Interest — Meaning, and Interest on Debentures and Deposits

5. Interest — Meaning, and Interest on Debentures and Deposits

Meaning of Interest. Interest is the price or compensation a borrower pays to a lender for the use of the lender's money over a period of time. When a company raises funds by borrowing — by issuing debentures or by accepting fixed deposits from the public or its members — it is legally and contractually bound to pay interest to the persons who lent it that money, at the rate agreed at the time the debentures were issued or the deposit was accepted.

Interest on Debentures. A debenture is a document acknowledging a company's debt, usually carrying a fixed rate of interest stated at the time of issue (e.g. "8% Debentures"). This interest is a contractual obligation of the company towards its debenture-holders, payable at fixed intervals (commonly half-yearly or annually) specified in the terms of issue, regardless of whether the company has earned a profit or made a loss in that period. Because debenture-holders are creditors of the company, not owners, interest on debentures is charged to the company's Statement of Profit and Loss as an expense, before arriving at the profit figure — it is deducted in computing profit, not distributed out of profit that has already been computed.

Interest on Deposits. Similarly, where a company accepts fixed deposits from members or the public (subject to the deposit-acceptance rules under the Companies Act, 2013 and the applicable Reserve Bank of India directions for non-banking companies), it must pay interest to the depositor at the rate agreed at the time the deposit was accepted, again as a fixed contractual obligation payable on the due dates irrespective of the company's profit or loss position for that period.

Why 'payable whether or not there is profit' matters. A company that fails to pay dividend commits no breach of contract towards its shareholders — dividend was never a debt until it was actually declared. But a company that fails to pay interest on its debentures or deposits on the due date is in default of a pre-existing contractual (and, for deposits, statutory) obligation — this can expose it to legal action by the debenture-holder or depositor, including, in serious cases, a petition for the company's winding up for inability to pay its debts. …