What is a Debenture Bond?
A debenture bond is a type of loan that a big company or a government takes from the public. For example, if a company wants to build a new factory, it might borrow money from people like you and me by issuing debenture bonds. A debenture bond is a document that promises to pay back the money with interest after a certain period of time.
A debenture bond is different from a bank loan, because it does not need any collateral or security. Collateral is something valuable that you give to the lender as a guarantee that you will pay back the loan. For example, if you take a car loan, you might have to give the car as collateral. If you don’t pay back the loan, the bank can take the car away from you.
A debenture bond does not need any collateral, because the people who lend money trust the company or the government that borrows money. They trust that the company or the government will make enough profit or revenue to pay back the loan. They also trust that the company or the government has a good reputation and credit rating. Credit rating is a score that shows how likely someone is to pay back their debts.
Why Do Companies or Governments Issue Debenture Bonds?
Companies or governments issue debenture bonds for various reasons, such as:
- To raise money for long-term projects or investments. For example, a company might issue debenture bonds to build a new factory, buy new equipment, or expand its business. A government might issue debenture bonds to build roads, bridges, schools, or hospitals.
- To take advantage of low interest rates. Interest rates are the extra money that you pay or receive when you borrow or lend money. When interest rates are low, it is cheaper to borrow money than to use your own money. For example, if a company can borrow money at 5% interest, but it can earn 10% profit by using the money, it makes sense to issue debenture bonds and borrow money.
- To diversify their sources of funds. Diversify means to have different options or choices. Companies or governments might not want to depend on only one source of funds, such as banks, shareholders, or taxes. They might want to have more options or choices, such as debenture bonds, bonds, or grants. This way, they can reduce their risk and increase their flexibility.
How Do Debenture Bonds Work?
Debenture bonds work as follows:
- The company or the government that wants to borrow money decides how much money it needs, how long it wants to borrow, and how much interest it wants to pay. It also decides who can buy the debenture bonds, such as the public, institutions, or foreign investors. It then prepares a contract that specifies all these details, such as the maturity date, the coupon rate, and the terms and conditions. This contract is called an indenture.
- The company or the government then sells the debenture bonds to the people who want to lend money. The people who buy the debenture bonds are called debenture bond holders or creditors. They pay the face value or the principal amount of the debenture bonds to the company or the government. The face value is the amount of money that the company or the government promises to pay back at the end of the loan period.
- The company or the government then pays interest or coupon payments to the debenture bond holders at regular intervals, such as every six months or every year. The interest or coupon rate is the percentage of the face value that the company or the government pays as interest. For example, if the face value of a debenture bond is $1,000 and the coupon rate is 6%, the company or the government pays $60 as interest every year.
- The company or the government then pays back the face value or the principal amount of the debenture bonds to the debenture bond holders at the end of the loan period or the maturity date. The maturity date is the date when the loan ends and the company or the government has to pay back the money. For example, if the maturity date of a debenture bond is 10 years, the company or the government pays back $1,000 to the debenture bond holder after 10 years.
Examples of Debenture Bonds
Some examples of debenture bonds are:
- Corporate debenture bonds: These are debenture bonds issued by companies to raise money for their business activities. For example, Apple Inc. issued $14 billion worth of debenture bonds in February 2021 to fund its share buyback and dividend programs.
- Government debenture bonds: These are debenture bonds issued by governments to raise money for their public spending or debt repayment. For example, the U.S. Treasury issued $58 billion worth of debenture bonds in May 2021 to finance the federal budget deficit.
- Convertible debenture bonds: These are debenture bonds that can be converted into shares or stocks of the issuing company at a certain price or ratio. For example, Tesla Inc. issued $1.8 billion worth of convertible debenture bonds in August 2017, which could be converted into Tesla shares at a price of $359.87 per share.
Debenture Bonds in Accounting
Debenture bonds in accounting are recorded as liabilities or debts of the issuing company or government. They are classified as long-term liabilities, because they have a maturity date of more than one year. They are also classified as non-current liabilities, because they are not expected to be paid within one year.
The accounting treatment of debenture bonds depends on the type and the features of the debenture bonds. Generally, the following rules apply:
- For non-convertible debenture bonds, the issuing company or government records the face value of the debenture bonds as a liability in the balance sheet, and records the interest or coupon payments as an expense in the income statement. The debenture bond holders record the face value of the debenture bonds as an asset in the balance sheet, and record the interest or coupon payments as an income in the income statement.
- For convertible debenture bonds, the issuing company or government records the face value of the debenture bonds as a liability in the balance sheet, and records the interest or coupon payments as an expense in the income statement. However, if the debenture bonds are converted into shares or stocks, the issuing company or government reduces the liability by the face value of the debenture bonds, and increases the equity by the same amount. The debenture bond holders record the face value of the debenture bonds as an asset in the balance sheet, and record the interest or coupon payments as an income in the income statement. However, if the debenture bonds are converted into shares or stocks, the debenture bond holders reduce the asset by the face value of the debenture bonds, and increase the investment by the same amount.
Summary of Debenture Bond
Here is a list of bullet points that summarize the main points of the term debenture bond:
- A debenture bond is a type of loan that a big company or a government takes from the public without any collateral or security
- A debenture bond pays interest or coupon payments to the people who lend money, and pays back the face value or the principal amount at the end of the loan period or the maturity date
- A debenture bond can be issued by companies or governments, and can be convertible or non-convertible
- A debenture bond is recorded as a liability or a debt in the accounting books of the issuing company or government, and as an asset or an investment in the accounting books of the debenture bond holders
