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Issue and Redemption of Debenture:

When a company desires to borrow a considerable sum of money for its expansion, it invites the general public to subscribe to its debentures. Debenture is a certificate issued by the company acknowledging the debt due by it to its holders and is issued by means of a prospectus in the same manner as shares.

Section 2 (12) of the Companies Act states that “a debenture includes debenture stock, bonds and any other securities of a company, whether constituting a charge on the assets of the company or not”.

Difference between shares and debentures:

  • Ownership: A shareholder is considered to be the owner of a company whereas a debenture holder is known to be a creditor. A share is a part of equity capital whereas a debenture is a part of a loan capital (borrowed capital).
  • Return: Returns on shares are known as dividends whereas that on debenture is called interest.
  • Appropriation: Dividend is an appropriation of profits whereas interest is a charge against profits.
  • Voting rights: Shareholders hold voting rights whereas debenture holders enjoy no such right.
  • Charge: Shares do not create any charge on the assets of the company, whereas debentures do.
  • Redemption: The share capital is not to be returned during the lifetime of the company, whereas amount of debentures has to be returned after a given period of time.
  • Purchase: A company cannot purchase its own shares, but can purchase its own debentures from the open market.
  • Convertibility: Shares cannot be converted into debentures. Debentures, on the contrary, can be converted into shares according to the conditions of issue of debentures.

Types of Debentures:

Convertibility point of view

  1. Convertible debentures: These can be converted into equity shares of the issuing company after a predetermined period of time. These may be Partly Convertible (part of these instruments are converted into Equity shares in the future at notice of the issuer) or Fully convertible Debentures (fully convertible into Equity shares at the issuer’s notice).
  2. Non-convertible Debentures: These are regular debentures which cannot be converted into equity shares. These are debentures without the convertibility feature; these usually carry higher interest rates than their convertible counterparts.

Security point of view

  1. Secured Debentures: These instruments are secured by a charge on the fixed assets of the issuer company. So if issuer fails to pay the principal or interest amount, assets can be sold to repay the liability towards debenture holders.
  2. Unsecured Debentures: These instruments are unsecured, meaning, that if the issuer defaults on payment of the interest or principal amount, the investor is treated like other unsecured creditors of the company.

Redemption point of view

  1. Redeemable Debentures: Redeemable debentures are those which are redeemed or paid off after the termination of fixed term. The amount paid off includes the principal amount and the current year’s interest. The company can choose between the options of redeeming a specific number of debentures each year or redeeming all the debentures at a specified date.
  2. Irredeemable or Perpetual Debentures: Irredeemable debentures are those debentures which do not have any particular date of redemption. They are redeemed either in the event of winding up or at a very remote period of time.

Issue of Debentures:

The process followed for issue of debentures involves the investors applying for debentures basis the prospectus issued by thr company. Either the entire amount is paid on application or it is paid in instalments. Debentures can be issued at par, discount or premium. They can also be issued for a consideration other than cash.

  1. Issue of Debentures at Par

Debentures are known to be issued at par when the issue price is equivalent to the face value.

On receipt of application money Bank A/c     Dr.
To Debenture Application
and Allotment A/c
On acceptance of  application money Debenture Application and Allotment A/c    Dr.
To Y% Debentures A/c
To Bank A/c

 

  1. Issue of Debentures at Discount

Debentures, when issued at a price below their nominal value, are said to be issued at a discount. Discount on issue of these debentures is a capital loss and is accounted for on the asset side of the balance sheet, under the head of Miscellaneous Expenditure, till it is written off (Either by debiting it to profit and loss account or out of the capital profits, during the debentures’ life time).

On receipt of application money Bank A/c                                           Dr.
To Debenture Application
A/c
On transfer of  application money Debenture Application A/c               Dr.
To Y% Debentures A/c
On Allotment money being due

 

Y% Debenture Allotment A/c          Dr.

Discount on Issue of Debetures A/c Dr.

To Y% Debentures A/c

On receipt of allotment money Bank A/c                                           Dr.

TO Y% Debenture Allotment A/c

 

  1. Issue of Debentures at a Premium

When debentures are priced at a value higher than the nominal value, they are issued at a premium. The amount of premium is credited to the Securities Premium Account and is shown on the liabilities side of the balance sheet, under the head of Reserves and Surplus.

On receipt of application money Bank A/c                                Dr.
To Debenture Application
A/c
On transfer of  application money Debenture Application A/c    Dr.
To Y% Debentures A/c
On Allotment money being due, including premium Y% Debenture Allotment A/c Dr.

To Y% Debentures A/c

To Securities Premium A/c

On receipt of allotment money Bank A/c                                 Dr.

TO Y% Debenture Allotment A/c

Issue of Debentures for Consideration Other Than Cash:

In some cases, when companies purchase assets from vendors, instead of making the payment in cash, chooses to issue debentures for a consideration thereof. In this case too, they can be issued at par, discount or for a premium.

On purchase of assets Sundry Assets A/c                   Dr.
To Vendor A/c
On issue of debentures at par Vendor A/c                              Dr.

To Debentures A/c

On issue of debentures at premium Vendor A/c                              Dr.

To Debentures A/c

To Securities premium A/c

On issue of debentures at discount Vendor A/c                                        Dr.

Discount on issue of debentures A/c Dr.

To Debentures A/c

Issue of Debentures as Collateral Security:

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 underlying idea of such an issue is that if the company does not repay the loan and the interest and the principal security is not sufficient, the bank becomes entitled to sell the debentures in the market or choose to keep the debentures with it. If the company repays the loan, the bank shall return the debentures issued as collateral security to the company.

In the accounting books of the company issue of debentures as collateral security can be credited in two way :

  1. First method : No Journal entry to be made in the books of accounts of the company for debentures issued as collateral security. A note of this fact is given in this case.
  2. Second method : Entry to be made in the books of accounts of the company.

Journal Entry:

Debenture Suspense A/c    Dr.

To Y % Debentures A/c

(Being the issue of Debentures of Rs…. each issued as collateral security)

Interest on Debentures:

Interest on Debentures is calculated at a fixed rate on its face value and is usually payable half yearly & is paid even company is suffering from loss because it is charge on profit.

1. When Interest is due
Debentures Interest A/c   Dr.
To Debentures holder A/c
To Income Tax Payable A/c
2. When Interest is paid
Debentures Holder A/c      Dr.
To Bank A/c
3. On payment of Income Tax to Government
Income Tax Payable A/c    Dr.
To Bank A/c
4. On Transfer of Interest on Debenture to statement of profit and Loss A/c
Statement of Profit and Loss    Dr.
To Debenture Interest A/c

Redemption of Debentures:

Redemption of debentures means repayment of the due amount of debentures holders for the purpose of discharging the company’s liabilities. It may be at par or at premium.

Time of Redemption

  1. At maturity : When repayment is made at the date of maturity of debentures which is determined at the time of issue of debentures.
  2. Before maturity : If articles of association and terms of issue mentioned in prospectus allows, then a company can redeem its debentures before maturity date.

Redemption  Methods

  1. Redemption in Lump-sum : When redemption is made at the expiry of a specific period, as per the terms of issue. The time of repayment is known in advance.
  • (If redeemed at par)

Y% Debentures A/c      Dr.

To Debenture holders A/c

Debenture holders A/c Dr.

To Bank A/c

  • (If redeemed at premium)

Y% Debentures A/c                                              Dr.

Premium of Redemption of Debentures A/c  Dr.

To Debenture holders A/c

Debenture holders A/c                                        Dr.

To Bank A/c

  1. Redemption by payment in installments : In this method a certain proportion of debentures are redeemed each, year, the debenture for which repayment is to be made is selected by draw of lots.
  • (If redeemed out of profits)

Profit and Loss Appropriation A/c  Dr.

To DRR A/c

Y% Debentures A/c                             Dr.

To Debenture holders A/c

Debenture holders A/c                       Dr.

To Bank A/c

  • (If redeemed out of capital)

Y% Debentures A/c                            Dr.

To Debenture holders A/c

Debenture holders A/c                       Dr.

To Bank A/c

  1. Redemption by purchases in open market : If articles of association of a company authorize, it may purchases its own debentures from open market i.e. stock exchange; for the purpose of cancellation.
  • (Purchase for immediate cancellation)

Debentures A/c                                                             Dr.

To Bank A/c

To Profit on Redemption of Debentures A/c

  • (On transfer of profit)

Profit on Redemption of Debentures A/c                Dr.

To Capital Reserve A/c

  1. Redemption by conversion into Shares: A company may choose to redeem its debentures by converting them into shares; which may be issued at par, discount or a premium. No DRR A/c  is required in case of convertible debentures as no funds are required for redemption.

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