Accountancy Chapter 2.2 – Issue and Redemption of Debentures

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Chapter 2.2 – Issue and Redemption of Debentures

Accountancy Chapter 2.2 – Issue and Redemption of Debentures

1. Introduction to Debentures

  • Definition:
    Debentures are long-term debt instruments issued by companies to raise funds. They are governed by Section 2(30) of the Companies Act, 2013, which defines them as securities (including bonds, debentures, or other instruments) that acknowledge a debt.
    • Legal Aspects:
      • Debentures must be repaid with interest, even if the company incurs losses.
      • They can be secured (backed by assets) or unsecured.
    • Key Features:
      • Fixed interest rate (coupon rate) paid periodically (e.g., semi-annually).
      • No voting rights for debentureholders.
      • Repayment terms: Redeemable after a fixed period or at the company’s discretion.

2. Differences Between Shares and Debentures

Expanding on the table with additional distinctions:

ParameterSharesDebentures
Legal StatusOwners of the company.Creditors of the company.
Tax TreatmentDividends are not tax-deductible.Interest is tax-deductible.
PriorityLast in liquidation.Priority over shareholders.
RiskHigher risk (variable returns).Lower risk (fixed returns).

3. Types of Debentures

A. Based on Security

  1. Secured Debentures:
    • Fixed Charge: Specific assets (e.g., land, machinery) are mortgaged. If the company defaults, these assets are sold to repay debentureholders.
    • Floating Charge: Covers general assets (e.g., inventory, receivables). The charge “crystallizes” (becomes fixed) upon default.
    • Example: A company issues Rs. 10 lakh debentures secured by its factory building.
  2. Unsecured Debentures:
    • No collateral. Rarely issued due to high risk for investors.

B. Based on Tenure

  1. Redeemable Debentures:
    • Repaid after a fixed period (e.g., 5–10 years).
    • Example: ABC Ltd. issues 8% debentures redeemable after 7 years.
  2. Irredeemable Debentures:
    • Repayable only upon company liquidation.

C. Based on Convertibility

  1. Convertible Debentures:
    • Fully Convertible: Entire debt converts to equity shares after a specified period.
      • Example: Rs. 100 debenture converts to 10 equity shares of Rs. 10 each.
    • Partly Convertible: Only a portion converts to shares.
  2. Non-Convertible Debentures (NCDs):
    • No conversion option. Common in India (e.g., Tata Motors NCDs).

D. Based on Coupon Rate

  1. Specific Rate Debentures:
    • Fixed Rate: 10% p.a. interest.
    • Floating Rate: Linked to benchmark rates (e.g., RBI repo rate + 2%).
  2. Zero Coupon Debentures:
    • Issued at a discount (e.g., Rs. 800 for Rs. 1,000 face value).
    • No periodic interest; profit = redemption value – issue price.

E. Based on Registration

  1. Registered Debentures:
    • Holder details recorded in a register. Transfer requires a deed.
  2. Bearer Debentures:
    • Transferable by delivery. Interest paid via coupons attached to debentures.

4. Accounting for Issue of Debentures

A. Issue at Par

  • Example: Rs. 100 debentures issued at Rs. 100.
    • Journal Entries:
 (1) Bank A/c Dr. 10,00,000 
      To Debenture Application & Allotment A/c 10,00,000 
   (Application money received) 
(2) Debenture Application & Allotment A/c Dr. 10,00,000 
      To 12% Debentures A/c 10,00,000 
   (Allotment completed) 
  • Balance Sheet Impact:
    • Liabilities: “12% Debentures” under Non-Current Liabilities.
    • Assets: “Cash at Bank” increases by Rs. 10,00,000.

B. Issue at Discount

  • Example: Rs. 100 debentures issued at Rs. 95 (5% discount).
    • Journal Entries:
Bank A/c Dr. 9,50,000 
Loss on Issue of Debentures A/c Dr. 50,000 
  To 12% Debentures A/c 10,00,000 
  • Amortization of Discount:
    • Written off over the debenture’s tenure (e.g., 5 years).
    • Entry Annually:
Statement of Profit & Loss Dr. 10,000 
  To Loss on Issue of Debentures A/c 10,000 

C. Issue at Premium

  • Example: Rs. 100 debentures issued at Rs. 110 (10% premium).
    • Journal Entries:
Bank A/c Dr. 11,00,000 
  To 12% Debentures A/c 10,00,000 
  To Securities Premium Reserve A/c 1,00,000 
  • Balance Sheet:
    • Liabilities: “12% Debentures” Rs. 10,00,000 + “Securities Premium Reserve” Rs. 1,00,000.

5. Special Cases of Issue

A. Over-Subscription

  • Example: Company issues 10,000 debentures but receives 14,000 applications.
    • Steps:
      1. Reject excess 4,000 applications.
      2. Adjust excess money:
        • Refund if no allotment.
        • Adjust surplus to allotment/call money.
    • Journal Entry for Adjustment:
Debenture Application A/c Dr. 5,60,000 
  To Debenture Allotment A/c 40,000 
  To Bank A/c 1,20,000 
  To 12% Debentures A/c 4,00,000 

B. Consideration Other Than Cash

  • Example: Purchasing machinery worth Rs. 2,00,000 by issuing debentures.
    • Journal Entries:
(1) Machinery A/c Dr. 2,00,000 
      To Vendor A/c 2,00,000 
   (Asset purchased) 

(2) Vendor A/c Dr. 2,00,000 
      To 12% Debentures A/c 2,00,000 
   (Debentures issued as payment)
  • Goodwill/Capital Reserve:
    • If purchase consideration ≠ net asset value, adjust via Goodwill (excess payment) or Capital Reserve (discount).

C. Collateral Security

  • Example: Loan of Rs. 10 lakh secured by debentures worth Rs. 12 lakh as collateral.
    • Accounting Methods:
      1. Disclosure Only:
        • Note in balance sheet: “Loan secured by 12,000 debentures as collateral.”
      2. Debenture Suspense Account:
Debenture Suspense A/c Dr. 12,00,000 
  To 12% Debentures A/c 12,00,000 
  • On Repayment: Reverse the entry.

6. Terms of Redemption

  • Redemption at Par: Repay face value (e.g., Rs. 100 debenture repaid at Rs. 100).
  • Redemption at Premium: Repay above face value (e.g., Rs. 100 debenture repaid at Rs. 110).
    • Accounting:
Loss on Issue of Debentures A/c Dr. 10 
  To Premium on Redemption A/c 10 
  • Premium is a liability until redemption.

7. Redemption Methods

A. Lump-Sum Payment

  • Journal Entries:
(1) 12% Debentures A/c Dr. 5,00,000 
      To Debentureholders A/c 5,00,000 
   (Liability recorded) 

(2) Debentureholders A/c Dr. 5,00,000 
      To Bank A/c 5,00,000 
   (Payment made) 

B. Installments

  • Example: Redeem Rs. 10 lakh debentures in 5 annual installments.
    • Steps:
      1. Create Debenture Redemption Reserve (DRR): 10% of outstanding debentures.
      2. Invest in specified securities (15% of redemption amount).
    • Journal Entry for DRR:
Statement of Profit & Loss Dr. 1,00,000 
  To Debenture Redemption Reserve A/c 1,00,000

C. Purchase in Open Market

  • Example: Buy back Rs. 100 debentures at Rs. 95.
(1) Own Debentures A/c Dr. 95 
      To Bank A/c 95 
   (Purchase) 

(2) 12% Debentures A/c Dr. 100 
      To Own Debentures A/c 95 
      To Capital Reserve A/c 5 
   (Cancellation and profit transfer) 

D. Conversion to Shares

  • Example: Convert Rs. 1,00,000 debentures into 10,000 equity shares (Rs. 10 each).
12% Debentures A/c Dr. 1,00,000 
  To Equity Share Capital A/c 1,00,000 
  • Premium on Conversion:
    • If shares issued at Rs. 12 (premium Rs. 2):
12% Debentures A/c Dr. 1,00,000 
  To Equity Share Capital A/c 1,00,000 
  To Securities Premium Reserve A/c 20,000 

8. Interest on Debentures

  • Accounting Entries:
(1) Debenture Interest A/c Dr. 1,00,000 
      To TDS Payable A/c 10,000 
      To Debentureholders A/c 90,000 
   (Interest due) 

(2) Debentureholders A/c Dr. 90,000 
      To Bank A/c 90,000 
   (Payment) 

(3) TDS Payable A/c Dr. 10,000 
      To Bank A/c 10,000 
   (Tax deposited)

9. Legal and Regulatory Compliance

  • SEBI Guidelines:
    • Debenture Redemption Reserve (DRR):
      • Unlisted Companies: 10% of outstanding debentures.
      • Listed Companies: Exempt for infrastructure projects.
    • Investment in Specified Securities:
      • 15% of redemption amount to be invested in government bonds or bank deposits.

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