Class 12 Accountancy Notes
Unit – 6: Issue and Redemption of Debentures
Q.1. What do you mean by “Debentures”
and “Bonds”? Mention its features. What are its advantages and disadvantages?
2007, 2013, 2015, 2017, 2018
Ans: Meaning of Debentures: According to Sec. 2 (30) of the companies Act, 2013,
debentures include “debenture stock, bonds and any other instruments of a
company evidencing a debt, whether constituting a charge on the assets of the
company or not.”
Debentures are
debt instruments issued by a joint stock company. Amounts collected by way of
debentures form part of the loan capital of a company. They are repayable after
a fixed period. Debenture holders get interest on their debentures. They are
creditors of the company. They do not get dividend. Only shareholders get
dividend.
The characteristics of debentures can be summarised as follows: 2017, 2019
a) Debentures are debt instruments.
b) They generally carry fixed rate of interest.
c) They may or may not be listed in the stock exchange.
d) Interest is payable on debentures at a fixed rate irrespective of the profit earned by the business.
e) Debentures may be issued with or without the security of assets of the company.
f) Debentures are issued against the floating charge on the assets of the company.
g) In the event of winding up of the company the debenture holders are treated as creditors and given priority in repayment of their money.
h) Debenture holders normally do not have voting rights in the company’s meeting.
i) If offered for public subscription, they should be rated by a credit rating agency approved by SEBI, prior to listing.
j) They are normally repayable at the end of a fixed period. Repayment of debenture or cancellation of debenture liability in the books of the company is known as redemption of debentures.
Advantages of debentures
a)
Less Costly: It involves less
cost to the firm than the equity financing.
b)
Long Term Source
of Fund: Debentures provide Funds to the company for a long period.
c)
Definite
period of Finance: Debentures provide funds to the company for a
specific period.
d)
Fixed
interest Rate: In a period of rising prices, debenture issue is advantageous.
e)
No dilution in control: Debentures
holders are the creditors of a company. They do not control over the company.
Disadvantages
of Debentures
a) Debenture
interest and capital repayment are obligatory payments. Failure to meet these
payments harms the solvency of the firm.
b) In the
case of debentures, interest has to be paid to the debenture holders irrespective
of profit.
c) Debenture
financing increases the financial risk associated with the firm.
d) Redemption
of debentures involves a large amount of cash outflow.
e) During
depression, the profit of the company goes on declining and it becomes
difficult for the company to pay interest.
Q.2. What are various Types of
Debentures? Explain them briefly. 2018
Ans: Types of Debentures: Debentures
are classified as follows:
1. On the
Basis of Repayment
a. Redeemable Debentures: These debentures are
paid off or redeemed after the prescribed period.
b. Irredeemable or Perpetual Debentures: These
debentures are permanent debentures of a company. They are paid back only in
the event of winding up of a company.
2. On the
Basis of Transferability
a. Registered Debentures: These are debentures
for which the company maintains record of debenture holders.
b. Bearer Debentures: These debentures are
transferable by mere delivery. There is no need or registration of transfer
with the company.
3. On the
Basis of Security
a. Simple Debentures: These are debentures not
secured by any asset of the company.
b. Mortgage Debentures: Mortgage debentures
are issued on the security of certain assets of the company.
4. On the
basis of Conversion
a. Convertible Debentures: These debentures
are issued with an option to debenture holders to convert them fully or partly
into shares after a fixed period. Where only a part of the debenture amount is
convertible into equity shares, such debentures are known as ‘partly
convertible debentures’. When full amount of convertible into equity shares,
such debentures are known as ‘fully convertible debentures.’
b. Non Convertible Debentures: These are
debentures issued without conversion option.
5. On the
Basis of Pre-Mature Redemption Rights:
a. Debenture with “Call” option: A callable
debenture is one in which the issuing company has the option of redeeming the
security before the specified redemption date at a pre-determined price.
b. Debenture with “Put” option: This is a
debenture in which the holder has the option of getting it redeemed before
maturity.
6. On the
Basis of Coupon Rate (interest rate)
a. Fixed Rate Debentures: Most of the time
debentures are issued with a prefixed rate interest. These debentures are
called fixed interest debentures
b. Floating rate Debentures: Floating rate as
the names suggests keeps changing.
c. Zero Coupon Bonds: These are debentures
issued with no interest specified. They are issued at a substantial discount to
compensate the investors. These bonds are known as deep discount bonds.
Q.3. What do you mean by Issue of
Debenture as Collateral Security? Explain its accounting treatment.
Ans: Issue of Debentures as Collateral
security and Its accounting Treatment
When debentures are issued as security in
addition to any other security against a loan or bank overdraft such an issue
of debentures is known as issue of debentures as collateral security. The use
of such an issue is that if the company does not repay the loan and the
interest and the main security is not sufficient, the bank will be entitled to
sell the debentures in the market or the bank may keep the debentures with it.
If the company repays the loan, the bank will return the debentures issued as
collateral security to the company.
Debenture issued as Collateral security can be
dealt in two ways:
First Method: No entry needs to be passed in
the books of the company because debentures are issued only as a collateral
security. Debentures become alive only when loan is not repaid. The fact of
such an issue of debentures must be clearly stated in the Balance Sheet by way
of a note under the loan and debentures.
Second Method: Under this method, a journal
entry is passed for the issue of debentures as collateral security:
When
debentures are issued
Debenture Suspense A/c Dr.
To Debenture A/c
(Being the issue of _____ debentures of Rs. _
each issued against ____ loan as collateral securities)
When the loan
is Repaid
Debentures A/c Dr.
To Debenture Suspense A/c
(Being the cancellation of ________ debentures
of Rs. _____ each issued as collateral security against ____ loan as the same
is repaid)
Q.4. What do you mean by Redemption of
Debentures? Explain its sources and Methods.
2012, 14, 15, 17, 19, 00
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Ans: Meaning of Redemption of Debentures: Redemption of debenture is the discharge of
debenture liability. It can be done either by repaying the money to debenture
holders or converting the debenture into shares. The conditions of redemption
are clearly stated at the time of issue of debenture in the prospectus.
Debentures can be redeemed at par, premium or discount as per the terms of
issue. The period of maturity, redemption amount, yield on redemption etc. will
be mentioned in the prospectus. In case the non convertible debentures proposed
to be rolled over (repayment extended for an additional period), a compulsory
option should be given to the debenture holders who wish to withdraw from the
debenture programme, as per the guidelines issued by SEBI.
Sources of Funds for Redemption of Debentures
For the purpose of redemption of debentures,
companies can choose the following sources:
a) Redemption of debentures out of capital:
Under this method, some of the fixed assets are disposed and sale proceeds are
utilised for the purpose of redemption of debentures. Sometimes companies also
use working capital to redeem the debentures.
b) Redemption of Debentures of profits: Under
this method an amount equal to the face value of the debentures redeemed is
transferred to debenture redemption reserve (DRR).
Journal
entries for redemption of debentures out of profit
a) When
debentures are due for redemption
Debentures a/c Dr
Premium on redemption of debentures a/c Dr (If debentures are redeemed
at a premium)
To Debenture holders a/c
b) When
payment is made to the debenture holders
Debenture holder a/c Dr
To Bank
c) When
amount equal to the face value of debenture to be redeemed is transferred to
DRR
Profit and loss appropriation a/c Dr
To Debenture redemption reserve a/c
Methods of Redemption of Debentures
i) Redemption of debentures in lump-sum at
maturity: Under this method the entire debentures are redeemed at the end of stipulated
date stated in the prospectus for the issue of debentures. The main drawback of
this method is that the company has to arrange a large amount at the time of
redemption.
Journal
entries for redemption of debentures under this method
a) When
debentures are due for redemption
Debentures a/c
Dr
Premium on redemption of debentures a/c Dr (If debentures are redeemed
at a premium)
To Debenture holders a/c
b) When
payment is made to the debenture holders
Debenture holder a/c
Dr
To Bank
ii) By Draw of Lots: Under this method the
company does not redeem all the debentures at the same time. Instead a part of
debentures redeemed at the end of each year. The company selects the debentures
for redemption by drawing lot and they are redeemed that year.
Journal
entries for redemption of debentures in installments (these entries are passed
every year)
a) When
debentures are due for redemption
Debentures a/c
Dr
Premium on redemption of debentures a/c Dr (If debentures are redeemed
at a premium)
To Debenture holders a/c
b) When
payment is made to the debenture holders
Debenture holder a/c
Dr
To Bank
c) When
amount equal to the face value of debenture to be redeemed is transferred to
DRR
Profit and loss appropriation a/c Dr
To Debenture redemption reserve a/c
iii) By Purchasing own debentures in the Open
Market: Debentures can be redeemed by purchasing them from the open market. If
a company finds its debentures are available in the open market at cheap rate
it will purchase those debentures and cancel them. The profit due to
cancellation of such debentures is transferred to capital reserve.
Journal
entries for cancellation of debentures under this method:
a) When
own debentures are purchased for cancellation:
Own debentures a/c Dr
To Bank a/c
b) When debentures are cancelled
Debentures a/c Dr
To own debentures a/c
To Profit on cancellation of own debentures a/c
c)
Transfer of profit to capital reserve
Profit on cancellation of own debentures
a/c Dr.
To Capital reserve a/c
iv) By Conversion into New Debentures or
Shares: Conversion of debentures into shares or new debentures is another
method of redemption. When debentures are converted to shares, the company does
not pay money to debenture holders. Instead the company issues share or
debenture certificates in place of debentures.
Journal
entries for conversion of debentures
a) When
debentures are due for redemption
Debentures a/c
Dr
Premium on redemption of debentures a/c Dr (If debentures are redeemed
at a premium)
To Debenture holders a/c
b) When
new share or debentures are issued to the debenture holders
Debenture holder a/c
Dr.
Discount on issue of debentures a/c Dr.
To Share Capital a/c
To Debentures a/c
To Securities premium reserve a/c (If shares
or debentures are issued at a premium)
Q.5. What do you mean by “Discount on
Issue of Debenture” and “Loss on Issue of Debenture”? Explain its treatment. 2012, 2013, 2014, 2019
Ans: When debentures are issued at a price lower than its face
value, then such debentures are said to be issued as “Debentures issued at a
Discount”. Discount on issue of debentures is a Capital loss and is show in the
Balance sheet on the Assets side under the head “Other not-current asset” till
it is written off.
When debentures are redeemable at a premium,
the extra amount payable over and above the nominal value on redemption is
called “Loss on Issue of Debenture”.
Again when debentures are issued at a discount, the discount on issue of
debenture is also a loss on issue of debentures. Thus when debentures are
issued at a discount and redeemable at a premium both the losses are
amalgamated under the head “Loss on Issue of Debenture Account”. It is a
Capital loss and is show in the Balance sheet on the Assets side under the head
“Other not-current asset” till it is written off.
The amount of debenture discount/Loss on issue
of debenture can be written off in two ways:
1. All debentures are to be redeemed after a
fixed period: When the debentures are to be redeemed after a fixed period, the
amount of discount/Loss will be distributed equally over the life of the
debentures. The amount of discount on issue of debentures to be written off
each year is calculated as: Amount of discount to be written off annually =
Amount of Discount / No of Years for which debentures are issued
2. Debentures are redeemed in installments:
Debentures may also be redeemed in installments but over a fixed period. In
that case the amount of debenture discount will be written off each year in
proportion to the amount of debentures outstanding at the end of each year.
Journal Entry for Writing of Discount on issue
of Debentures/Loss on issue of Debentures is:
Profit and Loss Account Dr.
To Discount on issue of Debentures Account or
To Loss on Issue of Debentures Account
Q.6. What is Sinking Fund? Why and How
it is created? 2013
Ans: Sinking fund is a fund into
which a company sets
aside money over
time, in order to retire its preferred stock, bonds or debentures. Such fund is created mainly for some specific
purposes which are:
1. To redeem or repay long term
liabilities. For example: debentures, long term loans etc.
2. To replace wasting assets. For example: mines
etc.
3. To replace an asset of depreciable nature. For
example fixed assets.
Creation
of Sinking fund for redemption of debentures:
For redemption of debentures
or other long term liabilities, a fixed amount is kept aside yearly as sinking
fund for the specific purpose and the same amount is invested in securities
etc. for a specific period so that the sufficient amount is available at
the time of redemption of long term liabilities. The amount to be set aside can
be determined with the help of Sinking fund table. The amount kept aside should
not be debited to Profit and loss account but
to Profit and loss appropriation account because the same is an allocation of
profit not expenditure.
Q.7.
What is Debenture Trust Deed and Zero coupon bonds/Debentures?
Ans: Debentures Trust Deed: It is a document created by the
company whereby trustees are appointed to protect the interest of debenture
holders before they are offered for public subscription. A company
issuing debentures by way of public issue is required to appoint trustees and
execute a trust deed. The trustees are expected to protect the interest of the
debenture holders through the powers granted by the trust deed. Debenture trust
deed is a document created by the company issuing debentures. Trust deed is
prepared before the issue of prospectus or letter of offer to the public for
subscription of debentures.
Zero Coupon Bonds: It is a type of
debentures which do not carry any rate of interest.
Q.8.
Explain the provisions of Debenture Redemption Reserve (DRR) according to the
Indian Companies Act, 2013.
Ans: Creation of Debenture Redemption
Reserve: The company shall create a Debenture Redemption Reserve for the
purpose of redemption of debentures, in accordance with the conditions given
below;
(a) the Debenture Redemption Reserve shall be
created out of the profits of the company available for payment of dividend;
(b) the company shall create Debenture
Redemption Reserve equivalent to at least 50% of the amount raised through the
debenture issue before debenture redemption commences
(c) in case of partly convertible debentures,
Debenture Redemption Reserve shall be created in respect of non-convertible
portion of debenture.
Creation of DRR is not necessary in the
following cases:
a.
Infrastructure companies
b. A
company issuing debentures with maturity period of less than 18 months.
Q.9. What are various
terms for issue and redemption of debentures?
Ans: Terms of issue and redemption of debentures:
a) Issue of debentures at par, and redeemed at par
b) Issue of debentures at a premium but redeemed at par
c) Issue of debentures at a discount but redeemed at par
d) Issue of debentures at par but redeemed at a premium
e) Issue of debentures at a premium and also redeemed at a premium
f) Issue of debentures at a discount but redeemed at a premium
Journal Entries
In the books of _______________
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Particulars |
L/f |
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(a) |
At the time of
Issue Bank A/c Dr. To Debenture A/c (Being the ___________ Debentures issued at par) |
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At the time of
redemption Debentures A/c Dr. To Bank A/c (Being the ___________ Debentures redeemed at par) |
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(b) |
At the time of
Issue Bank A/c Dr. To Debenture A/c To Securities
Premium Reserve A/c (Being the ___________ Debentures issued at a premium of _______) |
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At the time of
redemption Debentures A/c
Dr. To Bank A/c (Being the ___________ Debentures redeemed at par) |
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(c) |
At the time of
Issue Bank A/c Dr. Discount on issue of Debentures A/c Dr. To Debenture A/c (Being the ___________ Debentures issued at par, but redeemable at
a premium of ______________) |
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At the time of
redemption Debentures A/c
Dr. To Bank A/c (Being the ___________ Debentures redeemed at par) |
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(d) |
At the time of
Issue Bank A/c
Dr. Loss on Issue of Debentures A/c Dr. To Debenture A/c To Premium on
Redemption of Debentures A/c (Being the ___________ Debentures issued at par, but redeemable at
a premium of ____) |
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At the time of
redemption Debentures A/c
Dr. Premium on redemption of Debentures A/c Dr. To Bank A/c (Being the ____________ Debentures redeemed at a premium of ____) |
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(e) |
At the time of
Issue Bank A/c
Dr. Loss on Issue of Debentures A/c Dr. To Debenture A/c To Premium on
Redemption of Debentures A/c To Securities
Premium reserve A/c (Being the ___________ Debentures issued at a premium of ____, but
redeemable at a premium of ____) |
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At the time of
redemption Debentures A/c
Dr. Premium on redemption of Debentures A/c Dr. To Bank A/c (Being the ____________ Debentures redeemed at a premium of ____) |
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(f) |
At the time of
Issue Bank A/c
Dr. Loss on Issue of Debentures A/c Dr. (discount + premium on red.) To Debenture A/c To Premium on
Redemption of Debentures A/c (Being the ___________ Debentures issued at a discount of ____,
but redeemable at a premium of ____) |
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At the time of
redemption Debentures A/c
Dr. Premium on redemption of Debentures A/c Dr. To Bank A/c (Being the ____________ Debentures redeemed at a premium of ____) |
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