23. Redemption of debentures

Redemption of debentures means discharge of liability on account of debentures by making repayment to debenture holders. The method of redeeming debentures is decided at the time of issue. The following methods are adopted for redemption of debentures:
Redemption of Debentures after a Fixed Period : According to this method, the whole amount of debentures is paid to the debenture holders in lumpsum at the expiry of a specified period, i.e. at maturity.
Redemption at the Option of the Company : Sometimes, a company issues debentures on the condition that after a specified period, it can redeem the debentures at any time.
Redemption of Debentures by Drawing lots : Under this method the company redeems some of its debentures by making payment each year. The debentures to the redeemed every year are selected by lottery. Slips containing numbers of all debentures—one slip for one debenture—are placed in a drum and then the requisite number of slips are taken out blindfold.
Redemption by Purchasing own Debentures in the Open Market : The company, if authorised by its articles of association, can purchase its own debentures in the open market. If debentures are redeemed in such a way, then two purposes may be served—
(i) debentures so purchased may be cancelled or (ii) may be kept as investment. They may be utilised for re-issue when needed afterwards. Purchase of its own debentures is useful for the company when their market price is less than its printed price.
Redemption of Debentures by Conversion : Sometimes, debentures are redeemed by converting them into new classes of debentures or shares. If debenture holders find that the offer is beneficial to them, they will take advantage of this offer by converting their debentures into new class of debentures of shares.
Student should note that there are two resources to redeem the debentures as per the methods mentioned above.
(i) Redemption of debentures out of profits of the company.
(ii) Redemption of debentures out of capital of the company.
Redemption of debentures out of profits
Accounting Entries : When debentures are redeemed, their written price is debited to the debenture account and if the debentures are to be redeemed at premium, premium on redemption of debenture account is debited and the full amount of payment is credited to Cash or Bank account as follows :
Debenture A/c Dr
Premium on Redemption
of Debentures A/c Dr
To Bank A/c
(For debentures redeemed on premium)
Students may recall that at the time of issue of debentures at premium redemption account was credited. Now, this account has been closed by this entry.
If debentures are to be redeemed at discount, written price of debentures will be debited to debentures account and profit on redemption of debentures account is credited as under:
Debenture A/c Dr
To Profit on Redemption
of Debentures A/c
(For debentures repaid on discount)
On redemption of debentures at par, there will be following entry :
Debenture A/c Dr
To Bank A/c
(For debentures redeemed at par)
Redemption of Debentures out of Capital : When debentures are redeemed out of capital, the following journal entries will be made :
(i) Debentures A/c Dr
To Debentures Holder’s A/c
(For the amount of redemption became due to debenture holder’s A/c)
(ii) Debentures Holder’s A/c Dr
To Bank A/c
(For the debentures redeemed out of capital)
One entry can be done in place of above two entries :
Debentures A/c Dr
To Bank A/c
(For debentures redeemed out of capital)
redemption of debentures out of profit
According to this method, the amount required to redeem the debentures is transferred from profit & loss account to debenture redemption reserve account and debentures are redeemed. As a result, the amount of dividend becomes less. The following journal entries are made to redeem the debentures out of profit.
On redeeming the debentures: Debentures A/c Dr
To Bank A/c
(For the debentures redeemed)
On transferring amount from Profit and Loss Appropriation Account to Debentures Redemption Reserve Account :
Profit & Loss Appropriation A/c Dr.
Debentures Redemption
Reserve A/c or Dr
To General Reserve A/c
(For the amount of redemption transferred to Debentures Redemption Reserve A/c or General Reserve A/c)
So far as it is concerned where to show the debenture redemption reserve account, students know it pretty well that reserve account is shown on the liabilities side of the balance sheet. On the redemption of all the debentures, debenture redemption reserve account is transferred to general reserve account and in this way, this account is closed.
Redemption by provision
When a company makes provision for redemption of debentures, the debentures are redeemed out of this amount of provision. The amount thus provided is invested gainfully. So that this amount gradually grows and there is sufficient amount at disposal for the redemption of debentures. This provision is used in the following ways :
(i) By Sinking Fund Method.
(ii) By Insurance Policy Method.
Sinking Fund Method
It may not be worth while to withdraw a substantial amount from the working capital so as to pay off the debentures because it may affect the routine work of the company. Therefore, a fund is created to redeem the debentures. It is called sinking fund for redemption of debentures or debenture sinking fund.
A fixed amount is transferred for compound interest on this fund so as to provide desired amount after the fixed period. The money is invested in the fixed interest bearing securities along with annual amount of interest. This amount goes on growing. At the end of the specified period, these investments are sold. If the debentures are to be redeemed at a premium, that amount is also provided from these sinking funds.
The following accounting entries are passed in respect of transferring funds from the Profit and Loss Account :
At the end of the first year
On Transfer of a Specified Amount to Sinking Fund A/c :
Profit & Loss Appropriation A/c Dr
To Sinking Fund A/c
(For an amount of profit transferred to Sinking Fund A/c)
On the Investment of this Specified Amount in Securities:
Sinking Fund Investment A/c Dr
To Bank A/c
(For an amount invested in securities)
At the end of Subsequent years
On receipt of interest on investment, it is debited to Cash or Bank A/c and credited to Sinking Fund Investment A/c:
Bank or Cash A/c Dr
To Interest on Sinking Fund
Investment A/c.
(For annual interest received on sinking fund investment)
On Transfer of Interest to Sinking Fund Investment Account
Interest on Sinking Fund
Investment A/c Dr
To Sinking Fund A/c
(For interest received transferred to Sinking Fund Investment A/c)
On Transferring of the Annual Installment to Sinking Fund A/c:
Profit & Loss Appropriation A/c
To Sinking Fund A/c
(For the amount of annual instalment transferred to Sinking Fund
A/c)
On Investing the Annual Installment along with interest in Securities :
Sinking Fund Investment A/c Dr
To Bank A/c
(For the annual installment alongwith interest invested in Securities)
Note : Before the final year, the above four entries will be made every year.
At the end of the final years
On Receipt of Interest on Investment:
Bank or Cash A/c Dr
To Interest on Sinking Fund Investment A/c
(For interest received on investment)
On Transferring of Interest Received from Investment to Sinking Fund Account :
Interest on Sinking Fund A/c Dr
To Sinking Fund A/c
(For interest on investments transferred to sinking fund account)
Note : During the final year, interest is not invested.
A Specified Amount of Profit is Debited to Profit & Loss Appropriation Account and Credited to Sinking Fund Account
Profit & Loss Appropriation A/c Dr.
To Sinking Fund A/c
(For annual installment of profit transferred to Sinking fund Account)
Note : The amount of installment is not invested during the final year.
On Disposing off Investment : The amount received from the sale of investment is debited to Cash or Bank
A/c and credited to Sinking Fund Account as :
Bank or Cash A/c
To Sinking Fund Investment A/c
(For investment sold in the market)
Profit or Loss on Sale of Investment is Transferred to Sinking Fund Investment Account :
In case of Profit : Sinking Fund Investment Account in debited and Sinking Fund Account is credited as follows :
Sinking Fund Investment A/c Dr.
To Sinking Fund A/c
(For profit on sale of securities debited to a sinking fund investment account)
In Case of Loss : Sinking Fund Account is debited and Sinking Fund Investment Account is credited :
Sinking Fund A/c Dr
To Sinking Fund Investment A/c
(For Loss on sale of investment transferred to Sinking Fund A/c)
On Redemption of Debentures : Debenture Account is debited and bank account is credited to redeem debentures :
Debentures A/c Dr
To Bank A/c
(Being debentures redeemed on due date)
On Transfer of Sinking Fund Account to General Reserve Account :
Sinking fund account is debited and general reserve account is credited :
Sinking Fund A/c Dr
To General Reserve A/c
(For sinking fund account transferred to general reserve account)
Note : If a company transfers an account every year to sinking fund, which is sufficient to redeem the debentures, debenture redemption reserve account is not opened.
Insurance policy method
Under this method, an insurance policy is taken to redeem the debentures after a specified period and an installment for it is paid regularly in the beginning of every year. On the maturity of policy, the insured amount is received from the insurance company and with this amount debentures are redeemed. According to this method, insurance policy account is opened in place of redemption fund investment account. The following journal entries are made every year.
On Payment of Insurance Premium at the Beginning of Each Year:
Debentures Redemption Fund
Policy A/c Dr
To Bank A/c
(For the installment of annual premium paid)
On Making Provision for Installment of Insurance Premium :
Profit & Loss Appropriation A/c Dr
To Debenture Redemption Fund A/c
(For provision made for insurance premium)
On Receiving the Specified Amount of the Policy from the Insurance Company:
Bank A/c Dr
To Debenture Redemption Fund
Policy A/c
(For the Amount of policy received on maturity from the insurance company)
On Redemption of Debentures :
Debentures A/c Dr
To Bank A/c
(For the debentures redeemed)
On Transferring the Balance of Debentures Redemption Fund Account to General Reserve Account:
Debentures Redemption Fund A/c
To General Reserve A/c
(For the debentures redemption fund transferred to general reserve account)
redemption of debentures by lottery system
According to this method, a company redeems some debentures every year. Number of debentures to be redeemed are written separately on pieces of proper of equal size and are put in a drum and turned upside down properly. After that, the number of slips equivalent to number of debentures to be redeemed are taken out and the amount of debentures is paid to debenture holders as per the number of debentures written on the slips thus taken out. The following journal entry is made to redeem the debentures in this way :
Debenture A/c Dr
To Bank A/c
(For debentures redeemed)
Redemption by Purchasing Own Debentures in the Open Market : A company can redeem its debentures also by purchasing them in the open market. The company can either keep the debentures thus purchased as an amount of investment or cancel them. While purchasing its own shares in the open market, the price can be lesser or higher than the written price. In case of market price being higher than the printed price, the following journal entry will be made:
Debentures A/c Dr
To Loss on Redemption of
Debentures A/c
(For own debentures purchased in the open market at a premium)
On Purchasing Debentures in the Open Market at lower than the Printed Price :
Debentures A/c Dr
To Bank A/c
To Profit on Redemption of
Debentures A/c
(For own debentures purchased in the open market at discount)
Note : Loss on purchasing own shares at higher than the printed price should be transferred to Profit & Loss Account and profit on purchasing own shares at lower than printed price should be transferred to capital reserve account.
Redemption of Debentures by conversion
Sometimes, debentures are redeemed by converting them into a new class of debentures or shares. If the holders of the debentures get benefited by the offer, they will take advantage of this proposal. These new shares or debentures may be issued at par, at premium or at discount. But in case of issuing them at discount, permission of the Company Law Board is obligatory. It may be noted that no debenture redemption reserve is required in case of convertible debentures.
There is no legal restriction on conversion of debentures into share except when debentures to be converted were issued at discount. In such a situation, the actual proceeds of the issue (and not face value) of debentures should be considered in determining the number of shares to be issued in exchange of the debenture to be converted because the issue price of shares or new debentures must be equal to the amount actually received from the debentures holder at the time of issue of these debentures. If this rule is not followed the provision of the Companies Act, 1956 will be violated.