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.

 

Test Your Knowledge: Who are debenture holders?

  1. Company Owner

  2. Creditor

  3. Debtor

  4. Promoter

 

Types of Debenture

As per Companies Act, 2013, a company cannot issue debentures which accompany voting rights. Other than that, companies can issue these following debentures –

 

A. On the Basis of Security

  1. Secured debentures

  2. Unsecured debentures

B. On the Basis of Convertibility

  1. Convertible debentures

  2. Non-convertible debentures

 

C. On the Basis of Priority 

  1. First mortgage debentures

  2. Second mortgage debentures

 

D. On the Basis of Negotiability

  1. Bearer debentures

  2. Registered debentures

 

E. On the Basis of Permanence 

  1. Redeemable debentures

  2. 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:

  1. Redeemable Debentures

  2. Non-convertible Debentures

  3. Bearer Debentures

  4. Irredeemable Debentures

 

What is Interest on 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:

  1. Appropriation of Profits

  2. Charge Against Profit

  3. Transferred to General Reserve

  4. 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 interest on debenture 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 

Date 

Particulars

Amount (Dr)

Amount (Cr)


Interest payable on debentures A/C

ZZZZ



To Debenture holder A/C


ZZZZ


(Being interest payable)



B. In Case Interest on Debenture is Due and TDS is Levied – TDS Payable Journal Entry

Date 

Particulars 

Amount (Dr)

Amount (Cr)


Interest payable on debentures A/c

ZZZZ



To Debenture holders’ A/C


ZZZZ


To TDS Payable A/C 


ZZZZ


(Being interest is paid on debentures and TDS)



 

C. In Case of Payment of Interest on Debenture – Interest Payable Journal Entry

Date 

Particulars 

Amount (Dr)

Amount (Cr)


Debentures A/c

ZZZZ



To Bank A/C


ZZZZ


(Being interest paid is transferred to a bank)



 

D. In Case of Deposition of TDS – TDS Payable Journal Entry

Date  

Particulars 

Amount (Dr)

Amount (Cr)


TDS Payable A/C

ZZZZ



To Bank A/C


ZZZZ


(Being TDS amount is deposited in bank)



 

E. Transferring Interest to the Statement of Profit and Loss at Year-End.

Date 

Particulars 

Amount (Dr)

Amount (Cr)


Profit and Loss Statement

ZZZZ



  To Interest payable on debenture A/C


ZZZZ


(Being interest is paid on debentures is transferred P/L Statement)



 

Test Your Knowledge: What is the nature of a debenture application account?

  1. Personal account

  2. Real account

  3. Nominal account

  4. None of these

 

Task For You: Pass a journal entry for TDS deducted.

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FAQ (Frequently Asked Questions)

1. What is the Meaning of Interest?

Ans. In finance, interest can be defined as a percentage of loan value that borrowers pay to lenders in addition to the principal amount. Typically, it is charged or offered at a fixed rate. Debenture interest is an example of interest. 

2. What is a Debenture?

Ans. A debenture is a debt instrument with the help of which issuing companies intend on raising funds or capital.  It is mainly a certificate which serves as a piece of evidence that the company owes money to the debenture holder. 

3. What are the Types of Debentures?

Ans. Debentures are classified based on security, convertibility, permanence, priority and negotiability. The types include secured debenture, unsecured debenture, redeemable debenture, registered debenture, etc.