Issue of Debenture as Collateral Security

What is Issue of Debentures as Collateral Security?

A company may have to issue debentures as a subsidiary or secondary security in addition to the principal security when it takes a loan from a bank or from other party, this is known as Issue of Debentures as Collateral Security. Collateral security is the secondary security in addition to the principal security. No interest is entitled to the bank or the persons to whom such debentures are issued as collateral security. They are only entitled to get interest on the original loan advanced. The lender will first realise its debt from the principal security if a default is made either in the payment of interest or in the payment of principal debt. But it can claim all the rights of a debentureholder if the full amount of debt is not realised from the principal security.

A company can take its debentures back as soon as it pays the final instalments. There are two methods of dealing with such debentures in the books of accounts:

1. First Method:  In the first method, no entry is passed in the books of the company, as the debentures are not actually issued, but only given as collateral security. Entry is only passed for taking a loan under this method. If the loan is taken from a bank, the entry will be: 

*A note is appended below the loan that loan is secured by the issue of dentures as collateral security on the equity and liabilities side of the balance sheet.

Illustration:

Gulzar Ltd. has ₹ 10,00,000, 11% Debentures outstanding as on 1st April, 2021. The company took a loan of ₹2,00,000 for which the company placed debentures for ₹2,50,000 as Collateral Security with the bank. Pass the journal entries if required and show how debentures and Bank Loan will appear in the Company’s Balance Sheet as on 31st March, 2022. 

Solution:

Notes to Accounts:

2. Second Method: In the second method, the entry for issuing debentures as Collateral Security is also recorded with the entry for taking the loan:

A. On taking a loan:

B. On issuing the debentures as collateral security:

Illustration:

Gulzar Ltd. has ₹ 10,00,000, 11% Debentures outstanding as on 1st April, 2021. The company took a loan of ₹2,00,000 for which the company placed debentures for ₹2,50,000 as Collateral Security with the bank. Pass the journal entries if required and show how debentures and Bank Loan will appear in the Company’s Balance Sheet as on 31st March, 2022. 

Solution:

Notes to Accounts: