Issue of Debentures for Consideration Other Than Cash

The other day we looked at debentures and, in particular, working through an example and how it flowed through the trial balance and into the financial statements. In working on that article for our accounting tutorial series, I wanted to come back to write about the issue of debentures for consideration (i.e. payment) other than when we use cash. Although cash receipt is typical when businesses issue these debt instruments, it is not always the case. And that is the focus of today’s article.

What Are Debentures?

So a quick summary of what a debenture is and why we use them. A debenture is a debt instrument issued by a business to raise funds generally for capital expenditure (accountants love to call this CAPEX … makes them feel all sophisticated).

Debentures usually are unsecured instruments, meaning the issuer has not promised any of its assets to the buyers of the debentures in case of default. Other advantages of these instruments include they tend to be cheaper forms of borrowing compared to other debt (issuing and wind-up costs), and interest is often only required to be paid annually or even at the fixed redemption date.

Types of Non-cash Consideration

In addition to being issued for cash, the most common form of debentures issue, parties issue these instruments for non-cash consideration. The types of non-cash payments include:

• the receipt of other assets, for example non-current assets to be used in the business’ operations;
• the cancelling of other debt already held by the debenture holder; or
• the exchange of capital for debt.

Discounts and Premiums

As a quick recap, we have looked at what debentures are, some of their advantages over other forms of debt financing and the types of non-cash consideration that we can use in their issue.

Next, we move on to discounts and premiums. Like other forms of debt and capital, we can issue debentures at their par value, at a discount or a premium. These terms are from the buyers perspective, i.e. the discount or premium is to the buyer of the debentures, not the issuer. If there is a discount, the debenture buyer is paying less than the par value. While if a premium is in place, the buyer is paying above par value.

Debentures Issued at Par

The simplest of the issues for journal entries is for debentures selling at par. For example, the journal entry for a small warehouse being the consideration would be:

The debit reflects the increase in non-current assets the entity now has control over, this being the non-cash consideration they received. And the credit increases non-current liabilities, reflecting the issuing of the debentures. This type of non-cash consideration would often mean the debentures are issued to a single buyer, perhaps using owners financing.

Debentures Issued at a Discount

Now we get into slightly more challenging areas of discounts and premiums. We’ll work through a discount situation in the example section below, looking at the calculations involved. But for the journal entries, the primary three entries would be:

In the discount (also known as an original issue discount (OID)) example, the debit and credit of the original entry (issued at par) won’t be in balance because the non-cash consideration value is less than the debt taken on by the issuer. That difference is called a discount, which is a debit into an account named along the lines of “Discount on Debenture Issue”.

Debentures Issued at a Premium

A premium on the issue of debentures is the opposite of a discount, as we just covered. In the premium case, the additional credit required is to the “Premium on Debenture Issue” account. A sample of the journal entry is below.

Debentures Issue – Examples of Non-Cash Consideration With Journal Entries

The last section we need to cover is working through some examples with the calculations and debits, and credits. By working through the journal entries, we can better understand the theory we have already covered.

Let us turn to ABC Ltd, our trusty fictitious company, for an example of purchasing a building through the issue of debenture debt to the vendor. ABC has the opportunity to buy some warehouse space and has agreed that the seller will provide the finance for the purchase (also known as owner financing).

The facts of the transaction are:

• the sale will take place on June 15;
• the warehouse is being purchased for $350,000;
• the purchase is being financed by $1,000 (par value) debenture notes;
• the notes are for 10 years, paying 7% pa, compounding daily, paid annually; and
• the debentures are secured by the property and director guarantees.

With this information, ABC’s accounting team would prepare the following initial journal entries based on three scenarios we covered above, being; par, discount and premium.

Debentures at Par

In the first scenario, the debentures are issued at par, being $1,000. The total number of the debenture issue is:

non-cash consideration / price per debenture issued

$350,000 / $1,000 = 350 debentures to issue

And the formula for working out the debentures liability figure is (all rather straightforward when issued at par):

number of debentures issued x issue price

350 x $1,000 = $350,000

The debit to buildings increases the non-current asset balance for ABC, while the credit to debentures increases its non-current liabilities. So at the moment, there is no change in the net worth of the company.

Debentures at Discount

In our second scenario, to make the deal more attractive, ABC agreed to issue the debentures at a 10 per cent discount to par value. The total value of debentures liability to record is below.

The first thing is to work out what the issue price is per debenture:

$1,000 par value x (1 – 10 per cent discount) = $900

Now we have to work out how many debentures are to be issued:

$350,000 / $900 = 389 debentures to be issued

And the workings for the debentures liability and discount on issuance figures are:

389 x $1,000 = $389,000 debenture liability

$389,000 – $350,000 = $39,000 discount/(premium) on debenture issue

The debit to buildings stays the same, as the consideration has not changed at $350,000. However, we now have another debit of $39,000, this being the discount offered to the vendor in the financing agreement. And finally, the credit must be increased to reflect the discount offered. ABC now has a more significant sum of money to repay.

The discount on issue account is a contra account, and we pair it with an account of the opposite natural balance. The discount account carries a natural debit balance, while its friend, the debenture liability account, has a natural credit balance. We disclose these two accounts in the balance sheet (with additional disclosures in the notes to the accounts). With the discount balance being amortised over the life of the debenture, flowing through the profit and loss statement (statement of financial performance).

If you would like more information on the journal entries involved in the amortisation and the interest expense accounting each year, check out our article here.

Debentures at Premium

The third and final scenario is that involving ABC being able to obtain a premium from the vendor for the debentures. So let’s say, in this case, the vendor was willing to pay a premium of 10 per cent. Using the formulas we used above, the calculations would be:

$1,000 par value x (1 + 10 per cent premium) = $1,100 price per debenture

$350,000 / $1,100 = 318 debentures to be issued

318 x $1,000 = $318,000 debenture liability

$318,000 – $350,000 = $(32,000) discount/(premium) on debenture issue

Unsurprisingly we are now dealing with the opposite of what we saw with the discount. The buildings debit of $350,000 stays the same, but the credit to the debentures liability is now only $318,000 due to the premium ABC was able to command for its debt issue. The difference, of course, is now a credit of $32,000 to a premium on the debenture issue account.

Premium on debenture issue is classed as an adjunct account in that we add it to debentures as a natural credit balance in the balance sheet. From there, it is amortised over the life of the bond, flowing through the profit and loss statement (statement of financial performance). We have more on how this works in our article, covering how bond premiums are calculated and accounted for.

Conclusion

We hope this article has helped you understand how we account for the issue of debentures for consideration other than cash. We looked at the journal entries involved in issuing at par, discount and premium. And the calculations required to account for the discount or premium the debentures are being issued at. Remember, the discount or premium is from the customer’s point of view, i.e. is the customer receiving a discount or paying a premium for the debt issue?

We always welcome your feedback on our work here: comment below, ask a question or drop us a private message through the contact us page.