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/cor Tax Deducted at Source A/c.           with the amount of Income-                                                                                                                                                                  tax to be  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:

Journal Entries

Date	Particulars		Dr. (Rs.)	Cr.( Rs.)
2011 Sept. 30	Debenture Interest A/c	Dr	10,000
	To Income-tax Payable A/c			1000
	To Debenture holders A/c   (Interest due on ` 2,00,000, 10% debentures for 6 months and income-tax deducted at source thereon @ 10%)			9000
Sept. 30	Debenture holders’ A/c	Dr.	10,000
	To Bank (Payment of interest to debenture-holders)			10000
Sept. 30	Income-tax Payable A/c	Dr.	1000
	To Bank   (Deposit of income-tax deducted at source from Debenture Interest with the Government)			1000
2012 Mar. 31	Debenture Interest A/c	Dr.	10,000
	To Income-tax Payable A/c			1000
	To Debenture holders A/c   (Interest due on ` 2,00,000, 10% debentures for 6 months and income-tax deducted at source thereon @ 10%)			9000
Mar. 31	Debentureholders’ A/c	Dr.	9,000
	To Bank (Payment of interest to debenture-holders)			9,000
Mar. 31	Income-tax Payable A/c	Dr.	1000
	To Bank (Deposit of Income-tax deducted at source from Debenture Interest with the Government)			1,000
Mar. 31	Profit and Loss A/c	Dr.	20,000
	To Debenture Interest A/c (Transfer of Debenture Interest to Profit and Loss A/c)			20,000

 

Interest Accrued and Due (Outstanding): As stated above, interest on debentures is usually paid every six months; interest really becomes due when the six months are over and not earlier; in other words no one can demand that the company pay interest before the due date. Suppose a company has issued 13.5% Debentures for Rs. 10,00,000 interest is payable on 30th September and 31st March. The company will pay ` 67,500 in every six months. Suppose, the company closes its books on 31st March, the interest due on that date may be unpaid. In that case, there will be a liability which will be recorded

Debenture Interest  A/c                                                                     Dr.                               67,500

             To Debenture Interest Outstanding                                                                                               67,500

The liability will be shown in the Balance Sheet along with debentures.

Interest Accrued but not Due: On the closing date interest for the full period must be brought into books but, it is possible, that due date for payment of interest has not yet come. Suppose, in the example given above, the company closes its books on 31st December. Interest upto 30th September must have been paid but that upto 31st March is not yet due. For proper accounting, however, interest from 1st October to 31st December (3 months) must be taken into account. Interest for such a period is termed as ‘Interest accrued but not due’. The entry for recording this interest is:

Debenture Interest A/c                                                                 Dr.                                     33,750
To Debenture Interest Accrued but not Due                                                                                     33,750

Debenture Interest Accrued but not Due is shown in the balance sheet under Other Current Liabilities.