Preparation of Accounts for the Issue of Shares

Back to: FINANCIAL ACCOUNTING SS2

 

Welcome to class! 

In today’s class, we will be talking about the preparation of accounts for the issue of shares. Enjoy the class!

Preparation of Accounts for Issue of Shares

What is Loan Capital?

Loan Capital is the part of a company’s capital that is not equity capital but earns a fixed rate of interest instead of dividends, and must be repaid within a specified period; irrespective of the company’s financial position. Loan capital may be obtained from a bank or finance company in the forms of long-term loans, or debt-equity investors in the form of debentures or preferred stock (preference shares). It is usually secured by a fixed and/or floating charge on the company’s assets. Unlike debt capital, it does not include short-term loans (such as overdraft).

Loan Capital can also be defined as a long-term capital that is employed from sources other than common stock or savings. That is, loan capital is what a company has borrowed or issued in preferred stock. Loan capital is distinguished by the fact that a company is required to pay coupons or dividends periodically. That is, unlike common stock, loan capital carries a fixed liability for a company. Likewise, it is usually collateralized by one or more of the company’s assets.

In the same vein, A debenture is a type of debt instrument that is not secured by physical assets or collateral. Debentures are backed only by the general creditworthiness and reputation of the issuer. Both corporations and governments frequently issue this type of bond to secure capital. Like other types of bonds, debentures are documented in an indenture.

Types of Debentures

1. Redeemable and Irredeemable (Perpetual) Debentures
2. Convertible and Non-Convertible Debentures
3. Fully and Partly Convertible Debentures
4. Secured (Mortgage) and Unsecured (Naked) Debentures
5. First Mortgaged and Second Mortgaged Debentures
6. Registered Unregistered Debentures (Bearer) Debenture
7. Fixed and Floating Rate Debentures
8. Zero-Coupon and Specific Rate Debentures
9. Callable and Puttable Debentures/Bond

The distinction between Shares and Debentures

Comparison Chart

BASIS FOR COMPARISON	SHARES	DEBENTURES
Meaning	The shares are the owned funds of the company.	The debentures are the borrowed funds of the company.
What is it?	Shares represent the capital of the company.	Debentures represent the debt of the company.
Holder	The holder of shares is known as a shareholder.	The holder of debentures is known as debenture holder.
Status of Holders	Owners	Creditors
Form of Return	Shareholders get the dividend.	Debenture holders get interested.
Payment of return	The dividend can be paid to shareholders only out of profits.	Interest can be paid to debenture holders even if there is no profit.
Allowable deduction	The dividend is an appropriation of profit and so it is not allowed as deduction.	Interest is a business expense and so it is allowed as a deduction from profit.
Security for payment	No	Yes
Voting Rights	The holders of shares have voting rights.	The holders of debentures do not have any voting rights.
Conversion	Shares can never be converted into debentures.	Debentures can be converted into shares.
Repayment in the event of winding up	Shares are repaid after the payment of all the liabilities.	Debentures get priority over shares, and so they are repaid before shares.
Quantum	Dividend on shares is an appropriation of profit.	Interest on debentures is a charge against profit.
Trust Deed	No trust deed is executed in case of shares.	When the debentures are issued to the public, the trust deed must be executed.

Key Differences Between Shares and Debentures

The following are the major differences between Shares and Debentures:

1. The holder of shares is known as a shareholder while the holder of debentures is known as debenture holder.
2. Share is the capital of the company, but Debenture is the debt of the company.
3. The shares represent ownership of the shareholders in the company. On the other hand, debentures represent the indebtedness of the company.
4. The income earned on shares is the dividend, but the income earned on debentures is interest.
5. The payment of dividend can be made only out of the current profits of the business and not otherwise. Unlike the interest on debentures which has to be paid by the company to debenture holders, no matter company has earned profit or not.
6. A dividend is not a business expense and so is not allowed as deduction. On the contrary, interest on debentures is an expense and so allowed as a deduction.
7. In the event of winding up, debentures get priority of repayment over shares.
8. Shares cannot be converted as opposed to debentures are convertible.
9. There is no security charge created for payment of shares. Conversely, security charge is created for the payment of debentures.
10. A trust deed is not executed in case of shares whereas trust deed is executed when the debentures are issued to the public.
11. Unlike debenture holders, shareholders have voting rights.
12. Shares are issued at a discount subject to some legal compliance. Debentures can be issued at a discount without any legal compliance.

Evaluation

1. Mention 6 Key Differences Between Shares and Debentures
2. Highlight types of 7 Debentures

 

In our next class, we will be talking more about the Preparation of Accounts for Issue of Shares.  We hope you enjoyed the class.

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