INTEREST ON DEBENTURES :

Wherever a company issues debentures it undertakes to pay interest thereon at a fixed percentage. As the debentures acknowledge a debt, the payment of interest on the debt is obligatory on the part of the company issuing them irrespective of the fact whether the company earns profit or not. Thus, interest payable on debentures is a charge against the profits of the company. Interest on debentures is normally payable half-yearly and it is calculated at the fixed percentage on the nominal value of debentures issued and not on the issue price. Thus, the issue of debentures at par or at a premium or at a discount would not make any difference for the purpose of calculating interest on debentures. But, the effective rate of interest on the amount paid by the debentureholders would invariably differ in each of the above cases.

According to Income-tax Act, 1961 a company is liable to deduct income-tax at the prescribed rate from the
gross amount of interest payable on debentures before the actual payment is made to the debentureholders
and to deposit it with the Government. The balance amount after deduction of income-tax is actually payable to
the debentureholders. This is known as deduction of tax at source.

It is important to note in this connection that if the debentures are tax-free, the income-tax on such interest will be paid by the company itself on behalf of the debentureholders. However, the interest paid by the company has to be grossed up for calculating the interest expense of the company.

Accounting Entries: The following entries are required to be shown in the books of the company to deal with interest on debentures:

1. On interest becoming due

Debenture Interest A/c                                                                     Dr.         with the gross interest due

           To Income-tax Payable A/c or Tax Deducted at Source A/c.              with the amount of Income-tax to                                                                                                                                                        deducted at source

           To Debentureholders’ A/c                                                                         with the net amount payable after                                                                                                                                                    deduction of income-tax

2. On payment of interest to the debentureholders

Debentureholders’ A/c                                                                      Dr.             with the net amount of paid interest
To Bank A/c

3. On payment of income-tax to the Government

Income-tax Payable A/c                                                                     Dr.      with the amount of income-tax

                                                                                                            deducted at source and deposited  with the Government

 

                                    To Bank A/c

4. On transfer of Debenture Interest to Profit and Loss Account at the end of the year

Profit and Loss A/c                                                                           Dr.      with the gross amount of interest on debentures

                 To Debenture Interest A/c

Notes:

(1) Until and unless Income-tax payable/TDS payable is deposited by the company with the Government it will be treated as a liability and shown as a current liability in the of the Balance Sheet.

(2) While transferring Debenture Interest to Profit and Loss Account at the end of the period, it should be carefully noted whether interest for the full period for which the accounts are being prepared has been provided for or not. If not, the same has to be adjusted first before transferring it to the Profit and Loss Account.

(3) If the debentures are tax-free, the interest payable on debentures has to be grossed up. Since no company can really issue debentures on which no tax is payable. In this case, tax-free means that the relevant tax will be paid by the company.

Illustration 7
(Payment of Debenture Interest)

Zed Ltd. had issued ` 2, 00,000, 10% debentures on which interest was payable half-yearly on 30th September and 31st March. Show the necessary journal entries relating to debenture interest for the year ended 31st March, 2014 assuming that all moneys were duly paid by the company. Tax deducted at source is 10%.

Solution: