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?
Company Owner
Creditor
Debtor
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 –
On the Basis of Security
i. Secured debentures
ii. Unsecured debentures
On the Basis of Convertibility
i. Convertible debentures
ii. Non-convertible debentures
On the Basis of Priority
i. First mortgage debentures
ii. Second mortgage debentures
On the Basis of Negotiability
i. Bearer debentures
ii. Registered debentures
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:
Redeemable Debentures
Non-convertible Debentures
Bearer Debentures
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:
Appropriation of Profits
Charge Against Profit
Transferred to General Reserve
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
B. In Case Interest on Debenture is Due and TDS is levied – TDS Payable Journal Entry
C. In Case of Payment of Interest on Debenture – Interest Payable Journal Entry
D. In Case of Deposition of TDS – TDS Payable Journal Entry
E. Transferring Interest to the Statement of Profit and Loss at Year-End
Test Your Knowledge: What is the nature of a debenture application account?
Personal account
Real account
Nominal account
None of these
Task For You: Pass a journal entry for TDS deducted.
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FAQs on Interest on Debentures: Explained
1. What is the concept of Interest on Debentures in company accounts?
Interest on Debentures is the fixed periodic payment a company makes to its debenture holders as compensation for the loan provided by them. This interest is calculated at a predetermined rate, known as the coupon rate, on the face value of the debentures. It is treated as a charge against profit, meaning the company must pay it regardless of whether it makes a profit or a loss. This is a key difference from dividends paid to shareholders, which are an appropriation of profits. For more details on this distinction, you can explore the Difference Between Share and Debenture.
2. How is the rate of interest on debentures determined and what does '10% Debentures' signify?
The rate of interest, or coupon rate, is fixed by the company at the time of issuing the debentures. The term '10% Debentures' signifies that the company will pay interest at a fixed rate of 10% per annum on the nominal (face) value of these debentures. For example, if a debenture has a face value of ₹100, the annual interest payable on it would be ₹10, regardless of its issue price (whether issued at par, premium, or discount).
3. On what value is the interest on debentures calculated – the issue price or the face value?
Interest on debentures is always calculated on the nominal or face value of the debentures. It is not affected by the price at which the debentures are issued. For instance, if a debenture with a face value of ₹100 is issued at a discount for ₹95 or at a premium for ₹110, the interest will still be computed on ₹100. This ensures a fixed and predictable return for the debenture holder. You can learn more about this in the context of Issuing Debentures at Discount.
4. What are the essential journal entries for recording interest on debentures as per the CBSE Class 12 Accountancy syllabus 2025-26?
The accounting treatment for interest on debentures involves the following key journal entries:
- For interest becoming due:
Debenture Interest A/c Dr.
To Debenture holders’ A/c
(Being interest due on debentures) - For payment of interest to debenture holders:
Debenture holders’ A/c Dr.
To Bank A/c
(Being interest paid to debenture holders) - For transferring interest expense to the Statement of Profit and Loss at the end of the year:
Statement of Profit and Loss Dr.
To Debenture Interest A/c
(Being debenture interest transferred)
5. Where is 'Interest on Debentures' shown in a company's financial statements?
Interest on Debentures appears in two key parts of a company's financial statements:
- In the Statement of Profit and Loss: It is shown as an expense under the head 'Finance Costs'.
- In the Cash Flow Statement: The actual payment of interest is shown as a cash outflow under 'Financing Activities'. This is because issuing debentures is a financing activity for the company. You can review this treatment in the CBSE Class 12 Chapter 6 Cash Flow Statement Notes.
6. Why is interest on debentures considered a 'charge against profit' and not an 'appropriation of profit'?
Interest on debentures is a 'charge against profit' because it is a contractual and legal obligation of the company towards its creditors (debenture holders). This means the interest expense must be paid irrespective of the company's profitability. It is deducted from revenue to arrive at net profit. In contrast, an 'appropriation of profit', like dividends to shareholders, is a distribution of profits and is only paid if the company has earned sufficient profits and the directors decide to distribute them.
7. How does issuing debentures as collateral security impact the payment of interest?
When a company issues its debentures as collateral security against a loan, no interest is paid on these specific debentures. The primary obligation is the loan itself, and the company pays interest only on the loan amount. The debentures are merely a secondary security that the lender can claim if the company defaults on the loan repayment. Since these debentures are not 'held' by the lender in the conventional sense, the liability to pay interest on them does not arise. More can be understood from the page on Debentures as Collateral Security.
8. From a financial management perspective, how does the interest on debentures offer a tax advantage to a company?
Interest paid on debentures is a tax-deductible expense. This means the company can subtract the total interest paid from its gross income before calculating its corporate income tax liability. This reduces the company's taxable income, and therefore its tax burden. This tax shield makes debt financing, such as issuing debentures, a more cost-effective source of capital compared to equity financing, where dividends are not tax-deductible. This is a key factor in financial planning decisions.
9. What happens if a company fails to pay the interest on its debentures on the due date?
Failing to pay interest on debentures is a serious default. It has several negative consequences for the company:
- It is a breach of the trust deed, allowing debenture holders or their trustee to take legal action to recover their dues.
- It severely damages the company's creditworthiness and reputation in the financial market.
- In extreme cases, persistent failure to pay interest can lead to legal proceedings that may result in the winding-up of the company. This highlights the financial burden associated with debt capital.
