Accountancy for Class 12, Part 1, Chapter 2 Issue and Redemption of Debentures

Learn CBSE Accountancy Index Terms for Class 12, Part I, Chapter 2 Issue and Redemption of Debentures

1. Debentures – It refers to the second line of security that is applicable for the original loan taken by the company. If such a situation arises that the borrower fails to make payment of the original loan amount, then the collateral security can be realised.

A debenture is a kind of debt instrument that isn’t supported by any security and generally has a term of more than 10 years. Debentures are sponsored simply by the financial soundness and by the goodwill of the guarantor. The enterprises and governments, as often as possible, issue debentures to raise capital or assets.

2. Secured Debentures – Secured debentures are the kind of debentures where a charge is being established on the properties or assets of the enterprise for the purpose of any payment. The charge might be either floating or fixed.

The fixed charge is established against those assets which come under the enterprise’s possession for the purpose to use in activities not meant for sale. Whereas, the floating charge comprises all assets, excluding those accredited to the secured creditors. A fixed charge is established on a particular asset, whereas a floating charge is on the general assets of the enterprise.

3. Unsecured Debentures – They do not have a particular charge on the assets of the enterprise. However, a floating charge may be established on these debentures by default. Usually, these types of debentures are not circulated.

4. Redeemable Debentures – These debentures are due at the cessation of the time frame, either in a lump sum or in instalments during the lifetime of the enterprise. Debentures can be reclaimed either at a premium or at par.

5. Irredeemable Debentures – These debentures are also called ‘perpetual debentures’ as the company doesn’t make any attempt to repay money acquired or borrowed by circulating such debentures. These debentures are repayable on the closing up of an enterprise or on the expiry (cessation) of a long period.

6. Convertible Debentures – Debentures that are changeable to equity shares or in any other security, additionally, at the choice of the enterprise or the debenture holders, are called convertible debentures. These debentures are either entirely convertible or partly changeable.

7. Non-convertible Debentures – The debentures which cannot be changed into shares or in other securities are called non-convertible debentures. Most debentures circulated by enterprises fall in this class.

8. Specific Coupon Rate Debentures – Such debentures are circulated with a mentioned rate of interest, and it is known as the coupon rate.

9. Zero Coupon Rate Debentures – These debentures don’t normally carry a particular rate of interest. In order to restore the investors, such types of debentures are circulated at a considerable discount, and the difference between the nominal value and the circulated price is treated as the amount of interest associated with the duration of the debentures.

10. Registered Debentures – These debentures are such debentures within which all details comprising addresses, names, and particulars of holding of the debenture holders are filed in a register kept by the enterprise. Such debentures can be moved only by performing a normal transfer deed.

11. Bearer Debentures – These debentures are debentures that can be transferred by way of delivery, and the company does not keep any record of the debenture holders. Interest on debentures is paid to a person who produces the interest coupon attached to such debentures.

12. Issue of Debentures for Shares – The issue of debentures seems to be much like the issue of shares by an enterprise. Here, the money can be accumulated either in a lump sum or in instalments. The accounting treatment of the two is quite alike. Now, the debentures can be either issued for some other considerations or cash. Often, the issue or circulation of debentures is done as collateral security.

13. Issue of Debentures for Cash – Debentures in accustomed progress of the business concern are circulated for cash. Circulation of debentures that occurs can be categorised into three types, the issue of shares at a discount, at a premium, and at par.

14. Issue of Debenture at a Discount – When the debentures are circulated below the face value, this type of circulation of debentures is called a discount issue. Say, for instance, the debenture possesses a nominal value of 400 Rupees but is issued for 390 Rupees. This type of debenture is known to be issued at a discount.

15. Debentures Issued at a Premium – The issue of debentures at a premium is when the money is charged more than the nominal value. The premium amount charged to a special account is known as ‘Securities Premium Reserve A/c’. This account shall be depicted on the liabilities side of the balance sheet below the heading reserves and surplus. So, if a debenture with a face value of 400 Rupees is sold at 410 Rupees, then it is circulated at a premium.

16. Over Subscription of Debentures – Over subscription of debentures is referred to as the scenario when the company receives applications for debentures that are much more in number than the debentures offered by the company to the public.

17. Issue of Debentures for Consideration other than Cash – If a company purchases assets from its suppliers or vendors, then instead of paying them in cash, the company issues debentures to them. This is known as the issue of debenture for consideration other than cash. The issue of debenture for consideration other than cash serves the purpose of both the vendor as well as of the purchaser (company).

From the purchaser’s point of view, purchasing an asset against the issue of debentures requires no additional cost for raising loans or arranging funds immediately. On the other hand, the vendor gets interest on the amount of debentures received. In this case, payment is deferred by the issue of debentures, and interest is paid for time lag payment. Debentures may be issued at par, premium, or discount to the vendor.

18. Issue of Debentures as a Collateral Security – Collateral security is a system of subordinate (secondary) protection which is often required by the bank, and is implied to assure a debtor’s conduct on the debt obligation. The elementary security on the considerable trading loan is normally the part that is being financed, namely, shipment or a company car, or a factory. Collateral or secondary security might be requested by the bank to help in the process of guaranteeing so that the loan would be repaid on time. In such situations, the enterprise may circulate its own debentures to the bankers in addition to some other assets guaranteed. Such type of issue of debentures is referred to as ‘debentures issued as collateral security’.

19. Interest on Debentures – An interest paid is an award to all the debenture holders for investing in the debentures of an enterprise. Usually, interest is paid in a periodical systematic manner at a fixed rate of interest on the face value of the debentures and is being treated as a charge on the profits.

When an enterprise circulates debentures, it provides interest on debentures at a fixed rate on its nominal (face) value payable quarterly, half-yearly or yearly as per the terms of issue. This percentage is normally a part and parcel of the name of debentures like 8% debentures, 10% debentures, and interest payable is computed at the nominal value of debentures.

Interest on debenture is a charge opposite to the profit of the enterprise and has to be paid whether the enterprise has acquired any profit. According to the Income Tax Act, 1961, an enterprise must deduct income tax at the recommended rate from the interest payable on debentures if it surpasses the guided limit. It is known as Tax Deducted at Source (TDS) and is to be accumulated and deposited with the tax authorities. The debenture holders can allocate this amount against the tax that is due to them.

20. Writing off Discount or Loss on Issue of Debentures – The loss or discount on the issue of debentures is typically a capital loss or a fictitious asset and, hence, has to be written off during the debentures’ lifetime. The amount of loss or discount on the issue of debentures should not be written off during the year of its issue since the benefit of the debentures would accumulate to the enterprise till their restitution or redemption.

The loss or discount, hence, is considered a capital loss. The discount might be charged to either securities premium A/c or might be written off over three to five years via the statement of profit and loss as per guidance circulated by ICAI (The Institute of Chartered Accountants of India).

21. Redemption of Debentures – Redemption of debentures refers to the payment of the amount of debentures by the enterprise. When debentures are reclaimed, liability on account of debentures is being discharged.

To put it in other words, the amount of capital needed for the redemption of debentures is large, and hence, economic enterprises make adequate provision out of gains and accrue capital to reclaim debentures.

It means repayment of the number of debentures to the debenture holders. Debentures can be redeemed either at par or at a premium. The terms and conditions of redemption are usually given in the prospectus inviting applications for the issue of debentures.

22. Bond – “A bond is a fixed income instrument that represents a loan made by an investor to a borrower.” In simpler words, a bond acts as a contract between the investor and the borrower. Most companies and governments issue bonds and investors buy those bonds as a savings and security option.

These bonds have a maturity date, and when once that is attained, the issuing company needs to pay back the amount to the investor along with a part of the profit. This kind of dealing with bonds between the issuer and the investor is done by brokers.

23. Payment in Lump Sum – Redemption in lump sum implies that debentures are repaid to debenture holders in a lump sum (at once) after a specified period. The company pays the amount to the debenture holders in a lump sum as per the terms of the issue of such debentures.

In other words, when the company redeems its debentures, at the end of the tenure by a single payment is called payment in a lump sum. The enterprise reclaims the debentures by paying the fund in a lump sum (round sum) to the debenture holders during the maturity, as per the terms and conditions of the issue.

24. Payments in Instalments – Under this method, usually redemption of debentures is paid in instalments on a particular date, during the time in the position of the debentures. The total amount of debenture liability is divided by the total number of years. This must be noted that the authentic debentures reclaimable are recognised by the sources of drawing, the required number of lots out of the debentures outstanding for the payment.

25. Purchase in Open Market – In case an enterprise buys its own debentures with the aim of cancellation, such an act of buying and cancelling the debentures comprises redemption of debentures by purchase in the open marketplace.

26. Conversion into Shares or New Debentures – An enterprise can reclaim its debentures by transforming them into a new class of debentures or shares. If debenture holders find that the offer is useful to them, they can exercise their right of transforming their debentures into a new class of debentures or shares. These new shares or debentures can be either circulated at a premium, at a discount, or at par. It may be noted that this method is applicable only to convertible debentures.

27. Redemption by Conversion – Under this method, the debentures are redeemed by converting them into new class debentures or shares. At the time of conversion, new shares or debentures can be issued at par, at a premium, or at a discount.

28. Bond – In definition, “A bond is a fixed income instrument that represents a loan made by an investor to a borrower.” In simpler words, a bond acts as a contract between the investor and the borrower. Most companies and governments issue bonds and investors buy those bonds as a savings and security option.

These bonds have a maturity date, and when once that is attained, the issuing company needs to pay back the amount to the investor along with a part of the profit. This kind of dealing with bonds between the issuer and the investor is done by brokers.

28. Mortgaged Debenture – Debentures which are secured against asset/s of a company are known as mortgaged debentures. Mortgage debentures are of two types: fixed charge mortgage debentures and floating charge mortgage debentures.

When debentures are secured against a particular asset, then they are called fixed charge. Whereas, if the debentures are secured against all the assets of a company, then it is called a floating charge. Mortgage debentures can only be sold by the holder when the company fails to pay its loan or interest thereon.

29. Perpetual Debenture – Perpetual debentures are those debentures that cannot be repayable or redeemable by a company during its lifetime. These are repayable only at the time of winding up of the company. Perpetual debentures are also known as irredeemable debentures, which means debentures have an indefinite life. In India, nowadays, no company can issue irredeemable debentures.

30. Charge – A charge refers to the collateral assets given for securing a loan, credit or debt by way of a mortgage on the company’s assets. There are two types of charge, fixed charge and floating charge. A fixed charge is a charge based on the real asset of the company that is identifiable and ascertained when the charge is created. A floating charge is created over the asset circulatory in nature, that is, the charge is not attached to any definite property.

31. Fixed Charge – A fixed charge on a debenture offers banks additional security for their money. In the event that the borrower’s business becomes insolvent, the additional insurance comes from material assets, or from fixed assets like land, property, and machinery. These fixed resources can not be sold by the insolvent business, without either reimbursing the credit, or getting consent from the lender (bank).

32. Floating Charge – A floating charge is on the general assets of the enterprise. A floating charge is a charge over a specific class of resources (assets), like trade receivables and inventory. It is not possible to distinguish explicit individual resources like this, as they change every day as an organisation maintains its business.

The moment a business defaults, the charge will attach to all resources of that class that exist on that date; they will be ceased and sold straightaway. Often, both a fixed and floating charge will be conceded or granted on the same credit or loan.

33. First Charge – The first charge is generated against the asset by more than one lender. The lender/bank, in whose favour the charge is first made, is called the holder of the first charge.

34. Maturity Date – Debenture maturity date implies the date determined in accordance with the conditions of the debenture, as the date on which the head of the debenture is expected (due) and payable.

35. Draw of Lots – Under this method, the debentures are redeemed in lots or instalments from one particular year, provided it agrees with the terms of the issue of debentures.

36. Own Debentures – A company can purchase its own debentures, provided it is authorised by its Article of Association. As per the Companies Act, if a company is authorised by its Article of Association, only then it may purchase its own debentures from the open market.

The main purpose of such a purchase is for immediate cancellation of debenture liability if the interest rate on its debenture is higher than the market rate of interest. A company may also purchase its own debentures, with the motive of investment, and sell them at a higher price in future and thereby earning profit.

37. Redemption out of Capital – This is the situation where debentures are redeemed out of capital, and no profits are utilised for the redemption of the debentures; such redemption is termed redemption out of capital. In this situation, no profits are required to be transferred to the Debenture Redemption Reserve (DRR).

Here it is to be remembered that no company can redeem its debenture purely out of capital because, as per the guideline laid down by the Securities and Exchange Board of India (SEBI) and Section 117C of the Company Act of 1956, before starting any redemption process, a company is required to create a DRR equal to 50% of the debentures issued.

Therefore, it is not possible to redeem debentures purely out of capital, as it reduces the value of assets. There are exceptions in the following cases:

(i) Infrastructure companies (that is, those companies that are engaged in the business of developing, maintaining and operating infrastructure facilities).

(ii) A company that issues debentures with a maturity of up to 18 months.

(iii) In case of convertible debentures and a convertible portion of partly convertible debentures.

38. Redemption out of Profits – Debentures that are redeemed out of profit, then no capital is utilised for redemption. Before redeeming the debentures, profits are transferred to DRR from the profit and loss appropriation account. The creation of DRR is mandatory, as per the guidelines laid down by the Securities and Exchange Board of India (SEBI).

SEBI mandates transferring amounts equal to 50% of debentures issued to DRR before redeeming debentures. A transfer of the amount (profits) to the DRR profit and loss appropriation account reduces the amount of profit available for the distribution of dividends, so this redemption process is known as redemption out of profit.

DRR is shown under the head of reserves and surpluses on the liabilities side of the balance sheet. DRR account is closed by transferring it to general reserve only when all the debentures are redeemed.

39. Second Charge – The second charge is when a subsequent charge is created in favour of different lenders/banks against the same asset or resource on which the first charge already exists. This subsequent charge holder is called the holder of the second charge.

We hope that the offered Accountancy Index Terms for Class 11 with respect to Part 2, Chapter 2: Issue and Redemption of Debentures will help you.

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