Explain redemption of debenture by collateral security with journal entries.
Answers
Debentures are issued as collateral security in addition to the prime or principal security.
Explanation:
- Loans taken are secured by mortgage of the assets known as prime or principal security. Security given in addition to the prime or principal security is termed or known as Collateral Security Collateral security is realized by the lender only if the due amount (loan plus interest) can be recovered by realizing the principal security.
- Debentures are issued as collateral security when the borrower is not in a position to give an other asset as a collateral security. The debentures issued as collateral security are returned to the company when the loan is paid back .
- If loan is being repaid along with due interest and the lender has not demanded the loan to be repaid, it does not carry any right till that time. In case the company fails to repay the loan being demanded by the lender, the lender may exercise its right towards debentures being issued as collateral security.
Accounting Treatment: Debentures issued as a collateral security can be dealt with in two ways:
First Method: Entry for issue of debentures as collateral security is not passed in the books of account at the time of issuing such debentures. It is disclosed under the head Secured Loans in the Equity and Liabilities part of the Balance Sheet that debentures have been issued as collateral security.
Second Method: Debentures issued as collateral security are recorded in the books of account. The Journal entry passed is:
Debentures Suspense A/c Dr.
To ...% Debentures A/c
When the loan is paid to the lender, the above entry is cancelled by passing a reverse entry. In the Balance Sheet, the debentures issued as collateral security are shown separately from other debentures.