How to Calculate and Record Interest on Debentures (with TDS and Examples)
Interest on debentures is a crucial concept in financial accounting, especially for students preparing for board exams, competitive entrance tests, and anyone learning about business finance. Understanding its calculation, accounting treatment, and practical significance helps students answer exam questions and comprehend real-world company finances.
| Aspect | Details |
|---|---|
| What is Paid? | Periodic interest to debenture holders |
| Basis of Calculation | Nominal (face) value of debentures × Interest rate × Time |
| Nature in Accounts | Charge against profits (must pay even with no profit) |
| TDS Applicability | Tax is deducted at source before payment to holders |
| Frequency | Quarterly, half-yearly, or yearly as per debenture terms |
Meaning of Interest on Debentures
Interest on debentures is the regular payment a company makes to its debenture holders as compensation for lending funds to the business. It is calculated at a fixed rate on the face value of the debentures, regardless of company profits. This interest is a mandatory expense and is shown as a charge against profits in financial statements.
Importance and Applicability
Interest on debentures is important in both theoretical and practical accounting. Students often encounter questions about it in Class 12 and competitive exams. In the business world, it ensures companies honor their obligations to investors, helping them raise funds through debt.
- Common in board and competitive exam questions
- Essential for financial reporting and auditing
- Direct impact on company cash flows and taxation
Calculation and Formula for Interest on Debentures
Calculating interest on debentures follows a simple formula that students must be able to apply in exam situations and business analysis.
Formula:
Interest = Face Value of Debentures × Interest Rate × Time (in years or months)
For example, if a company has 12% debentures of ₹2,00,000 for six months, the calculation is:
Interest = 2,00,000 × 12% × (6/12) = ₹12,000
Journal Entries for Interest on Debentures (Including TDS)
Correct journal entries are vital for accounting treatment. These entries ensure accurate financial statements and compliance with tax laws. Below are the standard entries:
-
On making interest due and deducting TDS:
Interest on Debentures A/c Dr. Full amount of interest To Debenture holders' A/c Net amount (after TDS) To TDS Payable A/c TDS amount -
On payment of interest to debenture holders:
Debenture holders' A/c Dr. Net amount payable To Bank A/c Net amount paid -
On transferring debenture interest to the statement of Profit and Loss:
Statement of Profit and Loss A/c Dr. Total interest To Interest on Debentures A/c Total interest -
On payment of TDS to the Government:
TDS Payable A/c Dr. TDS amount To Bank A/c TDS paid
Example with TDS
If ₹10,000 interest is due (TDS rate 10%), entries are:
- Interest on Debentures A/c Dr. 10,000
To Debenture holders' A/c 9,000
To TDS Payable A/c 1,000 - Debenture holders' A/c Dr. 9,000
To Bank A/c 9,000 - Statement of Profit and Loss A/c Dr. 10,000
To Interest on Debentures A/c 10,000 - TDS Payable A/c Dr. 1,000
To Bank A/c 1,000
Treatment of Interest on Debentures in Accounts
Interest on debentures appears as a charge in the Profit and Loss Account, reducing profit before tax. It is shown as an operating cash outflow in the Cash Flow Statement. Unpaid interest at the balance sheet date is a current liability. TDS payable is also shown as a liability until paid to authorities.
| Statement | How Interest on Debentures Appears |
|---|---|
| Profit and Loss Account | As an expense/charge before net profit |
| Cash Flow Statement | Outflow under Operating Activities |
| Balance Sheet | Outstanding interest: Current liability TDS payable: Current liability |
Common Examples and Practice Questions
Solving questions builds your problem-solving skill for exams and real accounts. Here are solved examples:
Example 1: Simple Calculation
A company has ₹1,00,000 10% debentures. Calculate yearly interest and journal entry.
- Interest = 1,00,000 × 10% × 1 = ₹10,000
Journal Entry:
Interest on Debentures A/c Dr. 10,000
To Debenture holders' A/c 10,000
Example 2: With TDS
₹50,000 12% debentures, interest paid quarterly, TDS 10%.
- Quarterly interest = 50,000 × 12% × 3/12 = ₹1,500
- TDS = ₹1,500 × 10% = ₹150
- Net to holder = ₹1,350
Journal Entries:
- Interest on Debentures A/c Dr. 1,500
To Debenture holders' A/c 1,350
To TDS Payable A/c 150 - Debenture holders' A/c Dr. 1,350
To Bank A/c 1,350 - Statement of P&L A/c Dr. 1,500
To Interest on Debentures A/c 1,500 - TDS Payable A/c Dr. 150
To Bank A/c 150
Practice Questions
- A company has ₹2,50,000 8% debentures. Calculate and make journal entries for half-yearly interest (no TDS).
- Journalise yearly interest payment of ₹5,000 10% debentures if TDS is 10%.
- Show the effect of outstanding debenture interest in the balance sheet.
Links to Related Topics
- Issue and Redemption of Debentures
- Types of Debentures
- Redemption of Debentures
- DK Goel Solutions – Debentures
- Financial Statements of a Company
- Non-Current Liabilities
- Difference Between Assets and Liabilities
Understanding interest on debentures gives students a practical advantage in exams and business scenarios. This knowledge links directly with accounting statements, cash flows, tax compliance, and investment analysis. At Vedantu, we simplify concepts like debenture accounting for better learning and strong exam results.
FAQs on Interest on Debentures: Meaning, Calculation, and Accounting
1. What is the interest rate on a debenture?
The interest rate on a debenture is a fixed percentage, specified when the debenture is issued. For example, a 10% debenture means the holder receives 10% of the face value annually. This rate is crucial for calculating the periodic interest on debentures.
2. How is interest on debentures calculated?
Interest on debentures is calculated using a simple formula: Interest = (Face Value × Interest Rate × Time)/365. The time period is usually expressed in days or years. Remember, the face value is the nominal value of the debenture. This calculation is essential for understanding a company’s debenture expense accounting.
3. What does "interest on debentures is a charge against profit" mean?
Interest on debentures is a charge against profit, meaning it's deducted from revenue *before* calculating the net profit. This implies the company must pay this interest regardless of its profitability. This is a key concept for understanding the treatment of debenture interest in financial statements.
4. Where is interest on debentures shown in financial statements?
Interest on debentures is shown in several financial statements. It's presented as an expense in the Profit and Loss Account and also affects the Cash Flow Statement under operating activities. Its appearance in these statements is important to accurately reflect company liabilities.
5. Is TDS deducted on interest on debentures?
Yes, Tax Deducted at Source (TDS) is applicable on interest on debentures in India, as per the Income Tax Act. The company paying the interest must deduct TDS before remitting the payment to the debentureholder. Understanding TDS on debenture interest is crucial for both the company and the investor.
6. What is the journal entry for interest on debentures?
The journal entry for interest on debentures involves debiting Interest Expense and crediting Interest Payable. When TDS is involved, an additional entry credits TDS Payable. Accurate debenture interest journal entry is vital for maintaining accurate financial records.
7. How is interest on debentures shown in the balance sheet?
Interest on debentures payable is shown as a current liability in the balance sheet if payment is due within one year. If the payment is due after one year, it will be classified as a non-current liability. This is vital for understanding a company’s overall financial position.
8. Is interest on debentures an expense or income?
For the company issuing the debentures, interest on debentures is an expense. For the debentureholder, it's income. This distinction is critical in financial reporting and analysis.
9. How is interest on debentures treated in the cash flow statement?
Interest on debentures is typically classified as an outflow from operating activities in the cash flow statement. This reflects its nature as a regular operating expense of the company.
10. Is interest on debentures calculated on the face value or market value?
Interest on debentures is calculated on the face value (also known as the nominal value) of the debenture, not the market value. The face value is the stated value printed on the debenture certificate.
11. What are the implications of not deducting TDS on debenture interest?
Failure to deduct and deposit TDS on interest on debentures can result in penalties for the company. It can also create difficulties for the debenture holder when it comes to claiming tax benefits. Accurate accounting for TDS is vital to avoid these issues.
