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”.
Accounting Entries: The following are the 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:
(i) On issue of debentures as collateral security
Debentures Suspense A/c Dr. with the nominal value of the
debentures issued
To Debentures A/c
In this case, Debentures Suspense Account will appear on the asset side of the balance sheet under the heading Miscellaneous Expenditure. Debentures Account will appear as a liability on the liabilities side of the Balance
Sheet.
(ii) On repayment of the loan and release of debentures
Debentures A/c Dr. with the nominal value of the
debentures released
To Debentures Suspense A/c
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 5
Z Ltd. secured an overdraft of ` 50,000 from the bank by issuing 600, 12% Debentures of ` 100 each as collateral security. Prepare the Balance Sheet of the Company.
Solution
First Method:
Balance Sheet of Z Ltd. as at…..
EQUITY AND LIABILITIES
Current liability
Short term borrowings 1 50,000
Notes
1. Short term borrowings
Bank Overdraft 50,000
(Secured by the issue of 600, 12% Debentures of ` 100
each as collateral security)
Second Method:
Journal Entries
Dr Cr.
Debentures Suspense A/c Dr. 60,000
To Debentures A/c 60,000
(Issue of 600, 12% Debentures of ` 100 each as collateral security for a bank overdraft of ` 50,000 as per Board’s resolution dated…..)
Balance Sheet of Z Ltd. as at…..
I. EQUITY AND LIABILITIES
Non-Current Liabilities
Long term borrowing 1 60,000
Current liability
Short term loan 2 50,000
II. ASSETS
Non-Current Assets
Other non-current assets 3 60,000
Notes
1. Long term borrowings
600, 12% Debentures of `100 each 60,000
(Issued as collateral security as per contra)
2. Short term borrowings
Bank Overdraft 50,000
(Secured by the issue of 600, 12% Debentures
of 100 each as collateral security)
3. Other non-current assets
Debentures Suspense Account 60,000
(Issued as collateral security as per contra)