DEBENTURES ISSUED AS COLLATERAL SECURITY :

The term ‘Collateral Security’ implies additional security given for a loan. Where a company obtains a loan from a bank or insurance company, it may issue its own debentures to the lender as collateral security against the loan in addition to any other security that may be offered. In such a case, the lender has the absolute right over the debentures until and unless the loan is repaid. On repayment of the loan, however, the lender is legally bound to release the debentures forthwith. But in case the loan is not repaid by the company on the due date or in the event of any other breach of agreement, the lender has the right to retain these debentures and to realise them. The holder of such debentures is entitled to interest only on the amount of loan, but not on the debentures. Such an issue of debentures is known as “Debentures issued as Collateral Security”. There are two alternative ways by which debentures issued as collateral security can be dealt with:

(1) No accounting entry is required to be shown in the books of account at the time of issue of such debentures for the simple reason that the loan against which the debentures are issued as collateral security has already been credited, the debit being given to Bank. But the existence of such debentures issued as collateral security has to be mentioned by way of a note on the Balance Sheet under the specific loan account.

(2) If it is desired that such an issue of debentures as collateral security is to be recorded in the books of account, the accounting entries will be as follows:

Note: The net effect of the above two entries is nil. Both the Debentures Suspense Account and the Debentures Account are cancelled on repayment of the loan. As such, this method is rarely followed in practice.

Illustration :

Z Ltd. secured an a long-term loan of Rs. 50,000 from the bank by issuing 600, 12% Debentures of Rs. 100 each as collateral security. Show relevant items in the Balance Sheet of the Company under both the methods.

Solution:
(First Method):

 

Balance Sheet (relevant items only)

Particulars	Note No.	Amount (Rs.)
I Equity and Liabilities
Non-current Liabilities
Long-term Borrowings	1	50,000
Note:
1. Long-term Borrowings
Long term Secured Loan		50,000
(Secured by the issue of …….
12% Debentures of ` 100 each as collateral securities)

 

Solution (Second Method):

Journal Entries

Particulars	Dr. (Rs.)	Cr. (Rs.)
Debentures Suspense A/c                                                                 Dr.	60,000
To Debentures A/c		60,000
(Issue of 600, 12% Debentures of Rs. 100 each as collateral security for a bank overdraft of Rs. 50,000 as per Board’s resolution dated…..)

 

Balance Sheet (relevant items only)

Particulars	Note No.	Amount (Rs.)
I Equity and Liabilities
Non-current Liabilities
Long-term Borrowings	1	50,000
Note:
1. Long-term Borrowings	Rs.	Rs.
Long term Secured Loan		50,000
(Secured by the issue of …….
12% Debentures of ` 100 each as collateral securities)	60,000
Less: 12% De Debentures Accounts	(60,000)	Nil
		50,000