Shares vs debentures: owning a company vs lending to it

When a company needs money to grow, it can invite people to become part-owners, or it can borrow. Shares and debentures are the two instruments at either end of that choice.

On the surface they look alike. Both bring cash into the company and both reward the person who provides it. But they are opposites in almost every way that matters to accounting.

A share makes you an owner. A debenture makes you a lender.

A share buys a piece of the company

A share is a slice of ownership. A person who buys shares is not lending anything.

They put money in to become a part-owner, a shareholder. Their money becomes part of the company’s own resources, its equity, and it stays there.

The company does not have to hand it back on a set date. The shareholder shares in the company’s fortunes.

If the company prospers, their stake is worth more. If it struggles, they bear that too.

A debenture lends money to the company

A debenture is the opposite. A debenture holder owns no part of the company. They have lent it money, usually for a fixed term, for a promise of repayment and a fixed rate of interest. The relationship is creditor and business, not owner and business.

The money is borrowed and must be returned. If a company issues RM200,000 of debentures, it has RM200,000 more cash but owes exactly that amount to the lenders.

Ownership has not changed. The company has taken on debt, as a person does with a loan.

Dividends reward owners; interest rewards lenders

A shareholder receives a dividend, a share of the profit the directors decide to pay out. A dividend is paid only if there are profits and the directors choose to release some. In a poor year it may be cut or skipped.

A debenture holder receives interest. Interest is not optional. It is the agreed price of the loan and must be paid whether or not the company makes a profit, like rent or wages. So the owner’s reward moves with the company’s success, while the lender’s is fixed and comes first.

One is an expense; the other an appropriation of profit

This is the distinction students most often tangle. Debenture interest is an expense.

It is a real cost of using borrowed money. So it is charged in the income statement before the profit for the year is found, and it reduces that profit like any other expense.

A dividend is not an expense. It is an appropriation of profit, dealt with after the profit for the year is worked out, when the company decides what to do with its profit.

Interest helps produce the profit figure. A dividend is one of the things the profit is then used for.

Equity on one side, liability on the other

The two also land in different places on the statement of financial position. Share capital sits within equity.

Equity is the section that shows what the owners have put in and what the business has built up for them, such as reserves and retained earnings. Debentures sit among liabilities, usually as a non-current liability because they are repayable in more than a year.

So money coming into the company is recorded in opposite halves of the statement, depending on whether an owner or a lender provided it. Equity is the owners’ claim. Liabilities are outsiders’ claims.

Risk and reward point in opposite directions

A debenture holder has the safer position. Their interest is paid before any dividend.

If the company is wound up, lenders are repaid before owners receive anything. Their return is capped at the agreed interest but is fairly secure.

A shareholder takes more risk. They rank last, and their dividend depends on profits. In return they share in the growth of a successful company in a way a lender never does.

Why accounting keeps them apart

A reader of the accounts needs to know how much of the finance belongs to the owners and how much is borrowed and must be repaid. A company financed mostly by debentures has obligations that a company financed by shares does not, even if both hold identical assets.

Keeping shares in equity, debentures in liabilities, and dividends apart from interest shows who has a claim on the business and what kind of claim it is.

Two mirror images

• A share makes you an owner. A debenture makes you a lender.
• A share pays a dividend out of profit. A debenture pays interest as an expense.
• A share is part of equity and need never be repaid. A debenture is a liability that must be repaid.
• A share offers an uncertain reward and higher risk. A debenture offers a fixed reward and more safety.

If your child confuses shares and debentures or puts debenture interest in the appropriation account, one of our teachers can compare the two using company accounts questions. Book a trial class

Syllabus reference: Cambridge 0452 and 0985, syllabus for 2027 to 2029, sub-topic 5.3 Limited companies (page 16).