Company Accounts – Redemption of Debentures

Meaning: Redemption of debentures means repayment of the due amount of debentures holders. It’s may be at par or at premium.

Time of Redemption

a.    At Maturity: When repayment is made at the date of maturity of debentures which is determined at the time of issue of debentures.

b.    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.

2.    Redemption by draw of lots : In this method a certain proportion of debentures are redeem each, year, the debenture for which repayment is to be made is selected by draw of lots.

3.    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

Advantages of this Method

1.    When market price of own debentures is low than the redeemable value is less then the amount payable on maturity.

2.    Decrease the amount of interest payable to outsiders.

3.    If term of issue is provided that debentures are to be redeemed at premium then such premium can be reduced.

Sometimes company can purchases the debentures at more than the redeemable value due to the following reasons:

1.   To maintain the solvency ratio.

2.   To utilize the surplus money or funds which are lying idle with the company.

3.   When rate of interest on debentures is more than the current market rate of interest on debentures in the industry.

Sources of Redemption of Debentures

1.   Proceeds from fresh issue of Share Capital or Debenture holder.

2.   From accumulated profit.

3.   Proceeds from sale of fixed assets.

4.   A company may purchases its own debentures out of its surplus funds.

Two terms which are used in the redemption of debentures :

1.   Redemption out of capital : When a company has not used its reserve or accumulated profit for redemption of its debentures, it is called redemption out of capital, So company using this method have not transferred its profit to DRR A/c. But as per SEBI guidelines it is necessary for a company to transfer 50% amount of nominal value of debentures to be redeemed in DRR A/c before redemption of debentures commence.

2.   Redemption out of profit : Redemption out of profit means that adequate amount of profits are transferred to DRR A/c from Statement of Profit & Loss before the redemption of debenture commences. This reduces the amount available for dividends to shareholders.

3.   Debenture Redemption Reserve (DRR) : Section 71 (4) of the companies Act, 2013 requires the company to create DRR out of the profits available for dividend and the amount created in DRR shall not be utilized for any purpose except redemption. Rule 18(7) of Companies (share capital and Debentures) Rules, 2014 requires the following companies to create DRR of an amount equal to 25% of the value of Debentures:–

i.    NBFCs registered with RBI

ii.    Financial institutions other than all India Financial Institutions regulated by RBI.

iii.     Housing finance companies registered with National Housing Bank. DRR is required for publicly three classes of companies, not for privately placed.

iv.    Any other company (whether listed or unlisted), DRR to be created for both public and private placed debenture.

As per rule 18 (7) (c), every company required to create / Maintain DRR shall invest or deposit before 30th April specified. Securities a sum which shall not be less than 15% of the amount of debentures, maturing for payment during the year ending 31st March of the next year.

Exemption to create DRR:–

i.    All India Financial Institutions regulated by RBI.

ii.    Banking Companies.

Note:

1. It is assumed that company has invested 15% of redeemable amount an April 30 and incashed it as per Companies Act, 2013.

2.  It is assumed that company has created debenture Redemption Reserve @25% of the redeemable debenture and transferred it to General Reserve after redemption of all the debentures.

Redemption Method 3 : Redemption of debentures by the purchase of own debentures in the open market. According to the Companies Act, a company can redeem its debentures in full or in part by purchasing its own debentures in the open market (Stock exchange) provided the company is authorised to do so by its Articles of Association.

Suitability of this Method

1.    When interest rate on own debentures is higher than the market interest rate.

2.    When own debentures are quoted at a discount in the open market, a company can earn profit on redemption as debentures are available at below its nominal value in the market, otherwise normal redemption may be at par or at premium.

Debenture Redemption Reserve : Creation of Debenture Redemption Reserve (DRR) is necessary if debentures have been purchased for cancellation. Unless otherwise stated in question, it is assumed that the company has adequate balance in DRR before initiating the process of purchase of debentures for cancellation.

Accounting Treatment

  (A)   When Debentures are purchased from the open market for immediate 

        cancellation :

(i) When own debentures are purchased : e.g. if a company purchase 1,000 of its own debentures of 50 each at 49 (including all purchase exp.) in the open market for immediate cancellation.   

                                           Own Debentures A/c Dr.   49,000

                                     To Bank A/c Cr.                        49,000

(ii) For Cancellation of own Debentures:

There may be three case – (a) when own debentures are purchased at nominal price –          

The entry passed is for cancellation :   

           % Debentures A/c Dr. { Face Value/ Nominal Value }                                                      To Own Debentures A/c{ Purchase cost }

(B) When own debentures are purchased at price below Nominal value of Debentures : 

The entry pass is for cancellation:    

                                           % Debentures A/c Dr.

                                                                          To Own Debentures A/c

                                                                          To profit on Cancellation A/c

Hint: (Profit on Cancellation is the Excess of nominal value over purchase cost of own debentures cancelled)

[Profit on cancellation of own Debentures is a capital profit and therefore, is transferred to capital Reserve (or it may be used to write off discount / Loss on issue of debentures) the entry is:

To writing off Capital losses.]

(1) Profit on Cancellation of own Debentures A/c

       To Capital Reserve A/c    Or  Vice-versa in loss

In above example the entries for cancellation of debentures will be:

1.  % Debentures A/c Dr.  50,000

            To Own Debentures A/c       49,000

            To profit on Cancellation A/c  1000

2.Profit on cancelation A/c Dr.    1000

           To Capital reserve A/c                     1000

(C) When own debentures are purchased at a price above its face value. E.g. Debentures of the face value of Rs. 40,000 ate purchased in the open market at Rs. 42,000, the entry will be

1.    Own Debentures A/c Dr.    42,000

                     To Bank A/c                       42,000

2.    % Debentures A/c Dr.                 40,000

Loss on Issue of debentures A/c   2000

                                    To Own Debentures A/c      42,000

‘Loss on Redemption of Debentures’ is a capital loss and is therefore written off against capital profit or in the absence of capital profit is written off from statement of profit and loss.

(B) Purchase of own Debentures from open market for investment purpose : e.g. if

     a company purchase it 9% debentures of 50,000 at 49,000 as investment the entry will be:

Investment in Own Debentures A/c Dr.49,000

                      To Bank A/c                                       49,000

It should be noted that in the above entry an account named “Investment in own debentures A/c” is debited with purchase cost instead of “own debentures A/c” because own debentures have been purchased as an assets. “Investment in own debenture” will appear on the assets side under Non-Current Investment or current investment depending upon the time of Cancellation/Redemption or resell time.

Advantages : Reasons for Purchase of own Debentures as Investment :

i.    Debentures are available in open market at a price below its nominal value.

ii.    These debentures can be resold at profit in the market OR can be cancelled if the market price of such debentures further goes down.

iii.     Interest payment on such debentures is saved which would otherwise be paid to debenture holders.

Resell these debenture in the Market : the journal entries will be :

Bank A/c            Dr.(Net amount realised from own Deb.)

Loss on sale of own Debentures A/c*Dr. (Excess of cost over sale price)

                        To Investment in own Debentures A/c (cost of own debentures)

                      To Profit on sale of own Debentures A/c*(Excess of sale price over cost)

Note : *There will be one entries from two above Profit or Loss as the case. Loss or Profit on sale of own debentures will be transferred to Statement of profit and loss at the end of accounting year.

Profit on sale of own Debentures A/c           Dr.

                             To Statement of Profit and Loss A/c Cr.

B (II) On Cancellation of Debentures at a later date :

(a) X% Debentures A/c      Dr.

Loss on cancellation of own Debentures A/c         Dr..

                         To Investment in own Debentures A/c

                         To Profit on cancellation of own Debentures A/c

(b) Profit on cancellation of own Debentures A/c            Dr.

                                     To Capital Reserve A/c

Treatment of Interest on Own Debentures : when a Company purchase it own debentures for investment and has not cancelled them upto the interest payment due date. The company will pay interest only to outside debentures holders and interest on own debentures held by the company is retained by the company entries will be:

1.When Interest is Due :      Debenture Interest A/c Dr.( Total interest )

                                                            To Int. on Own Deb. A/c (Interest on Own Deb.)

                                                            To Deb. Holder A/c( Int. for outsiders )

2.On Payment of Interest to Outsiders debentures holders:    Deb. Holder A/c   Dr.

                                                                                         To Bank A/c

3.Transfer of Int. to Statement of P\L at the End of Accounting Year: 

                                                   Statement of P/L A/c Dr.

                                                                                                     To Deb.Int. A/c

4.Transfer of Interest on Own Debentures to statement of P/L A/c: 

                                            Interest on Own Deb. A/c Dr .

                                                                                          To Statement of P/L A/c