Issue of Debentures at Discount: An Overview
A debenture is the most common type of long-term debt that a firm can obtain. This is an important financial technique for raising funds from the general public in exchange for a predetermined interest rate. Debentures issued at a discount are debentures that a corporation might issue instead of shares. Giving debentures at a discount boosts the company's capital relative to the decreasing growth in cash. As a result, the firm suffers a loss while increasing demand for security.
Debentures: An Introduction
When an applicant is required to pay a sum less than the face value of the debenture, the debenture is said to have been issued at a discount. The discount amount differs between the face value and the issue price. It should be noted that firms are not prohibited by law from issuing discounted debt securities. Similarly, the Companies Act does not define a maximum limit for the discount on debentures. The Act requires that the discount amount be recorded on the assets side of the balance sheet until it is written off under the heading "Miscellaneous Expenditure."
Issue of Debentures
The corporation indicates by issuing debentures that it will issue a certificate carrying its stamp as an acknowledgement of the debt that it has incurred. The process of issuing debentures by a company is similar to issuing shares. Letters of allocation are issued, a prospectus is made available, and applications are sought. When applications are rejected, application fees are refunded. Any residual monies may be applied to future calls if an application is only partially allocated.
Debenture issues can take one of several forms:
Debentures issued in cash
Debentures issued in exchange for non-cash consideration
Securities that are issued as collateral
Treatment of Discount on Issue of Debentures
Some of the approaches utilised to treat the discount on debenture issue are as follows:
A capital loss results from a discount on a debenture issue. It will be listed on the asset side of the balance sheet until it is written off. It is expected to be written off as quickly as feasible. The discount on issuing debentures can be written off as a capital loss in two ways.
First Approach: In this scenario, the entire debenture discount amount is equally spread across the debenture term. Assume the discounted bonds had a five-year redemption duration when they were issued. The resultant payment will be charged to the profit and loss account for five years, five times the discount amount. This process is used to redeem debentures after a set period.
Second Approach: The amount of discount is deducted annually following the quantity of debenture utilisation. This method, which involves serving a notice and holding a lottery, is used to redeem debentures annually.
Case Study
ABC Co. Limited issued 10,000 Rs. 100 debentures at a 10% discount from face value. Determine the discount that was applied to the debentures issuance.
Solution:
Discount on issue of debenture(per debentures) = Face Value * Rate of Discount
= 100 * 10%
= Rs 10/- (per debentures)
The total amount of Discount = Number of debentures * Amount of Discount (per debentures)
= 10,000 * 10
= Rs. 1,00,000/-
Conclusion
So here we discussed the accounting entries for the issue of debentures, especially the Issue of debentures at discount. Discount on debenture issue is a capital loss that should be removed from the profit and loss account over time while also being recorded in the balance sheet for the amount not yet deducted. When debentures are issued, they are assigned a face value, and interest is always computed about that face value. Go through the FAQs below to understand more about the topic discussed above.
FAQs on Issue of Debentures at a Discount Explained
1. What does it mean when a company issues debentures at a discount?
Issuing debentures at a discount means the company sells them for a price less than their face value (or nominal value). For instance, if a debenture has a face value of ₹100 but is issued to the public for ₹95, the ₹5 difference is the discount. This is essentially a cost of borrowing funds, offered to make the debentures more attractive to investors.
2. What is the standard journal entry for the issue of debentures at a discount?
The journal entry records the cash received, the discount as a loss, and the full liability of the debentures. For example, if 1,000 debentures of ₹100 each are issued at a 5% discount:
- Bank A/c Dr. - ₹95,000 (The actual cash received)
- Discount on Issue of Debentures A/c Dr. - ₹5,000 (The total loss/discount)
- To Debentures A/c - ₹1,00,000 (The full face value of the liability)
(Being the issue of 1,000 debentures at a 5% discount)
3. Why is 'Discount on Issue of Debentures' initially shown as an asset in the Balance Sheet?
The 'Discount on Issue of Debentures' is a capital loss, not a regular revenue expense for a single year. The benefit of the borrowed funds (debentures) will be available to the company over the entire tenure of the debentures. Therefore, accounting principles require this loss to be spread out over the life of the debentures. Until it is completely written off against profits, it is shown on the Assets side of the Balance Sheet as a form of deferred expense.
4. How is the 'Discount on Issue of Debentures' presented in a company's Balance Sheet as per Schedule III of the Companies Act, 2013?
As per Schedule III, the unwritten-off portion of the 'Discount on Issue of Debentures' is shown on the Assets side under the head 'Non-Current Assets' and the sub-head 'Other Non-Current Assets'. If any portion of the discount is to be written off within the next 12 months, that portion is shown under 'Current Assets' within the sub-head 'Other Current Assets'.
5. How is the 'Discount on Issue of Debentures' written off by a company?
The discount must be written off over the life of the debentures. It is charged to the Statement of Profit and Loss each year. The amount to be written off annually can be calculated in two ways:
- Fixed Instalment Method: The total discount is divided equally by the number of years of the debenture's tenure.
- Fluctuating Instalment Method: The discount is written off in proportion to the amount of debentures outstanding each year. This method is used when debentures are redeemed in instalments.
6. What is the impact of writing off the discount on a company's Statement of Profit and Loss?
When the 'Discount on Issue of Debentures' is written off, it is treated as a finance cost. The amount written off for a particular year is debited to the Statement of Profit and Loss. This reduces the company's reported profit for that year. It effectively recognises a portion of the total cost of borrowing in each year the debentures are outstanding, ensuring a more accurate representation of the company's financial performance.
7. Is there any legal restriction on the rate of discount for issuing debentures?
Unlike the issue of shares at a discount which is prohibited by Section 53 of the Companies Act, 2013, there are no specific restrictions under the Act regarding the maximum rate of discount at which debentures can be issued. A company is free to issue debentures at any discount rate it deems necessary to attract investors, provided it complies with its Articles of Association.
8. How is the 'Discount on Issue of Debentures' treated when preparing a Cash Flow Statement?
The 'Discount on Issue of Debentures' is a non-cash expense. When preparing a Cash Flow Statement using the indirect method, the amount of discount written off during the year is added back to the 'Net Profit before Tax and Extraordinary Items' under the 'Cash Flow from Operating Activities' section. This is done to nullify its non-cash impact on the profit figure.
