4

Issue and Redemption of Debentures

The joint stock companies raise capital in different ways. One way of raising capital is through issue of “debentures”. This represents the loan capital of companies. They are debt instruments. They have to be discharged at the date of maturity after paying specific interest at regular intervals. All the provisions relating to issue of debentures and their redemption are discussed in detail in this chapter with a number of illustrations.

4.1 MEANING AND DEFINITION OF DEBENTURE

According to Section 2(12) of the Companies Act, 1956, “Debenture” includes, “a debenture stock, bonds and any other securities of the company whether constituting a charge on the assets of a company or not.”

According to Topham: “Debenture is a document given by a company as evidence of debt to the holder usually arising out of a loan and most commonly secured by a charge.”

The true meaning of a debenture can best be understood if we know the basic features of a debenture which are given as follows:

• Debenture is a document given by the company in the form of a certificate.
• It is an instrument of debt owed by a company
• Mostly, it is secured by a charge
• Generally, this instrument (Debenture) specifies
  • Value (Normal or par)
  • Rate of interest
  • Periodicity of payment
  • Tenure
  • Terms of Redemption
• Usually, they are issued under the common seal of the company

4.2 MEANING OF SOME TERMS

Bond: Bond, like debenture, is also an instrument of debt. Contents and texture are similar to that of debenture. However, the main difference between bond and debenture is with respect to issue condition: A bond can be issued without pre-determined rate of interest.

Example: Deep discount bond, Zero coupon bond.

Debenture stock: Generally, individual debenture certificates are issued. For instance, a single debenture may be issued to one person. Sometimes, a company will create one loan fund. This is intended for a specified group. Each person in the group will be given a debenture stock certificate which specifies the part of the loan to which such person is entitled. Debenture stock is a document representing the loan capital of the company. The loan is consolidated into a single composite unit. This unit may be divided into a number of units of fixed amount, which may be of any denomination. Certificates are issued indicating each debenture stockholder’s contribution.

The differences between “debenture” and “debenture stock” are depicted in the following table.:

Basis of Distraction	Debenture	Debenture Stock
1. Nature	Debenture is the description of an instrument.	This is the description of a debt.
2. Creation of charge	Each debenture may create a separate charge.	Charge is created by a “trust deed”.
3. Transferability	Debenture is transferable in its entirety. Transfer in parts may not be possible.	Debenture stock may be transferable in parts, if articles permit.
4. Payment	A debenture may be either fully paid or partly paid.	The debenture stock must be fully paid.
5. Amount	Debenture is always for a fixed sum.	Here, the sum is not a fixed but may be of any amount.

Charge:

A charge is an encumbrance to meet the obligation. That means, the company agrees to mortgage specific part of the assets towards the loan. Lenders have the right to secure their payment from the assets mortgaged. A charge may be first one or second charge. A charge may be either fixed charge or floating charge.

Some charges included in the category of charge are:

• A charge for the purpose of securing any issue of debenture.
• Uncalled share capital of the company.
• Any immovable property
• Any book debts of the company
• Any movable property (not pledged)
• Floating charge or any undertaking of the property
• Charge on calls unpaid
• Goodwill and other patents, copyrights obtained under Copyright Act

The Companies Act stipulates specifically that all charges should be registered with the Registrar of Companies.

Fixed charge: This is also known as “specific charge”. This is created on definite, specific assets of permanent nature.

Example: Land, machinery, etc.

Floating charge: A charge is said to be “floating” when no specific asset but all assets are charged as security.

Note: In the event of winding up, this category holders have preference over unsecured creditors to settle the claim.

4.3 TYPES OF DEBENTURES

Debentures may be classified from the following standpoints:

1. Security
2. Redemption
3. Records
4. Priority
5. Convertibility

4.3.1 From Security Viewpoint

This may further be classified into two categories: (i) secured debentures and (ii) unsecured debentures.

Secured debentures: When debentures are secured by either a fixed charge or floating charge on the property of the company, they are called mortgage or secured debentures. A “mortgage deed”, also known as Trust deed, has to be entered into between the parties.

Unsecured debentures: When debentures are issued without any charge or security, they are called unsecured or naked debentures. They have no security. They do not enjoy any special rights.

4.3.2 From Records Viewpoint

These can also be classified into two categories (i) registered debentures and (ii) bearer debentures.

1. Registered debentures:
   • Name, address and the required particulars of holders of this kind of debentures are entered in a register known as debenture ledger.
   • The register is maintained by the Registrar.
   • These are transferable but transfer requires execution of transfer deed.
2. Bearer debenture:
   • These need not get registered and the company does not maintain any records.
   • These can be transferred easily by mere delivery like a negotiable instrument.
   • The interest and the principal amount on these debentures shall be payable upon presentation and delivery of the coupons and debentures.

4.3.3 From Redemption Viewpoint

These also can be classified into two categories: (i) redeemable debenture and (ii) irredeemable debenture.

Redeemable debenture: These debentures are to repaid by the company at the end of the specified period. It is repaid during the existence of the company.

Irredeemable debenture: These are not repayable during the lifetime of the company. They are perpetual. When the company is wound up, these will be repaid.

4.3.4 From Priority Viewpoint

These also may be classified into two categories: (i) first debentures and (ii) second debentures.

First debentures: These debentures will be repaid before and prior to other debentures. They have priority over others.

Second debentures: These debentures will be repaid only after the first debentures are redeemed.

4.3.5 From Convertibility Viewpoint

These also may be classified into two categories: (i) convertible debentures and (ii) non-convertible debentures

Convertible debentures:

• These many be convertible into equity or preference shares of the company.
• This may be done in accordance with the agreement between the debenture holders and the company.
• Partly convertible debentures: These debentures consist of two parts: convertible and non-convertible. The convertible part may be converted into shares at the expiry of specified period whereas the non-convertible part is redeemed in cash or the expiry of specified period. (PCD)
• Fully convertible debenture: When the entire amount of debenture is converted into shares on the expiry of specified period, they are known fully convertible debentures (FCD).

The following table gives the differences between fully convertible debentures (FCD) and party convertible debentures (PCD):

Basis of Difference	Fully Convertible Debenture (FCD)	Party Convertible Debenture (PCD)
1. Classification: As equity and debt	Classified as equity for debt equity computation.	Convertible portion is classified as “equity” and non-convertible part as “debt”.
2. Debt equity ratio	Highly favorable debt–equity ratio.	Not high but favorable debt–equity ratio.
3. Capital base	High equity capital on conversion of debentures.	Lower equity capital on conversion of debentures.
4. Equity servicing	Higher burden of equity servicing.	Lower burden of equity servicing.
5. Suitability	Suitable for companies without established track record.	Not so much suitable as FCD.
6. Creation of redemption reserve	No need arises.	Required to be created for 50% of the face value of non-convertible part of debentures.
7. Buy-back facility	Not needed	Arrangements may be made for buy-back of non-convertible part.
8. Investor’s response	Popular among the investors	Not popular among the investors.

AS per SEBI Guidelines, no company shall issue FCDs having a conversion period of more than 36 months unless conversion is made optional with “put” and “call” option.

“Call” Option: An option to buy is known as “call” option

“Put” Option: An option to sell is known as “put” option.

“Put” & “Call” Option: An option to either buy or sell is known as “put call option”.

4.4 DIFFERENCES BETWEEN SHARES AND DEBENTURES

The following table shows the differences between shares and debentures:

Basis of Difference	Debentures	Shares
1. Status	A debenture holder is a lender, i.e., a loan credit or of the company.	A shareholder is a joint owner of the company.
2. Income	Interest on debenture is pre-determined and fixed.	Dividend on shares is neither predetermined nor fixed.
3. Income payable to the holders	Debenture holders are entitled to receive interest and it is immaterial whether the company makes profit or loss.	Shareholders are entitled to receive dividend only when the company earns profit.
4. Nature with respect to profit	Interest on debenture is a charge against profit.	Dividend on shares is an appropriation of profit.
5. Refund	A debenture holder gets back amount at date of maturity.	A shareholder may not be able to get back his money on shares.
6. Safety	Debentures are secured.	Share are unsecured
7. Voting right	A debenture holder has no voting right.	A shareholder has voting right.
8. Discount on issue	Debentures can be issued at a discount. There are no legal restrictions.	Shares can be issued as a discount subject to provisions of Section 79.
9. Purchase its own debenture/share	The company can purchase its own debentures without any legal restrictions.	A company cannot purchase its own shares.
10.Priority on winding up	A debenture holder gets priority in respect of repayment when the company is wound up	Shareholders get back their money only after settlement of all other claims.

At this stage, student should be able to understand about charge—its basic nature, first charge, second charge, PARI PASSU CLAUSE, unsecured creditors, etc.

We have already explained about secured and unsecured debentures. Here, we have to learn more about unsecured debenture. Here, we have to learn more about fixed and floating charge. A “charge” is nothing but mortgage. A fixed charge is generally created on immovable assets such as land, building, machinery and so on. In case a charge is fixed, the company may enjoy the possession of the assets but cannot sell or lease without consent of the charge holders. A floating charge is mostly on movables—properties that are frequently changing. In this case, it is not mortgage of property. Example, stock in trade. The floating charge will become or attain the status of a fixed charge under the following circumstances:

1. When the company fails to pay interest or principal or both
2. When the receiver is appointed
3. When the company ceases to function
4. When the company is being wound up

First charge and second charge: First charge implies the priority of repayment. The assets against which first charge is created are first used in paying the secured lenders holding the first charge. The balance amount is used for satisfying the claims of creditors holding second charge. In case the dues of second charge holders are not fully paid off, the unpaid amount of such lenders is to be treated as unsecured. To that extent they are paid along with unsecured creditors. This concept can be explained with the help of the following illustration:

Illustration 4.1

Following are the relevant figures extracted from the balance sheet of XZ Ltd. as on 31 March 2011:

NOTES TO BALANCE SHEET:

Land is valued at 2,000 lakh (Cost: 1,250 lakh)

Building is valued at 2,500 lakh (Book value: 2,000 lakh) including in gross black. Other fixed assets were estimated to be realized at 2,750 lakh and current assets are valued at 3,750 lakh.

You are required to estimate the deficiency of secured creditors who would rank as unsecured creditors. Also ascertain the amount of unsecured creditors.

Solution

 

	Value of Specific Assets	( in Lakhs)
Part I:
Step 1:	Calculation of Total Realizable Value of Land & Building: Realizable Value of Land (Given)	2,000
Add:	Realizable Value of Building (Given)	2,500
	Total realizable Value of Land & Building	4,500
Step 2:
Less:	First Charge Debenture Value, i.e.	3,000
	Amount Due to 12% A Debentures Surplus Amount	1,500
Step 3:	From the Surplus Amount Left out,
	Second Charge Debentures to Be Deducted, i.e.,
Less:	Amount Due to 12% B Debentures	2,500
	Deficiency	1,000
Step 4:	This Deficiency (Difference) Has to Be Ranked as Unsecured Creditor	1,000
Part II:	Determination of Total Unsecured Creditors:
		( in Lakhs)
Step 1:	Unsecured Creditors as Shown in Balance Sheet	2,500
Step 2:	Add: Deficiency Arose (Ref: Part I Step 4)	1,000
Step 3:	Total Unsecured Creditors	3,500

4.4.1 Debentures with Pari Passu Clause

“Pari Passu” means equal in respect of charge and repayment. Debentures issued with “Pari Passu” clause means they are to be ranked together for the purpose of security created. Even though they are issued on different dates, they are to be paid rateably. The amount realized on sale of assets secured is to be divided among the debenture holders in proportion to the amount. Thus, it differs from first charge and second charge.

In case debentures are issued without “Pari Passu” clause, debentures would be paid according to the date of issue. If some of them are issued on the same date, then they will be paid according to their serial number.

4.5 DEBENTURE TRUST DEED

In case, when a series of debentures are issued by a company, it will be difficult to create charges on the assets of the company to each individual debenture holder. This necessitates for a company to execute trust deed through which the assets of the company are charged by way of mortgage to the trustees.

Debenture trust deed is a document created by the company to protect the interest of debenture holders. It is a form of a contract between the company and the trustees for the debenture holders. Debenture trust deed is to be prepared before the debentures are offered for public subscription

Who can be trustees?

In case of issue of debenture with maturity of more than 18 months, the issuer shall appoint a debenture trustee for 18 months from the following eligible list:

1. A scheduled bank carrying on commercial activity.
2. A public financial institution within the meaning of Section 4 A(1) of The Companies Act, 1956.
3. An insurance company
4. A body corporate

Who cannot be A TRUSTEE:

The following cannot be appointed as a debenture trustee:

1. A person who benefi cially holds shares in the company.
2. A person who is benefi cially entitled to receive money which are to be paid to/by the company to the debenture trustee.
3. Persons entered into any guarantee in respect of principal debts, secured by debenture or interest thereon.

The primary function and duty of every debenture trustee is to:

1. Call for periodic report from the body corporate
2. Take possession of the trust properly in accordance with the provisions of the trust deed
3. Enforce security in the interest of shareholders
4. Verify that the charge created should be completed within 30 days of issue of allotment letter and dispatch of debenture certifi cated

The following are the advantages of creating a trust deed:

1. The interests of debenture holders are safeguarded
2. Volume of work of creating charge is reduced to a great extent for the corporate body
3. Trustees act effectively by enforcing security properly
4. They act as watch dogs
5. As they are empowered, problems are resolved amicably without delay

4.5.1 SEBI Guidelines

Any company has to comply with the provisions issued by SEBI. Some of the revisions are:

1. Credit rating from authorized credit rating agency will have to be obtained and the same should be disclosed in the document
2. All such credit ratings obtained during the three years preceding such issue have to be disclosed in the offer document
3. A trust deed shall be executed by the company in favour of the trustees within six months of the closure of the issue
4. Trustees shall be vested with requisite powers for protecting the debenture holders
5. Trustees shall ensure the implementation of the conditions regarding creation of security for debentures and debenture redemption reserve

4.6 COUPON RATE

Usually debentures are issued with a specific rate of interest, and this specified rate interest, and this specified rate, is termed as “coupon rate”. The specified rate may be fixed or floating.

The floating interest rate is usually tagged with the bank rate and yield on treasury bond plus a reward for risk. The bank rate and yield on treasury securities keep on fluctuating over a period of time. So such change is compensated in the risk premium.

Rate of interest in such a case is quoted as “PLR + 50 basis or 100 basis points”.

To illustrate:

Suppose if PLR is 9%, the rate of interest will be:

      PLR + 50 basis point (0.5) or 100 basis point (1)

      9% + 0.5 or 9% + 1%

      i.e., 9.5% or 10%

• “ + basis points” is determined in relation to risk involved.

4.6.1 Zero Coupon Bond

A zero coupon bond does not carry any specific rate of interest. To compensate the investors, such bonds are issued at a substantial discount. The difference between the face value and issue price is the total amount of interest related to the duration of the bond

Periodic change of interest is calculated by the following formula:

Where,	Bo	=	Value of zero coupon bond
	MV	=	Maturity value of zero coupon bond
	n	=	Life of zero coupon bond
	i	=	Required rate of return

To determine the value of (1 + i)ⁿ, Present value Interest Factor (PVIF) Table is used.

PVIF for “i” rate of interest and “n” years is written as PVIF, i, n.

(It is given in the table—the present value of 1. To ascertain the factor, the number of years column and rate of interest column may be referred).

From the formula given above, different factors can be computed:

 

or

or

Illustration 4.2

ABZ Ltd. issued a zero coupon bond having 20 years maturity with face value of 1,000. At what price the company should issue the bond, if the required rate of return is 12%?

Solution

Write the formula

 

	Bo	=	MV × PVIF i, n
	i	=	12% & n = 20 years

Refer the table, the present value is given as 0.1037.

Substitute the values in the formula:

 

	Bo	=	1,000 × 0.1037
		=	103.70

It implies that the investor will be able to get a zero coupon bond for 103.70 (today), the face value being 1,000.

4.7 ACCOUNTING FOR ISSUE OF DEBENTURES

The procedure and accounting entries for the issue of debenture are very much similar to that adopted for the issue of shares. After perusing the prospectus, the intending lenders apply for debentures in the prescribed form along with application money. Debentures, like shares, may be issued at par or at a premium or at a discount. If debentures are issued payable by application, allotment and call installments, the same procedure is to be followed as for shares; the required amount may be payable in lump sum or in instalments. Like shares, debentures can also be issued for cash, for consideration other than cash and as a collateral security.

4.7.1 Issue of Debentures for Cash

Accounting entries are same as in the case of shares, the difference being the world “debenture” instead of “share”, i.e., “debenture” has to be inserted in the place of “share”.

4.7.1.1 Issue of Debentures at Par

Debenture is said to be issued at par, when an investor (prospective debenture holder) pays an amount equal to the face value of the debenture.

 

Illustration 4.3

Model: Issue of debentures at par

ABZ Ltd. issued 5,000, 10% debentures of 100 each, payable 25 on application, 40 on allotment and 35, two months after allotment. All the debentures were duly applied for and paid.

Pass journal entries in the books of the company and also show how these will appear in the balance sheet.

Solution

 

Note: 35 received after allotment is to be received as “call” amount.

 

4.7.1.2 Over-subscription of Debenture

• A Company cannot allot more debentures than it has offered for subscription.
• When applications received are more than offered for subscription of debentures, it is termed as “oversubscription” in the case of debentures.
• When applications received are more than offered for subscription of debentures, it is termed as “oversubscription” in the case of debentures.

Treatment of “over-subscription”:

The following are the three alternative approaches for dealing over-subscription:

1. Outright rejection: The Board of Directors can reject the excess outright. Hence, the application money received has to be returned in full.
2. Partial or Pro-rata allotment: In case debentures are allotted pro-rata, excess application money has to be adjusted along with allotment money.
3. Full allotment: The directors may make full allotment to some applicants, partial allotment to some applicants, and no allotment to the rest.

For partial allotment, excess money received on application is adjusted with allotment money. For no allotment, application money is refunded entirely.

Illustration 4.4

Model: Debenture issued at a premium

BXY Ltd. issued 4,000 14% debenture of 100 each payable as:

 

On Application	20
On Allotment	50
On First & Final Call	30 (After 3 months Allotment)

The public applied for 6,000 debentures. Applications for 3,500 debentures were accepted in full. Applicants for 1,000 debentures were allotted 500 debentures and the remaining was rejected. Pass required journal entries.

Solution

Note: This is a case of over-subscription.

Number of Debentures Issued	=	4,000
Number of Debentures Subscribed	=	6,000
∴ Excess	=	2,000
Way of Allotment:
Fully Accepted Debentures	:	3,500
Partially Accepted Debentures	:	1,000 Debenture Applicants for 500 Debentures
Totally Rejected Debentures	:	1,500
(6,000 – 3,500 – 1,000)

• For partially accepted, excess application money has to be adjusted to allotment money.
• For totally rejected, application money should be refunded.

Accordingly, the following accounting entries are to be passed:

 

Illustration 4.5

Model: Over-subscription—Issue of debentures at a premium

Govil & Co. Ltd. issued 10,000, 10% debentures of 50 each at a premium of 20% payable as:

 

On Application	:	15
On Allotment	:	30 (Including Premium)
On First & Final Call	:	15

Applications were received for 20,000 debentures. All allotment was made proportionately, oversubscription being applied to the amount due on allotment. All money was duly received.

Pass necessary journal entries.

Also pass the entry if the whole amount of debenture is collected in one instalment only.

Solution

 

Note:

• In this question, the entire surplus application is adjusted towards allotment. Only the remaining balance is received on allotment.
• As in the case of shares, the premium is shown separately as “Securities Premium A/c” along with the due on debenture allotment.

Over-subscription and premium will be treated as above. The required entries will have to be passed in the books of Govil & Co. Ltd. as follows:

If the whole amount is collected in one instalment, then entry:

4.7.1.3 Issue of Debentures at a Discount

Illustration 4.6

Model: Debentures issued at discount

Azhar & Co. Ltd. issued 5,000, 10% debentures of 100 each at on discount of 5% payable 40 on application and the balance on allotment. Pass the necessary journal entries.

Solution

4.7.2 Issue of Debentures for Consideration Other than Cash

At times, a company purchases assets from a vendor and issue debentures is payment of purchase consideration.

Journal Entry:

 

(i) Assets A/c	Dr.	….
To Vendor A/c			….
(Purchase of Assets)
(ii) Vendor A/c	Dr.	….
To Debentures A/c			….
(Issue of Debentures)

Purchase consideration: Amount paid by the purchasing company for the purchase of assets is called “purchase consideration.”

This is computed as:

    Purchase Consideration = Value of Assets – Liabilities

These debentures may also be issued at par or at premium or at a discount.

Illustration 4.7

Model: Issue of debentures for consideration other than cash

Joy & Co. Ltd. purchased assets of the book value of 5,40,000 from another firm. It was agreed that the purchase price be paid by issuing 14% debentures of 100 each.

Pass necessary journal entries if the debentures are issued (a) at par; (b) at a discount of 10% and (c) at a premium of 25%

Solution

Note:

1. Since purchase consideration is given in the problem, no need to compute it.
2. Number of debentures issued to be determined as follows:
   1. Number of debentures issued a par
      
   2. Number of debenture to be issued at a discount of 10%
      
   3. Number of Debentures to be issued at a premium
      

Sometimes, a company purchases the business of another company:

Entry for this will be:

 

Sundry Assets A/c	Dr.	…
Goodwill A/c	Dr.	…
To Sundry Liabilities A/c			…
To Vendor’s A/c			…
To Capital Reserve A/c			…

However, in the entry of the two items—(i) goodwill A/c and (ii) capital reserve A/c—only one item will appear.

In the case, the value of net assets, i.e. Asset – Liabilities will not be equal to purchase consideration. There will be either goodwill A/c or capital reserve A/c.

Goodwill A/c: Payment in excess of the value of net assets is to be treated as goodwill A/c.

Capital Reserve A/c: If value of net assets is greater than purchase price, it results in gain to the company. It is to be treated as capital profit and transferred to capital reserve A/c.

Illustration 4.8

Model: Issue of debentures for consideration other than cash—Purchases the business of another company.

Vijay Ltd. took over the assets and liabilities of 50,00,000 and 5,00,000 of Ajay Ltd. Vijay Ltd. paid the purchase consideration of 48,00,000 by issuing debentures of 100 each at a premium of 20%. Pass journal entries in the books of Vijay Ltd.

Solution

 

Step 1:	This is a case of issue of debentures for consideration other than cash at premium and purchase of business of another company. This is not an individual vendor.
Step 2:	Determination of Amount of Debentures: *2 Value = 40,000 Debentures × 100 = 40,00,000
Step 3:	To Determine Goodwill or Capital Reserve: In This Question, the Purchase Consideration Exceeds the Value of Net Assets, i.e., Purchase Consideration > Net Assets Hence, Goodwill arises.

 

* Net Value of Assets	=	50,00,000 − 5,00,000
	=	45,00,000
*1Goodwill	=	Purchase Consideration − Value of Net Assets
	=	48,00,000 − *45,00,000
	=	3,00,000

Step 4:

 

Illustration 4.9

Model: Issue of debentures for other than cash—Assets and liabilities taken over

PQR Ltd. purchased assets of 4,50,000 and took over liabilities of 40,000 at an agreed value of 4,05,000 of ST Ltd. PQR Ltd. issued debentures of 100 each at a 10% discount in full satisfaction of the purchase price. Pass necessary journal entries in the books of PQR Ltd.

Solution

Note:

1. Determination of Capital Reserve/Goodwill:
   1. Value of Net Assets = Assets – Liabilities

              = 4,50,000 − 40,000

              = 4,10,000

       

   2. Purchase Consideration = 4,05,000
   3. Value of Net assets is More than Purchase Price, and hence the Difference is Treated as Capital Reserve
   4. ∴ Capital Reserve = 4,10,000 − 4,05,000

                                 = 5,000

2. Calculation of Number of Debentures to Be Issued:
   

4.7.3 Issue of Debentures as Collateral Security

It means issue of debentures as a subsidiary or secondary security. In other terms, collateral security means additional security.

• When the loan is repaid, i.e. discharged, such debentures issued as collateral security are returned to the company.
• The lender is not entitled to any interest on such debentures.
• The lender is entitled to interest only on the amount of loan, but never on debentures.
• But in case of any breach of terms and conditions, then the creditor is entitled to have a claim on all rights as a debenture holder.

Accounting Treatment:

• No immediate liability arises by pledging the debenture as a collateral security.
• Hence, no entry is required at the time of issue.
• However, this fact has to be shown in the balance sheet under the head “Secured Loans” on the liabilities side of the balance sheet.
• At times, the issue as a collateral security is entered as:

   

  Debenture Suspense A/c	Dr. …
  To Debentures A/c		…

• At the time of repayment of loan, this entry has to be reversed.

Illustration 4.10

Model: Issue of debentures as collateral security

Subh Ltd. secured a loan of 20,00,000 from a Nationalized bank, issuing 30,000, 15% debentures of 100 each as collateral security.

Record necessary accounting entries for such issue.

Solution

 

Approach I: An extract of balance sheet has to be drawn as follows:

 

Approach II:

4.8 TERMS OF ISSUE OF DEBENTURES

A limited company issues debentures on certain terms and redeems them under varying categories as follows:

 

Conditions of Issue	Conditions of Redemption
Issued at Par…	Redeemable at Par
Issued at Par…	Redeemable at Premium
Issued at Discount…	Redeemable at Par
Issued at Premium…	Redeemable at Par
Issued at Premium ….	Redeemable at Premium
Issued at Discount…	Redeemable at Premium

Note: Debentures are issued at par or premium or discount but redemption is only at par or premium and not at discount mostly.

Accounting Treatment:

Journal entries for different terms of issue and redemption are as follows:

Category I: Debenture Issued at Par and Redeemable at Par:

 

Entry:
(i) Bank A/c	Dr.	…
To Debenture Application A/c			…
(ii) Debenture Application A/c	Dr.	…
To …% Debenture A/c			…

Illustration 4.11

Model: Debenture issued at par and redeemable at par

Govil Ltd. issued 20,000, 12% debentures of 50 each payable on application and redeemable at par any time after 4 years from the date of issue. Pass entries for the issue of debentures in the books of Govil Ltd.

Solution

 

Category II: Debentures Issued at a Discount and Redeemable at Par:

 

Entry:
(i) Bank A/c	Dr.	…
To Debentures Application A/c			…
(ii) Debenture Application A/c	Dr.	…
Discount on Issue of Debentures A/c	Dr.	…
To …% Debentures A/c			…

Illustration 4.12

Model: Issue of debenture at discount redeemable at par

Goel Ltd. issued 25,000, 12% debentures of 100 each at discount of 10% redeemable at par at any time after 5 years. Record entries in the books of Goel Ltd. for the issue of debentures.

Solution

 

Category III: Debentures Issued at Premium, Redeemable at Par:

 

Entry:
(i) Bank A/c	Dr.	…
To Debentures Application A/c			…
(ii) Debenture Application A/c	Dr.	…
To …% Debentures A/c				…
To Securities Premium A/c				…

Illustration 4.13

Model: Issue of debentures at premium and redeemable at par

AB Ltd. issued 10,000 13% debenture of 100 at a premium of 10% redeemable at par. Pass journal entries for the issue of debentures.

 

The same question may be asked as:

AB Ltd. issued 10,00,000 13% debentures at a premium of 10% redeemable at par. Pass necessary journal entries for issue of debentures.

Solution

Category IV: Debentures are Issued at Par and Redeemable at Premium:

 

Entry:
(i) Bank A/c	Dr.	…
To Debentures Application A/c			…
(ii) Debenture Application A/c	Dr.	…
To …% Debentures A/c			…
(iii) Loss on Issue of Debentures A/c	Dr.	…

To Premium on Redemption of Debentures A/c     …

 

Entries (ii) and (iii) may be combined into a single entry as:

 

(ii) + (iii) Debenture Application A/c	Dr.	…
Loss on Issue of Debentures A/c	Dr.	…
To …% Debentures A/c			…
To Premium on Redemption of Debentures A/c			…

Illustration 4.14

Model: Issue of debentures at par and redeemable at premium

X Ltd. issued 10,00,000 10% debentures at par and redeemable at 25% premium. Pass journal entries in the books of X Ltd.

Solution

 

Category V: Debentures are Issued at a Discount and Redeemable at a Premium:

 

Entry:
(i) Bank A/c	Dr.	…
To Debenture Application A/c		…
(ii) Debenture Application A/c	Dr.	…
Discount on Issue of Debentures A/c	Dr.	…
To …% Debentures A/c			…
(iii) Loss on Issue of Debenture A/c	Dr.	…
To Premium on Redemption of Debentures A/c			…

Illustration 4.15

AZ Ltd. issued 10,00,000 9% debentures at a discount of 5% but redeemable at a premium of 5%. Give journal entry.

Solution

 

Category VI: Debentures are Issued at a Premium and Redeemable (Repayable) at Premium:

 

Entry:
(i) Bank A/c	Dr.	…
To Debenture Application A/c			…
(ii) Debenture Application A/c	Dr.	…
To … Debentures A/c			…
To Securities Premium A/c			…
(iii) Loss on Issue of Debentures A/c	Dr.	…
To Premium on Redemption of Debentures A/c			…

 

(ii) & (iii) in the combined form as:

 

Debenture Application A/c	Dr.	…
Loss on Issue of Debenture A/c	Dr.	…
To …% Debentures A/c			…
To Securities Premium A/c			…
To Premium on Redemption of Debentures A/c			…

Illustration 4.16

Model: Debentures issued at premium and redeemable at premium

A limited company issued 1,000 14% debentures of 100 each at a premium of 5% and redeemed at 10% premium. Make journal entries.

Solution

 

4.9 INTEREST ON DEBENTURES

Interest on debentures is payable by a company at a fixed percentage (Coupon rate). The rate of interest is prefixed before the name of debentures. Example: 9% debentures, 10% debentures

It is an acknowledgement of debt and hence interest is payable periodically without default. It is immaterial whether the company earns profit or incurs loss. Generally, interest is payable half-yearly on debentures. It is a charge against the profit of the company.

Interest is computed on the face value (Nominal value) of debentures, and not on the issue price. Hence, no difference on the interest amount will arise if they are issued at par or at a discount or at a premium.

A company has to deduct income tax at the prescribed rate compulsorily (TDS) on the gross amount of debentures interest and deposit with income tax authorities. The rate of tax on debentures interest varies from year to year, as it is notified in the Finance Bill every year.

Accounting Treatment:

The journal entries that are to be passed in the books of the company with respect to interest on debentures are as follows:

1. When Interest on Debentures Becomes DUE:

    

   Debenture Interest A/c	Dr.…		(Gross Amount of Interest Due)
   To Income Tax Payable A/c		…	(income Tax Amount Deducted)
   To Debenture Holders A/c		…	(Net Amount of Interest After TDS)

    

2. When Interest Was Paid:

    

   Debenture Holders A/c	Dr.…		(Net Amount of Interest = Gross − TDS)
   To Bank A/c		…

    

3. When Tax Was Paid to Tax Authorities:

    

   Income Tax Payable A/c	Dr.…		(Amount Deducted at Source − TDS)
   To Bank A/c		…

    

4. When Debenture Interest A/c is Closed:         (Transfer to P&L A/c)

    

   Profit & Loss A/c	Dr.…		(Gross Amount of Interest on Debentures)
   To Debenture Interest A/c		…

Illustration 4.17

Model: Debenture interest

Riddhu Ltd. issued 10,000 10% debentures of 100 each on 1 January 2010 at a discount of 5% and redeemable at a premium of 20%. Tax deducted at source is 10% interest payable on 30 June and 31 December as the company adopts calendar year as accounting year.

Pass journal entries for:

1. Issue of debentures
2. Debenture interest for the period ended 31 December 2010

Solution

Note:

1. First, students have to pass journal entries for issue of debentures.
2. Interest on debentures has to be computed as:

   Apply the Formula: Interest =

   Where P = Principal—here (10,000 × 100) = 10,00,000

       n = Period—here 6 months

       r = rate of interest—10 %

   Interest on debentures

   = 50,000—payable on 30 June and 31 December every year.

    

3. Tax Deducted at Source TDS:

   10% (Given) on 50,000 (Gross interest: Note 2)

   
4.  

4.9.1 Net Effective Rate of Interest

Net effective rate of interest represents the actual amount of interest paid. While determining the effective rate of interest, the actual amount received is to be taken into account. The main difference between the debenture interest calculation and net effective rate of interest is as follows:

Debenture interest is calculated on the nominal value whereas effective rate of interest is calculated on the actual amount received on debentures. That means, it has to be adjusted for premium and discount while determining the actual amount collected on debentures.

Illustration 4.18

Model: Net effective rate of interest

X Ltd. issued 10,00,000 12 % debentures of 100 each. Assuming that the debentures were issued (a) at par; (b) at a premium of 20% and (c) at a discount of 10%, calculate the net effective rate of interest on debentures.

Solution

One should note that the amount of interest on debentures is 1,20,000 in all the three cases because interest payable is calculated on the nominal value, i.e. 10,00,000 × But the effective rate of interest varies in each case, because it is calculated on the amount collected, i.e., 10,00,000 at par, 12,00,000 at premium and 9,00,000 at discount.

4.9.2 Interest Accrued and Due

Generally, interest on debentures is paid, every six months, periodically. Depending on the accounting policy, the date of payment of debentures varies. Suppose the accounting period ends on 31 March, a company pays interest on 30 September (first half-year) and 31 March (second half-year). That means, the company has an accounting policy of paying interest on 30 September and 31 March. Further assume that the company paid interest on 30 September but did not pay an 31 March, then in such a case, the debentures interest is accrued and due. This is technically called “outstanding interest”. It is important to note here that the debenture holder cannot demand the payment of interest before 31 March. If it remains unpaid only on or after such specified dates, such interest accrued and due is referred to “outstanding interest”.

Entry will be:

 

Debenture Interest A/c	Dr.	…
To Outstanding Debenture Interest A/c			…

In the balance sheet it will be shown as:

The outstanding interest on debenture is to be shown along with the nominal value of debentures on the liabilities side of the balance sheet under the head “Secured Loans”.

4.9.3 Interest Accrued but Not Due

As already said, payment of debenture interest depends on the accounting policy. Assume that a company pays interest on debentures on 30 June and 31 December and it closes its accounts on 31 March (i.e., financial accounting year) in such a case, after six months, i.e., 30 June. Technically speaking, interest from 1 January to 31 March has to be properly accounted for. This is technically termed as “interest accrued but not due” or simply “accrued interest.”

Entry:

 

Debenture Interest A/c	Dr.	…
To Accrued Debenture Interest A/c			…

Even in such a situation, a debenture holder cannot claim his right to pay interest for these 3 months.

The “accrued interest” has to be shown as “Current Liability” in the balance sheet.

Students should remember that “outstanding interest” is to be shown under “Secured Loans” and “accrued interest” is to be shown under “Current Liabilities”.

4.10 DISCOUNT OR LOSS ON ISSUE OF DEBENTURES

The discount on the issue of debentures or any loss on debentures is a fictitious asset. Hence, it has to be written off at an early date, by late before the expiry of the lifetime of debentures.

The following are the methods available to write off discount/loss on issue of debentures:

1. Fixed instalment method
2. Equated method

4.10.1 Fixed Instalment Method

This method is applicable when the debentures are redeemed at the end of a specified period. Under this method, the total amount of discount is to be written off by equal instalments.

To illustrate, assume that the total discount allowed is 30,000 and the debentures are to be redeemed at the end of 6 years, then the amount to be written off annually will be At the end of sixth year, discount will be written off completely.

4.10.2 Equated Method, Fluctuating or Variable Instalment Method

Under this method, the discount is to be written off by proportionately reducing instalments. This method may be explained by the following illustration:

Illustration 4.19

Model: Discount on issue of debentures—Variable instalment method

A public limited company issued 10% debenture of the face value of 10,00,000 at a discount of 6%. The debentures were repayable by annual drawings of 2,00,000.

How would you deal with the discount on issue of debentures? Show the discount account in the company’s ledger for the duration of debentures.

Solution

Note: As it is given in the problem that “the debentures were repayable by annual drawings”, variable instalment method is to be adopted.

 

Step 1:	Computation of Total Amount of Discount on Issue of Debentures:
	Face Value of Debenture	= 10,00,000
	Discount Rate	= 6%
	∴ Discount Amount	=
		= 60,000

 

Step 2:	This Total Amount 60,000 is to be Written Off in Proportion to the Debentures Outstanding at the Beginning of Each Year.
	The Ratio of the Amount in Use for Each Year is to be Determined as:
	Year		Amount
	End of
	First Year	10,00,000 →	10,00,000
	Second Year	(10,00,000 – 2,00,000)	8,00,000
	Third Year	(8,00,000 – 2,00,000)	6,00,000
	Fourth Year	(6,00,000 – 2,00,000)	4,00,000
	Fifth Year	(4,00,000 – 2,00,000)	2,00,000
	Outstanding Balance Ratio = 10,00,000 : 8,00,000 : 6,00,000 : 4,00,000 : 2,00,000

 

Step 3:	Amount of Discount to be Written off Every Year:
	First Year		20,000
	Second Year		16,000
	Third Year		12,000
	Forth Year:		8,000
	Fifth Year:		4,000
		Total

Step 4:    Preparation of Debenture Discount A/c:

 

Illustration 4.20

Model: Fixed installment method

Usha Ltd. issued 1,00,000 debentures at a discount of 10% repayable at the end of 5 years.

Prepare the discount account in the ledger for the period.

Solution

Debentures are to be redeemed at the end of 5 years.

 

Step 1:	Determination of Total Discount Amount:
	Face Value of Debentures	= 1,00,000
	Discount Rate	= 10%
	Discount Amount
Step 2:	Amount to be Written for 1 year is to be Computed:
	Every Year 2,000 Has to Be Written off.
Step 3:	Preparation of Debenture Discount A/c:

 

Illustration 4.21

Model: When first redemption falls in next-accounting period

A public limited company issued 10% debentures at 94% 5,00,000 on 1 July 2005 repayable by five equal annual instalments of 1,00,000. The company closes its accounts on 31 March every year. Indicate the amount of discount to be written off every accounting year assuming that the company decides to write off the debenture discount during the life of the debentures.

Solution

For each year amount outstanding has to be computed and on the basis of total amount for each year, the ratio has to be determined and finally the amount to be written off has to be ascertained on the basis of such ratio. This is done in the following three stages:

STAGE I:

STAGE II: Determination of Ratio:

∴ The Amount of Discount: 6% of 5,00,000 = 30,000 is to be Written off in the Ratio of 15 : 17 : 13 : 9 : 5 : 1. (OR)

STAGE III:: Amount of Discount on Issue of Debentures to be Written off Each Year is Determined as Follows:

Year Ended 31 March	Ratio	Amount to be Written off ()
2006		7,500
2007		8,500
2008		6,500
2009		4,500
2010		2,500
2011		500
	Total	30,000

Illustration 4.22

Model: First redemption after few years—Discount written off

New India Ltd. issued 1,000 debentures of 100 each as a discount of 6%. The expenses of issue amounted to 3,500. The debentures have to be redeemed at the rate of 10,000 each year commencing with the end of fifth year. How much discount and expenses should be written off each year?

Solution

First total amount to be written off has to be computed as follows:

 

Amount of Discount = 6% of (1,000 × 100)	= 6,000
Amount of Expenses (Given)	= 3,500
Total Amount to be Written off:	= 9,500

This amount 9,500 is to be written off in the ratio of amounts of debentures in use for the years, calculated as follows:

 

End of the Year	Outstanding Amount	Ratio
1	1,00,000	10
2	1,00,000	10
3	1,00,000	10
4	1,00,000	10
5	1,00,000	10
6	90,000	9
7	80,000	8
8	70,000	7
9	60,000	6
10	50,000	5
11	40,000	4
12	30,000	3
13	20,000	2
14	10,000	1
15	Nil	—
	Total of Ratios

1. Amount of Discount & Expenses to be Written off in First 5 years (each year individually):

   

   That means, at the end of 1st year, 2nd year, 3rd year, 4th year and 5th year, 1,000 each year will be written off respectively.

From 6th year to the end of 14th year, the amount to be written off is calculated as follows:

 

End of the Year	Ratio	Amount to be Written off
6		900
7		800
8		700
9		600
10		500
11		400
12		300
13		200
14		100

4.11 LOSS ON ISSUE OF DEBENTURES

Loss on issue of debentures is incurred at the time of issue of debentures and also on redemption of debentures. This is a capital loss.

The loss occurs thus:

1. When the debentures are issued at par but redeemable at premium. Here,

   Loss = Premium payable on redemption

2. When the debentures are issued at discount and redeemable at premium → Loss = Amount of discount on the issue of debentures + Premium payable on redemption

   Students should clearly distinguish this with “discount on issue of debentures” where it is the amount of loss incurred at the time of issue of debentures only.

   Accounting treatment is very much similar to that of discount on issue of debentures. Entry will be:

   Entry will be:

    

   P&L A/c	Dr. …		{Amount Written off}
   To Loss on Issue of Debenture A/c		…

Illustration 4.23

Model: Loss on issue of debentures

Bala & Co. Ltd. issued 8,000 12% debentures of 50 each payable at a discount of 10% repayable after 5 years at a premium of 10%.

You are required to record:

1. Journal entries at the time of issue and at the time of redemption
2. Loss on issue of debentures account for the period

Solution

In this question,

 

Loss	=	Amount of Discount on Issue of Debenture + Premium on Redemption
	=	(10% of 50 × 8,000) + (10% of 50 × 8,000)
	=	(5 × 8,000) + (5 × 8,000)
	=	40,000 + 40,000
	=	80,000

(B) Loss on Issue of Debenture:

Debenture life, i.e., to be redeemed at the end of 5 years

Loss has to be written off equally for these years.

Loss Amount to be Written off :

4.12 REDEMPTION OF DEBENTURES

4.12.1 Meaning and Features

Redemption of debentures means repayment of the amount due on debentures to debenture holders.

Its features are as follows:

• It is a discharge of liability
• It should be redeemed as per the terms and conditions of issue.
• Generally, debentures are to be redeemed at the expiry of the specified period mentioned in the debenture certificate or trust deed.
• At times, the debentures may be redeemed before the expiry period.
• The redemption may be made in instalments or by purchasing them in open market.
• A company can purchase is own debentures, cancel and re-issue them.
• When redeemed debentures are re-issued, no fresh mortgage is necessary
• However, a company cannot redeem and re-issue them with a different redemption date.
• Failure to redeem debentures on maturity will result in disqualification of a director for 5 years.

4.12.2 Methods of Redemption of Debentures

Debentures may be redeemed by the following methods:

1. Redemption on maturity in one lump sum
2. Redemption may be made in annual instalments or by draw of lots
3. By purchase of its own debentures in the open market
4. By conversion into shares

4.12.3 Sources of Redemption of Debentures

The following are the main sources for redeeming debentures:

1. Capital
2. Profits
3. Sale of assets
4. Fresh issue of shares and debentures
5. Surplus funds

4.12.4 Debenture Redemption Reserve (DRR)

In accordance with the provisions of Section 117 C of the Companies (Amendment) Act 2000, a company must create Debentures Redemption Reserve (DRR) for the redemption of debentures that have a maturity period of 18 months or more.

Some of the important provisions envisaged in the Companies Act with respect to DRR are as follows:

1. DRR must be created to which adequate amounts shall be credited from out of profits every year until such debentures are redeemed.
2. The DRR should not be utilized for any other purposes.
3. Transfer to DRR should be done every year continuously till the complete redemption of all debentures.
4. In case debentures are issued for project finance, DRR can be created up to the date of commercial production. DRR may be created in equal instalments or higher amounts of profits so permit.
5. Creation of DRR is obligatory only for non-convertible debentures and non-convertible portion of party convertible debentures. No need arises to create DRR for fully convertible debentures.
6. DRR is treated as a part of “general reserve” for bonus issues and price fixation.
7. A company should create DRR equivalent to 50% of the amount of debenture issue before redemption begins.
8. Drawal from DRR is permitted only after 10% of the debentures are redeemed actually.

   Accounting Entry to Create DRR:

    

   Profit and Loss Appropriation A/c	Dr.	…
   To Debenture Redemption Reserve A/c			…

Now, let us discuss the methods of redemptions of debentures one by one.

4.12.5 Redemptions in One Lump Sum After the Expiry of the Specified Period

Under this method, the repayment is made in one lump sum at the expiry of specified period, mentioned in debenture certificate. The debentures are redeemed either at par or at premium as per the terms of issue. In practice, debentures are NOT redeemed at discount.

Accounting Entries:

(A) When the Debentures are Redeemed at Par:

1. When Debentures Become DUE for Payment on Redemption:

    

   Debentures A/c	Dr. …
   To Debenture Holders A/c		…	{Face Value}

2. On Redemption (Amount Paid off):
   

(B) When the Debentures are Redeemed at Premium:

1. When Payment is Due:
   
2. On Redemption (Amount Paid off):

    

   Debenture Holders A/c	Dr.	…
   To Bank A/c			…

Under this method, the following two approaches are available for redemption of debentures:

1. Redemption out of capital
2. Redemption out of profit

1. Redemption out of capital: Debentures may be redeemed out of capital. Profits or money earned in course of the business is not utilized here. In such a case, no transfer is required to general reserve or DRR. Redemption out of capital results in reduction of capital.

   But, according to Section 117 C of the Companies (Amendment) Act 2000 and the SEBI Guidelines, 50% of the amount of issue of debenture is to be created under DRR before the commencement of debentures redemption. Hence, it is not possible to redeem debentures entirely out of capital. As such, this method is not in vogue.

2. Redemption out of profit: Redemption of debentures out of profit means redemption through DRR A/c. A certain sum of money is transferred from profit and loss appropriation A/c (Divisible profits) to a newly created account: DRR A/c. This is to be utilized exclusively for redemption of debentures.

   Accounting Treatment: When redemption of debentures is made out of profits, entries will be as follows:

   The first two entries, i.e., when debentures are redeemed at par and at premium, are the same as those discussed under the head: Redemption in One Lump Sum: A & B entries. Repeat those entries here and then proceed:

(C) On Appropriation of Divisible Profits:

 

P&L Appropriation A/c	Dr.	…
To DRR A/c			…

(D) On Payment to Debentures:

 

Debenture Holders A/c	Dr.	…
To Bank A/c			…

(E) Transfer of Balance in DRR A/c to General Reserve A/c:

 

Debentures Redemption Reserve A/c	Dr.	…
(DRR)
To General Reserve A/c			…

(F) On Closing of Premium on Redemption of Debentures A/c:

In case no entry was made for premium on redemption of debenture at the time of issue, now the following entry is to be made to close the same.

 

Securities Premium A/c	Dr.	…
Profit & Loss A/c	Dr.	…
General Reserve A/c	Dr.	…
To Premium on Redemption of Debentures A/c			…

Note:

1. DRR A/c is to be shown on the liabilities side of the balance sheet under the head: “Reserves & Surplus”.
2. When redemption is fully completed, this account is closed and transferred to “General Reserve”.

Illustration 4.24

Model: Redemption out of profits

U.V.R Ltd. had issued 10,00,000 12% debentures in 2006 and the same were to be redeemed on 1 January 2011, out of the profits. The DRR stood at 2,75,000. Show the entries assuming that the debentures were redeemed at a premium of 10%.

Solution

 

Illustration 4.25

Model: Redemption out of profit

XZ Ltd. has a balance of 12,00,000 in P&L A/c. The company decided to forego payment of dividend and instead utilize the profits to repay 12% 10,50,000 debentures on 30 June 2009 as a premium of 10%. Debentures interest is payable annually on 31 December every year when the accounts are closed. The company also has a balance of 6,00,000 in the debenture redemption reserve account.

Journalize the transactions.

Solution

 

4.12.6 Financing of Redemption of Debentures

Despite the fact that the creation of DRR A/c is aimed at protecting the debenture holders, it suffers from some serious limitations. In practice, the DRR fund may not be in the form of cash at the time of redemption. Even if it is available in cash, the companies are not able to meet the remaining 50% to redeem the debentures. Under these circumstances, it is advisable to set aside a part of divisible profits for investing outside the business. The following methods are usually adopted for investing the funds outside the business:

1. Sinking fund method
2. Insurance policy method

4.12.6.1 Sinking Fund Method (Or Debentures Redemption Fund)

Meaning: A sinking fund is a fund (i) created by an appropriation of certain profits and (ii) invested outside the business for the debentures redemption.

The following are the features of sinking fund method:

1. Under this method, a fixed amount is taken from the profits of the company, every year.
2. Such amount is invested in selected securities, outside the business.
3. Such investments are realized at the time of redemption of debentures.
4. The sinking fund may be either cumulative or non-cumulative.

Cumulative debentures redemption fund: Interest on sinking fund investment is credited to debentures redemption fund and is again re-invested.

Non-cumulative debentures redemption fund: Invest is credited to P&L A/c and not re-invested.

A fixed amount is computed on the basis of Sinking Fund Table, which is credited to debenture redemption sinking fund every year. This is like DRR.

The terms debenture redemption fund, sinking fund, debenture redemption reserve A/c, debenture sinking fund and debenture redemption sinking fund are synonymous.

These terms may be used interchangeably.

4.12.6.1.1 Cumulative Sinking Fund

Calculation of the amount to be appropriated every year:

Under this method, a certain pre-determined amount is transferred from divisible profits to sinking fund account.

This may be ascertained either by using Sinking Fund Table or by applying a formula.

Formula:

where	A	=	Annual appropriation
	P	=	Total amount to be paid on redemption
	i	=	Per unit rate of interest
	n	=	Number of years, after the expiry of which debentures are to be redeemed.

Sinking Fund Table: Instead of using the formula, the amount to be appropriated can easily be ascertained with the help of a mathematical table called Sinking Fund Table.

To find out the factor one has to refer the Table. For example, if i = 4 % and n = 10 years, if we refer the table, Row & Column intersects at .083291. We have to multiply the amount with this factor to arrive at the investment amount.

Illustration 4.26

Model: Sinking fund—Calculation of investment amount

A public limited company issued 5,000, 10% debentures of 100 each at par repayable at par after 10 years. It was decided to establish a sinking fund for their redemption and to invest in securities yielding 4% interest per annum. Compute the amount of profits to be set aside each year. (Reference to the Sinking Fund Table shows that 0.083291 invested at the end of year at 4% compound interest will produce 1 at the end of 10 years).

Solution

In the question, the factor—known as present value factor — is given. As such, no need to refer the Table.

Accounting Treatment

The accounting entries for maintaining a cumulative sinking fund are as follows:

Illustration 4.27

Model: Sinking fund method

Rajas Ltd. issued 20,00,000, 10% debentures on 1 January 2008. They were to be redeemed on 31 December 2010. For this purpose, the company established a sinking fund. Investments were expected to earn 5% interest p.a. Sinking Fund Table show that 0.317208 invested annually at 5% amount to 1 in 3 years. On 31 December 2010, the bank balance was 8,40,000 before receipt of interest on sinking fund investments. On that date, the investments were sold for 13,12,000. Interest is payable annually. Calculate the interest to the nearest of a rupee and investments are made in multiples of 100. Ignore tax on debenture interest.

Give journal entries. Also prepare the following accounts. (i) 10% debentures A/c; (ii) sinking fund A/c; (iii) sinking fund investments A/c and (iv) bank A/c in the books of the company.

Solution

 

Annual Appropriation	=	20,00,000 × 0.317208
Amount to Be Set Aside Annually	=	6,34,416

 

Illustration 4.28

Model: Preparation of ledger accounts straightaway

The following balances appeared in the books of Star Ltd. as on 1 April 2010:

 

12% Debentures	3,00,000
Debentures Redemption Reserve	2,50,000
Debentures Redemption Fund Investments	2,50,000

The debentures redemption fund investment was represented by 2,60,000 9% government securities. The annual instalment amount added to the fund was 41,200. On 31 March 2011, the bank balance before the receipt of interest on investments was 80,000. On the date, the investments were sold at 84% and debentures were duly redeemed.

You are required to prepare (i) debentures A/c; (ii) debentures redemption reserve A/c; (iii) debenture redemption fund investment A/c and (iv) the bank A/c for 2010–11.

The company closes its books on 31 March every year.

Solution

Note: The terms debenture redemption reserve, debenture redemption fund and sinking fund are synonymous.

The terms debenture redemption fund investment; debenture redemption reserve investment; sinking fund investment are synonymous. Though the terms differ, the sinking fund method is to be used.

Basic Calculation:

1. Calculation of Interest:

   Opening Balance = 2,60,000 (Given)

   Interest on It for 1 year
   	= 23,400

2. Redemption Amount:

    

   Duly Redeemed Debentures	:	84% (Given)
   	:	84% of 2,60,000
   	=	2,18,400*1

4.12.6.1.2 Non-cumulative Sinking Fund

Generally, there seems to be not much difference between two types of sinking funds—cumulative and non-cumulative—specifically with respect to profits.

The main difference between these two types lies in the treatment of interest. In cumulative sinking funds, interest received on sinking fund investments is transferred to sinking or debenture redemption account whereas in the case of non-cumulative sinking funds, the interest is transferred to P&L A/c.

Accounting Entries for Non-cumulative Sinking Funds:

4.12.6.2 Insurance Policy Method

Under this method, an annual sum is appropriated out of profits as is done is sinking fund method. But, such appropriated profits are not invested in marketable securities. But, an insurance policy is taken for the required amount to redeem the debentures.

An amount equal to profit set aside is paid as premium to the insurance company. On the date of maturity, the insurance company pays the accumulated amount to redeem debentures. “Debenture redemption fund policy A/c” is opened instead of redemption fund investment A/c.

No entry for interest is recorded.

Accounting Treatment:

 

Illustration 4.29

Model: Insurance policy method

Jasemine Ltd. issued 3,000 10% debentures of 100 each at par on 1 January 2007, redeemable after 3 years. The company took an insurance policy for 3,00,000 for the redemption of debentures and paid 90,000 as annual premium. At the end of the third year, policy amount was received and debentures redeemed. Show the journal entries and prepare the ledger accounts in the books of the company relating to issue and redemption of debentures.

Solution

 

4.12.7 Redemption of Debentures by Draw of Lots

A company may redeem its debentures by payment of a certain proportion voluntarily each year. In this method, the debentures are to be redeemed, selected through lottery—Draw by lot.

Procedure: Slips containing numbers of all debentures are prepared. They are put in a drum And requisite number of slips is taken out by lot. The holders of the debentures, whose numbers are on the drawn out slips, are paid. The procedure adopted thus for redemption is known as “drawing by lot”.

Illustration 4.30

Model: Redemptions by draw of lots

Evergreen Ltd. issued 9,000, 6% debentures of 100 each on 31 March 2006 redeemable at a premium of 10% in June 2011. The Board of Directors decided to transfer the required amount to DRR in three equal instalments starting from 31 March 2009. Pass necessary journal entries regarding issue and redemption of debentures.

Solution

 

Step 1:	Determination of Instalment Amount:
	Outstanding Amount on Debentures 9,000   100	9,00,000
	DRR to be Created	4,50,000
	Total (3) Equal Instalments Value	4,50,000
	Single Instalment Value
	Amount to be Transferred Every Year for 3 years	1,50,000
Step 2:	Value of Premium:
	10% on Outstanding Debentures of 9,00,000
		= 90,000
Step 3:	Passing Journal Entries

 

4.12.8 Redemption Out of the Proceeds of Fresh Issue of Shares or Debentures

Another method of redemption of debentures is by issuing of new shares or debentures and create funds for the purpose. Such fresh issue of shares or debentures may be at premium or discount. Under this method, the creation of Debenture Redemption Reserve is not required.

Accounting treatment will be the same as that of made for the issue of shares and debentures.

Illustration 4.31

Model: Redemption out of fresh issue

The following is the balance sheet of Vishal Ltd. as on 31 March 2011:

The debenture trust deed provides that the company may redeem the debentures at a premium of 5% at any time before maturity. The directors decided to exercise this option and issued 25,000 shares of 10 each at 12 per share and 1,000 12% debentures of 100 each for the purpose of redemption. Show the journal entries and post-redemption balance sheet in the prescribed form.

Solution

Note: The 10% debenture to be redeemed is met out from the issue of new equity shares and 12% debentures (new). As the entire debentures are redeemed, the creation of DRR is not required. The existing capital of the company remains unaffected.

 

 

4.12.9 Redemption of Debentures by Conversion (Redemption of Convertible Debentures)

Generally, companies redeem their debentures in cash. But at times, debentures are redeemed by converting them into NEW CLASS OF SHARES OR DEBENTURES. Such debentures are termed “convertible debentures”.

Debenture holders of convertible debentures are given the right to exercise the option to convert them into new class of shares or debentures. However, the issue of new shares and especially at a discount should be subject to the provisions of the Section 79 of the Companies Act. Such new shares/debentures may be issued at par or at premium or at discount.

Accounting Treatment:

For discharge into the obligation of redemption, journal entries for issuing of new class of shares/ debentures are given as follows:

Illustration 4.32

Model: Conversion of debentures into equity shares at par

X Ltd. redeemed 5,000, 12% debentures of 100 each, which were issued at a discount of 10% by converting them into equity shares of 10 each at par.

Journalize for the redemption.

Solution

Note:

1. Debentures were used at discount.
2. Redemption by conversion into equity shares
3. Number of equity shares to be issued has to be determined in the following steps:

Step 1:	Face Value of Debentures (5,000 × 100)	= 5,00,000
	Less: Discount as 10% (∴ Issued at Discount)	= 50,000
	10% of 5,00,000
	Actual Amount Received on Use of Debentures
Step 2:	Face Value of Equity Shares to Be Used = 10 (∵ At Par)
Step 3:	Number of Equity Shares to Be Issued

 

Illustration 4.33

Model: Conversion of debentures into equity shares at discount

Y Ltd. redeemed 9,600 14% debentures of 100 each which were issued at 110% by converting their into equity shares of 10 each issued at a discount of 4%. Journalize.

Solution

 

Step 1:	Amount Due to Debenture Holders is Determined as:
Step 2:	Determination of Number of Equity Shares to be Issued:
	Number of Equity Shares to be Issued

 

Illustration 4.34

Model: Conversion of debentures into equity shares at a premium

Z Ltd. redeemed 5,000 12% debentures of 100 each which were issued at a discount of 5% by converting them into equity shares of 10 each issued at a premium of 25%. Journalize.

Solution

 

Step 1:	Determination of Amount Due to Debenture Holders:
	Face Value of Debentures	=	5,00,000
	(5,000 × 100)
	Less: Discount @ 5% (On 5,00,000)	=	25,000
∴	Amount Due to Debenture Holders	=	4,75,000
Step 2:	Determination of Number of Shares to be Issued:
	Number of Equity Shares to be issued

 

Illustration 4.35

Model: Conversion of debentures into equity shares at a discount

AB Ltd. redeemed 6,000, 6.25% debentures of 100 each which were issued at a discount of 5% by converting them into equity shares of 10 each at a discount of 5%.

Journalize.

Solution

 

Step 1:	Determination of Amount Due to Debenture Holders:
	Face Value of Debentures	=	6,00,000
	( 100 × 6,000)
	Less: Discount @ 5%	=	30,000
	5% of 6,00,000
	Amount Due to Debenture Holders	=
Step 2:	Determination of Number of Shares to be Issued:
	Number of Equity Shares to be Issued

Illustration 4.36

Model: Redemption of debentures—Converting into new debentures

CD Ltd. redeemed 5,000, 12% debentures of 50 each by converting them into 15% debentures of 250 each.

Journalize.

Solution

Determination of Number of Debentures to be Issued

Illustration 4.37

Model: Redemption by new issue of debentures originally issued at premium—New debentures issued at discount

EF Ltd. redeemed 1,44,000, 9% debentures of 100 each, at 102% by converting them into 11% debentures at 96%.

Journalize.

Solution

 

Step 1:	Determination of Amount Due to Debenture Holders:
	Debentures Issued at 102% Means a Premium of 2%           = 1,44,000 + 2% Premium           = 1,44,000 + 2,880           = 1,46,880
Step 2:	Number of Debentures to be Issued

Illustration 4.38

Model: Redemption by conversion—Calculation of interest

On 1 January 2009, GK Ltd. issued 10,00,000, 10% debentures of 100 each at par repayable at 10% premium. As per terms of issue, the debenture holders had an option to convert their debentures into equity shares of 10 each at any time after 4 years.

On 31 December 2010, a holder of 100 debentures gave a notice of exercising the option.

Interest for full one year was accrued and stood unpaid till 31 December 2010

Interest for the past year was paid.

Pass necessary journal entries.

Solution

• Interest Rate = 10%

  Interest for 10,00,000

• Number of Debentures Issued at Par
• Entries for 2 years—2009 and 2010—i.e., till the date of exercising option, have to be recorded as follows:

Illustration 4.39

Model: Conversion of debentures into preference shares

LM Ltd. redeemed 5,00,000, 12% debentures at 110% by converting them into 15% cumulative preference share of 50 at 55.

Make Journal entries.

Solution

 

Step 1:	Determination of Amount Due to Debenture Holders:
Step 2:	Number of Preference Shares to be Issued:

Illustration 4.40

Model: Redemption before maturity

On 1 January 2010, PQ Ltd. issued 5,000, 10% debentures of 100 each at 90 each. Debenture holders were given an option to get their debentures converted into equity shares of 10 each at 50% premium per share.

On 31 December 2010, one year interest has been accrued, not paid till that date.

A holder of 500 debentures wanted to exercise the option. Those 500 debentures were redeemed by issuing equity shares with interest due on them.

Pass necessary journal entries.

Solution

 

Step 1:	Amount Due to Debenture Holders:
	Face Value: 5,000 × 100	=	5,00,000
	Less: Discount @ 10%	=	50,000
Step 2:	Number of Equity Shares to be Issued:
Step 3:

4.12.10 Redemption by Purchase in the Open Market

As debentures are transferable, companies can purchase their own debentures in the open market. But this has to be authorized by the Articles of Association of respective companies. By using its surplus cash, a company can purchase its own shares in the open market and they can be sold in stock exchange.

Debentures may be purchased for the following objectives:

• For immediate cancellation (Cancellation means redemption)
• For investment—Also called “own debentures”

Companies purchase their own debentures because they can effect saving of premium and interest payable in future.

Debentures may be purchased:

• On the date when interest is due
• On the date between two interest rates

Accounting Treatment:

I. Purchase of Debentures for Immediate Cancellation:

A. When No Sinking Fund Exists:

B. When a Sinking Fund Exists:

II. Purchase of Debentures for Investment (Own Debentures):

A. Where No Sinking Fund Exists:

B. Where Sinking Fund Exists:

Illustration 4.41

Model: Redemption by purchase in open market—Immediate cancellation

Krishan Ltd. purchased its own 1,000 debentures of the face value of 1,00,000 from the open market for immediate cancellation at 90. Make journal entries.

Solution

Note:

1. The company purchased its own debentures in the open market.
2. It is for immediate cancellation.
3. Nominal Value
4. Purchase price is less than that of market price. Hence it is profit.

Illustration 4.42

The balance sheet of Reddy & Co. Ltd. on 31 December 2010 shows:

• 15% Debentures of 10,00,000
• Debenture Redemption Reserve 4,00,000
• Debenture Sinking Fund Investments Represented by 1,00,000

Own Debentures purchased at 90% and remaining amount by 3,20,000, 10% stock.

On 31 March 2010, the directors redeemed all the debentures for this purpose, 10% stock was realized at par, an amount of 1,40,000 out of current year’s profit for redemption. Pass necessary journal entries.

Solution

Note:

1. In this question, both the factors, i.e., for cancellation and for investment purposes, can be noticed.
2. Computation of the Value of Own debentures:

   
   Own Debentures—90% (Given)       ∴ 90% of 1,00,000 = 90,000

   This is Debenture Sinking Fund Investment

    

3. Computation of Cost of Investment: (10% Stock)

    

   Debenture Redemption Reserve Fund Investment (Given)	=	4,00,000
   Less: Value of Own Debenture (Ref: 2 above)	=	90,000
   ∴ Cost of Investment

4. *¹4. Profit on Sale of 10% Stock : Sales − Cost of Investment
   

Illustration 4.43

Model: Both for the purpose of cancellation and investment without creating DRR

Subh Ltd. issued 10,000, 12% debutantes of 300 each. The Board of Directors decided to purchase 1,000 debentures at a price of 90 each for investment purpose. After 9 months, they decided to sell off these debentures @ 110 each. Pass journal entries.

Solution

Note:

1. In this question, both the factors, i.e., purchase of own debentures and for investment purposes, are present.
2. But in this question, nothing is mentioned about debenture redemption reserve. It is silent on this. In such a case, assume that there is sufficient balance in DRR.

 

4.12.10.1 Purchase of Debentures on a Day Other than Due Date of Interest

Usually, interest on debentures is paid on specific dates. But at times, debentures are purchased in the open market on a date other than the specified date of interest. In such a situation, accounting treatment differs. Here arises the factors: EX-INTEREST and CUM-INTEREST quotations.

Amount paid towards the cost of debentures = Capital Part + Revenue Part, i.e., amount paid towards interest from the last specified date to the actual payment.

4.12.10.1.1 Cum-interest

Where the price (quoted in the quotation) includes interest for the expired period, it is termed CUM-INTEREST

Such quotation includes:
(i) Payment of Debenture	=	Capital Part
and
(ii) Payment of Interest	=	Revenue Part
In this case,
Cost of Debenture = Price Paid − Interest for Expired Period.

4.12.10.1.2 Ex-interest

Where the price (quoted in quotation) does not include the interest for the expired period, it is termed EX-INTEREST

In this case,

Cost of Debenture = Price of Debenture + Interest Accrued

Illustration 4.44

Model: Cum-interest and Ex-interest

PQR Ltd. purchased from the market its own 1,000, 15% debentures of 100 each at 90 on 31 December 2010. Interest is paid on 31 March and 30 September every year. Journalize the entries for the quotations: (1) ex-interest and (2) cum-Interest

Solution

 

Step 1:	Determination of Expiry Period
	Interest is Paid on 31 March and 30 September (Given)
	Period of Expiry	=	1 October 2010 to 31 December 2010
		=	3 months (or) year
Step 2:	Calculation of Interest for Expired Period:
		=	1,000 Debentures
		=
Step 3:	Ex-Interest:
	Cost of Debenture	=	Price of Debentures + Interest Accrued
		=	(1,000 × 90) − 3,750
		=	90,000 + 3,750
		=	93,750
Step 4:	Cum-Interest:
	Cost of Debenture	=	Price of Debentures – Interest for Expired Period
		=	(1,000 × 90) − 3,750
		=	90,000 − 3,750 = 56,250
Step 5:

 

4.12.10.2 Interest on Own Debentures

As already mentioned, by purchasing own debentures, a company saves interest that would have otherwise been paid to outsiders.

In case a company purchases its own debentures, and if they are not cancelled immediately, then interest will become due on such debentures too.

Interest is paid only to outsiders.

Interest on own debentures is retained by the company.

Interest on own debentures is credited to “interest on own debentures A/c.”

Accounting Treatment:

Accounting Entries for the Interest on Own Debentures are:

Illustration 4.45

Model: Interest on own debentures

On 31 March 2010, the balance sheet of Rukmani Ltd. showed 2,000, 12% debentures of 100 each outstanding. Interest on debentures is payable on 30 September and 31 March every year. On 1 August 2010, the company purchased 400 of its own debentures as investment @ 95 ex-interest. The company cancelled all its own debentures on 1 March 2011. Books are closed on 31 March every year. Give necessary journal entries.

Solution

Students have to compute both interest and cost of debentures purchased in detail as follows:

 

Step 1:	Interest on Debentures Purchased on 1 August 2010:
	Expiry Period = From 31 March to 1 August 2010 = 4 months
	Interest      where P = (400 × 100);

Step 2:	Interest on Debentures Payable to Outsiders:
	Total Debentures	= 2,00,000
	Less: Debentures Held by the Company	= 40,000
		= 1,60,000
	Interest
		= 9,600

Step 3:    Cost of Debentures Purchased on 1 August 2010:

Step 4:    Interest on Own Debentures Due to Company:

Step 5:	Net Interest on Own Debentures:
	Out of 2,400 (As in Step 4), 1,600 had Already Been Paid by the Company at the Time of Purchasing Own Debentures (As in Step 1).
	∴ Net Interest on Own Debentures Credited = 2,400 − 1,600
	= 800

Step 6:	Interest on Debentures Payable to Outsiders on 31 March 2011:
Step 7:	Interest on Own Debentures Due to the Company from 30 September to 1 March

Step 8:	Total Interest on Debentures	=	12,000 + 11,600 + 1,600
		=	25,200
Step 9:	Total Interest on Own Debentures	=	800 + 2,000
		=	2,800
Step 10:

 

Illustration 4.46

Model: Sinking fund method

ABC Ltd. issued 4,000, 12% debentures of 100 each at par on 1 April 2008. These debentures are redeemable at the end of 5th year at 10% premium. It was resolved that sinking fund should be formed and invested in 10% development bonds of 100 each. Interest on bonds is payable on 31 March every year.

Reference to Sinking Fund Table 3 shows that 0.1638 invested at the end of every year at 10% compound interest will produce 1 at the end of 5th year.

10% Development bonds of the required amount were purchased on different dates at the following prices:

 

On March 2009	80
On March 2011	90
On March 2010	100

You are required to show debenture redemption fund A/c and debenture redemption fund investment A/c for the first 3 years in the books of ABC Ltd. Accounting year of this company ends on 31 March.

Solution

Basic Calculations:

 

Step 1:	Determination of Value of Debentures to Be Redeemed:
	Face Value of Debenture = 4,000 × 100	=	4,00,000
	Add: 10% Premium = 10% of 4,00,000	=	40,000
	Value of Debenture to be Redeemed	=	4,40,000

Step 2:	Annual Appropriation to be Created = 4,40,000 × 0.1638 = 72,072
Step 3:	Determination of Number of Bonds Purchased and Their Cost Price:

1. For Year Ended 31 March 2009: (First Year)

   Number of Bonds Purchased

   ∴ Cost Price of 901 Bonds     = 901 × 80 = 72,080

   Face Value                 = 901 × 100 = 90,100

    

2. For the Year Ended 31 March 2010 (Second Year):

   Number of Bonds Purchased

   

   Cost Price        = 901 × 90 = 81,090

   Face Value        = 901 × 100 = 90,100

    

3. For the Year Ended 31 March 2011 (Third Year):

    

   Number of Bonds Purchased
   Cost Price	= 901 × 100 = 90,100
   Face Value	= 901 × 100 = 90,100

Step 4:

 

Step 5:

 

Illustration 4.47

Model: Redemption through sinking fund

In March 2011, the following balances were extracted from the books of Suraj Ltd.:

 

14% Mortgage Debenture	25,00,000
Debenture Redemption Fund	25,00,150
Debenture Redemption Fund Investments	21,00,000

On 1 April 2011, all the investments were sold for 20,58,000 and debentures were redeemed at par. The company had sufficient bank balance. You are required to prepare:

• 14% First mortgage debentures
• Debenture redemption fund
• Debenture redemption fund investments A/c

Solution

Note: Loss on sale of investments : 21,00,000 − 20,58,000

 

Illustration 4.48

Model: Purchase of debenture in open market

Kamal Ltd. issued on 1 April 2007, 40,000 12% debenture of 100 each redeemable at the option of the company after the second year as 104 upon giving two months notice to the debenture holders. The company purchased the following debenture in the open market:

• On 12 June 2009, 8,000 nominal value as cum-interest cost 8,050
• On 24 August, 2009 14,000 nominal value as ex-interest cost 13,830

These debentures were retained as investments till 30 September 2010, on which date they were cancelled. Show the necessary ledger accounts as they would appear in the books of the company for 2009–10 and for 2010–11 assuming that the company closes its book of accounts every on 31 March. Interest is payable half-yearly on 30 September and 31 March. Ignore income tax.

Solution

 

Illustration 4.49

X Ltd. had issued 4,000 6% debenture of 100 each on 18 January 2006. Interest was payable half-yearly on 30 June and 31 December each year. They were repayable at par after 10 years with the option to redeem them at any time after 31 December 2010 as 103. On 1 January 2011, the balance in the debenture redemption fund A/c stood at 2,14,000 which was invested outside. On 30th June 2011, a notice was given for redemption of the above debenture with the option to receive one new 9% debenture of 100 each as 98 and 5 in cash for each 6% debenture in place of 103 in cash.

The holders of 3,600 debentures exercised this option and the remaining were paid cash. The company sold investments costing 1,44,000 for 1,74,800. The company completed the redemption. Give necessary ledger accounts offered by the above transactions. Ignore the tax.

Solution

 

Illustration 4.50

Pass journal entries in year 1 in the case of issue of debentures by XYZ Co Ltd., which issued 5,00,000, 11% debentures as 95% redeemable at the end of 10 years (1) at 102% and (ii) at 98%.

 

[C.A. Modified]

Solution

 

Illustration 4.51

Model: Redemption by conversion

Leo Ltd. made a public issue in respect of which the following information is available:

• Number of partly convertible debentures issued: 6,00,000; face value and issue price: 100 per debentures
• Convertible portion per debenture: 60%; date of conversion: on expiry of 6 months from date of allotment
• Date of closure of subscription: 1 May 2010; date of allotment: 1 June 2010, rate of interest on debentures: 12% payable from the date of allotment; values of equity share for the purpose of conversion: 60 (face value 10)
• Underwriting commission @ 2% on the amount devolving on the underwriting and @ 1% on amount subscribed for by the public
• Number of debentures applied for 4,50,000
• Interest payable on debentures half-yearly on 30 September and 31 March

Write relevant journal entries for all transactions arising out of the above during the year ended 31 March 2011 (including cash and bank entries)

 

[C.A. (Inter). Modified]

Solution

 

Illustration 4.52

Model: Redemption by conversion

The summarized balance sheet of XY as on 31 March 2011 stood as follows:

The debentures are due for redemption on 1 April 2011. The terms of issue of debentures provided they were redeemable at a premium of 5% and also conferred option to the debenture holders to convent 20% of their holding into equity shares as a pre-determined price of 15.75 per share and the payment in cash. Assuming that:

• Except for 1,000 debenture holders holding 1,00,000 debentures in all, the rest of them exercised the option for maximum conversion
• The investments realize 176 lakh on sale
• All the transactions are put though, without any lag, on 1 April 2011.

Redraft the balance sheet of the company as on 1 April 2011, after giving effect to the redemption. Show your calculation in respect of the number of equity shares to be allotted and the cash payment necessary.

 

[C.A. (Inter). Modified]

Solution

BASIC CALCULATIONS:

 

Step 1:	Determination of Number of Shares to be Allotted:
	Number of Debentures Opting for Conversion	: 4,00,000 − 1,00,000
		= 3,00,000

Step 2:    Determination of Cash to be Paid for Redemption

Step 3:

Cash and Bank Balance is to be Calculated by Preparing Cashbook as Follows:

 

Step 4:

General Reserve to be Shown in B/S is Ascertained by Preparing General Reserve A/c as Follows:

 

Step 5:

Step 6:

Illustration 4.53

Model: Redemption by conversion—Redemption of preferecne shares combined

The summarized balance sheet of Sri Vasudev Ltd. on 30 September 2010 was as follows:

On 30 September 2010, the following were due for redemption:

• 10,000 6% Redeemable preference shares at a premium of 25 per share.
• 4,000 10% Redeemable debentures shares at a premium of 10% the redemption was made on that date or subsequently this:
  • For half the year ending 30 September 2010, the debentures interest and preference dividend was paid out of profits of the company
  • On an offer made to the 10% debenture, the outsiders agreed to take new 12% debentures at par in exchange of old debentures ; the company also decided to assume the new debentures
  • A fresh issue of 2,000 equity shares of 100 each was made at a premium of 50 per shares and subscribed in full. All moneys due were received forthwith
  • Redemption of all preference shares was made on 10 October 2010
    You are required to show all journal entries for the above transactions to give the company’s opening balance sheet after giving effect to them.

[C.A. (Inter). Modified]

Solution

 

Working Notes for preparation of balance sheet:

 

1.	Calculation of Cash at Bank:
	Opening Balance		12,00,000
	Add: Calls-in-Arrears Received		10,000
	Fresh Issue Receipts		3,00,000
			15,10,000
	Less: Pref. Dividend	29,700
	Debentures Interest	10,000
	Pref. Shareholders	12,50,000	12,89,700
	∴     Amount to be Shown as Cash at Bank		2,20,300
2.	Calculation of Balance in P&L A/c:
	Opening Balance		6,00,000
	Add: Interest on Own Debentures		10,000
	Profit on Conversion of Debentures		30,000
	from 10% to 12%		6,40,000
	Less: Capital Redemption Reserve	4,00,000
	Pref. Dividend	29,700
	Interest to Debentures	20,000	4,49,700
	∴ Amount to be Shown in P&L A/c		1,90,300

 

Illustration 4.54

Model: Interest on own debentures

Kuber Ltd. has an authorized capital of 75,00,000 dividend into share of 10 each and its balance sheet as on 31 December 2010 was as follows:

The 6% debentures were due for redemption on 30 June 2011 at a premium of 5%.

The company decided:

• To issue to public 1,25,000 equity shares of 10 each at 15 per share. The money was duly received.
• To redeem the debentures on 30 June 2011 together with interest for 6 months.
• To give the debenture holders an option to receive either cash in repayment of the amount due or new 7% debentures at par. The holders of 5 lakh of the old debentures accepted new debentures.

The debentures which the company held as an investment were cancelled. Ignore tax.

Required: Journal entries to give effect to the above transactions.

 

[C.A. (Inter). Modified]

Solution

Note:

1. As nothing is mentioned specific, debenture interest on 5 lakh debentures is not converted into new debentures.
2. In this case, the profit on cancellation is transferred to capital reserve A/c instead of debenture redemption fund A/c.

Illustration 4.55

Model: Redemption of debentures

Shree Ltd. had 9,00,000 14% debentures outstanding on 1 April 2010 redeemable on 31 March 2011. On 1 April 2010, the debentures redemption fund stood at 7,49,000 represented by own debentures of the face value of 1,00,000 purchased at an average price of 99 per debenture and 10% stock acquired at par for 6,50,000. The annual instalment of transfer to the fund was 71,000. In March 2011, investments were sold for 6,46,800 and the debentures were redeemed.

Show 14% debentures A/c; debentures redemption fund A/c and debentures redemption fund investments A/c

 

[C.S. (Inter). Modified]

Solution

 

Illustration 4.56

Model: Purchase and cancellation of debentures

On 31 March 2010, Gemini Ltd.’s balance sheet showed 5,00,000 12% fully paid debentures of 100 each. Interest on debentures is payable on 30 September and 31 March every year. On 1 August 2010, the company purchased 1,00,000 of its own debentures as investment ex-interest 98. However, on 31 March 2011, the company cancelled all these debentures. The company had a balance of 30 lakh in its debentures redemption reserve A/c on that date.

Pass journal entries for all the transactions during the year ended 31 March 2011.

 

[C.S. (Inter). Modified]

Solution

 

		( in 000’s)
1.	Calculation of Cum-interest Payment:
	Ex-interest Price of 1,00,000 Own Debentures @ 98	= 9,800
	Add: Interest for 4 months @ 12%	= 400
	Cum-interest Payment	= 10,200
2.	Determination of Capital Profit:
	Per value of 1,00,000 Debentures @ 20 Each	= 10,000
	Less: Purchase Price of Own Debentures @ Ex-interest Price	= 9,800
	Capital Profit	= 200

Illustration 4.57

Model: Redemption by cancellation

X Ltd. had 6% 10,00,000 debentures outstanding in its books. On 1 April 2010 it had 4,00,000 balance in sinking fund A/c exactly represented by 8% investment (nominal values) ( 5,00,000). On 31 December .2010, it sold 1,00,000, 9% investments at 90,000 and with the amount on the same date purchased 1,00,000 own debentures for immediate cancellation. On 31 March 2011, it sold 50,000 8% investments for 38,000 and with that amount purchased 40,000 own debentures and cancelled them immediately. Interest date is 31 March 2011 for own debentures as well as for investments. Ignore tax. Annual appropriation entries for 31 March 2011 need not be passed. Prepare the necessary ledger accounts.

 

[C.S. (Inter). Modified]

Solution

Calculations:

1. Calculation of Amount Realized on Sale of Investments:

   

2. Calculation of Profit on Sale of Investments:

    

   Cost of Investment Sold	=
   Amount Realized (Ref: 1)	=	84,000 − 80,000
   Profit	=	4,000

3.  

   
4. Calculation of Loss on Sale of Investments:

    

   Cost Price of Investments Sold
   Amount Realized (Ref: 3)	= 34,000
   ∴ Loss	= (34,000 − 40,000)
   	= 6,000

5. Debenture Interest:
   Debenture Outstanding on 1 April 2010	= 10,00,000
   Less: Debentures Purchased & Cancelled	= 1,40,000
   Debenture O/S on 31 March 2011	= 8,60,000

   Interest

Debentures: A document which creates a debt and acknowledges it. Salient features of a debenture are: (i) a document; (ii) an acknowledgment of debt; (iii) periodical payment of fixed rate of interest; (iv) the sum will be repaid on a before maturity date; (v) security may be in either fixed or floating charge (vi) carries no voting rights (vii) may be convertible or partly convertible or non-convertible.

Debenture stock: Loan is consolidated into one composite debt which may be divided into small units and transferred.

Kinds of debentures: Various kinds. (Ref: Text)

Pari Passu: It means equal relating to charge and repayment.

Debenture trust deed: It is a sort of contract between the company and the trustees of debentures. SEBI imposes certain restrictions to become a debenture trustee.

Issue of debentures for cash: Debentures are issued at par or at premium or at discount. Accounting treatment is explained in detail for issue of debentures (Ref: Text).

Issue of debentures for consideration other than cash: Debentures are issued for purchase of assets instead of cash to the vendors. Debentures are issued as a collateral security. A collateral security is a subsidiary or secondary or additional security.

Terms of issue of debentures: Accounting treatment is explained in detail with illustrations in the text for the following: various categories of issue and redemption:

 

Issued at	Redeemable at
Par	Par
Discount	Par
Premium	Par
Par	Premium
Premium	Premium
Discount	Premium

Debenture interest: Interest is calculated at nominal value and not on the issue price. TDS is explained.

Net effective rate of interest: It is calculated on the actual amount received and not on nominal value.

Accrued interest and outstanding interest: For accounting treatment, refer text.

Redemption of debentures: Provisions of Section 117 C are explained.

Methods of redemption: (i) In one lump sum; (ii) by draw of lots (annual instalments); (iii) by conversion and (iv) by purchase of its own debentures in the open market.

Sources of redemption: (i) Out of capital; (ii) out of profits (iii) out of proceeds from fresh issue of shares and debentures and (iv) on sale of assets

Debenture Redemption Reserve (DRR): Exclusively created for debentures redemption. For SEBI Guidelines to create DRR, refer Text.

Sinking fund: This fund is created by appropriation of profits and buying from such amount investments, which will be utilized for redemption purpose. There are two types: (i) cumulative sinking fund and (ii) non-cumulative sinking fund. Accounting treatment for each is explained in detail (Ref: Text).

Insurance policy method: This is similar to sinking fund method except in respect of interest on investments.

Redemption by conversion: Convertible debentures are redeemed by conversion into shares in accordance with the provisions of Section 79 of the Companies Act.

Redemption by purchase in the open market:

For this, the following are the main objectives: (i) for immediate cancellation and (ii) for investment. Debentures purchased for investment are called “own debentures”.

Interest on own debentures: Interest payable held by outsiders and interest on own debentures—the two components have to be treated carefully.

Cum-interest and ex-interest quotations: When the price of the debentures includes interest, it is said to be cum-interest or cum-dividend quotation. When the price of the debentures excludes interest, it is said to be ex-interest or ex-dividend quotation. Accounting treatment is explained. (Ref: the text for illustration)

Debentures: A document that creates a debt secured by a charge on the assets of a company. It is the description of an instrument.

Debenture Stock: A single consolidated composite debt document instead of separate individual debentures certificate. It is a description of debt.

Convertible Debenture: Debentures that are converted into shares of a company on its maturity date.

Fixed Charge: Charge created on immovable assets.

Floating Charge: Charge created on movable assets.

Trust Deed: A contract between the company and the trustees for debenture holders.

Debenture Redemption Reserve (DRR): Creation of fund out of profits of the company for redemption of debentures.

Sinking Fund: A fund created by an appropriation of profits and purchase of investments.

Cum-Interest or Cum-Dividend Price: The price of debentures includes the interest for the expired period.

Ex-Interest or Ex-Dividend Price: The price of debentures does not include the interest for the expired period.

Own Debentures: A company that buys its debentures as investment.

QUESTION BANK

I: State whether the following statements are true or false

1. A fixed deposit receipt may also be treated as a debenture.
2. Interest on debenture is paid only when the company earns profit.
3. Debentures carry no voting rights.
4. Debentures lying idle in the company known as debentures stock.
5. Fully convertible debentures (FCD) have highly favourable debt equity ratio.
6. DRR must be created in respect of fully convertible debentures.
7. Dividend is a charge against profit.
8. There is no restriction on the purchase of is own debentures by a company.
9. A floating charge is a mortgage of property.
10. In case a trust deed is executed, then there will be no direct relationship between the shareholder and the company.
11. Technically, debentures A/c is different from that of debentures capital A/c.
12. Discount allowed on issue of debentures A/c is to be shown on the assets side of the balance sheet.
13. Convertible debentures can be issued as a discount.
14. In case of debentures redeemed as premium, then it should be treated as capital profit.
15. TDS, until it is actually paid to the government, should be treated as a liability and shown in the balance sheet of the company.
16. A company can redeem debentures and re-issue then with a different redemption date.
17. When a sinking fund A/c is created, then there is no need for creation of DRR.
18. The annual instalment for sinking fund the redeem of debentures is an appropriation of profit.
19. When a company retains its own debentures as an investment, then interest on them need not be calculated.
20. Profit on conversion of debentures is generally transferred to P&L A/c.

Answers:

1. False
2. False
3. True
4. False
5. True
6. False
7. False
8. True
9. False
10. True
11. False
12. True
13. False
14. False
15. True
16. False
17. True
18. True
19. False
20. True

II: Fill in the blanks with apt word(s)

1. A debenture means a document which creates a _____.
2. _____ rate of interest will be paid on debentures periodically.
3. Interest is a charge on profit whereas dividend is _____ of profit.
4. A fixed charge is created on _____.
5. Debentures of a series with Pari Passu clause have to be paid _____.
6. A trust deed is a contract between a company and the _____ for the debenture holders.
7. In accordance with the SEBI Guidelines, a trust deed is to be executed by the issuing company within _____ of the closure of the issue.
8. Securities premium A/c will be shown under the head “ _____ ” in the balance sheet.
9. Discount allowed on issue of debentures is to be treated as _____.
10. Where the value of debentures issued is more than the value of the assets acquired, the difference is to be debited to _____ A/c.
11. As a company cannot issue debentures in fraction, any fractional payment has to be made in _____ .
12. Premium or redemption is to be shown under the head “ _____ ”.
13. Interest on debentures is always calculated on the _____ value of debentures.
14. In case the debentures are tax free, interest payable on debentures has to be _____.
15. Net effective rate of interest is based on the _____ received on debentures and not on the nominal value.
16. DRR is created out of the _____ of the company.
17. A company should create DRR equivalent to _____ of the amount of debenture issue before redemption.
18. No DRR is required for issue of debentures with a maturity period of _____ or less.
19. The terms sinking fund, _____ , debentures sinking fund or debenture redemption sinking fund are synonymous.
20. Where no sinking fund exists, an amount equal to the nominal value of debentures redeemed should be transferred out of divisible profits to _____.

Answers:

1. debt
2. fixed
3. appropriation
4. immovable assets
5. rateably
6. trustees
7. 6 months
8. Reserve & Surplus
9. capital loss
10. goodwill
11. cash
12. Current Liabilities & Provision
13. face or nominal
14. grossed up
15. grossed up
16. profits
17. 50%
18. 18 months
19. debentures redemption fund
20. DRR

III: Multiple choice questions—Choose the correct answer

1. Debenture is
   • document which either creates a debt or acknowledges it
   • a certificate of ownership of a company
   • a certificate to participate in the meetings of a company
   • a certificate to be issued to the directors of a company
2. Debenture holders are the
   • employees of a company
   • creditors of a company
   • customers of a company
   • owners of a company
3. Debentures are shown under the following heads in the balance sheet:
   • Reserves & Surplus
   • Provision
   • Share Capital
   • Secured Loan
4. Interest on debentures is payable on the basis of
   • profits of a company
   • resolution passed in annual meeting
   • decision of board of directors
   • pre-determined fixed rate
5. The role played by the trustees is crucial when
   • debentures stock is issued
   • debentures are issued at premium
   • debentures are issued at discount
   • Debentures are issued at par
6. Premium on issue of debentures is to be credited to
   • debentures premium A/c
   • securities premium A/c
   • share capital A/c
   • none of the above
7. Discount allowed on issue of debentures is
   • capital profit
   • revenue profit
   • capital loss
   • revenue loss
8. Which of the following terms of issue of debentures (including terms of redemption) is not possible:
   • issue of debentures at par, redeemable as premium
   • issue of debentures at discount, redeemable at premium
   • issue of debentures at premium, redeemable at premium
   • issue of debentures at par, redeemable at discount
9. The liability for outstanding debenture interest will be shown in the balance sheet under the heading:
   • Secured Loans
   • Unsecured Loans
   • Share Capital
   • Miscellaneous Expenditure
10. Which of the following is not a source of redemption:
    • redemption out of capital
    • redemption out of borrowings from financial institutions
    • redemption out of profits of the company
    • redemption by conversion
11. Debenture redemption reserve is created
    • out of profits
    • by issue of fresh shares
    • by issue of fresh debentures
    • by sale of assets
12. The balance in the sinking fund A/c is transferred to (after the redemption of debentures)
    • capital reserve
    • sinking fund investment A/c
    • general reserve
    • P&L A/c
13. After the realization of investment, the balance in sinking fund investment A/c is transferred to
    • capital reserve
    • current liability and provisions
    • P&L A/c
    • sinking fund A/c
14. Own debentures mean
    • debentures purchased for investment
    • debentures purchased for immediate cancellation
    • debentures owned by the directors exclusively
    • none of the above
15. At the time of purchase of own debentures, own debentures account is to be debited with
    • cum-interest price
    • face value
    • ex-interest price
    • issue price

Answers:

 

1. (a)	2. (b)	3. (c)	4. (d)
5. (a)	6. (b)	7. (c)	8. (d)
9. (a)	10. (b)	11. (a)	12. (c)
13. (d)	14. (a)	15. (c)

1. Define: Debenture.
2. What do you mean by “debenture stock”?
3. What is a “secured debenture”?
4. What is a “naked” debenture?
5. Explain: Convertible debentures.
6. What is a “call option”?
7. What is a “put option”?
8. What is a fixed charge?
9. What is a floating charge?
10. When does a floating charge become crystallized?
11. Explain the term: “Pari Passu” clause
12. What is a debenture trust deed?
13. Who can act as a debenture trustee?
14. Name the various types of issue of debentures.
15. How interest on debentures will be calculated?
16. What do you mean by TDS?
17. Explain the term: Interest accrued and due.
18. What is the accounting entry for “accrued interest”?
19. Pass the journal entry for writing off the loss on issue of debentures.
20. What is a “sinking fund”?
21. Explain the term: Redemption by conversion.
22. Explain: Debenture redemption reserve.
23. Name the two components associated with sinking fund method.
24. What is the main difference between cumulative and non-cumulative sinking funds?
25. What are the advantages of insurance policy method?
26. What are the different options available for redemption of debentures?
27. What do you mean by “own debentures”?
28. How will you calculate interest on own debentures?
29. What is cum-dividend?
30. Explain: Ex-interest price quotations.
31. Mention any four differences between a share and a debenture.
32. Enlist the main differences between fully convertible debentures and partly convertible debentures.
33. Explain: Debentures issued as collateral security.
34. Write short notes on: Redemption by “draw of lot”.
35. Explain: Redemption of debentures out of capital.
36. Write notes on: Redemption out of profits.
37. Explain: Redemption of debentures by fresh issue of capital.

1. Define: Debenture. Enumerate the basic characteristics of debentures.
2. Distinguish between a shareholder and a debenture holder.
3. As an investor, which do you prefer: Shares or debentures? Substantiate your answer with apt reasons.
4. What are the various types of debentures which may be issued by a company? Discuss in detail.
5. What are the differences between fully convertible debentures and partly convertible debentures?
6. Describe the various categories of issue of debentures and their redemption.
7. Explain the different methods of redemption of debentures.
8. Explain with example: Redemption of debentures out of profits.
9. Write notes on:
   • Sinking fund
   • Sinking fund investment
   • Debenture redemption reserve
   • Own debentures acquired as investments
10. Explain the accounting treatment for cumulative sinking fund and non-cumulative sinking fund.
11. Write short notes on:
    • Interest on debentures
    • Ex-interest quotation
    • Cum-interest quotation
    • Call-option & put-option
12. What is meant by issue of debentures as a collateral security? What is the accounting treatment for it?
13. Highlight the important guidelines of SEBI with respect to accounting treatment of redemption of debentures out of profits?
14. Distinguish between sinking fund to replace an asset and sinking fund to repay a liability.
15. Explain the process of purchase of own debentures in the open market by a company.

 

 

1. Moon Light Ltd. issued 10% debentures of the face value of 100 each as follows:

• On 1 April 2011, 5,000 debentures at 98 each for cash to the public
• On 1 May 2011, 6,000 debentures at par to SBI as collateral security for the term loan of 5 lakh borrowed
• On 1 June 2011, 8,000 debentures to the vendors of land to settle the agreed price of 8,50,000

You are required to pass journal entries to record the above issues of debentures. Ignore interest and tax.

[Ans: Discount on issue: 10,000; Face value: 6,00,000; Face value: 8,00,000; premium: 50,000]

[Model: Issue of debentures]

2. X Ltd. made the following issues of debentures:

• For cash at 90% but repayable at 110% debentures of 50,000
• To a creditor who supplied machinery costing 10,00,000, 11,000 debentures of 100 each
• To bank for a loan of 21,00,000 as collateral security 30,000 debentures of 100 each

Journalize the transactions.

[Ans: (i) Discount on issue: 5,000; Loss on issue: 5,000; (ii) Discount on issue: 1,00,000; (iii) Face value: 30,00,000]

3. Y Ltd. acquired the business of “A” Ltd. for a consideration of 25,00,000. The vendors were paid 7,00,000 in cash and the balance in 10% debentures of 100 each, issued at 90%. Give journal entries.

[Ans: 20,000 debentures of 100 each as 10% discount]

4. Z Ltd. took over the business of “B” Ltd., the assets and liabilities being valued at 3,20,000 and 1,20,000, respectively. Z Ltd agreed to pay 2,88,000 as the purchase price, to be settled by the issue of 12% debentures of 10 each at a premium of 20%. Give journal entries.

[Ans: Goodwill: 88,000; 18,000 debentures of 10 each as 12]

5. A company purchased assets of 4,20,000 and took over liabilities of 40,000 for an agreed consideration of 3,60,000. The company issued debentures at 10% discount in full satisfaction of the purchase price. Give the journal entries in the book of the purchasing company.

[Ans: Capital reserve: 20,000; Number of debentures issued: 40,000]

6. On 1 January 2009, Z Ltd. issued 6,60,000, 9% debentures as a discount of 5% repayable as follows:

 

On 31 December 2009	1,20,000
On 31 December 2010	2,40,000
On 31 December 2011	3,00,000

Calculate the amount of discount to be written off in each of the three years.

[Ans: 2009: 14,520; 2010: 11,880; 2011: 6,600]

7. A public limited company redeemed 50,000, 10% debentures out of capital by drawing a lot and also redeemed 75,000 9% debentures out of profit by drawing a lot. Journalize.

[Ans: For “out-of-profit” redemption: Amount transferred to DRR 75,000]

8. A company issued as per 10,000, 6% debentures of 100 each. Interest is payable half-yearly on 30 September and 31 March. On 1 February 2011, the company purchased 100 its own debentures as investment at 97.

Calculate ex-interest and cum-interest price.

Journalize the transactions. Books are closed on 31 March. Ignore tax.

[Ans: Our debentures: 19,400; Interest: 400 for ex-interest; For cum-interest price → own debentures: 19,000; Interest: 400]

9. Rose Ltd. purchased for immediate cancellation 10,000 12% own debentures of 100 each on 1 December 2010, the interest dates being 30 September and 31 March.

Pass entries relating to the cancellation if

• Debentures are purchased at 92 ex-interest
• Debentures are purchased at 92 cuminterest

[Ans: (a) 80,000; (b) 1,00,000]

10. A company has outstanding 12% debentures of 5,00,000 on 1 January 2010. The company pays interest on 30 June and 31 December. It purchased debentures of 50,000 for cancellation on 1 May 2010 @ 102 cum-interest. On 1 September 2010, it further purchased for redemption debentures of 1,00,000 @ 95 ex-interest. Journalize.

[Ans: Profit on cancellation: 1,000 on 1 May and 5,000 on 1 September]

11. You are required to set out the journal entries relating to the issue of the following debentures in the books of ABC Ltd.

• 10% 2,000 100 debentures are issued at 5% discount and are repayable at par
• Another 13% 200 1,000 debentures are issued at 5% discount and repayable at 10% premium
• Further, 12% 100 1,000 debentures are issued at 5% premium
• In addition, another 250 1,000 debentures are issued as collateral securities against a loan of 2,50,000

12. Exee Ltd. issued 5,000 9% debentures of 100 each payable 20 on application and the balance on allotment. Applications were received for 7,500 debentures out of which applications for 4,500 were allotted fully. Applicants for 2,000 debentures were allotted 500 debentures and the remaining rejected. All sums due were received. Give journal entries and also show how these transactions will be reflected in the balance sheet of the company.

[Ans: Application money transferred to allotment A/c: 30,000; Refund on rejected applications: 20,000]

[Model: Discount on issue of debentures]

13. A company issued debentures of the face value of 8,00,000 at a discount of 6%. The debentures were repayable by annual drawings of 1,60,000. How would you deal with the discount on debentures?

Show the discount account in the company’s ledger for the period of duration of debentures.

[Ans: Proportionately written off; Discount A/c balance: 48,000.

At the end of 1st year → 32,000; At the end of 2nd year → 19,200; At the end of 3rd year → 9,600; At the end of 4th year → 3,200; At the end of 5th year → Nil]

[Model: Redemption by conversion]

14. On 1 January 2010, X Ltd. issued 1,000 5% debentures of 1,000 at 950 each. Debenture holders had an option to convert their holdings into 6% preference shares of 100 each at a premium of 25 per share. On 31 December 2010, one year’s interest has accrued on these debentures which was not paid. A holder of 100 debentures notified his intention to convert his holdings into 6% preference shares.

Journalize the above transactions and draw the company’s balance sheet as at 31 December 2010 assuming no other transactions took place.

[Ans: Conversion into 760 shares of 100 each: 76,000; at premium of 25: 19,000; B/s total: 10,45,000]

[Model: Redemption by purchase in the open market own debentures]

15. On 1 January, ABC Ltd. has 3,00,000 10% debentures. In accordance with the power under the deed, the directors have the powers to acquire the debentures in the open market for immediate cancellation.

The following purchases, of own debentures were made by the company:

1 March, 60,000 debentures @ 98 cuminterest

1 August, 1,20,000 debentures @ 99 exinterest

Debentures interest is payable half-yearly on 30 June and 31 December every year.

Show journal entries for purchase and cancellation of the debentures.

[Ans: 1 March: Cash paid— 58,800; Interest— 999; Profit on cancellation— 2,199; 1 August: Cash paid— 11,19,799; Interest— 999; Profit on cancellation— 1,200]

16. On 1 January, CX Ltd. has 10,00,000 6% debentures. In accordance with the power under the deed, the directors acquire the debentures as follows in the open market for immediate cancellation:

1 March, 2,00,000 at 98 cum-interest

1 August, 4,00,000 at 100.25 cum-interest

15 December, 1,00,000 at 98.5 ex-interest

Debenture interest is payable half yearly on 30 June and 31 December every year.

Show journal entries for purchase and cancellation of the debentures.

[Ans: 1 March: Interest— 2,000; Profit on cancellation— 6,000;

1 August: Interest— 2,000; Profit on cancellation— 1,000; 15 December: Interest— 2,750; Profit on cancellation— 1,500]

17. On 1 February 2010, a company purchased 20 of its own debentures of 1,000 each as investment at 970 and cancelled them on 30 June 2011. Rate of interest is 10% and the interest is payable on 30 June and 31 December each year.

Give journal entries for purchase and cancellation of debentures if

• The purchase price was ex-interest
• The purchase price was cum-interest

[Ans: (a) On 1 February 2010: Own debentures— 19,400; Interest— 167; Profit on cancellation of own debentures— 600

(b) On 30 June 2011: Profit on cancellation of own debentures— 767]

18. X Ltd. issued on 1 January 2008, 40,000 5% debentures of 100 each redeemable at the option of the company after 3 years at 105 per debenture upon giving 3 months notice to the holders.

The company purchased the following debentures in the open market:

1 April 2009 8,000 debentures at 8,050 cuminterest

1 November 2009 14,000 debentures at 13,830 ex-interest

These debentures were retained as investment till 31 December 2010 on which date they were cancelled.

Give journal entries to record the above transactions, assuming that the interest is payable half-yearly on 30 June and 31 December every year. Ignore taxation.

[Ans: Own debentures purchased on 1 April 2009: 7,950; Own debentures purchased on 1 November 2009: 13,830; Debenture interest: 1 April 2009— 100; 30 June 2009— 900; 1 November 2009— 234; 31 December 2010— 766; 30 June 2010— 1,000; 31 December 2010— 100 Interest on own debentures: 30 June 2009— 100; 31 December 2009— 316; 30 June 2010— 550; 31 December 2010— 550; Profit on cancellation of own debentures on 31 December 2010: 220]

[Model: Redemption—Sinking fund method]

19. A company issued 6% debentures of 5,00,000 with a condition that they should be redeemed after 3 years at 10% premium. The amount allocated for the redemption of debentures is invested in 5% state government securities. The Sinking Fund Table shows that 0.317209 at 5% compound interest in 3 years will become 1.

Pass journal entries and prepare ledger accounts for all the three years.

[Ans: Annual transfer: 1,74,464.95; Interest: 2nd year end— 8,723.25; At the end of 3rd year— 17,882.65; Amount repaid: 5,50,000]

20. A company issued 10,000 debentures of 100 each at par on 1 January 2006, redeemable at par on 31 December 2010. A sinking fund was established. Investments would earn 5% interest. Table shows that 0.180975 amounts to 1 at the end of 5 years @ 5%. On 31 December 2010, investments were realized at 7,80,00. The debentures were redeemed.

Give ledger accounts in the books of the company.

[Ans: Loss on sale of investments: 24.86; Transfer to general reserve: 9,99,976.24]

21. A company issued 4,00,000 in 5% debentures of 100 each at par, repayable at the end of 5 years at a premium of 6%. A sinking fund at 4% compound interest is created for redemption of debentures.

You are required to prepare sinking fund A/c and sinking fund investment A/c for 5 years.

( 1 per year at 4% compound interest amounts to 5.4163 in 5 years)

[Ans: Annual instalment: 78,242.22; Interest in 2nd year: 3,131.28; Interest in 3rd year: 6,387.82; Interest in 4th year: 9,774.64; Interest in 5th year: 13,296.90]

22. The following balances are extracted from the balance sheet of CY Ltd. as on 1 January 2010:

 

6% Debentures	5,00,000
Debentures Redemption Fund	4,25,000

Debentures Redemption Fund Investments 4,50,000 (in 100 value 4% certificates)

The annual investment was 57,000. On 31 October 2010, the investments were realized at 95 each and the debentures were redeemed. The bank balance on that date was 91,500.

Give ledger accounts relating to the redemption of debentures.

[Ans: Profit on sale of investments: 2,500; Transfer to general reserve: 5,02,500; Bank balance: 37,000]

23. A company has 3,00,000, 6% debentures outstanding on 1 January 2010. On that date, the debenture redemption fund stood at 2,50,000, represented by 2,95,000, 3% loan of Government of India. The annual instalment added to the debenture redemption fund is 41,150. On 31 December 2010, the balance at bank (after interest on investments has been received) was 78,200. On that date, the investments were sold at 83% net and the debentures were paid off.

Show the debentures account, redemption fund account, debenture redemption fund investment account for the year 2010.

[Ans: Loss on sale of investments: 5,150; Transfer to general reserve: 2,94,850; Bank balance: 23,050]

24. On 1 January 2010, X Ltd. had 4,00,00 5% debentures outstanding in its books redeemable on 31 December 2010. On 1 January 2010, the balance of sinking fund was 3,74,500 represented by

• 50,000 own debentures purchased at an average price of 99
• 3,30,000 nominal value of 3% government loan

The amount already credited to the sinking fund was 14,200.

The interest on debentures was paid by the company every year on 31 December and interest on government loan was also received on 31 December annually.

On 31 December 2010, the outside investments were realized at 98% and all the outstanding debentures were redeemed on that date.

You are required to write up necessary ledger accounts for the year 2010 in the books of the company.

[Ans: Loss on sale of investments in government loan: 1,600; Profit on cancellation of own debentures: 500; interest received on government loan: 9,900; Interest on own debentures: 2,500; Transfer to general reserve: 4,00,000]

[Model: Redemption insurance policy method]

25. Viswas Ltd. has made an issue of 2,00,000 5% debentures on 1 January 2006, the terms of which include that the company must provide for a sinking fund for the redemption on 31 December each year from 2008 for 3 years. The directors decide to take out an insurance policy to provide the necessary cash, the annual premium being 31,410.80 on which the return is at 3% p.a. at compound interest.

Show the ledger accounts.

[Ans: Balance of debenture redemption fund A/c on 31 December 2008— 64,706.24; on 31 December 2009— 1,31,353.68; on 31 December 2010— 2,00,000; Balance of debenture redemption policy A/c on 31 December 2008— 64,706.24; on 31 December 2009— 1,31,353.68; on 31 December 2010— cash realized 2,00,000]

[Model: Terms of issue and redemption—Various types]

26. Show by means of journal entries how will you record the following issues: Also show how they will appear in their respective balance sheets:

• A Ltd. issued 10,000, 10% debentures of 100 each at a discount of 5% redeemable at the end of 5 years at par
• B Ltd. issued 10,000, 11% debentures of 100 each at par redeemable at the end of 5 years at a premium of 5%
• C Ltd issued 10,000, 12% debentures of 100 each at a discount of 5% redeemable at the end of 5 years at a premium of 5%
• D Ltd issued 10,000, 13% debentures of 100 each at a premium of 5% redeemable at the end of 5 years at a premium of 5%

[Ans: (a) Discount on issue: 50,000; (b) Loss on issue: 50,000; (c) Discount & loss: 50,000; (d) Loss on issue: 50,000]

[Model: Treatment of discount]

27. A company issued 10,00,000 debentures at a discount of 10% on 1 April 2007. The debentures were repayable by annual drawings of 2,00,000. How would you deal with the discount on debentures? Show the discount account in the company’s ledger for the period of duration of the debentures. Accounting period ends on 31 December.

[Ans: Ratio = 15:17:13:9:5:1

Amount of discount: I year— 25,000, II year— 28,333, III year— 21,666; IV year— 15,000; V year— 8,333; VI year—1,666]

 

 

28. The following balances appeared in the books of a company on 1 April 2010:

 

12% Debentures	12,00,000
12% Debentures Sinking	9,00,000
Fund
12% Debentures Sinking	9,00,000−
Fund Investments	represented by
	10%
	10,80,000
	secured bonds of
	Government of
	India

Annual contribution to sinking fund was 1,92,000 made on 31 March every year. On March 2011, balance at bank was 6,00,000 after receipts of interest. The company sold the investments at 80% as debentures were paid off. Journalize the transactions.

[Model: Redemption by sinking fund method]

[I.C.W.A. (Inter). Modified]

29. X Ltd. issued 24,00,000 debentures during 2009 on the following terms and conditions:

• A sinking fund to be created by yearly appropriations of profit and similar amount to be invested outside.
• The company will have the right to purchase for cancellation of debentures from the market if available below par value.
• The debentures are to be redeemed on 31 December 2010 at a premium of 2%. The following balances appeared in the books of the company as on 1 January 2010:

Sinking Fund Investments	17,73,000
Sinking Fund	17,73,000
Debentures A/c	18,00,000

The following transactions took place during the subsequent 12 months:

• On 1 July 2010 1,20,000 debentures were purchased for 1,06,656 and cancelled immediately, the amount being provided out of sale proceeds of investments of the book value of 1,39,200 at 1,35,600.
• The income from sinking fund investments 88,800 received on 1 July 2010 was not invested.
• On 29 December 2010, 16,92,000 were received on sale of the remaining sinking fund investments.
• On 31 December 2010, the remaining debentures were redeemed.

You are required to show for the year ended 31 December 2010: (i) debentures A/c; (ii) sinking fund account; (iii) sinking fund investments account and (iv) debenture redemption A/c

 

[C.S. (Inter). Modified]

[Ans: Capital reserve: 71,544; Transfer to general reserve: 18,24,600]

[Model: Cum-interest and ex-interest]

30. The following balances appeared in the books of Cheerful Ltd. as on 1 April 2010:

12% Debentures	10,00,000
(Face Value 100)
Debentures Redemption Fund	6,25,000
Debentures Redemption Fund	6,25,000
Investments

(In 8% Government Bonds of the Face Value of 7,50,000)

Interest on the debentures was payable on 30 September and 31 March and interest on government bonds was receivable on the same dates. On 31 May 2010, the company purchased for immediate cancellation 1,250 debentures in the market at 96 each cum-interest. The amount required for this was raised by selling 8% government bonds of the face value of 1,35,000 cum-interest. On 31 March 2011, 1,04,000 was appropriated for the sinking fund and on the same date 8% government bonds were acquired for the amount PLUS the interest on investments. The face value of government bonds acquired was 1,86,000. You are required to show the ledger accounts in the books of the company. Ignore tax.

 

[C.S. (Inter). Modified]

[Ans: Profit on cancellation of 1,250 debentures: 7,500; Profit on sale of government Bonds: 5,700; Balance in debenture redemption fund account: 6,55,000 after transferring 13,200 to capital reserve and 1,25,000 to general reserve account]

31. Seawage Ltd. had 9,00,000 14% debentures outstanding in April 2010 redeemable on 31 March 2011. On 1 April 2010, the debenture redemption fund stood at 7,49,000 represented by own debentures of the face value of 1,00,000 purchased at an average price of 99 per debenture and 10% stock acquired at par for 6,50,000. The annual instalment of transfer to the fund was 71,000. On 31 March 2011, investments were sold for 6,46,800 and the debentures were redeemed. Show 14% debentures A/c, debentures redemption fund A/c and debentures redemption fund investments A/c.

 

[C.S. (Inter). 2002 Modified]

[Ans: 14% Debentures A/c: 9,00,000; Debenture redemption fund A/c: 8,99,000; Debenture redemption fund investments A/c: 7,49,000]

[Model: Redemption—Sinking fund method]

32. X Ltd. has 12% 2,00,000 debentures outstanding in its books on 1 January 2010. It also had 1,20,000 balance in sinking fund A/c represented by 8% investments (Face value 1,50,000).

On 30 December 2010, it sold investments of face value of 20,000 @ 90 and purchased own debentures of the face value of 20,000 out of proceeds for immediate cancellation. The interest dates for both debentures and investments are 30 September and 31 March. All transactions are made on cum-interest basis. Show debentures A/c, sinking fund A/c and sinking fund investment A/c.

[B.Com (Hons) Delhi 2002 Modified]

[Ans: Profit on cancellation of debentures: 2,600]

[Model: Cum-interest and ex-interest]

33. Rasi Ltd. purchases from market its own 800 12% debentures of 100 each at 90 on 31 December 2010. Calculate the price paid exclusively for the debentures if the quotations are (i) cum-interest and (ii) ex-interest. Debenture interest is paid on 31 March and 30 September each year. Also journalize in both the cases assuming that these debentures are not yet cancelled.

[B.Com (Hons) Delhi 2003 Modified]

[Ans: (i) 69,000; (ii) 74,400]

[Model: Cum-interest and ex-interest]

34. Parker Ltd. issued 15% 20,000 debentures of 100 each on 1 January 2006 redeemable at a premium of 10% after 5 years. A sinking fund is created for the purpose of redemption of debentures and the money is invested in 5% government securities at par. The investments are to be made in multiples of 100 only. 1 invested p.a. at 5% over 5 years amounts to 5.5256. Investments were realized for 17,50,000 on 31 December 2010 and bank balance on that date was 7,50,000 before receipt of interest and sale of government securities.

Show debentures A/c, sinking fund A/c, sinking fund investments A/c, premium on redemption of debentures A/c and bank A/c.

Bank A/c is to be prepared only on 31 December 2010. All calculations are to be made in nearest rupee.

[B.Com (Hons) Delhi 2010 Modified]

[Ans: Debentures A/c: 20,00,000; Sinking fund A/c: 22,33,962; Sinking fund investment A/c: 1st year— 3,98,150; 2nd year— 8,16,000, 3rd year— 12,55,150, 4th year— 17,16,050; 5th year— 17,50,000; Bank A/c: 25,85,802]

35. A limited company has an authorized capital of 20 crore in shares of 10 each of which 120 lakh shares have been issued and are fully paid. A summary of its balance sheet on 31 March 2010 is as follows:

Interest on debentures had been paid up to 31 March 2010. On 1 April 2010, the directors gave notice to redeem the 12% debenture holders on 1 July 2010, giving the holders the option to be repaid either wholly in cash or by issue of four shares of 10 each (fully paid) for every 100 debentures. 60% of the holders exercised the option to take shares, and the cash of the remainder was obtained by realizing a sufficient amount of the investment at their market value on 31 March 2010.

Draft journal entries to record these transactions and any consequent transfers which you consider necessary.

 

[C.S. (Inter). Modified]

[Ans: Balance of debenture redemption fund: 960 lakh]

36. Chand Ltd. issued on 1 April 2007 60,000, 12% debentures of 100 each, redeemable at the option of the company after the second year at 104 upon two months’ notice. The following debentures were purchased in the open market:

• On 12 June 2009, 12,000 nominal at cum- interest cost of 12,075
• On 24 August 2009, 21,000 nominal at ex- interest cost of 20,745

These debentures were retained as investments till 30 September 2010 when the debentures were cancelled. Due dates for interest on debentures are 30 September and 31 March. The books of accounts are closed every year on 31 March. Show the following ledger accounts for the year 2009–10; and 2010–11.

 

[C.A. (Inter). Modified and C.S. (Inter).Modified]

[Ans: Profit on redemption: 468 or 1,788]

37. A company had 17,20,000, 14% debentures outstanding on 1 April 2010. On that date, the sinking fund was 14,98,000 represented by 3,00,000 own debentures purchased at 90 on an average and 14,00,000 10% government loan. The annual contribution to the sinking fund was 40,000. On 31 March 2011, the investments were realized at 90% and all debentures were redeemed at a premium of 4%.

Pass journal entries and prepare accounts relating to the matters stated above.

[C.A. (Inter). Modified]

[Ans: Profit on cancellation: 30,000; Profit on sale of investments: 32,000]

38. Acompany had issued, sometime ago, 50,000 12% debentures of 100 each at 97.50 redeemable at the end of 10 years at par, or previously by 6 months’ notice at 102 at the company’s option. On 31 March 2010, the accounts showed balances in debenture redemption fund of 2,67,500 represented by 10% 2,14,000 nominal value government loan bonds, purchased at an average price of 101 and 51,360 uninvested in cash. On 1 April 2010, the company decided to purchase 55,000 of its own debentures at an inclusive cost of 51,360 instead of further government loan bonds and this was carried out forthwith. On 30 September 2010, the company gave 6 months’ notice to holders of 2,00,000 worth of debentures and on 31 March 2011 carried out the redemption by sale of 2,04,000 of government loan bonds at par and cancelled the same together with their own holding.

Journalize the forgoing transactions as well as those for interest on government loan bonds and on the company’s own debentures throughout the year ended 31 March 2011. The interest on the bonds being payable on 31 March and on the debentures on 30 September and 31 March.

 

[C.A. Modified]

[Ans: Profit on cancellation of own debentures: 3,640; Loss on sale of investments: 2,040]

39. MM Ltd. had the following among their ledger opening balances as on 1 April 2010:

11% Debentures A/c (2,000 Issue)	25,00,000
Debenture Redemption Fund A/c	22,50,000
13.5% Debentures in XX Ltd. A/c	9,75,000
(Face Value 10,00,000)
Own Debentures A/c	9,25,000
(Face Value of 10,00,000)

As 31 March 2011 was the date of redemption of the 2,000 debentures, the company started buying own debentures and made the following purchases in the open market:

1 May 2010 1,000 debentures at 98 cum- interest

1 September 2010 1,000 debentures at 99 ex- interest

Half-yearly interest is due on the debentures on the 30 September and 31 March in the case of both the companies.

On 31 March 2011, the debentures in XX Ltd were sold for 95 each ex-interest. On that date, the outstanding debentures of MM Ltd. were redeemed by payment and by cancellation.

Show the entries in the following ledger accounts of MM Ltd. during 2010-11:

• Debenture redemption fund A/c
• Own debenture A/c

The face value of a debenture was 100. (Round off calculations to the nearest rupee)

 

[C.A. (Inter). Modified]

[Ans: Interest on own debentures: 1,26,500; Transfer to general reserve: 24,86,500]

40. X Ltd. issued 10,000 12% debentures of 100 each at par on 1 April 2008. These debentures are redeemed at the end of the fifth year at 5% premium. It was resolved that sinking fund should be formed and invested in 10% development bonds of 100 each. Interest of bonds is payable on 31 March every year.

Reference to Sinking Fund Table shows that 0.1638 invests at the end of every year at 10% compound interest will produce 1 at the end of the fifth year.

10% Development bonds of the required amount were purchased on different dates at the following prices:

On 31 March 2009	94
On 31 March 2010	96
On 31 March 2011	98

You are required to show debenture redemption fund, debenture redemption fund investment A/c and interest on debenture redemption fund investments A/c for the first three years in the books of X Ltd. Accounting year of the company ends on 31 March.

[Ans: Balances: Debenture redemption fund— 5,72,370; Debenture redemption fund investment A/c—5,72,310; Interest: 18,300 and 38,100; Bonds purchased: 1,830; 1,980 and 2,145]