A debenture is a debt instrument issued by a company to raise medium-term or long-term funds from the public. It is similar to a loan, where the company borrows money and promises to repay the principal amount along with interest after a specified period. According to the definition given in the Companies Act, 1956, a debenture is a document that either creates a debt or acknowledges it. Debentures are generally issued at a fixed rate of interest, known as the coupon rate, which is specified on the debenture certificate. The debenture holder receives interest based on this rate, usually calculated on the face value of the debenture. Interest on debentures is a compulsory expense for the company and must be paid regardless of whether the company earns a profit or incurs a loss. Since it is a charge against profits, it is debited to the Profit and Loss Account. At the end of the debenture term, the company repays the principal amount to the debenture holders.
Accounting Treatment of Interest on Debentures:
Case 1: Interest Accrued and interest due
It refers to the interest that has accumulated up to a particular date and has also become payable on that same date. For example, if a company pays interest on debentures half-yearly on 30th June and 31st December and closes its books on 31st December, then the interest accrued from 1st July to 31st December becomes due for payment on 31st December itself. Since the interest is both accrued and payable, it is treated as Interest Accrued and Due. The amount is recognized as an expense in the Profit and Loss Account and as a liability until it is paid to the debenture holders:
Journal Entries:
1. When interest is due and tax is deducted at source(TDS):
2. On payment of debenture interest to the Debenture holder:
3. On Payment of tax deducted at source to the Government:
4. On transfer of debenture interest to Profit & Loss A/c at the end of the year
Illustration:
Madden Ltd. issued 6000, 12% debentures of ₹100 each at 10% discount on 1 January 2023. Madden Ltd. pays interest half yearly on 30th June and 31st December every year, TDS being 5%. The firm closes its books on 31st December. Pass the necessary Journal entries.
Solution:
Case 2: Interest accrued but not due
Interest Accrued but not due refers to a situation where interest has been accumulated up to a certain date but is not due for payment on that date itself. A company paying interest half-yearly on 30th June and 31st December while closing its books on 31st March has accumulated interest on its debentures from 1st January to 31st March, but is not yet liable to pay it until the next 30th June.
Journal Entries:
1. When interest is accrued but not due:
2. When interest is paid:
Illustration:
Ghariyal Ltd. issued 5000, 15% debentures of ₹100 each at 5% discount on 1 May 2022. It pays interest on debentures on 30th June and 31st December every year, TDS being 5%. Pass the necessary Journal entries, if the books are closed on 31 March every year.
Solution:
Working Notes:
1. Number of months from 1 May 2022 to 30 June 2022 = 2
Interest =
2. Number of months from 1 July 2022 to 31 December 2022 = 6
Interest =
3. Number of months from 1 Jan 2023 to 31 March 2023 = 3
Interest =