost always secured by the company’s assets. Repayment follows a structured schedule (EMIs). Terms are governed by a detailed loan agreement with covenants that may restrict the borrower’s financial decisions (e.g., dividend payout, further borrowing).

4. Public Deposits

Companies can invite fixed deposits from the public and shareholders, governed by stringent rules under the Companies Act, 2013 and RBI/SEBI guidelines. There are limits on the amount that can be raised (linked to paid-up capital and reserves). The tenure is generally between 6 months to 36 months. Interest rates are fixed. This is an unsecured form of debt, making it riskier for depositors. Companies must maintain a deposit repayment reserve and provide deposit insurance. It’s a less common source now due to strict regulations.

5. Commercial Paper (CP)

A Commercial Paper is an unsecured, short-term money market instrument issued by large, creditworthy corporations to meet working capital requirements. It is issued at a discount to its face value and has a maturity period between 7 days and 1 year. CPs are regulated by the Reserve Bank of India (RBI). They provide a cheaper alternative to bank borrowing for top-rated companies. Investors include banks, mutual funds, and insurance companies. It represents a quick, flexible source of short-term debt capital but is only available to firms with high credit ratings.

6. Bank Overdrafts and Cash Credits

These are short-term, revolving credit facilities provided by banks. An overdraft allows a company to withdraw funds from its current account up to an approved limit, paying interest only on the amount utilized. A cash credit is a similar facility but is typically secured against inventory or receivables (hypothecation). They are primarily used for managing day-to-day working capital needs and business cycles. These facilities offer high flexibility but usually carry a higher interest rate than term loans and require regular renewal.

7. Inter-Corporate Deposits (ICDs)

These are short-term, unsecured loans made by one company to another, usually for a period of up to one year. They are typically arranged through brokers and carry a higher interest rate than bank loans due to the absence of security. ICDs are used for urgent, temporary funding needs. They are not regulated by specific legislation but are governed by the loan agreement between the companies. This source is less formal and carries higher credit risk for the lending company.

8. Asset-Backed Securities / Securitization

This involves converting a company’s illiquid assets (like receivables, loans, or lease rentals) into tradable securities, which are then sold to investors. The company receives immediate cash, and future cash flows from the assets are used to pay interest and principal to investors. It is a structured finance instrument that helps in off-balance-sheet financing and liquidity management. In India, securitization is governed by RBI and SEBI guidelines. It’s a sophisticated form of debt capital, often used by NBFCs and housing finance companies.

Accounting for Debt Capital:

Debt capital is recorded as a liability because it represents borrowed funds. In corporate accounting, debt capital mainly includes debentures and long term loans. Accounting is done at the time of issue, interest payment, and repayment.

1. Issue of Debt Capital

2. Interest on Debt Capital Due

3. Payment of Interest

4. Redemption of Debt Capital