Which of the following is not correct about collateral security? OR 'A company is formed according to the provisions of Company Law' indicates which of the following characteristics of a company?
Which of the following is not correct about collateral security? OR 'A company is formed according to the provisions of Company Law' indicates which of the following characteristics of a company?
Options
Correct option: (A) It is a primary security.
This statement is NOT correct about collateral security — collateral security is always an ADDITIONAL/subsidiary/secondary security offered besides the primary security, never the primary security itself.
Marking Scheme
- 11 mark: for correctly identifying option (A) as the statement that is NOT correct about collateral security.
Hint
Collateral security is always additional/secondary to the primary charge — never the primary security itself.
Quick Oral Answer
Collateral security is only an additional/backup security beside the primary security — so calling it a 'primary security' is the incorrect statement, making option (A) the answer.
Analysis & Explanation
Concept: When a company borrows a loan and, in addition to a primary asset already charged, issues debentures as further/backup security, such debentures are called 'Debentures issued as Collateral Security.' The lender can invoke this security only if the primary security falls short in realising the loan amount.
Why (A) is the correct answer (i.e., the incorrect statement about collateral security): Collateral security, by definition, is an ADDITIONAL or SECONDARY charge, not the main/primary charge on the loan. Calling it a 'primary security' contradicts its very meaning.
Why the other options are actually TRUE (hence not the answer):
- (B) 'It is an additional security' — true; it is offered in addition to the primary security.
- (C) 'It is a subsidiary security' — true; it plays a secondary/backup role.
- (D) 'It is a secondary security' — true; it can only be enforced if the primary security proves insufficient.
OR Part (b) — for reference: 'A company is formed according to the provisions of Company Law' describes the characteristic of a company being a Body Corporate (option C) — i.e., it is created only through registration/incorporation under the Companies Act, unlike a partnership which arises from a simple agreement.
Common Mistakes
- 1Confusing collateral security with primary security — students often think collateral means the 'main' security rather than a backup.
- 2Missing that the question asks for the INCORRECT statement, not a correct one, and picking a true statement by mistake.
Interesting Facts
When debentures are issued as collateral security and NOT recorded through a journal entry (i.e., no entry made), the fact is still disclosed as a foot-note under the loan liability in the Balance Sheet.
Alternatively, if a formal entry IS passed, 'Debentures Suspense Account' is debited and 'Debentures A/c' is credited with the nominal value of debentures issued as collateral, shown on both sides of the Balance Sheet.
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Frequently Asked Questions
What is meant by 'debentures issued as collateral security'?
It means a company, while taking a loan, issues debentures as an ADDITIONAL security besides the primary asset already charged. The lender can enforce the collateral debentures only if the primary security is insufficient to recover the loan amount.
How are debentures issued as collateral security shown in the Balance Sheet?
If no journal entry is passed, it is disclosed only as a foot-note to the loan item. If an entry is passed, 'Debentures Suspense A/c' is shown as a deduction from 'Debentures' on the liabilities side, so the net effect on the Balance Sheet total is nil.