Chapter 2 Issue and Redemption of Debentures

Learning Objectives

After studying this chapter, you will be able to:

State the meaning of debenture and explain the difference between debentures and shares;
Describe various types of debentures;
Record the journal entries for the issue of debentures at par, at a discount, and at a premium;
Explain the concept of debentures issued for consideration other than cash and the accounting thereof;
Explain the concept of issue of debentures as a collateral security and the accounting thereof;
Record the journal entries for issue of debentures with various terms of issue, terms of redemption;
Show the items relating to issue of debentures in the company’s balance sheet;
Describe the methods of writing-off discount/loss on issue of debentures;
Explain the methods of redemption of debentures and the accounting thereof;
Explain the concept of sinking fund, its use for redemption of debentures, and the accounting thereof.

Meaning of Debentures

A debenture is a medium- to long-term debt instrument used by large companies to borrow money, at a fixed rate of interest. Debentures are the most common form of long-term loans that a company can take. They are essentially an acknowledgment of debt, under which the company agrees to repay the borrowed amount after a specific period. Debentures are unsecured, meaning they are not backed by any collateral. Instead, they rely on the creditworthiness and reputation of the issuer.

Debentures can be issued in various forms, such as convertible and non-convertible debentures, based on the terms and conditions of conversion into equity shares. They can also be classified based on redemption terms, such as redeemable and irredeemable debentures.

Summary of Financial Concepts

Distinction between Shares and Debentures

Shares represent ownership in a company and entitle shareholders to a portion of the profits in the form of dividends. Shareholders have voting rights in company matters. Debentures, on the other hand, are a form of debt and do not confer ownership or voting rights. Debenture holders are creditors to the company and receive fixed interest payments, regardless of the company's profitability.

Types of Debentures

Debentures can be classified into various types based on different criteria:

Convertible Debentures: These can be converted into equity shares after a specific period.
Non-Convertible Debentures: These cannot be converted into equity shares.
Redeemable Debentures: These are repaid after a fixed period.
Irredeemable Debentures: These are not repaid during the lifetime of the company; they are perpetual.
Secured Debentures: These are backed by the company's assets as collateral.
Unsecured Debentures: These are not backed by any collateral.

Issue of Debentures

Companies issue debentures to raise long-term funds. The process involves several steps:

Resolution: The company must pass a resolution in a board meeting to approve the issuance of debentures.
Prospectus: A prospectus is issued to inform potential investors about the debentures' terms and conditions.
Subscription: Investors subscribe to the debentures by submitting applications along with the required payment.
Allotment: The company allots debentures to the investors, issuing debenture certificates as proof of ownership.

Questions for Practice with Answers

Question: How do shares differ from debentures?
Answer: Shares represent ownership in a company and provide voting rights, while debentures are a form of debt without ownership or voting rights. Shareholders receive dividends based on profits, whereas debenture holders receive fixed interest payments.
Question: What are convertible debentures?
Answer: Convertible debentures can be converted into equity shares of the issuing company after a specified period, providing the debenture holder with the option to become a shareholder.
Question: What is the process for issuing debentures?
Answer: The process involves passing a resolution in a board meeting, issuing a prospectus, collecting subscriptions from investors, and allotting debentures with corresponding certificates.
Question: What distinguishes secured debentures from unsecured debentures?
Answer: Secured debentures are backed by the company's assets as collateral, providing additional security for the debenture holders. Unsecured debentures are not backed by any collateral and rely solely on the issuer's creditworthiness.

Questions for Practice

Short Answer Questions

What is meant by a Debenture?
A debenture is a medium to long-term debt instrument used by large companies to borrow money, at a fixed rate of interest.
What does a Bearer Debenture mean?
A bearer debenture is a type of debenture that is not registered in the company's books and can be transferred by mere delivery.
State the meaning of ‘Debentures issued as a collateral security’.
Debentures issued as collateral security are additional security given to the lenders along with the primary security.
What is meant by ‘Issue of debentures for consideration other than cash’?
This means issuing debentures in exchange for assets, services, or other considerations instead of cash.
What is meant by Issue of debenture at discount and redeemable at premium?
This means issuing debentures at a price lower than their face value and redeeming them at a higher price than the face value.
What is ‘Capital Reserve’?
A capital reserve is a reserve created out of capital profits which are not normally distributed as dividends.
What is meant by an ‘Irredeemable Debenture’?
An irredeemable debenture is a type of debenture that does not have a fixed maturity date.
What is a ‘Convertible Debenture’?
A convertible debenture is a type of debenture that can be converted into equity shares of the issuing company after a specified period.
What is meant by ‘Mortgaged Debentures’?
Mortgaged debentures are secured debentures where specific assets of the company are mortgaged to the debenture holders.
What is discount on issue of debentures?
It refers to the difference between the face value and the lower issue price of the debentures.
What is meant by ‘Premium on Redemption of Debentures’?
This means the amount over the face value that is paid to debenture holders at the time of redemption.
How debentures are different from shares? Give two points.
1. Debentures are a form of debt, whereas shares represent ownership in the company.
2. Debenture holders are creditors, whereas shareholders are owners.
What is meant by redemption of debentures?
Redemption of debentures refers to the repayment of the principal amount of debentures to the holders at maturity.
Can the company purchase its own debentures?
Yes, a company can purchase its own debentures from the open market under certain conditions.
What is meant by redemption of debentures by conversion?
It means converting debentures into equity shares of the company instead of paying cash to the debenture holders.
How would you deal with ‘Premium on Redemption of Debentures’?
The premium payable on redemption is transferred to the 'Premium on Redemption of Debentures' account.
What is meant by redemption of debentures by “Purchase in Open Market”?
This means that the company buys back its debentures from the open market before their maturity.

Long Answer Questions

Explain the different types of debentures?
Debentures can be classified into various types based on security (secured and unsecured), convertibility (convertible and non-convertible), and duration (redeemable and perpetual).
Distinguish between a debenture and a share. Why debenture is known as loan capital? Explain.
Debentures are debt instruments and must be repaid, whereas shares are equity and represent ownership. Debentures are known as loan capital because they represent a loan taken by the company.
Describe the meaning of ‘Debenture Issued as Collateral Securities’. What accounting treatment is given to the issue of debentures in the books of accounts?
Debentures issued as collateral securities are used as secondary security. They are recorded by debiting the Debenture Suspense Account and crediting the Debentures Account.
Explain the different terms for the issue of debentures with reference to their redemption.
Debentures can be issued at par, at a premium, or at a discount. They can be redeemable at par, at a premium, or at a discount.
Differentiate between redemption of debentures out of capital and out of profits.
Redemption out of capital means repaying debenture holders from the company’s capital, whereas redemption out of profits means using profits to repay debentures.
Explain the guidelines of SEBI for creating Debenture Redemption Reserve.
SEBI mandates that companies must create a Debenture Redemption Reserve out of profits to protect debenture holders. The reserve must be maintained until the debentures are redeemed.
Describe the steps for creating Sinking Fund for redemption of debentures.
A Sinking Fund is created by setting aside a certain amount each year from profits to ensure that funds are available for redeeming debentures at maturity.
Can a company purchase its own debentures in the open market? Explain.
Yes, a company can purchase its own debentures in the open market to either cancel them or hold them as investments, under certain legal provisions.
What is meant by conversion of debentures? Describe the method of such a conversion.
Conversion of debentures means converting debentures into equity shares. This is done as per the terms of issue and involves issuing new equity shares in exchange for debentures.

Numerical Questions

G. Ltd. a listed company issued 75,00,000, 6% debentures of Rs. 50 each at par payable Rs. 15 on application and Rs. 35 on allotment, redeemable at par after 7 years from the date of issue of debentures. Record necessary entries in the books of Company.
Journal Entries:
- On Application:
  Bank A/c Dr. 11,25,00,000
  To Debenture Application A/c 11,25,00,000
- On Allotment:
  Debenture Application A/c Dr. 11,25,00,000
  To 6% Debentures A/c 3,75,00,000
  To Bank A/c 7,50,00,000
Y. Ltd. issued 2,000, 6% debentures of Rs. 100 each payable as follows: Rs. 25 on application; Rs. 50 on allotment and Rs. 25 on first and final call. Record necessary entries in the books of the company.
Journal Entries:
- On Application:
  Bank A/c Dr. 50,000
  To Debenture Application A/c 50,000
- On Allotment:
  Deb enture Application A/c Dr. 50,000
  To 6% Debentures A/c 50,000
- On Allotment Money Due:
  Debenture Allotment A/c Dr. 1,00,000
  To 6% Debentures A/c 1,00,000
- On Allotment Money Received:
  Bank A/c Dr. 1,00,000
  To Debenture Allotment A/c 1,00,000
- On First & Final Call Due:
  Debenture First & Final Call A/c Dr. 50,000
  To 6% Debentures A/c 50,000
- On First & Final Call Received:
  Bank A/c Dr. 50,000
  To Debenture First & Final Call A/c 50,000