Question

How is 'Discount on Issue of Debentures' treated in the books of accounts? How will you deal with the 'Discount on issue of debentures' when the debentures are to be redeemed in instalments?

Answer 1

Debentures which are issued at a value less than its face value (nominal value) is said to be issued at discount. There is no restriction on companies for issuing debentures on discount.

The following treatment is done when discount is applied on issue of debenture:
$$\begin{array}{ccccc}\text{Date}& \text{Particulars}& \text{LF}& \text{Amt.(Dr)}& \text{Amt.(Cr)}\\ & \text{Debenture Allotment A/c}Dr& & & \\ & \text{Discount on Issue of Debenture A/c}Dr& & & \\ & \text{To Debentures A/c}& & & \\ & \text{(Debentures issued at discount)}& & & \end{array}$$

At the time of writing off the discount on issue of debentures at the end of each year.
$$\begin{array}{ccccc}\text{Date}& \text{Particulars}& \text{LF}& \text{Amt.(Dr)}& \text{Amt.(Cr)}\\ & \text{Profit and Loss A/c}Dr& & & \\ & \text{To Discount on Issue of Debenture A/c}& & & \\ & \text{(Discount on issue of debentures written off)}& & & \end{array}$$

There are two methods for writing off discount on issue of debenture.

1. Fixed Installment Method: Also known as equal installment method. This method is used when debentures are redeemed in lump sum and after a specific time period. In this method an equal amount of discount or loss is written off till the debenture is not paid off. The formulae used to calculate the discount amount is given below.

Amount of instalment

$=\frac{\text{Total Amount of Discount}}{\text{Number of year after which Debenture are redeemed}}$

Variable Instalment Method: This method is also known as Fluctuating or Reducing Instalment Method or Proportion Method. In this method debentures are paid in annual drawings or instalments. The amount of discount that is written off every year should be in proportion to debentures that are outstanding at the beginning of each year. Therefore the amount of discount will vary each year, and it will be more in the initial years and will subsequently reduce at the end of redemption.

e.g., if a company has issued 10% debentures of Rs. 12,00,000 at 5% discount redeemable annually by Rs. 2,40,000 each year. The total amount of discount on Rs. 12,00,000 debentures @ 5% is Rs. 60,000, i.e., $(12,00,000\times \frac{5}{100}=Rs.60,000)$. The amount of discount to be written off every year is calculated as

$$\begin{array}{cccc}\text{Year}& \text{Amount of Debenture}& \text{Ratio}& \text{Amount of Discount to}\\ & \text{Used up During the Year}& & \text{be Written off each Year}\\ \text{First Year}& 12,00,000& 5& 60,000\times \frac{5}{15}=20,000\\ \text{Second Year}& 9,60,000& 4& 60,000\times \frac{4}{15}=16,000\\ \text{Third Year}& 7,20,000& 3& 60,000\times \frac{3}{15}=12,000\\ \text{Fourth Year}& 4,80,000& 2& 60,000\times \frac{2}{15}=8,000\\ \text{Fifth Year}& 2,40,000& 1& 60,000\times \frac{1}{15}=4,000\end{array}$$

Total amount of Discount on 12,00,000 debentures @ 5% pa is Rs. 60,000.

Hence, the amount of the total discount of Rs. 60,000 will be written off in the ratio 5:4:3:2:1 i.e., '20,000, 16,000, 12000, 8000 and 4,000 respectively.