CHAPTER 10
REDEMPTION OF
DEBENTURES
ONE WORD TO ONE SENTENCE QUESTIONS
Q.1. What is
meant by Redemption of debentures?
Ans. Redemption
of debentures refers to the repayment or return of the principal amount of the
debentures to the debentureholders by the issuing company. It is the process by
which the company fulfills its obligation to repay the borrowed funds raised
through the issuance of debentures. The redemption of debentures typically
occurs at the end of the debenture's specified term or maturity period as
outlined in the terms and conditions of the debenture agreement.
During
redemption, the company repays the principal amount to the debentureholders
either in a lump sum or through installment payments as per the terms of the
debenture agreement. The redemption amount is paid by the company to the
debentureholders either through direct payment or by transferring the funds to
the debentureholders' bank accounts.
Redemption
of debentures reduces the liability of the company and provides a source of
repayment to the debentureholders. It is important for the company to plan and
arrange funds for the redemption of debentures in advance to meet its financial
obligations. The redemption process ensures that the company fulfills its
contractual commitment and returns the borrowed funds to the debentureholders.
The
redemption of debentures may involve certain legal and regulatory requirements,
and companies need to comply with the applicable laws, company regulations, and
the terms of the debenture agreement while redeeming the debentures.
Q.2. Name any
one source of finance for redemption of debentures?
Ans. One
source of finance for the redemption of debentures is the company's internal
accruals or retained earnings. When a company generates profits over time and
retains a portion of those earnings instead of distributing them as dividends,
it can use those accumulated funds to finance the redemption of debentures.
This allows the company to fulfill its obligation to repay the debentureholders
without needing to raise external funds or borrow additional money.
Q.3. When can
the debentures be redeemed?
Ans. Debentures
can be redeemed by the company at a predetermined date mentioned in the
debenture agreement. The redemption can occur after a specific period of time
known as the maturity date. The company must fulfill its obligation to repay
the debentureholders by returning the principal amount along with any accrued
interest at the time of redemption.
Q.4. After
redemption of debentures, Sinking fund is transferred to which account?
Ans. After
the redemption of debentures, the sinking fund is transferred to the
"Capital Reserve Account".
Q.5. Profit on
redemption of debentures is transferred to which account?
Ans. Profit
on redemption of debentures is typically transferred to the "Capital
Reserve Account" or the "General Reserve Account".
Q.6. Name the
head under which the debenture redemption reserve account appears in the
balance sheet?
Ans. The
debenture redemption reserve account appears under the "Reserves and
Surplus" section in the balance sheet of a company.
Q.7. Name the
various methods of redemption of debentures?
Ans. The various methods of redemption of debentures are:
Redemption in Lump Sum: The entire amount of debentures is redeemed in
a single payment on a specified redemption date.
Redemption by Installments: The debentures are redeemed in periodic
installments over a specific period of time until all the debentures are fully
redeemed.
Redemption
through Purchase in Open Market: The company buys back its own debentures from the
open market to redeem them.
Redemption through Conversion: Debentures may be converted into shares of the
company at a predetermined conversion ratio, allowing debentureholders to
convert their debentures into shares instead of opting for redemption.
Redemption through Fresh Issue of
Shares: The company may issue new shares and
use the proceeds to redeem the debentures.
It's
important to note that the specific method of redemption may vary depending on
the terms and conditions stated in the debenture agreement.
Q.8. What is
meant by redemption of debentures out of profit?
Ans. Redemption
of debentures out of profit refers to the utilization of company's profits for
the purpose of redeeming or repaying the outstanding debentures. When a company
has accumulated sufficient profits, it can use a portion of those profits to
redeem the debentures before their maturity date. This allows the company to reduce
its debt and liabilities.
The
redemption of debentures out of profit is typically done by creating a
Debenture Redemption Reserve (DRR) account. The company transfers a certain
amount of profit to this reserve, which is then used to redeem the debentures.
The purpose of creating the DRR is to ensure that the company sets aside
adequate funds specifically for the redemption of debentures.
It's important
to comply with the legal and regulatory requirements when redeeming debentures
out of profit, including any restrictions or conditions mentioned in the
debenture agreement and relevant company laws and regulations.
Q.9. How will
you deal with debenture redemption reserve account when all the debentures are
redeemed?
Ans. When all
the debentures are redeemed, the balance in the Debenture Redemption Reserve
(DRR) account is no longer required as there are no more debentures to be
redeemed in the future. In such a case, the DRR account is closed and its
balance is transferred to the General Reserve or Surplus account.
The journal
entry to deal with the closure of the DRR account and transfer of its balance
would typically be as follows:
Close the Debenture
Redemption Reserve account:
Dr.
Debenture Redemption Reserve
Cr. General
Reserve (or Surplus)
This entry
effectively transfers the balance of the DRR account to the General Reserve or
Surplus account, thereby integrating the reserve into the overall accumulated
profits of the company.
It's
important to note that the specific accounting treatment may vary depending on
the company's internal policies, legal requirements, and accounting standards
followed. Consulting with a qualified accountant or financial advisor is
recommended to ensure proper compliance with accounting principles and
regulations.
Q.10. How will
you deal with premium on redemption of debentures account?
Ans. When
the premium on redemption of debentures is realized, it needs to be accounted
for appropriately. The following steps are generally followed to deal with the
Premium on Redemption of Debentures account:
Transfer the
Premium on Redemption of Debentures account to the Securities Premium Reserve
(SPR) or Capital Redemption Reserve (CRR) account:
Dr. Premium
on Redemption of Debentures
Cr.
Securities Premium Reserve (or Capital Redemption Reserve)
This entry
reflects the transfer of the premium amount from the Premium on Redemption of
Debentures account to either the Securities Premium Reserve or the Capital
Redemption Reserve account, depending on the company's internal policies and
legal requirements.
The
transfer to the Securities Premium Reserve (SPR) is typically done when the
company has sufficient funds in the SPR account and intends to utilize it for
specific purposes as allowed by law, such as issuing bonus shares or writing
off share issue expenses.
The
transfer to the Capital Redemption Reserve (CRR) is applicable when the company
has redeemed the debentures using the share capital, and the premium amount is
transferred to the CRR as a reserve for future use.
It's worth
noting that the specific accounting treatment may vary based on the company's
circumstances, regulatory requirements, and accounting standards. Consulting
with a professional accountant or financial advisor is recommended to ensure
compliance with relevant regulations and accounting principles.
Q.11. How will
you treat the interest on sinking fund investment if sinking fund is
cumulative?
Ans. When the sinking fund is cumulative, the interest earned on the sinking
fund investment is treated as follows:
Recognize
the interest income:
Dr. Sinking
Fund Investment
Cr.
Interest Income
This entry
records the interest earned on the sinking fund investment as income for the
company.
Transfer
the interest income to the Sinking Fund Account:
Dr.
Interest Income
Cr. Sinking
Fund Account
This entry
reflects the transfer of the interest income from the Income Statement to the
Sinking Fund Account, which is used to accumulate funds for the redemption of
debentures.
By
transferring the interest income to the Sinking Fund Account, it increases the
balance of the fund, allowing for the gradual accumulation of funds to meet the
future redemption obligations.
It's important
to note that the specific accounting treatment may vary based on the company's
accounting policies, regulatory requirements, and applicable accounting
standards. Consulting with a professional accountant or financial advisor is
recommended to ensure compliance with relevant regulations and accounting
principles.
Q.12. How will
you tread the interest on sinking fund investment if sinking fund is
non-cumulative?
Ans. If the
sinking fund is non-cumulative, the interest earned on the sinking fund investment
is treated as follows:
Recognize
the interest income:
Dr. Sinking
Fund Investment
Cr.
Interest Income
This entry
records the interest earned on the sinking fund investment as income for the
company.
Transfer
the interest income to the General Revenue Account:
Dr.
Interest Income
Cr. General
Revenue Account
Since the
sinking fund is non-cumulative, the interest income is not specifically
allocated to the sinking fund. Instead, it is treated as general revenue and
added to the company's overall funds.
By
transferring the interest income to the General Revenue Account, it becomes
part of the company's available funds and can be used for various purposes,
including operating expenses, investments, or distributions to shareholders.
It's
important to note that the specific accounting treatment may vary based on the
company's accounting policies, regulatory requirements, and applicable
accounting standards. Consulting with a professional accountant or financial
advisor is recommended to ensure compliance with relevant regulations and
accounting principles.
Q.14. How will
you deal with sinking fund when only a portion of debentures are redeemed?
Ans. When
only a portion of debentures are redeemed, the sinking fund is adjusted
accordingly. Here's how it can be dealt with:
Determine
the amount of sinking fund available:
Calculate
the total amount accumulated in the sinking fund.
Subtract
the redemption amount from the sinking fund to determine the remaining balance.
Adjust the
sinking fund account:
Dr. Sinking
Fund Account (reducing the balance)
Cr.
Debenture Redemption Reserve Account (to transfer the released funds)
This entry
reflects the reduction in the sinking fund balance due to the redemption of
debentures. The amount is transferred to the Debenture Redemption Reserve
Account, which is maintained to meet future redemption requirements.
Record the
redemption of debentures:
Dr.
Debentureholders Account (for the redeemed amount)
Cr.
Debenture Liability Account (reducing the outstanding debentures)
This entry
represents the reduction in the outstanding debentures due to the redemption.
The debentureholders' account is debited, indicating the repayment made to
them, while the debenture liability account is credited to reflect the
reduction in the company's outstanding debt.
The
specific accounting entries and treatment may vary based on the company's
accounting policies and applicable accounting standards. It is recommended to
consult with a professional accountant or financial advisor to ensure accurate
and compliant accounting practices.
Q.15. How will
you deal with sinking fund when all the debentures are redeemed?
Ans. When
all the debentures are redeemed, the sinking fund is fully utilized. Here's how
it can be dealt with:
Determine the amount available in the
sinking fund:
Calculate
the total amount accumulated in the sinking fund.
Adjust the sinking fund account:
Dr. Sinking
Fund Account (reducing the balance)
Cr.
Debenture Redemption Reserve Account (to transfer the released funds)
This entry
reflects the reduction in the sinking fund balance as it is fully utilized for
the redemption of debentures. The amount is transferred to the Debenture
Redemption Reserve Account, which is maintained to meet future redemption
requirements.
Record the redemption of debentures:
Dr.
Debentureholders Account (for the redeemed amount)
Cr.
Debenture Liability Account (reducing the outstanding debentures)
This entry
represents the redemption of all the outstanding debentures. The
debentureholders' account is debited, indicating the repayment made to them,
while the debenture liability account is credited to reflect the elimination of
the company's outstanding debt.
After
completing these entries, the sinking fund account will have a zero balance,
indicating that all funds allocated for the redemption of debentures have been
utilized.
The
specific accounting entries and treatment may vary based on the company's
accounting policies and applicable accounting standards. It is recommended to
consult with a professional accountant or financial advisor to ensure accurate
and compliant accounting practices.
VERY SHORT ANSWER TYPE QUESTIONS
Q.1. What are the various
sources of redemption of debentures?
Ans. The various sources of redemption of debentures are:
Redemption out of profits: The company can use its retained earnings or
accumulated profits to redeem the debentures. This source is commonly known as
redemption out of profits.
Redemption out of capital: In certain cases, subject to legal requirements
and approval, a company may choose to utilize its share capital or capital
reserves for the redemption of debentures. This source is called redemption out
of capital.
Redemption through fresh issue of
shares: The company can raise funds by
issuing new shares and utilize the proceeds to redeem the debentures. This
method is known as redemption through a fresh issue of shares.
Redemption through sinking fund: A sinking fund is created by setting aside
specific funds periodically to accumulate a sufficient amount for the redemption
of debentures at maturity. The accumulated amount in the sinking fund is then used
to redeem the debentures.
Redemption through debenture
conversion:
If the debentures are
convertible, the company can offer the debentureholders the option to convert
their debentures into equity shares or other securities. By exercising this
option, the debentureholders become shareholders, and the debentures are
effectively redeemed.
It's
important to note that the specific sources of redemption available to a company
may depend on legal provisions, contractual agreements, and the company's
financial position. The choice of redemption source is determined by various
factors, including the company's financial stability, profitability, legal
requirements, and the terms and conditions of the debentures.
Q.2. Name the
methods of redemption of debenture?
Ans. The methods of redemption of debentures are as follows:
Redemption by payment in lump sum: Under this method, the company redeems the
entire outstanding debentures in a single payment on the specified redemption
date.
Redemption by draw of lots: In this method, a portion of the debentures is
selected for redemption by a random draw of lots. The debentureholders whose
debentures are selected are paid the redemption amount, while the remaining
debentures continue to remain outstanding.
Redemption by purchase in the open
market: The
company may choose to
buy back its own debentures from the open market before the redemption date.
The purchased debentures are then canceled or held as treasury stock.
Redemption by conversion: If the debentures are convertible, the
debentureholders have the option to convert their debentures into equity shares
or other securities of the company. By exercising this option, the debentures
are effectively redeemed.
Redemption through sinking fund: A sinking fund is created by the company, and
regular contributions are made to accumulate a sufficient amount for the
redemption of debentures at maturity. The accumulated funds in the sinking fund
are used to redeem the debentures.
It's
important to note that the specific method of redemption chosen by a company
may depend on factors such as the terms and conditions of the debentures, legal
requirements, financial position, and the preferences of the debentureholders.
Q.3. What do
you mean by redemption of debentures out of capital?
Ans. Redemption
of debentures out of capital refers to the process of utilizing the company's
capital or share premium account to redeem its debentures. This practice involves
using the company's internal resources, specifically its accumulated profits or
reserves, to repay the debentureholders instead of using funds generated from
ongoing operations or external sources.
Redemption
of debentures out of capital is not a common practice and is subject to
specific legal provisions and regulatory requirements in many jurisdictions. In
general, companies are not allowed to use their capital for redemption purposes
unless certain conditions are met, such as obtaining approval from relevant
authorities and complying with applicable laws.
It's worth
noting that the concept of redeeming debentures out of capital is different
from redeeming debentures out of profits. When debentures are redeemed out of
profits, the company uses its accumulated profits or reserves that are
specifically available for distribution to shareholders or debentureholders. In
contrast, redeeming debentures out of capital involves using the company's
capital, which is typically considered a more restricted source of funds.
Companies
considering the redemption of debentures out of capital should seek appropriate
legal and professional advice to ensure compliance with relevant regulations
and to properly address the impact on their financial statements and capital structure.
Q.4. Write any
two differences between ‘’Premium on issue of debentured’’ and ‘’Premium on
redemption of debentures?
Ans. Nature of
Occurrence: "Premium on issue of
debentures" refers to the additional amount received by the company when
it issues debentures at a price higher than their nominal value. This premium
is received at the time of issuing the debentures. On the other hand,
"Premium on redemption of debentures" refers to the additional amount
paid by the company over and above the nominal value of the debentures at the
time of their redemption. This premium is paid when the debentures are being
redeemed.
Accounting Treatment: The "Premium on issue of
debentures" is credited to a separate account called the "Securities
Premium Account" or "Debenture Premium Account." This account
reflects the premium received on the initial issuance of the debentures and is
shown as part of the shareholders' equity in the balance sheet. On the
contrary, the "Premium on redemption of debentures" is debited to the
"Profit and Loss Account" or "Capital Redemption Reserve
Account" since it represents an expense incurred by the company in
redeeming the debentures. This premium is treated as a reduction in the
company's profits or reserves.
It's
important to note that the accounting treatment may vary depending on the
specific circumstances and accounting practices followed by the company.
Consulting with accounting professionals or referring to applicable accounting
standards can provide more precise guidance in a given context.
Q.5. What do
you mean by redemption of debenture out of profit?
Ans. "Redemption
of debentures out of profit" refers to the utilization of the company's
accumulated profits or reserves to redeem or repay the debentures issued by the
company. When debentures are redeemed out of profit, the company uses its
earnings or retained earnings to fulfill its obligation towards
debentureholders.
Here's a
brief explanation of the process of redemption of debentures out of profit:
Accumulated Profits: The company must have sufficient profits or
reserves available to cover the redemption amount. These profits are typically
accumulated over time from the company's operations.
Board Approval: The decision to redeem debentures out of profit
is made by the board of directors. They assess the financial position of the
company, evaluate available profits, and decide on the portion of profits to be
utilized for debenture redemption.
Allocation of Funds: The identified amount of profits or reserves is
allocated specifically for the redemption of debentures. This allocation is
typically done through a resolution passed by the board of directors.
Redemption Process: The company initiates the redemption process by
making the necessary payments to the debentureholders, including the principal
amount and any applicable premium or interest. The redemption is typically done
in accordance with the terms and conditions stated in the debenture agreement.
Accounting Treatment: The amount used for the redemption of
debentures is debited to the "Debenture Redemption Reserve Account"
or "Capital Redemption Reserve Account," which reflects the reduction
in accumulated profits or reserves. The debentureholders' liability is reduced,
and the corresponding entry is made in the liability side of the balance sheet.
It's
important to comply with legal and regulatory requirements, including any
restrictions on the utilization of profits or reserves for debenture
redemption. Consulting with accounting professionals or referring to applicable
laws and regulations is advised to ensure proper compliance.
Q.6. What do
you mean by redemption by conversion?
Ans. "Redemption
by conversion" refers to the method of redeeming debentures by converting
them into shares of the issuing company. In this process, the debentureholders
have the option to convert their debentures into equity shares at a predetermined
conversion ratio or price.
Here's a
brief explanation of redemption by conversion:
Conversion Option: When debentures are issued, the terms and
conditions may include a provision that allows debentureholders to convert
their debentures into equity shares of the company. This provision specifies
the conversion ratio or price at which the conversion can take place.
Conversion Ratio/Price: The conversion ratio determines the number of
equity shares that will be issued in exchange for each debenture.
Alternatively, the conversion price represents the price at which each equity
share will be issued upon conversion. These conversion terms are established
during the issuance of the debentures.
Conversion Process: If debentureholders decide to exercise their
conversion option, they notify the company about their intention to convert
their debentures into equity shares. The company then processes the conversion
requests based on the predetermined conversion ratio or price.
Allotment of Shares: Upon receiving the conversion
requests, the company issues new equity shares to the debentureholders in
exchange for the surrendered debentures. The allotment of shares is done in
accordance with the conversion terms specified in the debenture agreement.
Accounting Treatment: The accounting treatment for redemption by
conversion involves the recognition of the conversion of debentures into equity
shares. The liability of the debentures is reduced, and the corresponding entry
is made in the equity or share capital section of the balance sheet to reflect
the increased share capital.
It's
important to note that redemption by conversion provides an alternative means
for debentureholders to participate in the ownership of the company by
acquiring equity shares. The conversion option is typically beneficial to both
the company and debentureholders, as it allows for the efficient utilization of
funds and provides an opportunity for capital appreciation.
SHORT ANSWER TYPE QUESTIONS
Q.1. What do
you mean by redemption of debentures? Explain the procedure of redemption of
debenture out of fresh issue?
Ans. Redemption
of debentures refers to the repayment or retirement of the debentures by the
issuing company. It is the process through which the company returns the
principal amount to the debentureholders upon the maturity of the debentures or
as per the agreed-upon terms.
Here's an
explanation of the procedure for the redemption of debentures out of a fresh
issue:
Issuance of Debentures: The company decides to raise funds by issuing
debentures to investors. The terms and conditions of the debentures, including
the redemption period, redemption premium (if any), interest rate, and
repayment schedule, are specified in the debenture agreement.
Creation of Debenture Redemption
Reserve (DRR): As per legal requirements, the company creates a Debenture Redemption
Reserve account. The company sets aside a portion of its profits and transfers
it to the DRR account over the years to accumulate funds for the redemption of
debentures.
Redemption Schedule: The company determines the redemption schedule
for the debentures, specifying the dates and amounts of debentures to be
redeemed. The redemption schedule can be spread over several years, or it can
be a lump sum redemption at the end of the debenture tenure.
Provision of Funds: The company ensures that it has sufficient
funds available for the redemption. The funds can come from various sources
such as accumulated profits, specific reserve funds, fresh issue of shares or
debentures, or the utilization of the Debenture Redemption Reserve.
Redemption Process: On the specified redemption dates, the company
makes the necessary arrangements to repay the debentureholders. It pays the
principal amount along with any redemption premium as per the terms of the
debenture agreement.
Communication with Debentureholders: The company communicates the redemption
details, including the redemption dates, redemption amount, and the process for
claiming the redemption proceeds, to the debentureholders well in advance. This
allows the debentureholders to prepare for the redemption and claim their dues.
Accounting Treatment: The redemption of debentures is recorded in the
company's books of accounts. The debenture liability is reduced by the amount
redeemed, and a corresponding entry is made to reflect the payment in the
balance sheet. The Debenture Redemption Reserve is adjusted to reflect the
utilization of funds for the redemption.
The
procedure for the redemption of debentures out of a fresh issue involves
careful planning, communication, and allocation of funds to ensure a smooth
repayment process. It allows the company to fulfill its financial obligations
and maintain a healthy capital structure.
Q.2. Explain
redemption out of profit and out of capital?
Ans. Redemption of debentures can be done either out of profit or out of
capital. Here's an explanation of both methods:
Redemption out of Profit:
Redemption
out of profit refers to the repayment of debentures using the profits earned by
the company. The redemption amount is paid to the debentureholders from the
accumulated profits of the company. The key points to understand about
redemption out of profit are:
Legal Requirements: According to company law regulations in many
jurisdictions, debentures can only be redeemed out of profit. Companies need to
ensure that they have sufficient distributable profits available for the
redemption.
Creation of Debenture Redemption
Reserve (DRR): As a legal
requirement, companies are required to create a Debenture Redemption Reserve
(DRR) account. A portion of the company's profits is transferred to the DRR
over the years to accumulate funds for the redemption of debentures.
Accounting Treatment: The redemption out of profit is
accounted for by debiting the debenture liability and crediting the respective
bank or debentureholders' account. The amount transferred from the Debenture
Redemption Reserve is also adjusted accordingly.
Redemption
out of Capital:
Redemption
out of capital refers to the repayment of debentures using the company's
capital instead of profits. The capital can include various sources such as the
share premium account, the proceeds from the issue of new shares, or any other
capital reserves. The key points to understand about redemption out of capital
are:
Legal Requirements: Companies must comply with legal requirements
and obtain necessary approvals before redeeming debentures out of capital. In
some jurisdictions, it may require court approval or passing a special
resolution.
Capital Sources: Companies can utilize various sources of
capital to fund the redemption, such as the share premium account, capital
reserves, or the proceeds from the fresh issue of shares.
Accounting Treatment: The redemption out of capital is accounted for
by debiting the debenture liability and crediting the respective bank or debentureholders'
account. The capital utilized for the redemption is adjusted accordingly,
reflecting the reduction in the company's capital structure.
It is
important for companies to carefully consider their financial position, legal
requirements, and available resources before opting for redemption out of
profit or out of capital. They should ensure compliance with applicable laws
and maintain transparency in the redemption process to protect the interests of
debentureholders.
Q.3. What do
you mean by redemption of debenbtures? When the procedure for redemption of
debebtures in instalments?
Ans. Redemption
of debentures refers to the repayment or retirement of debentures by the
company to the debentureholders on or before the maturity date. It is the
process of returning the principal amount to the debentureholders along with
any interest or premium, if applicable.
When the
redemption of debentures is to be done in instalments, it means that the
repayment will be spread over multiple payments instead of a lump sum. The
procedure for redemption of debentures in instalments typically involves the
following steps:
Review the Terms: Companies need to review the terms and
conditions mentioned in the debenture agreement regarding the redemption of
debentures. It includes the specific provisions related to redemption, such as
the instalment amount, frequency of payments, and the dates for each
instalment.
Prepare Redemption Schedule: Based on the terms mentioned in the debenture
agreement, a redemption schedule is prepared. The schedule outlines the details
of each instalment, including the amount, due date, and any interest or premium
payable.
Notify Debentureholders: The company communicates the redemption plan to
the debentureholders by sending them a notice. The notice includes the details
of the redemption schedule, payment instructions, and any other relevant information.
Set Aside Redemption Amount: The company sets aside the funds required for
each instalment as per the redemption schedule. These funds can be sourced from
the company's profits, capital reserves, sinking fund, or any other designated
source.
Redemption Payment: On the specified due dates mentioned in the
redemption schedule, the company makes the redemption payments to the
debentureholders. The payments are typically made through electronic transfers
or cheques.
Accounting Treatment: The redemption payments are
recorded in the company's books of accounts. The debenture liability is reduced
by the amount redeemed, and the corresponding bank or debentureholders' account
is credited.
By
redeeming debentures in instalments, companies can spread out the repayment
over a period of time, reducing the immediate financial burden. This allows for
better financial planning and management of cash flows. However, it is crucial
for companies to strictly adhere to the redemption schedule and make timely
payments to fulfill their obligations towards the debentureholders.
