How to Calculate Debenture Interest

Debenture is a liability instrument with a fixed rate of interest, and the holders of debenture are considered as creditors of the limited company. Interest on debentures is calculated at a fixed rate of interest on the face value (not on the issue price), and is charged to Profit and Loss Account. Note that such interest must be paid to the debenture holders even if the company is not making a profit or incurring losses.

Nature of Debentures

Debentures are long-term debt instruments issued by companies, typically with a fixed interest rate and a set maturity date. They are a key tool for companies looking to secure funding without diluting ownership, as debentures do not confer any equity rights to the holders. Instead, debenture holders act as creditors, and their claims on the company are generally subordinate to other types of liabilities such as bank loans or trade payables.

Debentures are classified as unsecured or secured. Secured debentures are backed by a specific asset or set of assets that the company pledges as collateral, while unsecured debentures (also known as debenture stock) do not have such collateral backing. Despite this difference, both types of debentures share a common characteristic: they are issued with the promise of a fixed rate of interest, known as the coupon rate, which is paid to the debenture holders periodically.

The most critical aspect of debentures from the company’s perspective is that interest payments are obligatory. Regardless of the company’s financial position, debenture holders must receive their interest payments as stipulated. This contrasts with dividends on equity shares, which are paid only if the company generates sufficient profit. In other words, even if the company is facing losses, it is still required to make interest payments to debenture holders.

Interest on Debentures

The interest on debentures is calculated based on the face value of the debenture and is typically paid at regular intervals, such as annually, semi-annually, or quarterly. The interest rate, also known as the coupon rate, is fixed at the time of issue and does not change throughout the life of the debenture.

One of the key features of debenture interest is that it is calculated on the face value of the debenture, not the price at which it was issued. This means that even if the debentures are issued at a discount (i.e., below their face value), the company is still required to pay interest based on the full face value, rather than the discounted issue price. Additionally, this interest expense is recorded in the company’s Profit and Loss Account as a financial cost.

The payment of debenture interest is a legal obligation for the company, and failure to meet this obligation may lead to default. This characteristic makes debentures a relatively secure investment for bondholders, as they are assured of regular interest payments, provided the company does not default on its obligations.

Calculating Interest on Debentures

Learn how to calculate interest on debentures with the following examples:

(1) A company issued 8% Debentures of the face value of $100,000 in Year 2 (repayable in Year 12). Then, the debenture interest due for the year = 8% x $100,000 = $8,000.

(2) CK Company issued 10% Debentures of the face value of $200,000 at a discount of 6% on 1 January 2010. A half-year's debenture interest is unpaid during the year. Calculate the debenture interest that must be transfered to profit and loss account for the year ended 31 December 2010.

Solution:
Total interest on debentures = 10% x $200,000 = $20,000 (Note that this full amount must be charged to the profit and loss account, whether paid or not).