Interest on Debentures

Owners of businesses often borrow money from public sectors when a business’s financial needs are not met due to a shortage of funds or due to the need for expansion. Raising funds is one of the most difficult tasks that a company has in its early stages. Though several choices are available, including Angel Investors, Bank Loans, Venture Capital, and Personal Investment, obtaining capital through the public issue of debt is regarded as the greatest option for a new company.

To be more specific, there are a variety of ways for business owners to raise money. So far, Debentures is undoubtedly the best way. Debentures tend to benefit both the owner of the business and the holder of the debenture. To be more precise, the business owner can increase the needed amount of funds, whereas the holder of debentures will generate the income via debenture interest.

Interests on Debentures can be acknowledged as a factor of accounting treatment provided by the company, which needs to be paid with interest at a fixed rate whether or not the business makes a profit.

Debentures issued for consideration other than cash

There are times when a company tends to buy assets from traders and henceforth issues debentures instead of paying the amount in cash. Thus, this type of transaction is called debentures issued for consideration.

The Debentures may also be issued as:

• At a par

• At a premium

• At a discount

Accounting Treatment

Journal Entries mentioned below are recorded in textbooks under the topic Interests on debentures.

When interest becomes due

Debenture Interest A/c                            Dr.

                   To Income Tax payable A/c

                   To Debenture holders A/c

(Being interest on debentures made due and the income tax deducted as source)

Entry for interest being paid to debenture holders

Debenture holders A/c                            Dr.

                 To Bank A/c

(Being interest amount paid to debenture holders)

Interest on debentures transferred to Statement Profit and Loss account

Statement of Profit and Loss              Dr.

               To Debenture Interest A/c

(Being interest on debentures transferred to profit and loss A/c)

Tax deducted on Interest paid to Government

Income Tax Payable A/c                     Dr.

               To Bank A/c

(Being income tax paid to the government)

Debentures can be termed as a firm’s debt where the firm is required to pay back the principal amount, including the interests. This debt needs to be paid even if the firm is not accumulating profits. 

Features and Examples on Interest of Debenture

• Debenture can be referred to as an acknowledgment of the debt instrument of a company.

• A set rate of interest is attached to a debenture.

• The method of paying back the amount with interest is fixed and cannot be changed whatsoever.

• According to the Companies Act of 2013, no company may issue a debenture with a maturity date greater than 10 years.

Points to remember regarding the accounting treatment of interests on debentures

• It is always a deduction from the profit made by the company.

• It is calculated using a nominal amount and an already determined rate of interest.

• On Debentures that are offered in opposition to the collateral securities, the company does not pay any sort of interest.

• Interest rates are determined when the debenture is issued. 

• By the time of year-end, the interest balance of the debenture accounting treatment needs to be transferred to the loss and profit account.

• The interests that are due or not due can be seen under current liabilities.

Advantage of Debentures

• Matters related to debenture do not dilute the involvement of equity owners because they do not have any sort of authority to participate in the company’s management.
• Interest on debenture is a tax-deductible expenditure, and thus, it saves income tax.
• The cost of a debenture is lower than the cost of preference shares or equity shares.
• Matters of debentures are profitable during inflation times.
• Debenture interest is meant to be paid even if the company is not making any profits. Thus, the holders of debenture bear no risk whatsoever.

Disadvantages of Debentures

• Interest on debenture must be paid without any hindrance. Thus, it becomes quite problematic when the company is not making any profit.
• Debentures are used for trading on equities, but a company’s financial risk grows drastically if it relies too much on them.
• Debenture redemption demands a bigger funds outflow.
• During a depression, a company’s profits continue to decline, making it harder for the interest to be paid back.

Conclusion

To summarise, we can say that interest in debentures is profitable to both the holder of debenture and the company’s owner. When a company’s financial demands are not met because of a lack of money or the necessity for expansion, owners of companies borrow money from public sectors. Debentures have proven to be the most effective method for the transaction. To be more specific, the company owner can raise the necessary finances, whereas the holder of debentures will earn money through debenture interest.