Question

Long Answer Question

Distinguish between a debenture and a share. Why is debenture known as loan capital? Explain.

Answer 1

 

Basis of Difference	Shares	Debenture
1. Owner or Creditor	Share holders are the owners since shares forms a are part of owned capital	Debenture holder are Creditors since debentures are a part of loan
2. Voting Rights	Share holders have the voting rights	Debenture holders do not have any voting rights.
3. Returns	Share holders are entitled for returns in  the form of dividend.	Debenture holders are entitled for returns in the form of interest.
4. Rate of Return	The rate of dividend is not fixed and varies from year to year.	The rate of interest is fixed and do not vary from year to year.
5. Obligations of Return	Dividend is appropriation of profit. Dividend will not be paid if losses are incurred by the company	Interest is charged against profit, interest is payable even if there is no profit.
6. Repayment of Amount	The amount of share is not returned during the life time of the company	The amount of debenture is returned according to the term of issue.
7. Issue	The issue of shares at discount need adherence to the restrictions imposed by the Section 79 of the Company Act.	There are no such restrictions for issuing debentures on discount.
8. Conversion	Shares cannot be converted into debentures.	Debentures can be converted into shares.
9. Risk	Shares are more risky than debenture as these are unsecured.	If debentures are secured against asset, the risk involved is the minimal.
10. Repayment Priority	Payment to the share holders is made after settlement of all external liabilities, i.e. after debenture holders.	Payment to the debenture holders is made before the share holders.

Issue of debentures implies incurring long-term indebtedness. Generally, a company issues debentures for acquiring long-term borrowings to achieve its long-run targets and growth. Like the owner’s capital, interest is also payable on the principal amount of the debenture. The interest paid is regarded as an expense for the company and is deductible under Income Tax Act. Therefore, debentures are also known as loan capital because they are redeemable after a long period of time.