Class 12 Accountancy Notes Chapter 2 (Issue and Redemption of Debentures) – Accountancy-II Book

Detailed Notes with MCQs of a crucial chapter for your exams: 'Issue and Redemption of Debentures'. This chapter deals with how companies raise long-term debt capital and how they eventually repay it. Understanding the concepts and accounting treatments here is vital.

Chapter 2: Issue and Redemption of Debentures - Detailed Notes

1. Meaning and Definition of Debentures

• Definition: As per Section 2(30) of the Companies Act, 2013, "Debenture" includes debenture stock, bonds, or any other instrument of a company evidencing a debt, whether constituting a charge on the assets of the company or not.
• Nature: It is essentially a written acknowledgement of debt taken by the company.
• Key Characteristics:
  • Loan Capital: Represents borrowed funds, not ownership capital.
  • Fixed Rate of Interest: Debenture holders receive interest at a predetermined fixed rate, payable periodically (usually half-yearly), irrespective of profits.
  • Charge on Assets: Debentures can be secured (creating a fixed or floating charge on company assets) or unsecured. Secured debentures offer more safety to investors.
  • No Voting Rights: Debenture holders are creditors, not owners, and generally do not have voting rights in company meetings.
  • Repayment: Principal amount is repaid on a specified future date (maturity) or earlier as per terms.

2. Distinction between Shares and Debentures

3. Types of Debentures

• (a) From Security Point of View:
  • Secured Debentures: Secured by a charge (fixed or floating) on the assets of the company.
  • Unsecured Debentures: Not secured by any specific charge on assets.
• (b) From Tenure Point of View:
  • Redeemable Debentures: Repayable at the end of a specific period or upon notice.
  • Irredeemable (Perpetual) Debentures: Not repayable during the company's lifetime; repaid only on winding up or after a very long period. (Note: Companies Act, 2013 restricts issue of irredeemable debentures).
• (c) From Convertibility Point of View:
  • Convertible Debentures: Can be converted into equity shares or other securities after a specified period.
  • Non-Convertible Debentures: Cannot be converted into shares.
• (d) From Coupon Rate Point of View:
  • Specific Coupon Rate Debentures: Carry a fixed rate of interest (e.g., 9% Debentures).
  • Zero Coupon Rate Debentures: Do not carry a specific interest rate. Issued at a discount and redeemed at par/premium. The difference is the implicit interest.
• (e) From Registration Point of View:
  • Registered Debentures: Recorded in the company's Register of Debenture holders. Interest and principal are paid only to registered holders. Transfer requires a formal deed.
  • Bearer Debentures: Transferable by mere delivery. Interest is paid via coupons attached to the debenture certificate.

4. Issue of Debentures

Debentures can be issued:

• (A) For Cash:

  • At Par: Issue Price = Face Value (Nominal Value).

  • At Premium: Issue Price > Face Value. (Premium is a capital profit, credited to 'Securities Premium Account').

  • At Discount: Issue Price < Face Value. (Discount is a capital loss, debited to 'Discount on Issue of Debentures Account'). Note: Section 53 of the Companies Act, 2013 prohibits the issue of shares at a discount, but allows the issue of debentures at a discount subject to conditions.

  • Accounting Entries (Lump Sum Payment):

    • On Application Receipt: Bank A/c Dr. / To Debenture Application & Allotment A/c
    • On Allotment (At Par): Debenture Application & Allotment A/c Dr. / To X% Debentures A/c
    • On Allotment (At Premium): Debenture Application & Allotment A/c Dr. / To X% Debentures A/c / To Securities Premium A/c
    • On Allotment (At Discount): Debenture Application & Allotment A/c Dr. / Discount on Issue of Debentures A/c Dr. / To X% Debentures A/c

  • Accounting Entries (Instalments): Similar to share issue - Application, Allotment, First Call, Final Call stages.

• (B) For Consideration Other than Cash:

  • To Vendors (Purchase of Assets/Business): When a company buys assets or a running business and pays the vendor by issuing debentures.
    • Purchase Entry: Sundry Assets A/c Dr. / (Goodwill A/c Dr. - if Purchase Consideration > Net Assets) / To Sundry Liabilities A/c / To Vendor A/c / (To Capital Reserve A/c - if Purchase Consideration < Net Assets)
    • Issue of Debentures (At Par): Vendor A/c Dr. / To X% Debentures A/c
    • Issue of Debentures (At Premium): Vendor A/c Dr. / To X% Debentures A/c / To Securities Premium A/c
    • Issue of Debentures (At Discount): Vendor A/c Dr. / Discount on Issue of Debentures A/c Dr. / To X% Debentures A/c
  • To Promoters: For services rendered (incorporation expenses).
    • Incorporation Costs/Formation Expenses A/c Dr. / To Promoters A/c
    • Promoters A/c Dr. / To X% Debentures A/c (or with Premium/Discount as applicable)
  • To Underwriters: For underwriting commission.
    • Underwriting Commission A/c Dr. / To Underwriters A/c
    • Underwriters A/c Dr. / To X% Debentures A/c (or with Premium/Discount as applicable)

• (C) As Collateral Security:

  • Meaning: When a company takes a loan (primary security) and provides its debentures as additional security (collateral security) to the lender.
  • Accounting Treatment:
    • Method 1 (No Entry): No journal entry is passed for issuing debentures as collateral. A note is simply added in the Balance Sheet below the loan details.
    • Method 2 (Entry Passed):
      • On Issue: Debenture Suspense A/c Dr. / To X% Debentures A/c
      • Balance Sheet Presentation: X% Debentures shown under Long-Term Borrowings, and Debenture Suspense A/c deducted from it. Net effect is Nil until the loan defaults.
      • On Loan Repayment: Reverse the entry: X% Debentures A/c Dr. / To Debenture Suspense A/c.

5. Terms of Issue of Debentures (Considering Redemption)

This combines issue price (Par, Premium, Discount) with redemption price (Par, Premium). Note: Redemption at discount is generally not practical.

• Case 1: Issued at Par, Redeemable at Par: Standard entry.
• Case 2: Issued at Discount, Redeemable at Par: Discount on Issue A/c Dr. at the time of issue.
• Case 3: Issued at Premium, Redeemable at Par: Securities Premium A/c Cr. at the time of issue.
• Case 4: Issued at Par, Redeemable at Premium:
  • At Issue: Bank A/c Dr. / Loss on Issue of Debentures A/c Dr. (Amount of Premium on Redemption) / To X% Debentures A/c / To Premium on Redemption of Debentures A/c (Liability)
• Case 5: Issued at Discount, Redeemable at Premium:
  • At Issue: Bank A/c Dr. / Loss on Issue of Debentures A/c Dr. (Discount + Premium on Redemption) / To X% Debentures A/c / To Premium on Redemption of Debentures A/c (Liability)
  • Note: 'Loss on Issue of Debentures A/c' includes both discount and the premium payable on redemption.
• Case 6: Issued at Premium, Redeemable at Premium:
  • At Issue: Bank A/c Dr. / Loss on Issue of Debentures A/c Dr. (Premium on Redemption) / To X% Debentures A/c / To Securities Premium A/c (Premium on Issue) / To Premium on Redemption of Debentures A/c (Liability)

6. Interest on Debentures

• Nature: A charge against profits, payable even if the company incurs losses.
• Calculation: Calculated at the fixed coupon rate on the face value of debentures for the relevant period.
• TDS (Tax Deducted at Source): Company usually deducts income tax at the prescribed rate before paying interest to debenture holders and deposits it with the government.
• Accounting Entries:
  • For Interest Due: Debenture Interest A/c Dr. / To Debenture holders A/c / To TDS Payable A/c
  • For Payment to Debenture holders: Debenture holders A/c Dr. / To Bank A/c
  • For Payment of TDS: TDS Payable A/c Dr. / To Bank A/c
  • Transfer to P&L: Statement of Profit and Loss Dr. / To Debenture Interest A/c (Total interest amount)

7. Writing Off Discount / Loss on Issue of Debentures

• Nature: Capital loss.
• Writing Off: Should be written off over the tenure of the debentures. However, if allowed by accounting standards/law, it can be written off earlier.
• Source for Writing Off (Order of Preference):
  1. Securities Premium Account (if available)
  2. Capital Reserve (if available and represents realised capital profits)
  3. Statement of Profit and Loss
• Accounting Entry:
  • Securities Premium A/c Dr. (or)
  • Capital Reserve A/c Dr. (or)
  • Statement of Profit and Loss Dr.
  • To Discount on Issue of Debentures A/c
  • To Loss on Issue of Debentures A/c

8. Redemption of Debentures

Meaning: Repayment of the amount of debentures to the debenture holders.

Sources of Finance for Redemption:

• Proceeds from fresh issue of Shares or Debentures.
• Accumulated Profits (Out of Profits).
• Sale of Assets (Out of Capital - generally implies redemption without specific earmarking of profits).

Legal Requirements (Companies Act, 2013 & SEBI Guidelines):

• (A) Debenture Redemption Reserve (DRR):

  • Purpose: To protect investors' interests by ensuring funds are set aside from profits for redemption.
  • Creation: An amount must be transferred from Surplus (Statement of P&L) to DRR before redemption starts.
  • Requirement: Generally, DRR equal to at least 25% of the nominal value of outstanding debentures must be created (for non-NBFCs/HFCs/Listed Companies).
  • Exemptions: All India Financial Institutions (AIFIs), Banking Companies, Other Financial Institutions, Listed Companies (other than NBFCs/HFCs), Unlisted NBFCs/HFCs are generally exempt from creating DRR for privately placed or publicly issued debentures. Always check current regulations as they can change.
  • Accounting Entries:
    • Creation: Surplus (Statement of Profit and Loss) Dr. / To Debenture Redemption Reserve A/c
    • Utilisation (After redemption): Debenture Redemption Reserve A/c Dr. / To General Reserve A/c

• (B) Debenture Redemption Investment (DRI):

  • Purpose: To ensure liquid funds are available for redemption.
  • Requirement: Companies required to create DRR must, on or before 30th April each year, invest or deposit a sum which shall not be less than 15% of the amount of debentures maturing during the year ending on 31st March of the next year.
  • Investment: In specified securities/deposits.
  • Accounting Entries:
    • Making Investment: Debenture Redemption Investment A/c Dr. / To Bank A/c
    • Encashing Investment (at time of redemption): Bank A/c Dr. / To Debenture Redemption Investment A/c (Profit/Loss on sale also accounted for).

Methods of Redemption:

• (a) Redemption in Lump Sum at Maturity: All debentures redeemed on the specified date.

  • Entry (if redeemed at Par): X% Debentures A/c Dr. / To Debenture holders A/c
  • Debenture holders A/c Dr. / To Bank A/c
  • Entry (if redeemed at Premium): X% Debentures A/c Dr. / Premium on Redemption of Debentures A/c Dr. / To Debenture holders A/c
  • Debenture holders A/c Dr. / To Bank A/c

• (b) Redemption in Instalments (Draw of Lots): Redemption happens in parts over several years, decided by drawing lots. Entries are similar to lump sum, but only for the portion being redeemed. DRR/DRI rules apply proportionally.

• (c) Redemption by Purchase in Open Market: Company buys its own debentures from the market if available at a favourable price (below redemption value).

  • Purpose: Usually for cancellation (saves interest, avoids premium on redemption if bought below par).
  • Accounting Entries (for immediate cancellation):
    • Purchase: Own Debentures A/c Dr. (Purchase Cost) / To Bank A/c
    • Cancellation (if purchased at discount): X% Debentures A/c Dr. (Face Value) / To Own Debentures A/c (Purchase Cost) / To Profit on Redemption/Cancellation of Debentures A/c (Capital Profit -> Transfer to Capital Reserve)
    • Cancellation (if purchased at premium): X% Debentures A/c Dr. (Face Value) / Loss on Redemption/Cancellation of Debentures A/c Dr. (Loss) / To Own Debentures A/c (Purchase Cost) (Loss -> Write off against Capital Reserve/Sec Premium/P&L)

• (d) Redemption by Conversion: Debenture holders are given an option to convert their holdings into shares or new debentures.

  • Accounting Entry (Conversion into Equity Shares at Par):
    • X% Debentures A/c Dr. (Face Value) / (Premium on Redemption A/c Dr. - if applicable) / To Debenture holders A/c
    • Debenture holders A/c Dr. / To Equity Share Capital A/c / (To Securities Premium A/c - if shares issued at premium) / (Discount on Issue of Shares A/c Dr. - if allowed & applicable, generally not allowed now)
  • Note: The number of shares issued depends on the amount due to debenture holders and the issue price of the new shares.

Multiple Choice Questions (MCQs)

1. Debentures represent:
   a) Owner's capital
   b) Long-term borrowings of a company
   c) Short-term borrowings of a company
   d) Directors' share in the company

2. Interest paid on debentures is:
   a) An appropriation of profit
   b) A charge against profit
   c) A transfer to reserve
   d) Dependent on company profitability

3. When debentures are issued at a discount but redeemable at a premium, the total loss (Discount + Premium on Redemption) is debited to:
   a) Discount on Issue of Debentures A/c
   b) Premium on Redemption of Debentures A/c
   c) Loss on Issue of Debentures A/c
   d) Statement of Profit and Loss

4. As per SEBI guidelines (for companies required to create DRR), Debenture Redemption Reserve (DRR) should be created equivalent to at least what percentage of the face value of debentures to be redeemed?
   a) 10%
   b) 15%
   c) 25%
   d) 50%

5. A company purchased assets worth ₹9,00,000 and issued 10% Debentures of ₹100 each at a discount of 10% to the vendor. The number of debentures issued is:
   a) 9,000
   b) 10,000
   c) 8,100
   d) 9,900

6. Debentures issued as collateral security will be shown in the Balance Sheet:
   a) As Long-Term Borrowings only
   b) As Short-Term Borrowings only
   c) By way of a note to the loan account or by deducting Debenture Suspense from Debentures under Long-Term Borrowings
   d) Not shown anywhere in the Balance Sheet

7. Profit on cancellation of own debentures (purchased in the open market at a discount) is transferred to:
   a) General Reserve
   b) Statement of Profit and Loss
   c) Capital Reserve
   d) Securities Premium Account

8. Debenture Redemption Investment (DRI) must be made on or before 30th April of the year in which redemption is due, amounting to at least:
   a) 15% of debentures maturing during the current year
   b) 25% of debentures maturing during the current year
   c) 15% of debentures maturing during the next year (by March 31st)
   d) 100% of debentures maturing during the current year

9. Which account is debited when interest on debentures becomes due?
   a) Bank A/c
   b) Debenture holders A/c
   c) Debenture Interest A/c
   d) Statement of Profit and Loss

10. Zero Coupon Bonds are issued:
    a) At premium
    b) At par
    c) At a discount
    d) With variable interest rate

Answer Key for MCQs:

1. b
2. b
3. c
4. c
5. b (Calculation: 9,00,000 / (100 - 10) = 9,00,000 / 90 = 10,000 debentures)
6. c
7. c
8. c
9. c
10. c

Remember to thoroughly understand the journal entries for each scenario, especially the treatment of loss on issue when redemption is at a premium, and the requirements related to DRR and DRI. Good luck with your preparation!