Debentures, Types, Accounting Treatment

Debenture is a long-term debt instrument issued by a company to raise capital from the public. It represents a loan taken by the company, making the holder a creditor, not an owner. Debentures are governed by the Companies Act, 2013 and often secured by a charge on the company’s assets. Key features include a fixed interest rate (coupon rate), a redemption date, and a trust deed executed with a debenture trustee to protect investors’ interests. They are a vital source of borrowed funds for corporate financing, ranking above equity in repayment during liquidation. Unlike shares, they do not carry voting rights.

Types of Debentures:

1. Secured vs. Unsecured Debentures

Secured Debentures are backed by a charge (mortgage or hypothecation) on the company’s specific or general assets. If the company defaults, debenture holders can recover their dues by selling these assets. This security makes them less risky. Unsecured Debentures (or “Naked Debentures”) have no such charge. Holders are general creditors with no preferential claim on assets, making them riskier and typically offering higher interest. In India, public issues of debentures are almost always secured to protect investors, with a mandatory debenture trustee.

2. Convertible vs. Non-Convertible Debentures

Convertible Debentures grant holders the right to convert their debt into equity shares of the company after a specified period, at a predetermined ratio. This offers the potential for capital appreciation. Non-Convertible Debentures (NCDs) lack this conversion feature and are redeemed at maturity. NCDs are more common in the Indian market. Convertible debentures are further classified into Fully Convertible (FCDs) and Partly Convertible (PCDs), where only a portion of the value is converted.

3. Redeemable vs. Irredeemable Debentures

Redeemable Debentures are issued with a specific maturity date, on which the company repays the principal amount to holders. Redemption can happen at par, premium, or discount. Most debentures are redeemable. Irredeemable Debentures (or Perpetual Debentures) have no fixed repayment date. They are repayable only upon the company’s liquidation or as per the terms of issue (e.g., after a long notice period). Under the Companies Act, 2013, all debentures issued in India must have a redemption date, effectively eliminating true irredeemable debentures.

4. Registered vs. Bearer Debentures

Registered Debentures are recorded in the company’s register of debenture holders. Transfer requires a proper instrument of transfer and registration with the company. Interest is paid via cheque/directly to the registered holder. Bearer Debentures are negotiable instruments, transferable by mere delivery. Whoever physically holds (bears) the debenture is its owner. Interest is claimed by submitting attached coupons. Due to anonymity and potential misuse, bearer debentures are now largely obsolete and prohibited in India under regulatory norms to prevent money laundering.

5. Specific vs. Floating Charge Debentures

This relates to the nature of security. Specific Charge Debentures are secured by a mortgage on identifiable, fixed assets like land or machinery. These assets cannot be sold without the debenture holder’s consent. Floating Charge Debentures are secured by a charge on the company’s general, fluctuating assets like stock-in-trade or receivables. The company can freely deal with these assets until “crystallization” (e.g., default or winding-up), when the charge becomes fixed. Often, debentures are secured by both a specific and a floating charge.

Steps Treatment of Accounting for Debentures:

1. Issue of Debentures

When debentures are issued for cash or consideration

2. Debenture Allotment Due

When amount becomes payable on allotment

3. Receipt of Debenture Allotment Money

4. Interest on Debentures Due

Interest payable on debentures

5. Payment of Interest on Debentures

6. Redemption of Debentures

At the time of repayment