What is meant by conversion of debentures? Describe the method of such a conversion.

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Q. What is meant by conversion of debentures? Describe the method of such a conversion.

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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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Conversion of Debentures

Conversion of debentures means exchanging debentures (loan instruments) for shares or other securities of the company, as per the terms agreed at the time of issue. This is a contractual right given to debenture holders — they can choose to convert their debentures into equity shares or preference shares at a predetermined ratio and price.

The conversion can be fully convertible (entire amount converts) or partly convertible (only a portion converts, the rest is redeemed in cash).

Method of Conversion

When debentures are converted into shares, the company follows these steps:

Calculate the amount due — the face value of debentures plus any accrued interest or premium payable on conversion.
Determine the number of shares — divide the amount due by the issue price of shares (which may be at par, at a premium, or at a discount).
Pass the journal entry — debit the Debentures Account and any outstanding interest, and credit the Share Capital Account (and Securities Premium Account if shares are issued at a premium).

Journal Entry for Conversion

Particulars	Debit (₹)	Credit (₹)
10% Debentures A/c Dr.	1,00,000
To Equity Share Capital A/c		80,000
To Securities Premium A/c		20,000
(Being 10% debentures of ₹1,00,000 converted into 8,000 equity shares of ₹10 each issued at a premium of ₹2.50 per share)

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Conversion of debentures means exchanging debentures for shares or other securities as per the terms of issue. The method involves cancelling the debenture liability and issuing shares at an agreed valuation, with any difference adjusted through the capital reserve or securities premium account.

Understanding Conversion of Debentures

When a company issues debentures, it borrows money from debenture holders. The company may later offer these holders the option to convert their debentures into equity shares or preference shares instead of receiving cash repayment. This is called conversion of debentures.

The key accounting principle here is that the company's liability (debentures) is being replaced by shareholders' funds (share capital). The debenture holder becomes a shareholder, and the company no longer has to repay the principal amount.

The Method of Conversion

The conversion can happen in two ways:

At par – The debenture's face value equals the value of shares issued.
At a premium or discount – The debenture's face value differs from the share value, requiring adjustment.

Step-by-Step Accounting Treatment

Step 1: Record the conversion request

When debenture holders exercise their option, the company must cancel the debenture liability. The journal entry is:

Particulars	Debit (₹)	Credit (₹)
10% Debentures A/c Dr.	1,00,000
To Debenture Holders A/c		1,00,000
(Being the amount due to debenture holders on conversion)

Step 2: Issue shares to debenture holders

The company issues shares at the agreed value. If shares are issued at par:

Particulars	Debit (₹)	Credit (₹)
Debenture Holders A/c Dr.	1,00,000
To Equity Share Capital A/c		1,00,000
(Being 10,000 equity shares of ₹10 each issued at par to debenture holders)

If shares are issued at a premium, the premium amount is credited to Securities Premium Reserve A/c.

Watch out

A common mistake is to directly credit Share Capital A/c without first creating the Debenture Holders A/c. Always pass through the Debenture Holders A/c to clearly show the settlement of the liability.

Step 3: Handle any difference

If the debenture's book value differs from the share issue value (e.g., due to discount on issue of shares), the difference is transferred to Capital Reserve (if gain) or Discount on Issue of Shares (if loss).

Example for Clarity

Suppose a company has ₹1,00,000 10% debentures. Debenture holders opt to convert into equity shares of ₹10 each at a premium of ₹2 per share.

Working Note 1: Number of shares to be issued

Face value of debentures = ₹1,00,000
Issue price per share = ₹10 + ₹2 = ₹12
Number of shares = ₹1,00,000 ÷ ₹12 = 8,333.33 shares

Since shares cannot be issued in fractions, the company may issue 8,333 shares and pay cash for the balance. …

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Q.What is meant by conversion of debentures? Describe the method of such a conversion.

Understanding Conversion of Debentures

The Method of Conversion

Step-by-Step Accounting Treatment

Example for Clarity

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