Q.What is meant by ‘Issue of Debentures as a Collateral Security’ ?
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Start your 14-day free trial to unlock the full solution →Issue of debentures as collateral security means depositing debentures with a lender (usually a bank or financial institution) as a secondary or additional security for a loan, without actually selling them; the lender can realise these debentures only if the company defaults on the primary security.
Concept: Debentures as Collateral Security
When a company borrows money from a bank or financial institution, the lender typically demands security to safeguard the loan. The primary security might be the company's assets—land, building, stock, or book debts. Sometimes the lender insists on additional security to cover the risk. Instead of creating a fresh charge on other assets, the company may issue debentures and deposit them with the lender. These debentures act as a backup or collateral security.
The key point: the company has not sold these debentures to raise funds. The debentures remain with the lender as a safety net. If the company repays the loan on time, the debentures are returned unexercised. If the company defaults, the lender has the right to sell the debentures in the market or enforce the charge they represent, recovering the outstanding amount.
Accounting Treatment
Because the debentures are not actually issued to the public or sold for cash, no liability arises at the time of deposit. The company has merely pledged them. There are two accepted methods of recording this transaction in the books:
Method 1: No Entry at All
Many accountants argue that since no sale has occurred and no cash has been received, no journal entry is needed. The fact is simply disclosed by way of a note in the Balance Sheet under the heading 'Secured Loans' or as a footnote to the loan account, stating:
"Loan from XYZ Bank ₹5,00,000 (secured by deposit of 10% Debentures of ₹10,00,000 as collateral security)."
This method keeps the books clean and reflects the true position—the debentures are a contingent charge, not an actual liability yet.
Method 2: Entry for Record and Control
Some companies prefer to record the deposit in the books for internal control and to maintain a complete audit trail. The entry is:
| Date | Particulars | L.F. | Debit (₹) | Credit (₹) |
|---|---|---|---|---|
| Debentures Suspense A/c Dr. | ₹10,00,000 | |||
| To Debentures A/c | ₹10,00,000 | |||
| (Being issue of 10% Debentures as collateral security for loan from XYZ Bank) |
Here, Debentures Suspense Account is a contra-asset account (it appears on the asset side of the Balance Sheet) and Debentures Account is shown on the liability side. The two cancel each other out in the Balance Sheet, so the net effect on total assets and liabilities is nil. This entry serves as a memorandum record.
When the loan is repaid and the debentures are returned, the entry is reversed:
| Date | Particulars | L.F. | Debit (₹) | Credit (₹) |
|---|---|---|---|---|
| Debentures A/c Dr. | ₹10,00,000 | |||
| To Debentures Suspense A/c | ₹10,00,000 | |||
| (Being return of debentures held as collateral security on repayment of loan) |
If the company defaults and the lender enforces the debentures (sells them or converts them into actual liability), then the company must pass the normal entries for issue of debentures for consideration other than cash, recognising the liability and adjusting the loan account. …
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