Question

Long Answer Question

Describe the meaning of ‘Debenture Issued as Collateral Securities’. What accounting treatment is given to the issue of debentures in the books of accounts?

Answer 1

The term collateral security means additional or secondary security in addition to the primary security. Sometimes, when a company takes loan from a financial institution, then besides the primary security, the company may issue debenture for additional security (as collateral security). The lender who receives debenture as collateral security is not entitled for interest on these debentures. If any default is made by the company in paying back the principal amount (i.e. the loan amount) or interest on the loan, then the lender has the full right to recover his/her dues from the sale of primary security. But, if the primary security is not sufficient to recover the amount of debt, then the debentures issued as collateral may be used for recovery of the remaining amount.

Accounting Treatment

There are  two ways to record issue of debentures as collateral security:

1. No Entry

As no liability has been created so no Journal entry is recorded in the books of account. As per the Revised Schedule-VI of the Companies Act, the issue of debenture as collateral security is shown as a Long-Term Borrowings under the heading of Non-Current Liabilities on the Equity and Liabilities side of the Balance Sheet. In the Notes to Accounts of Long-Term Borrowings, the Loan so taken is shown. And in the Notes to Accounts of Cash and Cash Equivalents, the amount of loan so received (in cash) is shown. This can be better understood with the help of the below explained example.

Example- Suppose Best Bus Ltd. issued 4,000 9% Debentures of Rs 100 each as collateral security to NBP bank for a loan of Rs 3,00,000.

Best Bus Ltd.

Balance Sheet

Particulars	Note No.	Amount  (Rs)
I. Equity and Liabilities
1. Shareholders’ Funds
2. Non-Current Liabilities
a. Long-Term Borrowings	1	3,00,000
3. Current Liabilities
Total		3,00,000
II. Assets
1. Non-Current Assets
2. Current Assets
a. Cash and Cash Equivalents	2	3,00,000
Total		3,00,000

NOTES TO ACCOUNTS

Note No.	Particulars	Amount   (Rs)
1	Long-Term Borrowings
	Loan (Secured by issue of  9% Debentures of Rs 4,00,000 as Collateral Security)	3,00,000
2	Cash and Cash Equivalents
	Cash at Bank	3,00,000

2. By Making Entry

In order to record the issue of debentures as collateral security, the following necessary Journal entries are made in the books of account. 

At the time of Issue of Debentures as Collateral Security

Debenture Suspense A/c		Dr.
	To Debenture A/c
(Debentures issued as collateral security)

In this case, as per the Revised Schedule VI of the Companies Act, Debentures so issued as collateral security will be shown as Long-Term Borrowings under the head of Non-Current Liabilities of the Equity and Liabilities side of the Company's Balance Sheet. Unlike Method-1, in this method, Debentures Suspense Account is deducted from the Debentures Account in the Notes to Accounts of Long-Term Borrowings.

Best Bus Ltd.

Balance Sheet

Particulars	Note No.	Amount  (Rs)
I. Equity and Liabilities
1. Shareholders’ Funds
2. Non-Current Liabilities
a. Long-Term Borrowings	1	3,00,000
3. Current Liabilities
Total		3,00,000
II. Assets
1. Non-Current Assets
2. Current Assets
a. Cash and Cash Equivalents	2	3,00,000
Total		3,00,000

NOTES TO ACCOUNTS

Note No.	Particulars		Amount   (Rs)
1	Long-Term Borrowings
	Secured:
	Loan (Secured by issue of  9% Debentures of Rs 4,00,000 as Collateral Security)		3,00,000
	9% Debentures (Issued as Collateral Security to Bank against loan)	4,00,000
	Less: Debenture Suspense Account	(4,00,000)	-
			3,00,000
2	Cash and Cash Equivalents
	Cash at Bank		3,00,000