SOURCES OF REDEMPTION OF DEBENTURES
Redemption of debentures means the amount of repayment to the debenture holders of the debt due to them. The debentures are usually repaid after the expiry of certain time period. When debentures are redeemed, liability on account of debentures is discharged. Amount of funds required for redemption of debentures is quite large and therefore prudent companies make sufficient provisions out of profits and accumulate funds to redeem debentures.The amount involved in the redemption of debentures is very large. Thus the company has to arrange for the funds from various sources. The Sources of Redemption of Debentures are as follows:
REDEMPTION OUT OF FRESH ISSUE OF SHARES AND DEBENTURES
Under this method, the company arranges the funds from the issue of the new Equity shares or preference shares or new debentures. The money collected is used for the repayment of the amount due on the old debentures. In this method:
- Creation of DRR is not required.
- Investment of the amount of DRR in the specified securities is not required.
JOURNAL ENTRIES
RECEIPT OF APPLICATION MONEY ON SHARES AND DEBENTURES
| ON ISSUE OF SHARES |
| Bank Account Dr. To share application a/c |
| ON ISSUE OF DEBENTURES |
| Bank Account Dr. To debentures application a/c |
TRANSFER OF SHARE APPLICATION ACCOUNT
| SHARE APPLICATION MONEY |
| In case of shares issued at par Share Application A/c Dr. To share capital a/c |
| In case of shares issued at premium Share Application A/c Dr. To share capital a/c To securities premium a/c |
| DEBENTURE APPLICATION MONEY |
| In case debentures are issued at par Debenture Application A/c Dr. To debenture a/c |
| In case debentures are issued at premium Debenture Application A/c Dr. To Debenture A/c To Securities Premium A/c |
| In case debentures are issued at discount Debenture Application A/c Dr. Discount on issue of debentures A/c Dr. To debenture A/c |
AMOUNT DUE ON REDEMPTION OF DEBENTURES
| In case debentures are redeemed at par Debenture A/c Dr. To Debentureholders A/c |
| In case debentures are issued at premium Debentures A/c Dr. Premium on redemption of debentures A/c Dr. To debentureholders A/c |
PAYMENT TO DEBENTUREHOLDERS
| Debentureholders A/c Dr. To Bank A/c |
REDEMPTION OUT OF THE PROFITS
The company can also redeem the debentures out of the profits of the company. Profits mean the balance or Surplus as per the Income statement of the company. In this method:
- 100 % of the amount to be repaid on debentures must be transferred to the DRR.
- The 15 % of amount reserved must be invested in the specified securities before 30th April of the year.
- The amount invested must be used only for the purpose of redemption of debentures.
If the debentures are redeemed by this method, then there is no adverse effect on the existing liquid resources of the company.
REDEMPTION OUT OF THE CAPITAL
A company can redeem the debentures out of the capital. In the following of this method the following provisions apply to the company:
- 100 % of the amount to be repaid on debentures must be transferred to the DRR.
- The 15 % of amount reserved must be invested in the specified securities before 30th April of the year.
- The amount invested must be used only for the purpose of redemption of debentures.
The above make the redemption of debentures not out of the capital purely, as the Debenture Redemption reserve is created out of the surplus of income statement.
JOURNAL ENTRIES
| WHEN DRR IS CREATED |
| Surplus in statement of profit and loss A/c Dr. To Debenture Redemption Reserve Account |
| WHEN INVESTMENT OR DEPOSIT IS MADE IN SPECIFIED SECURITIES |
| DRR A/c Dr. To Bank A/c |
| WHEN INTEREST RECEIVED IN DEBENTURE REDEMPTION INVESTMENT |
| Bank A/c Dr. TDS Collected A/c Dr. To Interest on Debenture Redemption Investment A/c |
| SALE OF INVESTMENT FOR REDEMPTION |
| Bank A/c Dr. To Debenture Redemption Investment Account |
| AMOUNT DUE TO DEBENTUREHOLDERS ON REDEMPTION |
| Debentures A/c Dr. Premium on Redemption of Debentures A/c Dr. To Debentureholders A/c |
| PAYMENT MADE TO DEBENTUREHOLDERS |
| Debentureholders A/c Dr. To Bank Account |
| TRANSFER OF DRR ON REDEMPTION OF ALL DEBENTURES |
| DRR A/c Dr. To General Reserve A/c |
REDEMPTION BY CONVERSION
The debentures may also be redeemed by the conversion into the shares and debentures. The option to convert the debentures into the equity or preference shares would only be exercised by the debenture holders only if the offer is beneficial to them.
JOURNAL ENTRIES
| Debentures A/c (old) Dr. (with face value) Discount on issue of debentures A/c Dr. (when debentures are issued at discount) To share capital A/c (new) (with nominal value) To debentures account (with nominal value) To Securities Premium A/c (if new shares or debentures are issued at premium) |
REDEMPTION OUT OF PROVISION
It may happen that the company makes the provision of redemption of debentures out of the funds provided for in the advance. Under this method, the provision can be made in two ways:
- Sinking Fund Method
- Insurance Policy Method
SINKING FUND METHOD
ACCORDING TO BG VICKERY
“Sinking fund may be defined as the fund created by a charge against or an appropriation of profits represented by specific investments, which is brought into existence for a specific purpose.”
Under this method, sinking fund or debenture redemption fund of an equal amount is created out of the profits every year. The amount to be created to sinking fund is calculated with the help of sinking fund table. This fund is invested outside the business in securities every year. The amount invested in securities is debited to ‘Sinking Fund Investment’ or ‘Debenture Redemption Fund Investment Account’.
The amount invested in securities is allowed to accumulate with compound interest. The face value and market price of securities may differ. But the interest is always calculated on the face value of securities.
Sinking fund is of two types:
- Cumulative Sinking fund
- Non- Cumulative Sinking Fund
JOURNAL ENTRIES
AT THE END OF THE FIRST YEAR
| ON TRANSFER OF PROFIT TO SINKING FUND |
| Surplus in Statement of Profit and Loss A/c Dr. To Sinking Fund Account |
| ON INVESTMENT IN SINKING FUND |
| Sinking Find Investment A/c Dr. To Bank A/c |
AT THE END OF SUBSEQUENT YEARS
| ON RECEIPT OF INTEREST ON SINKING FUND INVESTMENT |
| Bank A/c Dr. To Sinking Fund Investment A/c |
| ON TRANSFER OF INTEREST TO SINKING FUND |
| Surplus in statement of profit and loss A/c Dr. To Sinking Fund Account |
| ON INVESTMENT OF ANNUAL APPROPRIATION OF PROFIT AND INTEREST RECEIVED ON INVESTMENT |
| Sinking Fund Investment A/c Dr. To Bank A/c |
AT THE END OF THE LAST YEAR
| ON RECEIPT OF INTEREST ON SINKING FUND INVESTMENT |
| Bank A/c Dr. To Sinking Fund Investment A/c |
| ON TRANSFER OF INTEREST TO SINKING FUND |
| Surplus in statement of profit and loss A/c Dr. To Sinking Fund Account |
| ON INVESTMENT OF ANNUAL APPROPRIATION OF PROFIT AND INTEREST RECEIVED ON INVESTMENT |
| Sinking Fund Investment A/c Dr. To Bank A/c |
| ON SALE OF INVESTMENT |
| Bank A/c Dr. To Sinking Fund Investment A/c If sold on Profit Sinking Fund Investment A/c Dr. To Sinking Fund Account If sold on loss Sinking Fund Account Dr. To Sinking Fund Investment A/c |
| ON REDEMPTION OF DEBENTURES |
| Debentures A/c Dr. Premium on Redemption of Debentures A/c Dr. To Debentureholders A/c |
| TRANSFER OF PREMIUM ON REDEMPTION |
| Sinking Fund A/c Dr. To Premium on Redemption of Debentures Account |
| ON TRANSFER OF THE BALANCE OF THE SINKING FUND ACCOUNT |
| Sinking Fund Account Dr. To General Reserve Account (with revenue profits) To Capital Reserve A/c ( with capital profits) |
INSURANCE POLICY METHOD
Under this method, an insurance policy for an amount necessary to pay off the debentures after the fixed period is taken out. The company pays the premium annually or half yearly to the insurance company. After the expiry of certain specified period, the policy matures and insurance company repays the insured amount to the company. The debentures are thus, redeemed from the proceeds received from insurance company. The journal entries are as follows:
AT THE END OF THE FIRST YEAR
| ON PAYMENT OF INSURANCE PREMIUM IN THE BEGINNING OR DURING THE YEAR |
| Debenture Redemption Policy Fund A/c Dr. To Bank A/c |
| FOR ANNUAL APPROPRIATION OF PROFIT AT THE END OF THE YEAR |
| Surplus in statement of profit and loss A/c Dr. To debenture redemption fund account |
| RECORDING OF INCREASE IN THE VALUE OF THE POLICY |
| Debenture Redemption Fund Policy Account Dr. To Debenture Redemption Fund Account |
AT THE END OF LAST YEAR
| ON PAYMENT OF INSURANCE PREMIUM IN THE BEGINNING OR DURING THE YEAR |
| Debenture Redemption Policy Fund A/c Dr. To Bank A/c |
| FOR ANNUAL APPROPRIATION OF PROFIT AT THE END OF THE YEAR |
| Surplus in statement of profit and loss A/c Dr. To debenture redemption fund account |
| RECORDING OF INCREASE IN THE VALUE OF THE POLICY |
| Debenture Redemption Fund Policy Account Dr. To Debenture Redemption Fund Account |
| ON REALISATION OF POLICY |
| Bank A/c Dr. To Debenture Redemption Fund Policy A/c |
| ON REDEMPTION OF DEBENTURES |
| Debentures A/c Dr. To Bank Account |
| ON TRANSFER OF BALANCE OF DEBENTURE REDEMPTION FUND ACCOUNT |
| Debenture Redemption Fund Account Dr. To General Reserve Account |
There is another method also to treat the interest accrued on the policy. As per this, the interest is not accrued o the yearly basis, but is transferred to Debenture Redemption Fund Account at the end of the last year.