When a company takes a loan from a bank or any other lender, it may issue debentures as an additional guarantee for repayment of the loan. These debentures are called Collateral Security because they serve as a secondary security in addition to the main (principal) security.
Key Points:
- Collateral security is an additional security for the lender.
- No separate interest is paid on these debentures.
- The lender receives interest only on the original loan.
- If the company defaults in repayment, the lender first realizes the debt from the principal security.
- If the debt is still not fully recovered, the lender can exercise the rights of a debenture holder.
- Once the loan is fully repaid, the company takes back the debentures issued as collateral security
1. First Method: In the first method, no entry is passed in the books of the company, as the debentures are not actually issued, but only given as collateral security. Entry is only passed for taking a loan under this method. If the loan is taken from a bank, the entry will be:
*A note is appended below the loan that loan is secured by the issue of dentures as collateral security on the equity and liabilities side of the balance sheet.
Illustration:
Gulzar Ltd. has ₹ 10,00,000, 11% Debentures outstanding as on 1st April, 2021. The company took a loan of ₹2,00,000 for which the company placed debentures for ₹2,50,000 as Collateral Security with the bank. Pass the journal entries if required and show how debentures and Bank Loan will appear in the Company's Balance Sheet as on 31st March, 2022.
Solution:
Notes to Accounts:
2. Second Method: In the second method, the entry for issuing debentures as Collateral Security is also recorded with the entry for taking the loan:
A. On taking a loan:
B. On issuing the debentures as collateral security:
Illustration:
Gulzar Ltd. has ₹ 10,00,000, 11% Debentures outstanding as on 1st April, 2021. The company took a loan of ₹2,00,000 for which the company placed debentures for ₹2,50,000 as Collateral Security with the bank. Pass the journal entries if required and show how debentures and Bank Loan will appear in the Company's Balance Sheet as on 31st March, 2022.
Solution:
Notes to Accounts:
