Issue and Redemption of Debentures Question Answers: NCERT Class 12 Accountancy - Company Accounts and Analysis of Financial Statements

A debenture is an instrument used by a lender, such as a bank, when providing capital to companies and individuals. It enables the lender to secure loan repayments against the borrower’s assets – even if they default on the payment. A debenture can grant a fixed charge or a floating charge. A fixed charge is normally taken out against a tangible asset such as property. It enables the lender to take ownership of the borrower’s assets and sell them off in the event of a payment default. With a fixed charge, the borrower would not be able to sell the asset without the lender’s consent.

Bearer debentures are unregistered debentures that can be transferred by mere delivery. No records are maintained in the company's debenture-holders' register for the ownership of these securities. Such debentures are issued physically, i.e., on paper.

When the security offered by company to take loan is not enough , company offers it's own debentures to the lender as collateral security. On repayment of such loan lender should surrender debentures as well.

Debentures can be issued for non-cash considerations. The company may have purchased assets from some vendors or acquired some other business. Then instead of paying cash, the company may issue debentures to such vendors. Such an issue for debentures can be at par, or for a discount or at a premium.

When debentures are issued below its par value (or the face value) but are redeemed at price higher than its par value, then it is termed as issue of debenture at discount and redeemable at premium. The difference between the issue price and the redemption price is treated as loss on issue of debenture.

A capital reserve is an account in the equity section of the balance sheet that can be used for contingencies or to offset capital losses. It is derived from the accumulated capital surplus of a company, created out of capital profit. The term capital reserve is sometimes used for the capital buffers that banks have to establish to meet regulatory requirements and can be confused with reserve requirements, which are the cash reserves the Government requires banks to maintain.

Irredeemable Debentures are those debentures that are not repayable or redeemable by a company during its life time. These are repayable only at the time of winding up of the company. These are .also known as Perpetual Debentures that means debentures having indefinite life. In India, now’ days, no company can issue irredeemable debentures.

Convertible debentures are the debentures that are capable of converting into shares at a future date. These are to be considered in calculating the diluted EPS and thereby increases the number of shares. hence the EPS reduces because of Convertible debentures.

Mortgaged Debentures are those debentures that are secured against assets of a company.These are also known as secured debentures. If the debentures are secured against a particular asset, then it is called fixed charge v here as, if the debentures are secured against all the assets of a company, then it is called floating charge. In case the company fails to pay back the principal amount of debenture or fails to meet its interest obligations on the due date, then the debenture holders have the right to sell the mortgage asset in order to realise their amount due to the company.

Discount on issue of debentures is a capital loss and over a period of 3 to 5 years or is charged to “Securities Premium Account” as per the guidelines issued by ICAI. The discount on issue of debentures can be written-off either by debiting it to profit and loss or to securities premium account.

Premium on redemption of debentures is a personal account and it is a liability of the company which is payable on redemption.

When the debentures are redeemed at a price more than its face value or the par value, then it is said that the debentures are redeemed at premium. The difference between the redeemed price and the par value is regarded as a capital loss and this loss is written off till the redemption of the debentures.  The Premium on Redemption of Debenture is shown on the Liabilities side of the Balance Sheet under the head of Current Liabilities and Provisions until debentures are redeemed.  

Share is the capital of the company, but Debenture is the debt of the company. The shares represent ownership of the shareholders in the company. On the other hand, debentures represent indebtedness of the company. The income earned on shares is the dividend, but the income earned on debentures is interest.

Discount on Issue of debentures is a capital loss and it will be written off out of the profit of coming years, Therefore, it is shown on the Assets side of the Balance Sheet under the heading of “Miscellaneous Expenditures” until it is written off.

Redemption of debentures is a process of repayment of loan taken by issue of debentures. Generally debentures are issued with the notice that they may be redeemed at the option of the company within a specified period and at a specified price.

Yes, a company, if authorised by its Articles of Association, can purchase its own debentures in the open market.  The main purposes of such purchase may be as follows  (i) A company may purchase its own debenture for immediate cancellation for reducing the debenture liability especially in case when the interest rate on its debenture is higher than the market rate of interest.  (ii) A company may also purchase its own debentures with the motive of investment and sell them at higher price in future and thereby earn profit. When a company purchase its own debenture,in the open market it can happen in either of the two ways first debentures may be purchased at premium for cancellation and debenture may be purchase at discount for cancellation.  The following will be the accounting treatment in both the situation: 

If Debentures are Purchased at Discount for Cancellation When the company purchase its own debentures at discount for cancellation, then the following Journal entries are recorded.

1)  Own Debentures A/c                                                  Dr

     To Bank A/c

(Being own Debentures purchased in the open market)

 2) Debenture A/c                                                              Dr

             To Own Debentures A/c

             To Profit on Redemption of debentures A/c

(Being own debentures cancelled)

3) Profit on Cancellation of Own Debentures A/c.       Dr

            To Capital Reserve A/c

(Being profit on cancellation of own debentures transferred to Capital reserve account)

When a debenture holder can convert his/her debentures into shares or new debentures after – the expiry of a specified period of time, then it is known as redemption of debentures by conversion. As the company do not need to pay any funds for the redemption, so there is no need to maintain the Debenture Redemption Reserve (DRR). The new shares or debentures may be issued at par, premium or at discount.

When the debentures are redeemed at a price more than its face value or the par value, then it is said that the debentures are redeemed at premium. The difference between the redeemed price and the par value is regarded as a capital loss and this loss is written off till the redemption of the debentures.  The Premium on Redemption of Debenture is shown on the Liabilities side of the Balance Sheet under the head of Current Liabilities and Provisions until debentures are redeemed.  Accounting Treatment for Premium on Redemption on Debentures.

1) At the time of the issue of Debentures

Bank/Debenture Allotment A/c                        Dr

Loss on issue of Debenture A/c                       Dr

        To Debenture A/c

        To Premium on Redemption of Debenture A/c

(Being debenture are issued with the term of

redemption at premium)

 

2) For Loss Written Off

Profit and Loss A/c.                                          Dr     

        To Loss on Issue of Debenture A/c

To Debenture A/c  

(Being loss on issue of Debenture written off )   

3) At the time of Redemption of Debentures

Debenture A/c.                                                   Dr

Premium on Redemption A/c.                         Dr

        To Debenture holders A/c

(Being amount of debentures due to Debenture holders)

When debentures are redeemed out of capital and no profits are utilised for redemption, then such redemption is termed as redemption out of capital. In such a situation, no profits are transferred to the Debenture Redemption Reserve (DRR)

According to companies Act, a company can redeem its debentures by purchasing them in the open market. If the company purchases the debentures at a premium, the amount paid in excess of the face value will be debited to 'loss on redemption of debentures' which will be transferred to profit and loss account and closed.

As per the Revised Schedule VI, Debenture Redemption Reserve (DRR) is shown in the Notes to Accounts of Reserve and Surplus. The final balance after adding DRR is shown as the subhead ‘Reserves and Surplus’ under the main head of Shareholders’ Funds on the Equity and Liabilities side of the Company’s Balance Sheet.

Types of Debenture

1. Secured and Unsecured: Secured debenture creates a charge on the assets of the company, thereby mortgaging the assets of the company. Unsecured debenture does not carry any charge or security on the assets of the company.

2. Registered and Bearer: A registered debenture is recorded in the register of debenture holders of the company. A regular instrument of transfer is required for their transfer. In contrast, the debenture which is transferable by mere delivery is called bearer debenture.

3. Convertible and Non-Convertible: Convertible debenture can be converted into equity shares after the expiry of a specified period. On the other hand, a non-convertible debenture is those which cannot be converted into equity shares.

4. First and Second: A debenture which is repaid before the other debenture is known as the first debenture. The second debenture is that which is paid after the first debenture has been paid back.

Debentures issued as collateral security is secondary or parallel security for the original loan taken by the company. The lender can realize the collateral security in case borrower fails to make the payment of the original loan. In this article, we will learn more about the debentures issued as collateral security and accounting treatment.

Debentures issued as Collateral Security

Collateral means secondary. Thus, collateral security refers to supporting or secondary security for a loan. In case the borrower fails to pay the original loan amount on the due date, the lender can sell the collateral security to realize the amount of loan.

Usually, the borrower places a particular asset or a group of assets as collateral security. When he fails to pay the loan, these assets are sold and the loan is paid from the sale proceeds.

The different terms for the issue of debentures with reference to their redemption can be the combinations of at par, at premium and at discount. Normally, the debentures are not redeemable at-discount. The permutation and the combination of the various terms of issue and redemption of debentures give rise to following six situations:

1. Issue at Par, Redeemable at Par. 

2. Issue at Premium, Redeemable at Par. 

3. Issue at Discount, Redeemable at Par. 

4. Issue at Par, Redeemable at Premium. 

5. Issue at Premium, Redeemable at Premium. 

6. Issue at Discount Redeemable at Premium.

Issue at Par and Redeemable at Par:  When the debentures are issued and are redeemed at their face value, then the following Journal entry is passed: 

Bank A/c Dr (with the amount receive

To Debenture Application A/c (with the face value)

 

(Debenture Application money received)

Debenture Application A/c Dr

To Debenture A/c

(Application money transferred to Debenture Account)

 

Issue at Premium and Redeemable at Par:  When the debentures are issued at premium and are redeemable at par, then the following Journal entry is passed. As premium is again for a company so it is credited in the Journal entry:

Bank A/c Dr

To Debenture Application A/c

(Debenture Application money received)

 

Debenture Application A/c Dr

To Debenture A/c

To Securities Premium A/c

(Debentures issued at premium and redeemable at par)

 

Issue at Discount and Redeemable at Par: When the debentures are issued at discount and are redeemable at par, then the following Journal entry is passed. As discount is a loss for a company so it is debited in the Journal entry.

Bank A/e Dr

To Debenture Application A/c

(Debenture Application money received)

 

Debenture Application A/c Dr

Discount on Issue of Debenture A/c Dr

To Debenture A/c

(Debentures issued at discount and redeemable at par)

 

Issue at Par and Redeemable at Premium: When debentures are issued at par and redeemable at premium, then the following Journal entry is passed. In such case, the company did not suffer any loss at the time of issue but there will be loss at the time of redemption.

Bank A/c Dr

To Debenture Application A/c 

(Debenture Application money received)

 

Debenture Application A/c Dr 

Loss on Issue of Debenture A/c Dr 

To Debenture A/c 

To Premium on Redemption of Debenture A/c 

(Debentures issued at par and redeemable at premium)

 

Issued at Premium and Redemption at Premium: When the debentures are issued and redeemable at premium, then the following Journal entry is passed. 

Bank A/c Dr 

To Debenture Application A/c 

(Debenture Application money received) 

 

Debenture Application A/c Dr 

Loss on Issue of Debenture A/c Dr 

To Debenture A/c 

To Securities Premium A/c 

To Premium on Redemption of Debenture A/c 

(Debentures issued at premium and redeemable at premium)

 

Issue of Discount and Redemption at Premium: When the debentures are issued at . discount and redeemable at premium, then the following Journal entry is passed:

Bank A/c Dr 

To Debenture Application A/c 

(Debenture Application money received) 

 

Debenture Application A/c Dr 

Loss on Issue of Debenture A/c Dr 

To Debenture A/c 

To Premium on Redemption of Debenture A/c 

(Debentures issued at discount and redeemable at premium)

Debentures can be redeemed out of capital and out of profits. The following are the difference between these two methods. Redemption of Debentures Out of Capital: This is the situation where debentures are redeemed out of capital and no profits are utilised for redemption of the debentures such redemption is termed as redemption out of capital. In this situation no profits are required to be transferred to the Debenture Redemption Reserve DRR. Here it is to be remembered that no company can redeem its debenture purely out of capital because as per the guideline laid down by Securities and Exchange Board of India SEBI and the Section 117C of Company Act of 1956 before starting any redemption process a company is required to create a DRR equal to 50% of the debentures issued.

Therefore it is not possible to redeem debentures purely out of capital as it reduces the value of assets. There are exceptions in the following case i Infrastructure companies i.e. those companies that are engaged in the business of developing maintaining and operating infrastructure facilities ii A Company that issues debentures with a maturity up to 18 months. iii In case of convertible debentures and convertible portion of partly convertible debentures. Redemption of Debenture Out of Profits:When debentures are redeemed out of profit then no capital is utilised for redemption. Before redeeming the debentures profits are transferred to DRR from Profit and Loss Appropriation Account.

The creation of DRR is mandatory as per the guidelines laid down by Securities and Exchange Board of India SEBI. SEBI mandates transferring amount equal to 50% of debentures issued to DRR before redeeming debentures. As transfer of amount profits to the DRR from Profit and Loss Appropriation Account reduces the amount of profit available for distribution of dividend so this redemption process is known as redemption out of profit. DRR is shown under the head of Reserves and Surpluses on the Liabilities side of the Balance Sheet. DRR account is closed by transferring it to General Reserve only when all the debentures are redeemed.

Securities and Exchange Board of India (SEBI) have provided some guidelines for redemption of debentures.  The focal points of these guidelines are: 

(i) Every company shall create Debenture Redemption Reserve in case of issue of debenture redeemable after a period of more than 18 months from the date of issue. 

(ii) The creation of Debenture Redemption Reserve is obligatory only for non-convertible debentures and non-convertible portion of partly convertible debentures. 

(iii) A company shall create Debenture Redemption Reserve equivalent to at least 50% of the amount of debenture issue before starting the redemption of debenture. 

(iv) Withdrawal from Debenture Redemption Reserve is permissible only after 10% of the debenture liability has already been reduced by the company. 

 

SEBI guidelines would not apply under the following situations: 

(i) Infrastructure company (a company wholly engaged in the business of developing, maintaining and operating infrastructure facilities), and 

(ii) A company issuing debentures with a maturity period of not more than 18 months.

The steps involved in creation of Sinking Fund on redemption of Debenture are: 

(i) Calculate the amount of profit to be set-aside annually with the help of sinking fund table. 

(ii) Set aside the amount of profit at the end of each year and credit to Debenture Redemption Fund (DRF) Account. 

(iii) Purchase the investments of the equivalent amount at the end of first year and debit Debenture Redemption Fund Investment (DRFI) Account. 

(iv) Receive interest on investment at the end of each subsequent year. 

(v) Purchase the investments equivalent to the fixed amount of profit set aside and the interest earned every year except last year (year of redemption). 

 

(vi) Receive interest on investment for the last year. 

 

(vii) Set aside the fixed amount of profit for the last year. 

(viii) Encash the investments at the end of the year of redemption. 

(ix) Transfer the profit/loss on sale of investments reflected in the balance of Debenture Redemption Fund Investment Account to Debenture Redemption Fund Account. 

(x) Make payment to debenture holders. 

(xi) Transfer Debenture Redemption Fund A/c balance to General Reserve.

Yes, a company, if authorised by its Articles of Association, can purchase its own debentures in the open market. 

The main purposes of such purchase may be as follows: 

(i) A company may purchase its own debenture for immediate cancellation for reducing the debenture liability especially in case when the interest rate on its debenture is higher than the market rate of interest. 

(ii) A company may also purchase its own debentures with the motive of investment and sell them at higher price in future and thereby earn profit. When a company purchase its own debenture,in the open market it can happen in either of the two ways first debentures may be purchased at premium for cancellation and debenture may be purchase at discount for cancellation.

The following will be the accounting treatment in both the situation: 

If Debentures are Purchased at Discount for Cancellation When the company purchase its own debentures at discount for cancellation, then the following Journal entries are recorded:

1) Own Debentures A/c                         Dr

To Bank A/c

(Being own debentures purchased in the open market)

 

2) Debenture A/c                                    Dr

          To Own Debentures A/c

          To Profit on Redemption of Debenture A/c

(Being own debentures cancelled)

 

3) Profit on Cancellation of Own Debentures A/c      Dr

           To Capital Reserve A/c

(Being profit on cancellation of Own Debentures transferred to capital reserve account)

 

(ii) If Debentures are Purchased at Premium for Cancellation

1) Own Debentures A/c                                Dr

          To Bank A/c

(Being own debentures purchased in the open market)

 

2) Debenture A/c                                            Dr

Loss on Redemption of Debenture A/c.     Dr

         To Own Debentures A/c

(Being own debentures cancelled)

When a debenture holder can conveit his/her debentures into shares or new debentures after the expiry of a specified period of time, then it is known as redemption of debentures by conversion. As the company does not need to pay any. funds for the redemption, so there is no need to maintain Debenture Redemption Reserve (DRR). The new shares or debentures may be issued at par, premium or at discount.

If a debenture holder exercises the conversion option, then the issue price of shares must be equal to or less than the amount actually received from debentures.

Accounting Treatment For amount due to debenture holders 

Debenture A/c.                       Dr 

To Debenture holders A/c 

(Debentures redeemed) 

 

For discharging liability to the debenture holders .

 Debenture holders A/c         Dr 

To Shares/Debentures (New) A/c 

(Debenture holder amount discharged)