MCom I Semester Corporate Accounting Redemption Debentures Study Material notes ( Part 2 )
Table of Contents
MCom I Semester Corporate Accounting Redemption Debentures Study Material notes ( Part 2 ) : Redemption Debentures Annual Drawings Journal Entries Purchase debentures investment Interest on Own Debentures Discussion Questions Long Answer Questions Numericals Questions : ( Most Important Notes for MCom Students )
CTET Paper Level 2 Set VIII Model Paper in English
Redemption of Debentures at the option of the company
Often, the terms of issue of debentures allow the company to redeem the debentures after a specified period at its option prior to the fixed period of debentures. While exercising this right, the company may also give the debenture holders the option to convert their debentures into shares or debentures of a new class on the basis of the terms specified.
Illustration 16. On 1st January 2000, a company issued 20,000, 15% Debentures of Rs. 100 each for 10 years on this condition that the company can redeem the debentures at a premium of 2% by giving 6 months notice at any time after 5 years, according to the option of the debenture holders either in cash or by allotment of shares or by debentures.
On 1st March 2005, a notice was served to the debentureholders, informing them the intention of the company to redeem debentures on 1st September 2005 either by payment in cash or by allotment of 14% Preference Shares of Rs. 100 each at Rs. 120 per share or by issuing 14% Debentures of Rs. 100 each at Rs. 98 per debenture.
4.000 debenture-holders accepted 14% Preference Shares, 9.800 debentureholders accepted 14% Debentures and the remaining demanded cash.
Notes:
(1) Number of Preference Shares issued 4,08,000 + 120 = 3,400 shares.
(2) Number of new Debentures issued = 9,99,600 – 98 – 10.200 debentures.
(3) In case of redemption of debentures by conversion into new shares and debentures, the company was not required to part with its bank balance. But in redeeming debentures of Rs. 6,20,000, the company has paid cash to the debentureholders. Hence, it is a matter of sound policy to transfer an amount equal to the face value of the debentures redeemed from Profit & Loss Appropriation Account to General Reserve Account, so as to make the redemption out of profit. SEBI’s guidelines require such transfer to Debenture Redemption Reserve Account.
Illustration 17. A Ltd. had issued 2,000, 12% debentures of Rs. 100 each on 1st January 2000. Interest was payable half yearly on 30th June and 31st December each year. They are repayable at par on 31st December 2009 with the option to redeem them at any time after 31st December 2004 at Rs. 103. On January 1, 2005, the balance in the debenture redemption fund account stood at Rs. 1,07,000, which was invested outside. On 30th June 2005, a notice was given for the redemption of the above debentures with the option to receive one new 14% debenture of Rs. 100 each at Rs. 98 and Rs. 5 in cash for each 12% debenture in place of Rs. 103 in cash.
The holders of 1,800 debentures exercised this option and the remaining were paid in cash. The Company sold the investments costing Rs. 72,000 for Rs. 87,400. The company completed the redemption. Give necessary ledger accounts affected by the above transactions ignoring interest payments.
Notes : (1) Profit on redemption of debentures is a capital profit and so it should be transferred to Capital Account, if no sinking fund exists: to Sinking Fund Account, if sinking fund exists. mis amount may also be used to write off the discount on issue of debentures or any other capital Loss.
Similarly, loss on redemption of debentures is a capital loss. If sinking fund exists in the company then such loss should be written off against Sinking Fund Account. But if no such sinking fund exists then it can be written off against capital profits including Securities Premium Account or Profit and Loss Account (if the amount of loss is immaterial). The amount of loss on redemption not so written off is treated as deferred revenue expenditure and is written off against Profit and Loss Account over a number of years.
(2) If no sinking fund exists, a sum equal to the nominal value of debentures cancelled should be transferred to the Debenture Redemption Reserve Account out of divisible profits of the company. If Sinking tund exists then such transfer will be from Debenture Redemption Fund Account (or Sinking Fund Account) to General Reserve Account
(3) If under the terms of issue, debentures are to be redeemed at premium then at the time of passing entry for their allotment, ‘Premium on Redemption of Debentures Account may be credited with the amount of premium payable on redemption. In such a case, if the company cancels certain debentures by purchase in the open market, then Debenture Account and Premium on Redemption of Debentures Account both will be debited respectively by the nominal value of debentures cancelled and by the amount of premium paid on them and profit or loss on cancellation will be calculated by comparing the amount paid on cancellation with the total of nominal value of debentures cancelled and premium payable on their redemption.
Illustration 19. On 1st January 2004, a company made an issue of 10,000 14% Debentures of Rs. 100 each at Rs. 96 per debenture. The terms of issue provided for the redemption of Rs. 50,000 debentures every year commencing from 2005 either by purchase in the open market or by drawings at par at the company’s option. Rs. 10,000 was also written off the Debenture Discount Account in each of the years 2004 and 2005.
During 2005, the company purchased for cancellation debentures of the face value of Rs. 20,000 at Rs. 95 per debenture and Rs. 30,000 at Rs. 90 per debenture, the expense being Rs. 200.
Journalize the above transactions dealing with the profit on redemption in the way you consider fit. Ignore interest on debentures.
(1) On purchase of debentures as investment :
Investment in Own Debentures Account Dr.
Or Own Debentures Account Dr. with the price paid
To Bank Account
Notes :Ill these debentures are disposed of or cancelled in future, the question of profit or loss on redemption will not arise.
(2) On disposal of Own Debentures in future : Dr.
Bank Account with the price realised
To Own Debentures Account
Note : Profit or loss on resale of own debentures is of revenue nature, hence it should be transferred to Profit and Loss Account.
(3) On cancellation of own debentures in future :
Debentures Account Dr. with the nominal value of debentures cancelled
To Own Debentures Account
Note: (1) Profit or loss on cancellation of Own Debentures is of capital nature. Hence, it is credited or debited, as the case may be, to Sinking fund Account, if sinking fund exists; if no sinking fund exists then profit on cancellation of own debentures is credited to Capital Reserve Account and in case of loss, the amount is debited to Loss on Cancellation of Debentures Account.
(2) If sinking fund exists, an amount equal to the nominal value of debentures cancelled is transferred from Debenture Redemption Fund Account (Sinking Fund Account) to General Reserve Account and if no sinking fund exists then such transfer should be to Debenture Redemption Reserve Account out of divisible profits of the company.
Illustration 21. Following information is available in the Balance Sheet of X Company on December 31, 2005:
(a) 12% Debentures of Rs. 100 each Rs. 4,00,000
(b) Debenture Redemption Fund Rs. 1,70,000
(c) Debenture Redemption Fund Investment represented by Rs. 40,000 own debentures purchased at Rs. 98 each and the remaining amount by Rs. 1,40,000 8% Stock.
On the above date the directors redeemed all the debentures. For this purpose they realized 8% Stock at par. They utilized Rs. 60,000 for redemption out of current year’s profits. Give journal entries.
Interest on Own Debentures
If the company purchases its own debentures for immediate cancellation, outstanding debentures are reduced by the amount of debentures cancelled. It effects saving of interest on cancelled debentures. So, in such a case Debenture Interest Account is debited only with the net amount of interest payable on the reduced amount of debentures. But if the company holds the debentures purchased as live debentures (i.e. as investment) the total debentures (including those which are held by the company) are deemed to be outstanding and in such a case Debenture Interest Account is debited with interest on the whole amount of debentures, the interest on own debentures will be retained by the company and the interest on debentures held by outsiders will be actually paid by the company. Thus, the accounting entries in such a case will be as follows:
(1) On interest becoming due on debentures :
Debenture Interest Account Dr. (with interest on the whole debentures)
To Debenture holders Account (with interest payable to outsiders))
To Interest on Own Debentures Account (with interest on debentures held by the Co.)
Note: If income-tax is deducted by the company at source on the interest payable to outsiders then, the amount so deducted is credited to Income Tax Payable Account and only the balance is credited to Debenture holders Account.
(2) On payment of interest on debentures :
Debenture holders Account Dr To Bank Account
(3) On transfer of Debenture Interest Account to P. & L. Account:
Profit & Loss Account Dr
To Debenture Interest Account
(4) On transfer of interest on Own Debentures Account:
(A) Where Sinking Fund does not exist : Dr
Interest on Own Debentures Account
To Profit & Loss Account
(B) Where Sinking Fund exists:
Interest on Own Debentures Account Dr
Purchase of Debentures before dating of payment of interest
Interest on debentures is paid to the holders on certain specified dates, e.g. 30th June and JIS December every year. If debentures are purchased exactly on these specified dates then it involves problem because interest will be paid to the holders of the debentures. But where debentures are purchased on a date other than the date of payment of interest, then the question arises whether the price paid for the debentures includes the interest for the expired period (i.e. the period from the previous date of payment of interest upto the date of purchase) or not. It really depends on the quotation. It can be of two types -() cuminterest quotation and (2) ex-interest quotation.
If the quotation is cum-interest then the price quoted for debentures includes the interest for the expired period and so the price quoted minus the interest for the expired period should be treated as the true cost of such debentures. But if the quotation is ex-interest then the price quoted for the debentures is for debenture alone, i.e., it does not include interest for the expired period and hence interest for the expired period is paid to the holders in addition to the price paid for the debentures. In any case, the amount paid by way of interest should be treated separately from the price actually paid for the debentures. For example, assume that a company purchases its own 12% debentures of the nominal value of Rs. 20,000 at Rs. 98 on 28th February 2005, the dates of payment of interest being 30th June and 31st December. This transaction will be recorded in the books of the company as follows :
Discussion Questions
Long Answer Questions
1 What is meant by ‘Redemption of Debentures ?’ Explain with the help of journal entries how Sinking Method for Redemption of Debentures is used ?
2. What are the various methods of redemption of debentures ? Describe their characteristics and explain their effects on accounts of a company.
3. How are debentures paid ? Describe the Sinking Fund Method of Debenture Redemption.
4. Explain debenture redemption fund method of redemption of debentures and pass journal
5. Explain the terms ex-interest and cum-interest in connection with the purchase and sale of debentures.
Numerical Questions
1 Pass necessary journal entries in the books of the company in the following cases for redemption of 6,000, 10% debentures of Rs. 10 each issued at par:
(a) Debentures redeemed at par by conversion into 12% preference share of Rs. 100 each.
(b) Debentures redeemed at a premium of 10% by conversion into equity shares issued at par.
(c) Debentures redeemed at a premium of 10% by conversion into equity shares issued at a premium of 25%
(Ans. Share capital issued (1) Rs. 60,000 (ii) Rs. 66,000 (iii) 52,800)
ii. On 1-5-2005, A purchased from B 500, 12% Debentures of Rs. 100 @ Rs. 96. Interest is due on 30th June and 31st December. Give journal entries in the books of A if(i) price is cum- interest (ii) price is ex-interest.
(Ans. (1) Cost price Rs. 46,000 (ii) Ex-price Rs. 48,000)
iii. Nov. 1, 2005, U.S. Products Ltd, purchased Rs. 30,000 of its own 6% debentures in the open market at Rs. 98 cum-interest for immediate cancellation. Interest dates are 31st March and 30th September. Show necessary Journal Entries.
(Ans. Capital Reserve Rs. 750) iv. On 1st January 2005, a company has a balance of Rs. 1,00,000 in its 12% debentures account. The
interest is paid on 30th June and 31st December every year. On 1st May 2005, the company purchases its own debentures, as investment of Rs. 10,000 at 98 exinterest, and cancelled them on 31st December 2005. You are required to pass journal entries in the books of the company.
(Ans. Capital Reserve Rs. 200)
Kalka Ltd. issued 20,00,000, 6% debentures of Rs. 50 each at premium of 8% on June 30, 2005 redeemable on June 30, 2006. How much amount of debenture redemption reserve is to be created before redemption of debentures?
(Ans. No debenture redemption reserve is to be created since the issue is for a period less than 18 months.)
Abhishek Ltd. (an infrastructure company) made a public issue of 50,00,000, 9% debentures of Rs. 20 each on April 1, 2005 redeemable on April 1, 2011. How much amount of debenture redemption reserve is required before the redemption of debentures?
(Ans. Rs. 25,00.000)
viii Leena Ltd. purchases from the market its own 400, 12% debentures of Rs. 100 each at Rs. 90 on 31st December 2005. Calculate the price paid exclusively for the debentures if the quotations are : (i) Cum-interest (ii) ex-interest. Debenture interest is paid on 31st March and 30th September each year.
(Answer: (i) Rs. 34,800, (ii) Rs. 36,000) ix. Excess Ltd. purchased its own 12% debentures of the face value of Rs. 100 each interest payable on 30th September and 31st March) as sinking fund investment as follows:
