What is a 'Convertible Debenture'?

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Q. What is a 'Convertible Debenture'?

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Concept understanding — Debenture Definition

Debentures: The Company's Way of Borrowing Money

Think of a debenture like this: you need ₹5,00,000 to expand your business. Instead of asking a bank for a loan, you go to the public and say, "Lend me money, and I'll pay you interest every year. After 5 years, I'll return your full amount." Each person who lends you money gets a certificate — that certificate is a debenture.

The Precise Meaning

A debenture is a written instrument issued by a company under its common seal, acknowledging a debt. It contains a promise to repay the borrowed amount at a specified date (maturity) and to pay interest at a fixed rate at regular intervals (usually half-yearly or yearly).

Note

A debenture holder is a creditor of the company, not an owner. They have no voting rights and no share in profits — only a fixed interest payment.

Why Debentures Matter

Companies issue debentures because:

They raise large funds without diluting ownership (unlike shares)
Interest paid on debentures is a tax-deductible expense (reduces taxable profit)
Debentures are safer for investors than shares (fixed return, priority in repayment)

For investors, debentures offer:

Fixed, predictable income
Higher safety than equity shares
Priority over shareholders if the company is liquidated

Accounting Treatment

When a company issues debentures, the journal entry is:

Particulars	Debit (₹)	Credit (₹)
Bank A/c Dr.	[Amount received]
To Debentures A/c		[Face value]
To Securities Premium Reserve A/c (if issued at premium)		[Premium amount]
(Being debentures issued at premium)

Key points:

Debit Bank A/c with the actual amount received
Credit Debentures A/c with the face value (nominal value)
If issued at a premium (e.g., ₹100 debenture issued for ₹110), credit the extra ₹10 to Securities Premium Reserve A/c
If issued at a discount (e.g., ₹100 debenture issued for ₹95), debit the discount to Discount on Issue of Debentures A/c (a fictitious asset written off over the debenture's life)

Watch out

Never confuse debentures with shares. Debentures are liabilities (shown under "Non-Current Liabilities" in the Balance Sheet), while shares are equity (shown under "Shareholders' Funds").

Interest on Debentures

Interest is calculated as:

Interest = Face Value of Debentures × Rate of Interest × Time Period

For example, if a company issues ₹10,00,000 worth of 9% debentures, the annual interest is:

₹10,00,000 × 9% = ₹90,000 per year

The journal entry for interest payment:

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A convertible debenture is a debt instrument that can be converted into equity shares (or other securities) of the issuing company at a predetermined time and ratio, giving the holder the option to become a shareholder.

Concept and Accounting Treatment

A debenture is a written instrument acknowledging a debt under the company's common seal. It is essentially a loan taken by the company from the public, carrying a fixed rate of interest. The company is the borrower, and the debenture holder is a creditor — not an owner.

A convertible debenture adds a special feature: the holder has the right (or the company has the obligation) to convert the debenture into equity shares after a specified period. This makes it a hybrid instrument — part debt, part equity.

The accounting treatment follows the nature of the instrument at the time of issue:

At the time of issue: The debenture is recorded as a liability, exactly like a non-convertible debenture. The entry is:
- Debit Bank Account (with the amount received)
- Credit Debentures Account (with the face value)
- If issued at a discount or premium, the difference goes to Discount on Issue of Debentures Account or Securities Premium Reserve Account.
At the time of conversion: The liability is extinguished, and equity shares are issued. The entry is:
- Debit Debentures Account (with the face value of debentures being converted)
- Credit Share Capital Account (with the face value of shares issued)
- Any difference (e.g., if the conversion is at a premium or discount) is adjusted through Securities Premium Reserve or Discount on Issue of Shares.

Watch out

Common Pitfall

Do not treat the conversion as a sale or redemption. It is simply a swap of one financial instrument (debenture) for another (equity share). No profit or loss arises unless the terms of conversion involve a premium or discount that is not aligned with the face values.

Tip

Shortcut

Remember: Convertible debentures are initially recorded as debt. Only at conversion do we remove the liability and create share capital. The interest paid before conversion is a charge against profit, not an appropriation.

Example Journal Entries (Illustrative)

Suppose a company issues 1,000, 10% Convertible Debentures of ₹100 each at par, convertible into 10 equity shares of ₹10 each after 3 years.

At the time of issue:

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Same / Similar Concept — real previous-year questions on the same or a closely similar concept, not this exact question.

Showing the 12 most recent of 88 on this concept.

CBSE 2026Set 67/5/11 markMCQ
$Q. (a) Reserve capital is that portion of the ________ capital that can be called only in the event of winding up of the company. (A) called-up (B) uncalled (C) paid-up (D) subscribed$
(OR)
$(b) The debentures which do not carry a specific rate of interest are known as : (A) Irredeemable debentures (B) Bearer debentures (C) Specific coupon rate debentures (D) Zero coupon rate debentures$
›Reveal solutionSolution

Part (a): Reserve capital is a part of uncalled capital — option (B).

Part (b): Debentures with no specific interest rate are Zero coupon rate debentures — option (D).

Part (a)

Under Section 65 of the Companies Act, 2013, a company may by special resolution decide that a portion of its uncalled share capital shall not be called except on winding up. This ring-fenced portion is Reserve Capital — extra security for creditors. …
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CBSE 2026Set MARCH1 mark
$Q. Who is called debenture holder?$
›Reveal solutionSolution
A debenture holder is a creditor (lender) of the company who owns its debentures.

A debenture is a written acknowledgement of a debt taken by a company, usually carrying a fixed rate of interest. The person who buys/holds such debentures is called a debenture holder.

Key points:

He is a creditor of the company, not a shareholder/owner.

He receives a fixed rate of interest whether or not the company earns profit.

He has the right to get his principal back on redemption. …
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CBSE 2026Set ANNUAL1 mark
$Q. Fill in the blank: The rate of return on debentures is called __________. (Dividend/Interest)$
›Reveal solutionSolution

The rate of return on debentures is called interest.

Debentures represent borrowed capital (debt) of the company, not ownership. Therefore debenture-holders are creditors who receive a fixed, pre-agreed rate of return called interest, which is a charge against profit and payable irrespective of profits. 'Dividend' …

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CBSE 2026Set ANNUAL1 mark

Q. Write the difference between share and debenture on the basis of voting right.

›Reveal solution

On the basis of voting right: shareholders have it, debenture-holders do not.

Basis	Share	Debenture
Nature	Ownership capital	Borrowed capital (loan)
Voting right	An equity shareholder has the right to vote in the company's general meetings	A debenture-holder, being only a creditor, has no voting right in company affairs
…

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CBSE 2026Set ANNUAL1 markMCQ
$Q. Debenture holders are the$
(a) Customers of the company
(b) Owners of the company
(c) Creditors of the company
(d) All of them
›Reveal solutionSolution

Debenture-holders are creditors of the company - option (c).

A debenture is part of a company's borrowed capital. The debenture-holders have lent money to the company and are therefore its creditors; they are entitled to interest at a fixed rate (whether or not the company earns a profit) …

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CBSE 2026Set ANNUAL1 mark
$Q. Fill in the blank: Debentures represents a ________ term loan taken by the company.$
›Reveal solutionSolution

Answer: Long (long-term loan).

A debenture is a written acknowledgement of a loan raised by a company, usually repayable after a long period. It forms part of the company's borrowed (long-term) capital. Henc …

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CBSE 2026Set ANNUAL1 mark
$Q. State whether True or False: Debentureholders are owners of the company.$
›Reveal solutionSolution

The statement is False.

A debenture is an acknowledgement of a loan given to the company, so debentureholders are creditors who get fixed interest. The owners of the com …

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CBSE 2026Set ANNUAL1 markMCQ
$Q. Under which major head are debentures shown on the liabilities side of the balance sheet of a company?$
(a) Current Liabilities
(b) Non-current Liabilities
(c) Share Capital
(d) Reserves and Surplus
(a) Current Liabilities
(b) Non-current Liabilities
(c) Share Capital
(d) Reserves and Surplus
›Reveal solutionSolution
Debentures are shown under the Non-current Liabilities major head.

Under Schedule III, Part I of the Companies Act, 2013, the Equity and Liabilities side of a company's balance sheet is grouped under three major heads:

Shareholders' Funds

Non-current Liabilities — includes Long-term Borrowings (debentures, term loans, etc.), Deferred Tax Liabilities, Long-term Provisions

Current Liabilities — includes Short-term borrowings, Trade payables, Other current liabilities, Short-term provisions …
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CBSE 2026Set ANNUAL1 markMCQ
$Q. What does company pay to debentureholders as return on debentures?$
(a) Interest
(b) Dividend
(c) Salary
(d) Goodwill
(a) Interest
(b) Dividend
(c) Salary
(d) Goodwill
›Reveal solutionSolution
A company pays Interest to debenture holders as the return on their debentures.

Debentures represent borrowed/loan capital of a company; a debenture holder is a creditor of the company, not a member/owner. In return for lending money to the company, a debenture holder is entitled to receive a FIXED rate of return mentioned on the debenture certificate (e.g. 9% Debentures, 12% Debentures), called Interest.

Key distinguishing features of interest on debentures:

It is a CHARGE against profit — the company is legally bound to pay it whether it earns a profit or incurs a loss.

It is paid at a fixed, predetermined rate.

It is a business expense, debited to the Statement of Profit and Loss, and reduces the company's taxable profit. …
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CBSE 2026Set ANNUAL1 mark
$Q. Which type of debentures can not be converted into shares?$
›Reveal solutionSolution
Non-Convertible Debentures cannot be converted into shares.

On the basis of convertibility, debentures are classified into two types:

Convertible Debentures — these carry an option/right for the holder to convert them (fully or partly) into equity shares (or sometimes preference shares) of the company, after a specified period and on specified terms. …
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CBSE 2026Set ANNUAL1 markMCQ
$Q. Interest on Debentures is a charge against$
(a) Share Capital
(b) General Reserve
(c) Dividend
(d) Profit
›Reveal solutionSolution
Interest on Debentures is a mandatory contractual expense (a "charge"), deducted while computing profit itself — it is payable even if the company makes a loss, unlike dividend.

Debentures represent borrowed funds — debenture holders are creditors of the company, not its owners/members. The company is therefore legally and contractually bound to pay interest on debentures at the stated rate, regardless of whether the company earns a profit or incurs a loss in a given year. This makes it a charge against profit — an expense debited to the Statement of Profit & Loss before arriving at the figure of net profit — exactly like rent, salaries, or depreciation.

This is fundamentally different from:

Dividend, which is a mere appropriation of profit — it can be paid only if the company has earned a profit, and the Board/shareholders can choose not to declare it even when profits exist. …
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CBSE 2026Set ANNUAL1 markMCQ
$Q. Debentures which do not carry any specific rate of interest are known as$
(a) registered debentures
(b) zero-coupon rate debentures
(c) bearer debentures
(d) secured debentures
›Reveal solutionSolution
A "zero-coupon" debenture carries no stated interest rate at all — the investor's entire return comes from the gap between its (discounted) issue price and its redemption value.

Debentures can be classified on several bases, and "rate of interest" is one of them:

Specific Coupon Rate Debentures — carry a fixed, stated rate of interest (e.g., "9% Debentures"), paid periodically to the debenture holder.

Zero-Coupon Rate Debentures — carry no stated/specific rate of interest at all. They are typically issued at a substantial discount to their face value and are redeemed at face value (or a value close to it); the difference between the issue price and the redemption value itself constitutes the investor's effective return, functioning like implicit interest.

This is a different classification axis from:

Registered vs. Bearer Debentures (based on whether the company maintains a record of the holder's name), …
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Q.What is a 'Convertible Debenture'?

Concept and Accounting Treatment

Example Journal Entries (Illustrative)

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