Inaugurated by IN-SPACe
ISRO Registered Space Tutor
S7-SA7-0315
What is Debentures (Accounting)?
Grade Level:
Class 12
AI/ML, Physics, Biotechnology, FinTech, EVs, Space Technology, Climate Science, Blockchain, Medicine, Engineering, Law, Economics
Definition
What is it?
Debentures are like loans taken by a company from the public or financial institutions. Instead of issuing shares (which give ownership), companies issue debentures to borrow money, promising to pay it back with interest after a fixed period.
Simple Example
Quick Example
Imagine your school needs money to build a new computer lab. Instead of asking parents to become owners of the school, the school asks parents to lend money, promising to pay them back in 5 years with a little extra money (interest) for their help. These 'loan slips' given to parents are similar to debentures.
Worked Example
Step-by-Step
A company, 'Bharat Tech Ltd.', needs to raise Rs. 10,00,000 for a new project. They decide to issue 10% Debentures of Rs. 100 each.
Step 1: Calculate the number of debentures issued. Total amount needed / Value per debenture = Rs. 10,00,000 / Rs. 100 = 10,000 debentures.
---Step 2: Calculate the annual interest payment. 10% of Total amount = 10% of Rs. 10,00,000 = Rs. 1,00,000.
---Step 3: Journal Entry when debentures are issued (assuming full subscription and money received). Bank Account Dr. Rs. 10,00,000 | To Debenture Application & Allotment Account Cr. Rs. 10,00,000 (Being application money received).
---Step 4: Journal Entry for allotting debentures. Debenture Application & Allotment Account Dr. Rs. 10,00,000 | To 10% Debentures Account Cr. Rs. 10,00,000 (Being 10,000 debentures of Rs. 100 each allotted).
---Step 5: Journal Entry for interest payment at year-end. Interest on Debentures Account Dr. Rs. 1,00,000 | To Debentureholders Account Cr. Rs. 1,00,000 (Being interest due).
---Step 6: Journal Entry for paying interest. Debentureholders Account Dr. Rs. 1,00,000 | To Bank Account Cr. Rs. 1,00,000 (Being interest paid).
Answer: The company successfully issued 10,000 debentures and will pay Rs. 1,00,000 in interest annually.
Why It Matters
Understanding debentures is crucial for anyone interested in FinTech or Economics, as it's a fundamental way companies raise money. Financial analysts and investment bankers use this knowledge daily to advise on company funding. Even in fields like AI/ML, understanding financial instruments helps build better predictive models for market trends.
Common Mistakes
MISTAKE: Thinking debentures give ownership in a company. | CORRECTION: Debentures are loans; debenture holders are creditors, not owners. They don't have voting rights.
MISTAKE: Confusing debentures with shares. | CORRECTION: Shares represent ownership (equity) and give voting rights, while debentures represent debt and give a fixed interest payment.
MISTAKE: Assuming debentures always pay interest annually. | CORRECTION: While common, interest payment frequency (annual, semi-annual) is specified in the debenture terms.
Practice Questions
Try It Yourself
QUESTION: What is the main difference between a debenture holder and a shareholder? | ANSWER: A debenture holder is a creditor (lender) to the company, while a shareholder is an owner of the company.
QUESTION: 'Metro Foods Ltd.' issued 5,000, 8% Debentures of Rs. 200 each. Calculate the total value of debentures issued and the annual interest payable. | ANSWER: Total value = 5,000 debentures * Rs. 200/debenture = Rs. 10,00,000. Annual interest = 8% of Rs. 10,00,000 = Rs. 80,000.
QUESTION: A company issues 10,000 debentures of Rs. 50 each at a 10% interest rate, redeemable after 5 years. If the company pays interest semi-annually, how much interest will a debenture holder with 100 debentures receive in one year? | ANSWER: Total value of 100 debentures = 100 * Rs. 50 = Rs. 5,000. Annual interest = 10% of Rs. 5,000 = Rs. 500. Since interest is paid semi-annually, the debenture holder will receive Rs. 250 every six months, totaling Rs. 500 in one year.
MCQ
Quick Quiz
Which of the following is NOT a feature of debentures?
They carry a fixed rate of interest.
They are a form of borrowed capital.
Debenture holders are owners of the company.
They are repayable after a fixed period.
The Correct Answer Is:
C
Debenture holders are creditors (lenders) to the company, not owners. Owners hold shares. Options A, B, and D are all true features of debentures.
Real World Connection
In the Real World
Many large Indian companies, from Tata Motors to Reliance Industries, issue debentures to raise funds for expansion or new projects, similar to how they might take a bank loan. These debentures are traded on stock exchanges like NSE and BSE, and financial apps often show their prices and interest rates, allowing investors to buy and sell them.
Key Vocabulary
Key Terms
DEBENTURE: A document issued by a company acknowledging a debt, promising to repay with interest | INTEREST: The extra money paid for borrowing funds | CREDITOR: A person or entity to whom money is owed | REDEMPTION: The repayment of the debenture amount by the company to the debenture holders | FACE VALUE: The nominal value of a debenture, typically Rs. 100 or Rs. 1,000
What's Next
What to Learn Next
Next, you should learn about 'Types of Debentures' and 'Issue of Debentures at Par, Premium, and Discount'. This will help you understand the different varieties of debentures and how their initial sale price affects a company's finances, building on what you've learned today.
