Chapter 2: Issue & Redemption of Debentures

Issue and Redemption of Debentures
Short Answer Questions

1. What is meant by a Debenture?
A Debenture is a written instrument acknowledging a debt under the common seal of the company. It contains a contract for the repayment of the principal sum at a specified date and for the payment of interest at a fixed rate per cent per annum.
2. What does a Bearer Debenture mean?
Bearer Debentures are those which are payable to the bearer (holder) of the instrument. They are transferable by mere delivery, and the company does not keep a record of the name and address of the holder. Interest coupons are attached to them.
3. State the meaning of ‘Debentures issued as a collateral security’.
When a company obtains a loan (usually from a bank) and issues debentures as a secondary or additional security (in addition to the principal security), it is called the issue of debentures as collateral security. If the company pays the loan, these debentures are returned; if it defaults, the lender can exercise rights on these debentures.
4. What is meant by ‘Issue of debentures for consideration other than cash’?
It refers to the situation where debentures are issued to vendors against the purchase of assets (like machinery, land) or to promoters for their services, instead of receiving cash.
5. What is meant by Issue of debenture at discount and redeemable at premium?
This implies a double loss for the company. The debentures are issued at a price less than the face value (Discount) but the company promises to repay an amount higher than the face value (Premium) at the time of maturity.
6. What is ‘Capital Reserve’?
Capital Reserve is a reserve created out of capital profits which are not available for distribution as dividends to shareholders. Examples include profit on the sale of fixed assets, profit on forfeiture of shares, or profit on redemption of debentures.
7. What is meant by a ‘Irredeemable Debenture’?
Irredeemable (or Perpetual) Debentures are those for which the company does not fix any specific date for repayment. The company is liable to pay interest regularly, but the principal amount is repaid only at the time of winding up of the company.
8. What is a ‘Convertible Debenture’?
Convertible Debentures are those that give the holder the option to convert the debt amount into Equity Shares or other securities of the company after a specified period and at a specified rate.
9. What is meant by ‘Mortgaged Debentures’?
Also known as Secured Debentures, these are secured by a charge (Fixed or Floating) on the assets of the company. In case of default in payment of interest or principal, the debenture holders can recover their dues from the mortgaged assets.
10. What is discount on issue of debentures?
It is the difference between the Nominal (Face) Value and the Issue Price when the issue price is lower. It is a Capital Loss for the company and is usually written off over the tenure of the debentures.
11. What is meant by ‘Premium on Redemption of Debentures’?
It refers to the additional amount (over and above the face value) that a company promises to pay to the debenture holders at the time of redemption (maturity). It is a liability and a capital loss recorded at the time of issue.
12. How debentures are different from shares? Give two points.
  • Status: A Shareholder is an owner of the company, whereas a Debenture holder is a creditor (lender) of the company.
  • Return: Shareholders receive Dividends (which vary based on profit), while Debenture holders receive Interest at a fixed rate (regardless of profit).
13. What is meant by redemption of debentures?
Redemption of debentures means the repayment of the amount due to debenture holders by the company. It results in the discharge of the liability on account of debentures.
14. Can the company purchase its own debentures?
Yes, a company is authorized to purchase its own debentures from the open market. This is often done for immediate cancellation (redemption) or for investment purposes (to save on interest payments).
15. What is meant by redemption of debentures by conversion?
It refers to the process of redeeming debentures by converting them into new shares (Equity or Preference) or new debentures instead of paying cash. This is applicable only for convertible debentures.
16. How would you deal with ‘Premium on Redemption of Debentures’?
The premium payable on redemption is a liability and a loss. At the time of issue, it is credited to “Premium on Redemption of Debentures A/c” and debited to “Loss on Issue of Debentures A/c”. It is shown under Non-Current Liabilities in the Balance Sheet until paid.
17. What is meant by redemption of debentures by “Purchase in Open Market”?
It refers to the method where the company purchases its own debentures from the stock exchange, just like any other investor. This is typically done when debentures are trading at a discount, allowing the company to redeem its debt at a lower cost and earn a profit on redemption.
Chapter 2: Long Answer Questions

Long Answer Questions
Chapter 2: Issue and Redemption of Debentures

Q1. Explain the different types of debentures?

Debentures can be classified on various bases as follows:

  1. Security Point of View:
    • Secured (Mortgaged) Debentures: Secured by a charge (fixed or floating) on the assets of the company.
    • Unsecured (Naked) Debentures: Not secured by any charge on assets. They are treated as unsecured creditors.
  2. Redemption Point of View:
    • Redeemable Debentures: Repayable after a specific period or at the discretion of the company.
    • Irredeemable (Perpetual) Debentures: Not repayable during the lifetime of the company; repaid only at winding up.
  3. Registration Point of View:
    • Registered Debentures: Names of holders are recorded in the company’s register. Transfer requires a proper deed.
    • Bearer Debentures: Payable to the bearer; transferable by mere delivery.
  4. Convertibility Point of View:
    • Convertible Debentures: Can be converted into equity shares after a specific period.
    • Non-Convertible Debentures: Cannot be converted into shares.
Q2. Distinguish between a debenture and a share. Why debenture is known as loan capital? Explain.

Difference between Share and Debenture

Basis Share Debenture
Nature It is a part of the capital of the company. It is an acknowledgment of debt (loan).
Status Shareholder is an owner. Debenture holder is a creditor.
Return Dividend (appropriation of profit). Interest (charge against profit).
Voting Rights Has voting rights. No voting rights.

Why is it called Loan Capital?

A debenture is known as “Loan Capital” because it represents a long-term borrowing for the company. Although it acts as a source of funds (capital) for the business operations, legally it is a debt (loan) that must be repaid with interest, unlike ownership capital.

Q3. Describe the meaning of ‘Debenture Issued as Collateral Securities’. What accounting treatment is given?

Meaning: Collateral security means secondary or additional security. When a company takes a loan (e.g., from a bank) and issues its own debentures to the lender as an extra security in addition to the primary mortgage of assets, it is called “Issue of Debentures as Collateral Security”.

Accounting Treatment

There are two methods to deal with this:

  • First Method (No Entry): No journal entry is passed for the issue of debentures. A note is simply appended below the “Long-term Borrowings” in the Balance Sheet stating the fact.
  • Second Method (Entry Passed): An entry is passed to record the issue in the books.
    Debenture Suspense A/c … Dr.
        To % Debentures A/c
    (Being debentures issued as collateral security)
    In the Balance Sheet, “Debenture Suspense” is shown as a deduction from the “Debentures” on the Liability side.
Q4. Explain the different terms for the issue of debentures with reference to their redemption.

Debentures can be issued under different terms based on the Issue Price (Par/Discount/Premium) and Redemption Price (Par/Premium). There are 6 common cases:

  1. Issued at Par, Redeemable at Par: Issued at 100, Repaid at 100.
  2. Issued at Discount, Redeemable at Par: Issued at 95, Repaid at 100. (Discount is a loss).
  3. Issued at Premium, Redeemable at Par: Issued at 105, Repaid at 100. (Premium is a gain).
  4. Issued at Par, Redeemable at Premium: Issued at 100, Repaid at 105. (Premium on redemption is a loss provided for at issue).
  5. Issued at Discount, Redeemable at Premium: Issued at 95, Repaid at 105. (Double loss: Discount + Premium on Redemption).
  6. Issued at Premium, Redeemable at Premium: Issued at 105, Repaid at 110.
Q5. Differentiate between redemption of debentures out of capital and out of profits.
Basis Redemption out of Capital Redemption out of Profits
Meaning No profits are set aside for redemption. Capital/Assets are used to pay debt. Profits are transferred to DRR (Debenture Redemption Reserve) before paying debt.
Effect on Dividends Profits remain available for dividends. Profits available for dividends are reduced.
Financial Position May adversely affect working capital/liquidity. Does not affect liquidity as profits are retained in the business.
DRR Requirement Usually not allowed (DRR creation is mandatory for most companies now). 100% of the nominal value is transferred to DRR (for pure redemption out of profits).
Q6. Explain the guidelines of SEBI for creating Debenture Redemption Reserve (DRR).

According to Section 71(4) of the Companies Act 2013 and SEBI Guidelines, companies must create a DRR to protect debenture holders.

  • Requirement: Companies must create a DRR of at least 10% of the value of outstanding debentures before starting redemption. (Note: For unlisted companies).
  • Source: It must be created out of profits available for dividend payment.
  • Exemptions:
    • All India Financial Institutions (AIFIs) regulated by RBI.
    • Banking Companies.
    • Listed companies (both NBFCs and others) are generally exempted from creating DRR.
  • Investment (DRI): Companies required to create DRR must also invest at least 15% of the amount of debentures maturing during the year in specified securities by April 30th.
Q7. Describe the steps for creating Sinking Fund for redemption of debentures.

A Sinking Fund (or Debenture Redemption Fund) is a method to accumulate funds gradually for repayment.

  1. Calculate Annual Appropriation: Determine the fixed amount to be set aside from profits annually based on annuity tables.
  2. Transfer Profit: Debit “Surplus in Statement of P&L” and Credit “Sinking Fund A/c”.
  3. Investment: An equivalent amount of cash is invested outside the business (e.g., Govt Bonds). Entry: Debit “Sinking Fund Investment A/c”, Credit “Bank”.
  4. Receive Interest: Interest earned on investments is received and reinvested along with the annual installment.
  5. Sale of Investment: At the time of redemption, investments are sold to generate cash. Profit/Loss on sale is transferred to the Sinking Fund A/c.
  6. Redemption: The cash realised is used to pay off debenture holders.
  7. Closure: The balance in Sinking Fund A/c is transferred to General Reserve.
Q8. Can a company purchase its own debentures in the open market? Explain.

Yes, a company can purchase its own debentures from the open market if its Articles of Association authorize it.

Purposes:

  • For Immediate Cancellation: If debentures are available in the market at a discount, the company buys and cancels them to make a profit and reduce debt immediately.
  • For Investment (Own Debentures): The company may buy them and hold them as an asset (“Own Debentures”). This is done to save on interest payments or to sell them later when the market price rises.
Q9. What is meant by conversion of debentures? Describe the method of such a conversion.

Meaning: Conversion means redeeming debentures by issuing new shares (Equity/Preference) or new Debentures to the holders instead of paying cash. This option is available only to Convertible Debentures.

Method:

  • The company calculates the amount due to the debenture holder.
  • It determines the Issue Price of the new shares (which can be at Par or Premium).
  • Number of Shares = Amount Due / Issue Price per Share.
  • Journal Entry:
    % Debentures A/c … Dr.
        To Equity Share Capital A/c
        To Securities Premium A/c (if issued at premium)
Chapter 2: Numerical Questions (1-5)

Issue of Debentures
Numerical Questions 1-5

Question 1
G. Ltd. issued 75,00,000, 6% Debentures of Rs. 50 each at Par. Application Rs. 15, Allotment Rs. 35.
Question 2
Y. Ltd. issued 2,000, 6% Debentures of Rs. 100 each. App 25, Allot 50, Call 25.
Question 3
A. Ltd. 10,000 Debentures @ Rs. 100 + 5% Premium. App 10, Allot 20 (inc prem), Call Balance.
Calculation of Installments:
Face Value = 100. Premium = 5.
Application = 10.
Allotment (including premium) = 20. (Capital = 15, Premium = 5).
Balance on Call = Total (105) – 10 – 20 = 75.
(Alternatively: Face Value Balance = 100 – 10 – 15 = 75).
Balance Sheet of A. Ltd. (Extract)
Notes to Accounts:
1. Reserves: Securities Premium Reserve = 50,000.
2. Long-term Borrowings: 10,000 10% Debentures @ 100 = 10,00,000.
3. Cash & Cash Equiv: Cash at Bank = 10,50,000.
Question 4
A. Ltd. issued 90,00,000 Debentures @ Rs. 50 at a discount of 8%.
Correction: The question text says “at a of 8%”. Based on typical accounting problems where redeemable is at par, this implies a Discount of 8%.
Discount Amount = 8% of 50 = Rs. 4.
Issue Price = 50 – 4 = Rs. 46.
Question 5
A. Ltd. 4,000 Debentures. 4,800 Applied. Pro-rata and Rejection.
Working Note: Analysis of Applications
1. Full Allotment: 3,600 Applied -> 3,600 Allotted.
2. Pro-rata: 800 Applied -> 400 Allotted. Excess Application Money = (800-400) × 20 = Rs. 8,000. (Adjusted to Allotment).
3. Rejection: 400 Applied -> Nil. Refund = 400 × 20 = Rs. 8,000.
Total: 4,800 Applied -> 4,000 Allotted.
Allotment Money Due: 4,000 × 20 = 80,000. Less Adjusted (8,000) = 72,000 to be received.
Chapter 2: Numerical Questions (6-10)

Issue of Debentures
Numerical Questions 6-10

Question 6
T. Ltd. 2,00,000 Debentures @ Rs. 500. Premium 10% (50). App 200 (inc Prem). Pro-rata Allotment (3L applied).
Working Note:
1. Application Money Received: 3,00,000 × 200 = 6,00,00,000.
2. Adjustments:
– Capital (Face Value on App): 2,00,000 × 150 = 3,00,00,000.
– Securities Premium: 2,00,000 × 50 = 1,00,00,000.
– Excess (Adjusted to Allotment): 1,00,000 × 200 = 2,00,00,000.
3. Allotment Due: Balance = 500 – 150 = 350 per debenture.
2,00,000 × 350 = 7,00,00,000.
4. Allotment Received: 7,00,00,000 – 2,00,00,000 (Excess) = 5,00,00,000.
Question 7
X. Ltd. 10,000 Debentures. 13,500 Applied. Pro-rata Categories.
Working Note: Application Analysis
Total Applications: 13,500.
1. Category A (Full): 8,000 Applied -> 8,000 Allotted.
2. Category B (Partial): 5,000 Applied -> 2,000 Allotted (40%).
– Excess App Money: (5,000 – 2,000) × 20 = 60,000.
– Allotment Due on these: 2,000 × 60 = 1,20,000.
– Excess fully adjusted towards allotment.
3. Category C (Reject): 500 Applied -> Nil. (13,500 – 8,000 – 5,000).
– Refund: 500 × 20 = 10,000.
Question 8
R. Ltd. 20,00,000 Debentures @ 200. Discount 7%. Redeemable at Premium 8%.
Loss Calculation:
Discount on Issue: 7% of 200 = Rs. 14.
Premium on Redemption: 8% of 200 = Rs. 16.
Total Loss on Issue = 14 + 16 = Rs. 30 per debenture.
Question 9
M. Ltd. took over Assets (9 Cr) and Liabilities (70L) of S. Ltd. Issued 8% Debentures.
Question 10
B. Ltd. purchased Assets (4L) & Liab (50k) for PC 3.8L. Goodwill Calculation. Issue Cases.
Step 1: Calculate Goodwill/Capital Reserve
Net Assets = Assets (4,00,000) – Liabilities (50,000) = 3,50,000.
Purchase Consideration = 3,80,000.
Since PC > Net Assets, difference is Goodwill = 3,80,000 – 3,50,000 = 30,000.
Chapter 2: Numerical Questions (11-15)

Issue of Debentures
Numerical Questions 11-15

Question 11
X. Ltd. purchased Machinery (4,40,000) from Y. Ltd. Issued 12% Debentures of 100 at 10% Premium.
Calculation of Number of Debentures:
Purchase Consideration = Rs. 4,40,000.
Issue Price = 100 + 10 = Rs. 110.
No. of Debentures = 4,40,000 / 110 = 4,000 Debentures.
Question 12
X. Ltd. issued 15,000, 10% Debentures. Journal Entries & Balance Sheet for 4 Cases.
Journal Entries
Balance Sheet Presentation (Extract – Case iii)
Notes to Accounts (Case iii):
1. Long-term Borrowings:
Bank Loan: Rs. 12,00,000
(Secured by issue of 15,000, 10% Debentures of Rs. 100 each as collateral security)

10% Debentures: 15,00,000
Less: Debenture Suspense: (15,00,000) -> Nil
Question 13
Journalise Issue entries for 3 Conditions (Face Value 100).
Question 14
A. Ltd. 50,00,000 Debentures @ 100. Issued @ 6% Disc, Redeemable @ 4% Prem. Prepare Loss Account.
Calculation of Total Loss:
No. of Debentures = 50,00,000.
Discount on Issue (6%) = Rs. 6.
Premium on Redemption (4%) = Rs. 4.
Total Loss per Debenture = Rs. 10.
Total Loss Amount = 50,00,000 × 10 = Rs. 5,00,00,000.
Journal Entry for Issue
Discount/Loss on Issue of Debentures Account
*Note: The question asks to prepare the account. The loss is written off over the tenure (2020-2022) based on outstanding balance or Statement of P&L rules. The account shows the initial booking of the loss.
Question 15
A Listed Company. 5 Cases. Record (a) Issue and (b) Repayment Entries.
Chapter 2: Numerical Questions (16-20)

Issue & Redemption of Debentures
Numerical Questions 16-20

Question 16
Listed Co. issued 5L Debentures @ 6% Discount on Apr 1, 2014. Redeemable by annual drawings of 1L from Mar 31, 2016.
Working Note: Writing off Discount
Total Discount = 6% of 5,00,000 = Rs. 30,000.
Written off in ratio of outstanding balance:
2014-15: 5L (5); 2015-16: 5L (5); 2016-17: 4L (4); 2017-18: 3L (3); 2018-19: 2L (2); 2019-20: 1L (1).
Ratio = 5:5:4:3:2:1. Total = 20.
Write off (1st Year): 30,000 × 5/20 = 7,500.
Question 17
B. Ltd. issued Debentures at 94% for Rs. 4,00,000. Repayable by 5 equal drawings of 80k.
Question 18
B. Ltd. 1000, 12% Debentures @ 100. Disc 5%, Prem 10%. Interest Entries with TDS 10%.
Interest Calculation:
Total Interest = 1,00,000 × 12% = 12,000 p.a.
Half Yearly Interest = Rs. 6,000.
TDS @ 10% = Rs. 600.
Net Payment to Holder = Rs. 5,400.
Question 19
Jay Kay Ltd. 60k Debentures @ 100. Red. Prem 20%. DRR created in 3 installments. DRI invested.
Working Notes:
1. Face Value: 60,000 × 100 = 60,00,000.
2. Premium on Redemption: 20% of 60L = 12,00,000 (Loss on Issue).
3. Writing Off Loss: Available Sec. Prem = 5,00,000. Balance Loss (7,00,000) from P&L.
4. DRR Requirement: Assuming 10% Rule (as per modern norms) = 6,00,000. 3 Installments = 2,00,000 each.
5. DRI Requirement: 15% of 60,00,000 = 9,00,000.
6. Interest: 12% of 60L = 7,20,000 p.a. TDS 10%.
Question 20
Madhur Ltd. 9% Debentures of 50L. DRR created in parts. DRI invested. Ledger Accounts.
DRR Calculation: Requirement (10% of 50L) = 5,00,000.
Created Mar 2018: 2,00,000.
Balance Created Mar 2019: 3,00,000.
DRI Calculation: 15% of 50L = 7,50,000.
Ledger: 9% Debentures Account
Ledger: Debenture Redemption Reserve (DRR) Account
Ledger: Debenture Redemption Investment (DRI) Account
Chapter 2: Numerical Questions (21-23)

Issue & Redemption of Debentures
Numerical Questions 21-23

Question 21
MK Ltd. Outstanding 30,000 Debentures @ 100. Redeemable at 10% Premium in installments (10k, 12k, 8k).
Assumption: The text says “Rs. 30,000 11% debentures” but lists installments of “10,000 debentures”. It is assumed the total is 30,000 Debentures (Total Face Value Rs. 30,00,000).
Redemption Premium: 10% of Face Value.
Question 22
X Ltd. 20,000 12% Debentures @ 100 redeemable on June 30, 2019.
Question 23
XYZ Ltd. 6,000 Debentures @ 50. Issue & Redemption Entries for 6 Cases.
Common Data: Total Face Value = 6,000 × 50 = Rs. 3,00,000.
Redemption: 4 equal installments (75,000 each) starting end of 3rd year.
Journal Entries: At the time of Issue (April 1, 2014)
Journal Entries: At the time of Redemption (Installment 1)
Note: Entries shown for the 1st installment (Year 3). These repeat for 4 years.
Group A: Cases (i), (ii), (iii) – Redeemed at Par (Rs. 75,000).
Group B: Cases (iv), (v), (vi) – Redeemed at 10% Premium (Rs. 75,000 + 7,500).
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