AHSEC - 12: Issue and Redemption of Debentures Important Notes for March 2025 Exam [AHSEC Class 12 Accountancy Notes]

Class 12 Accountancy Notes

Unit – 6: Issue and Redemption of Debentures 

Important Notes for March 2025 Exam [AHSEC Class 12 Accountancy Notes]

Q.1. What do you mean by “Debentures”? Mention its features. What are its advantages and disadvantages? 2007, 2013, 2015, 2017, 2018, 2022, 2024

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, 2022

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, 2023

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 2023

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.  2023

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, 22

ALSO READ (AHSEC ASSAM BOARD CLASS 12):

1. AHSEC CLASS 12 ACCOUNTANCY CHAPTERWISE NOTES

2. AHSEC CLASS 12 ACCOUNTANCY IMPORTANT QUESTION (THEORY)

3. AHSEC CLASS 12 ACCOUNTANCY IMPORTANT QUESTION BANK (PRACTICAL)

4. AHSEC CLASS 12 ACCOUNTANCY PAST EXAM PAPERS (FROM 2012 TILL DATE)

5. AHSEC CLASS 12 ACCOUNTANCY SOLVED QUESTION PAPERS (FROM 2012 TILL DATE)

6. AHSEC CLASS 12 ACCOUNTANCY CHAPTERWISE MCQS

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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 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.

ALSO READ: ACCOUNTANCY CHAPTERWISE COMPLETE NOTES

1. BASICS OF PARTNERSHIP (INCLUDING GOODWILL)
2. RECONSTITUTION OF PARTNERSHIP (ADMISSION, RETIREMENT AND DEATH)
3. DISSOLUTION OF PARTNERSHIP FIRM
4. ACCOUNTING FOR SHARE CAPITAL
5. ISSUE AND REDEMPTION OF DEBENTURES
6. FINANCIAL STATEMENTS OF A COMPANTY
7. FINANCIAL STATEMENTS ANALYSIS
8. RATIO ANALYSIS
9. CASH FLOW STATEMENTS

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 _______________