Redemption of Debentures

What is Redemption of Debentures?

Redemption of debentures refers to 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 redemption of debentures is large and, hence, economic enterprises make adequate provision out of gains and accrue capital to reclaim debentures.

Meaning of Redemption of 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.

There are 4 ways by which the debentures can be reclaimed. Namely :

  1. Payment in lump sum
  2. Payment in installments
  3. Purchase in the open market
  4. By conversion into shares or new debentures

Also Check: Important Questions for Redemption of Debentures

Methods of Redemption of Debentures:

Redemption of Debentures

  • Payment in lump sum : The enterprise reclaims the debentures by paying the fund in lump sum (roundsum) to the debenture holders during the maturity hereof as per the terms and conditions of issue.
  • Payment in installments: Under this method, usually redemption of debentures is paid in instalments on the particular date during the time in the position of the debentures. The total amount of debenture liability is being 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.
  • Purchase in open market: When an enterprise buys its own debentures for the aim of cancellation, such an act of buying and cancelling the debentures comprises redemption of debentures by purchase in the open marketplace.
  • 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 proffer is useful to them, they can exercise their right of transforming their debentures into 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.
(1) Debenture Redemption Reserve
  • DRR is a reserve created out of profits for redeeming debentures. According to section 74(4) of the Company’s Act, 2013 and Rule 18(7) of the Companies (Share Capital and Debentures) Rules, 2014, a Company is required to transfer an amount equal to at least 25% of the value of debentures to the Debenture Redemption Reserve a/c before redemption of debentures.
(2) Investment in the Specified Securities:
  • As per Rule 18(7) of the Companies (Share Capital and Debentures) Rules, 2014, at least 15% of the nominal value of the debentures to be redeemed during the year should be invested on or before 30th April of the year in which the redemption is to be made.
(3) Exemption to Create DRR:
  • All India Financial Institutions (AIFIs) regulated by RBI
  • Banking Companies
(4) Disclosure of DRR:
  • Shown in the Equity and Liability part of the Balance Sheet under the head ‘Shareholders’ fund and sub-head ‘Reserves and Surplus’.
(5) Transfer of DRR:
  • When all the debentures are redeemed, DRR Account is closed by transferring the amount to General Reserve.
(6) Sources of Finance for the Redemption of Debentures: The amount required for redemption may be arranged:

  • From the proceeds of fresh issue of shares or debentures
  • Out of capital that is a redemption of debentures without the utilization of any profits of the company. It is possible only in case of AIFIs and Banking companies as these are exempted from creating DRR
  • Out of profits: if a company retains a part of divisible profits every year and utilizes it for the purpose of redemption of debentures.
(7) Methods of Redemption of Redemption:
  • By Lump-sum Payment: under this method, the company redeems the debentures by paying the whole amount at once that is lump-sum
  • In Installments through a draw of lots: under this method, debentures are redeemed in installments and debentures to be redeemed are selected by draw.
  • By purchase from open market: Under this method, the company purchases its own debentures through stock exchanges for the purposes of cancellation
3-4 Marks Questions
Q.1- What Do You Mean by Redemption of Debentures by Lump-sum Payment? Give Journal Entries
Answer:
(a) Meaning of Redemption of Debentures by Lump-sum Payment
  • When the total amount of debentures is paid to the debenture holders in lump-sum on maturity or even before maturity, it is known as Redemption of debentures in lump-sum.
  • In this case, the time of repayment is known in advance and the company can plan its financial resources accordingly
(b) Journal Entries Passed Are:
(1) On Transfer of Profits From Surplus

 

Surplus A/c                                                           Dr. *****To Debenture Redemption Reserve A/c               *****
(2) On Investment or Making Deposit in the Specified Securities Debenture Redemption Reserve A/c                Dr. *****

To Bank A/c                                                                 *****

(3) On Debentures Becoming Due for Payment a) If debentures are to be redeemed at Par:

Debentures A/c                                                       Dr. *****

To Debenture holders A/c                                           *****

b) If debentures are to be redeemed at Premium:

Debentures A/c                                                        Dr. *****

Premium on Redemption of Debentures A/c     Dr. *****

To Debenture holders A/c                                              *****

(4) On Encashment of Investment Bank A/c                                                                     Dr. *****

To Debenture Redemption Reserve A/c                   *****

(5) On Redemption of Debentures Debenture holders A/c                                             Dr. *****

To Bank A/c                                                                    *****

(6) On Transfer of DRR to General Reserve Debenture Redemption Reserve A/c                      Dr. *****

To General Reserve A/c                                              *****

Q.2- What Do You Mean by Redemption of Debentures in Draw by LOTs?
Answer:
Meaning of Redemption of Debentures in Draw by LOTs
  • Under this method, the debentures are redeemed in installments and debentures to be redeemed are selected by draw
  • For example, total debentures of `2,00,000 may be redeemed at the rate of `50,000 per annum. Debentures of `50,000 to be redeemed each year are selected by lottery

 

Q.3- What Do You Mean by Redemption of Debentures by Conversion?
Answer:
(a) Meaning of Redemption of Debentures 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 or at a premium or at a discount
( b) Journal Entry to Be Passed is:
Debentures A/c Dr. (with a face value of debentures converted)

Discount on issue of shares/debentures Dr. (with the amount of discount)

To Share Capital/Debentures(new) (with face value of new shares or debentures issued)

To Securities Premium (with the amount if securities premium)

Q.4- What Do You Mean by Redemption of Debentures by Purchase From Open Market?
Answer:
(a) Meaning of Redemption of Debentures by Purchase From Open Market
  • When a company purchases its own debentures through stock exchanges for the purpose of cancellation such an act of purchasing and cancellation is known as Redemption Of Debentures By purchasing them in the Open Market
(b) Journal Entries to Be Passed Are:
When Debentures Are Purchased for Immediate Cancellation:
A company may immediately cancel the debentures so purchased. For this, a resolution must be passed by the Board of Directors
1. When Purchase Cost of Own Debentures = Nominal Value of Debentures (i) On Purchase of Own Debentures:

Own Debentures A/c (with purchase cost)                    Dr.

To Bank A/c

(ii) On Cancellation of Own Debentures:

….%Debentures A/c                                                            Dr.

To Own Debentures A/c

2. When Purchase Cost of Own Debentures < Nominal Value of Debentures (i) On Purchase of Own Debentures:

Own Debentures A/c (with purchase cost)                 Dr.

To Bank A/c

(ii) On Cancellation of Own Debentures:

….%Debentures A/c                                                          Dr.

To Own Debentures A/c

To Gain or Profit on Cancellation of Own Debentures A/c

(iii) On transfer of profit on cancellation of debentures

Gain or Profit on Cancellation of Own Debentures A/c                       Dr.

To Capital Reserve A/c

The above mentioned is the concept, that is elucidated in detail about the Redemption of Debentures for the class 12 Commerce students. To know more, stay tuned to BYJU’S.

Multiple Choice Questions
Q.1- Debentures may be redeemed in:
a. Lump-sum

b. Drawing lots

c. Purchase from open market

d. All of the above

Q.2- Debentures may be redeemed at:
a. Par

b. Premium

c. Either (a)&(b)

d. Both (a)&(b)

Answer Key
1-d, 2-d

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