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Question

What advantages does issue of debentures provide over the issue of equity shares?

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Solution

Debentures are long term debt instruments which bear a fixed rate of interest. The debenture issued by a company is an acknowledgment that the company has borrowed a certain amount of money, which it promises to repay at a future date. Debenture holders are paid a fixed stated amount of interest at specified intervals say six months or one year.

Issue of Zero Interest Debentures (ZID) which do not carry any explicit rate of interest. It has also become popular in recent years. In the case of ZIDs, the difference between the face value of the debenture and its purchase price is the return to the investor.

Merits of Debentures over Equity Shares:

(i) Debentures are preferred by investors who want fixed income at lesser risk.

(ii) Debentures are fixed charge funds and do not participate in profits of the company.

(iii) The issue of debentures is suitable in the situation when the sales and earnings are relatively stable.

(iv) Financing through debentures does not dilute control of shareholders on management as debentures do not carry voting rights.

(v) Financing through debentures is less costly as compared to the cost of equity capital as the interest payment on debentures is tax deductible.

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Similar questions

Assuming that the Debt-Equity Ratio is 2 : I, state, giving reasons, which of the following transactions would (I) Increase; (ii) Decrease; (ii.) Not alter the Debt-Equity Ratio :

(i) Issue of new shares (Preference/Equity) for Cash.

(ii) Issue of new shares (Preference/Equity) against purchase of fixed asset.

(iii) Buy-back of its own shares by a Company.

(iv) Issue of Debentures for Cash.

(v) Issue of Debentures against purchase of fixed asset.

(vi) Repayment of Long-term Borrowings.

(vii) Conversion of Debentures into Equity Shares/Preference Shares.

(viii) Sale of a fixed asset at par.

(ix) Sale of a fixed asset at profit.

(x) Sale of a fixed asset at loss.

(xi) Purchase of a fixed asset on a credit of 2 months.

(xii) Purchase of a fixed asset on long-term deferred payment basis.

(xiii) Issue of Bonus Shares.

Q. On April 01, 2014, a company made an issue of 5,000, 8% debentures of Rs 100 each at Rs 94 per debentures. The terms of issue provided for the redemption of 1,000 debenture every year starting from March 31, 2016 either by purchase from open market or by converting them into Equity shares of Rs 10 each at a premium of Rs 2.50 per share. On March 31, 2016, the company redeemed 1,000 debentures by converting them into equity shares. Give the necessary journal entries.

Q. BPL Ltd. converted

500

9 %

debentures of

R s .100

each issued at a discount of

6 %

into equity shares of

R s .100

each issued at a premium of

R s . 25

per share. Discount on issue of

9 %

debentures has not yet been written off. Showing your working notes clearly, pass necessary journal entries for conversion of

9 %

debentures into equity shares.

Q. Does the procedure for the issue of debentures is very much similar to that of the issue of shares?

Assuming that Proprietary Ratio is 0.6 : 1, state giving reasons, whether the ratio will increase, decrease or will not change in each one of the following cases:

(i) Issue of new equity shares for cash.

(ii) Issue of equity shares against purchase of machinery.

(iii) Issue of debentures against purchase of machiney.

(iv) Redemption of debentures for cash.

(v) Conversion of debentures into preference shares.

(vi) Buy-back of its own shares by a company.

(vii) Purchase of a fixed asset for cash.

(viii) Purchase of a fixed asset on long-term deferred payment basis.

(ix) Sale of a fixed asset costing Rs. 1,00,000 for Rs. 80,000.

(x) Sale of a fixed asset costing Rs. 2,00,000 for Rs. 2,50,000.

(xi) Issue of Bonus Shares.

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