From the Point of view of Security

Secured vs Unsecured Debentures

The classification of debentures from the point of view of security is about what happens if the company fails to pay interest or repay the principal. The key question is: does the debenture holder have a claim on any specific asset of the company?

(a) Secured Debentures

A debenture is called secured when the company creates a charge on its assets in favour of the debenture holders. A charge is a legal right given to the lender (the debenture holder) over the borrower's (the company's) assets. If the company defaults, the debenture holders can sell those assets to recover their money.

There are two types of charges:

• Fixed Charge: This is created on a specific, identifiable asset — for example, a particular piece of land, a building, or a specific machine. The company cannot sell that asset without first obtaining the consent of the debenture holders. Fixed charges are typically created on assets that the company holds for long-term use in its operations, not for sale in the ordinary course of business.

• Floating Charge: This is created on the general assets of the company — for example, stock-in-trade, debtors, or cash. The company is free to deal with these assets in the normal course of business (buy, sell, replace) without needing permission from the debenture holders. A floating charge "floats" over the assets until a specific event (like default) occurs. At that point, the floating charge crystallises into a fixed charge on the assets that exist at that time.

(b) Unsecured Debentures

An unsecured debenture (also called a naked debenture) does not have a specific charge on any asset of the company. The holder relies only on the general creditworthiness of the company.

However, the textbook notes that even for unsecured debentures, a floating charge may be created by default — meaning that in the event of liquidation, the unsecured debenture holders may still have a claim on the company's general assets, but they rank behind secured creditors.

Accounting Treatment

The accounting treatment for issuing secured vs unsecured debentures is identical in the journal entries. The distinction between secured and unsecured does not affect the debit/credit entries at the time of issue. The journal entry is always: