Debentures Issued as Collateral Security

Debentures issued as collateral security look difficult because the word “issued” makes students think that a normal debenture issue has happened.

But in this topic, the company is not raising money from debenture holders in the usual way.

The company has taken a loan from a bank or financial institution. The bank may already have a main security, such as land, building, plant, or other assets. Still, it may ask for an additional safety cover. To give that extra cover, the company deposits its own debentures with the lender.

That is why these debentures are called collateral security.

Once this point is clear, the journal entries become much easier.

First Understand the Story

Imagine a company takes a bank loan of Rs. 10,00,000.

The bank says:

“We are giving you the loan, but we also want extra security. If you do not repay, we should have another way to recover the amount.”

The company may then issue debentures to the bank as collateral security. These debentures are kept by the bank as a backup. The bank is not treated like an ordinary debenture holder from day one.

The main liability is still the bank loan.

The collateral debentures are only additional support for that loan.

Item	What it means
Bank loan	Main borrowing of the company
Main security	Primary asset given against the loan
Collateral security	Extra security given as backup
Collateral debentures	Debentures deposited with the lender as extra security

This is the reason students must not record the collateral debentures like a normal cash issue unless the question asks for the entry method.

Why Companies Give Debentures as Collateral Security

A lender wants confidence that the loan can be recovered.

Suppose the company gives a building as the main security. If the company fails to repay the loan, the bank can sell the building. But what if the sale value of the building is not enough to recover the full loan?

Collateral security gives the lender a second layer of protection.

The debentures can be used by the lender if the company defaults and the main security does not fully cover the amount.

This small difference decides the entire accounting treatment.

The Two Accounting Treatments

Debentures issued as collateral security can be shown in two ways:

Treatment	What happens
First method	No journal entry is passed for the collateral debentures. A note is shown with the loan.
Second method	A journal entry is passed using Debenture Suspense A/c.

Both methods appear in accountancy questions. The question may directly say which method to use. If it says nothing, read the wording carefully and follow the format expected in the question.

First Method: No Journal Entry

Under the first method, no entry is passed for issuing debentures as collateral security.

Why?

Because the company has not received money from the debentures. It has received money from the bank loan. The debentures are only deposited as extra security.

The entry for receiving the bank loan will be:

Particulars	Debit	Credit
Bank A/c Dr.	Rs. 10,00,000
To Bank Loan A/c		Rs. 10,00,000

There is no separate entry for collateral debentures under this method.

Instead, the balance sheet note will show that the loan is secured by issue of debentures as collateral security.

This is often the cleaner method because it keeps the focus on the real liability: the loan.

Balance Sheet Treatment Under the First Method

Suppose a company takes a bank loan of Rs. 10,00,000 and issues 12,000, 10 percent debentures of Rs. 100 each as collateral security.

The collateral debentures have a face value of:

12,000 x Rs. 100 = Rs. 12,00,000

But the actual loan is Rs. 10,00,000.

Under the first method, the balance sheet extract can be understood like this:

Particulars	Amount
Long-term borrowings	Rs. 10,00,000

Notes to accounts:

Particulars	Amount
Bank Loan, secured by issue of 12,000, 10 percent debentures of Rs. 100 each as collateral security	Rs. 10,00,000

Notice that the balance sheet does not add Rs. 12,00,000 as a separate loan amount.

The company owes Rs. 10,00,000 to the bank. The debentures are security for that borrowing.

Second Method: Entry Method

Under the second method, the issue of debentures as collateral security is recorded through a journal entry.

The entry is:

Particulars	Debit	Credit
Debenture Suspense A/c Dr.	Face value of debentures
To Debentures A/c		Face value of debentures

For example, if 12,000 debentures of Rs. 100 each are issued as collateral security, the entry will be:

Particulars	Debit	Credit
Debenture Suspense A/c Dr.	Rs. 12,00,000
To 10 percent Debentures A/c		Rs. 12,00,000

The narration may say:

Being 12,000, 10 percent debentures of Rs. 100 each issued as collateral security for bank loan.

This entry does not mean the company received Rs. 12,00,000 in cash.

It only records the collateral debentures formally in the books.

That is why Debenture Suspense A/c is so important in this method.

What Is Debenture Suspense A/c?

Debenture Suspense A/c is a temporary account used in the entry method.

It is debited because the debentures are being credited, but the company has not received cash or any asset against those debentures. The suspense account balances the entry.

Think of it as a holding account that says:

“These debentures have been recorded, but they are only collateral.”

In the balance sheet note, Debenture Suspense A/c is deducted from the debentures. This keeps the net effect of the collateral debentures at nil.

Balance Sheet Treatment Under the Second Method

Use the same example:

Bank loan = Rs. 10,00,000
Collateral debentures = 12,000 debentures of Rs. 100 each
Face value of collateral debentures = Rs. 12,00,000

The journal entries will be:

Particulars	Debit	Credit
Bank A/c Dr.	Rs. 10,00,000
To Bank Loan A/c		Rs. 10,00,000

Particulars	Debit	Credit
Debenture Suspense A/c Dr.	Rs. 12,00,000
To 10 percent Debentures A/c		Rs. 12,00,000

The notes to accounts may be shown like this:

Particulars	Amount
Bank Loan	Rs. 10,00,000
12,000, 10 percent Debentures of Rs. 100 each	Rs. 12,00,000
Less: Debenture Suspense A/c	Rs. 12,00,000
Total long-term borrowings	Rs. 10,00,000

The total remains Rs. 10,00,000 because the actual borrowing is the bank loan.

The collateral debentures and Debenture Suspense A/c cancel each other for presentation.

What Happens When the Loan Is Repaid?

If the company repays the bank loan, the collateral security is no longer needed.

Under the first method, there was no collateral debenture entry, so there is no reverse entry for those debentures. The loan repayment is recorded normally.

Entry for repayment of loan:

Particulars	Debit	Credit
Bank Loan A/c Dr.	Rs. 10,00,000
To Bank A/c		Rs. 10,00,000

Under the second method, the collateral debenture entry is reversed:

Particulars	Debit	Credit
Debentures A/c Dr.	Face value of debentures
To Debenture Suspense A/c		Face value of debentures

For the example:

Particulars	Debit	Credit
10 percent Debentures A/c Dr.	Rs. 12,00,000
To Debenture Suspense A/c		Rs. 12,00,000

This cancels the collateral debenture record from the books.

That simple matching rule prevents many mistakes.

Do These Debentures Get Interest?

In normal debenture issue questions, debenture holders receive interest at the given rate.

But collateral debentures are different. As long as the loan is being paid normally, the lender receives interest on the loan. The collateral debentures are only security.

So, in ordinary school-level treatment, do not calculate separate interest on collateral debentures unless the question gives a special default situation and asks you to handle it.

For regular journal entry questions, keep interest focused on the bank loan unless the question clearly changes the situation.

A Full Solved Example

Let us solve one example in a simple way.

ABC Ltd. took a loan of Rs. 8,00,000 from a bank. The loan was secured by plant as the main security. In addition, ABC Ltd. issued 9,000, 8 percent debentures of Rs. 100 each as collateral security. Show the treatment under both methods.

Step 1: Record the Bank Loan

The company received Rs. 8,00,000 from the bank.

Particulars	Debit	Credit
Bank A/c Dr.	Rs. 8,00,000
To Bank Loan A/c		Rs. 8,00,000

This entry is needed under both methods because the loan has actually been received.

Step 2: Find the Face Value of Collateral Debentures

9,000 debentures x Rs. 100 = Rs. 9,00,000

This Rs. 9,00,000 is the face value of collateral debentures. It is not the loan amount.

Step 3: First Method Treatment

No entry is passed for the collateral debentures.

The note to accounts will show:

Particulars	Amount
Bank Loan, secured by plant and by issue of 9,000, 8 percent debentures of Rs. 100 each as collateral security	Rs. 8,00,000

Step 4: Second Method Treatment

Pass the collateral debenture entry:

Particulars	Debit	Credit
Debenture Suspense A/c Dr.	Rs. 9,00,000
To 8 percent Debentures A/c		Rs. 9,00,000

The notes to accounts will show:

Particulars	Amount
Bank Loan	Rs. 8,00,000
9,000, 8 percent Debentures of Rs. 100 each	Rs. 9,00,000
Less: Debenture Suspense A/c	Rs. 9,00,000
Total long-term borrowings	Rs. 8,00,000

The final amount is still Rs. 8,00,000.

This is the main lesson of the example.

How to Decide Which Amount to Use

Many mistakes happen because students mix the loan amount and the face value of debentures.

Use this table:

Question asks for	Use this amount
Bank Loan A/c	Loan amount received
Bank A/c	Loan amount received or repaid
Debentures A/c in entry method	Face value of debentures issued as collateral
Debenture Suspense A/c	Face value of debentures issued as collateral
Total borrowing shown after deduction	Actual loan amount

So, if the loan is Rs. 10,00,000 and collateral debentures are Rs. 12,00,000, do not force both amounts to become equal.

They represent different things.

Once you separate these two amounts, most questions become straightforward.

Common Mistakes to Avoid

The first mistake is passing a normal debenture issue entry:

Bank A/c Dr.
  To Debentures A/c

This is wrong for collateral debentures because the company did not receive cash from debenture holders. It received a loan from the bank.

The second mistake is adding the loan and collateral debentures as if both are separate borrowings.

If a loan is Rs. 10,00,000 and collateral debentures are Rs. 12,00,000, the total borrowing is not automatically Rs. 22,00,000. Under the second method, the collateral debentures are offset by Debenture Suspense A/c.

The third mistake is forgetting the note under the first method.

Even when no journal entry is passed, the information is still shown in notes to accounts. “No entry” does not mean “ignore the collateral security completely.”

The fourth mistake is reversing an entry that was never passed.

If the first method was used, there is no collateral debenture entry to reverse. Only the bank loan repayment is recorded.

Quick Revision Format

Use this compact format when revising:

Meaning:
Additional security given to lender for a loan.

First method:
No entry for collateral debentures.
Show a note with the loan.

Second method:
Debenture Suspense A/c Dr.
  To Debentures A/c

On repayment under second method:
Debentures A/c Dr.
  To Debenture Suspense A/c

Most important point:
Loan amount and collateral debenture face value may be different.

If you can write this much from memory, you already understand the heart of the topic.

Frequently Asked Questions

What are debentures issued as collateral security?

They are debentures given to a lender as additional security for a loan. The company has already taken a loan, and these debentures act as backup protection for the lender.

Is cash received when debentures are issued as collateral security?

No. Cash is received because of the bank loan, not because of the collateral debentures. This is why a normal entry like Bank A/c Dr. To Debentures A/c is not used for the collateral issue.

What is the journal entry under the second method?

The entry is:

Debenture Suspense A/c Dr.
  To Debentures A/c

The amount is the face value of the debentures issued as collateral security.

Why is Debenture Suspense A/c debited?

It is debited because the debentures are credited, but no cash or asset is received against those debentures. The suspense account balances the entry and is later deducted from debentures in the notes to accounts.

Is any entry passed under the first method?

No entry is passed for the collateral debentures under the first method. A note is shown with the loan, stating that the loan is secured by issue of debentures as collateral security.

What happens when the loan is repaid?

The bank loan is repaid normally. If the second method was used, the collateral debenture entry is also reversed by debiting Debentures A/c and crediting Debenture Suspense A/c.

Should collateral debentures be added to the loan amount?

No. The loan amount is the actual borrowing. The collateral debentures are additional security. Under the entry method, Debenture Suspense A/c is deducted from Debentures A/c, so the net effect of collateral debentures remains nil.

Do collateral debentures get separate interest?

Usually, no separate interest is calculated on collateral debentures while the loan is being paid normally. The lender receives interest on the main loan. Treat collateral debenture interest only if the question gives a specific situation that requires it.