Redemption of Debentures - Saraf College

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Redemption of Debentures

Theory:

Redemption refers to repayment.
Redeemable debentures are redeemed at a specified future date
mentioned on the Debenture Certificate.
Irredeemable debentures are not to be redeemed as long as
company exists. These are repaid only when company is wound
up/liquidated.
Debentures may be redeemed either at par or at premium.
Premium though payable on redemption, must be provided as a
liability at the time of issue itself.

Methods of Redemption:-

Redemption of Debentures out of Capital:

On redemption the debenture holders are paid out of Cash/Bank A/c.
This reduces working capital of company. When no amount is set
aside out of profits for such redemption, it is said to be out of capital
of the company.

In practice and especially in the view of legal requirements such
redemption out of capital is rare. It will happen only-

a) If debentures are for the period of less than 18 months.
b) If profits are not sufficient enough for creating provision for

redemption.

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Illustration 1

On 1/4/2005 ABC Ltd. issued 3000 10% Debentures of Rs.100 each at
par, redeemable on 31/03/2008 at 10% premium out of capital. Pass
necessary journal entries from issue to redemption.

Problem 1

Bharat Ltd. issued 50000, 15% Debentures of Rs.1000 each at Rs.952
per debenture. The debentures are redeemable in five annual
installments of Rs.200 each. It is decided to write off discount on
debentures finance usage over the various years.

You are asked to:

1. Prepare statement for write off of discount over the five years
period.

2. Pass appropriate journal entries in year 1 & 2.

Redemption of Debentures out of Profits:

In this case provision is made out of Profit & Loss A/c at the end of
every year for the purpose of redemption. This is done by-

a) Creating Debenture Redemption Reserve (DRR) out of profits
every year. OR

b) By creating Sinking Fund out of profits of every year.

Debenture Redemption Reserve (DRR):-

a) A company which issues debentures for a term exceeding 18
months must create DRR A/c. for redemption of debentures out
of profits every year until such debentures are redeemed.

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b) The amount to be transferred to DRR A/c shall depend up on
the amount of debentures and the period over which these are
redeemable.

For e.g. If debentures of Rs.1000000 are redeemable after 5 years,
the company should create DRR A/c out of profits of every year to
the tune of Rs.200000.

The following entries are passed on creation of DRR:-

Profit & Loss Appropriation A/c -------------Dr.

To DRR A/c

This entry is passed every year end until debentures are redeemed.

After redemption of all debentures the balance in DRR A/c is
transferred to General Reserve A/c.

DRR A/c -------------------------------------- Dr.

To General Reserve A/c

Problem 2

X Ltd. issued 2000, 15% Debentures of Rs.100 each on 1/4/2001 at
10% discount, redeemable at 10% premium out of profits. Show
journal entries for all years, when debentures are redeemable in
lump sum after four years and company decided to create DRR.

Redemption out of Sinking Fund:-

Under this method, the company sets aside every year a part of
divisible profits and invests the same in outside securities. The
investment is made in such a manner that cash required for
redemption will be equal to the amount of debentures. The amount
is made available by selling the investments.

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Procedure followed for Sinking Fund Method along with journal
entries:

1. Calculate the amount to be set aside every year.
2. Set aside profit for Sinking Fund

Profit & Loss Appropriation A/c -----------Dr.
To Sinking Fund A/c

3. Invest in the securities at the end of each year (except last
year)

Sinking Fund Investment A/c ---------------------- Dr.

To Bank A/c

4. Record receipt of interest at the end of each year

Bank A/c----------------------------------------------- Dr.

To Sinking Fund A/c

5. Repeat Step No.2 each year. Repeat Step No.3 each year
except last year. Repeat Step No.4 each year.

6. Record Sale of Investment in the year of Redemption

Bank A/c ----------------------------------------------Dr.
To Sinking Fund Investment A/c

7. When there is profit on sale of Sinking Fund Investment
Sinking Fund Investment A/c ---------------------Dr.
To Sinking Fund A/c

• Reverse entry is passed in case of loss
8. When debentures are redeemed at premium then Premium on

Redemption is transferred to Sinking Fund A/c.

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9. At the end balance in Sinking Fund A/c is transferred to
General Reserve A/c
Sinking Fund A/c ---------------------------------------Dr.
To General Reserve A/c

Problem 3

ITC Ltd. issued 1100, 5% Debentures of Rs.100 each on 1/1/1999
redeemable at par. The company decided to set aside every year a
sum of Rs.34893 to be invested @ 5% outside the business. The
investments were sold at Rs. 71580 at the end of the third year and the
debentures were redeemed. Give journal entries; also prepare Sinking
Fund & Sinking Fund Investment A/c. (Ignore Debenture Interest)

Problem 4

A company issued 10000, 8% Debentures of Rs. 100 each at par on
1/1/2001 redeemable on 31/12/2004 at par. The company decided to
invest money outside business to provide funds for redemption. The
outside investments were made @ 5% p.a. on the last day of each year.
On 31/12/2004 the company sold all investments for Rs. 725000 and
redeemed the 8% Debentures. The Sinking Fund value of Rs. 1 @ 5%
interest for 4 years is 0.23012.

Prepare for all the four years:

1. 8% Debentures Account
2. Sinking Fund Account
3. Sinking Fund Investment Account

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Problem 5

On 30th September, 2001 the following balances stood in the books of
S.P. Ltd.

Particulars Rs. Particulars Rs.
7% Second Mortgage Sinking Fund
Debenture Stock
400000 Investments:

Income Received on Rs. 80000, 5% State 76000
Sinking Fund 14500 Development Loans 100000
Discount on Issue of
Debentures Rs. 90000, 6% National
25000 Defence Bond

Sinking Fund 365500 Rs. 70000, 7% Plan

Progress Loan 70000
185000
Rs. 180000, 7 ½ %

Central Securities

On the same day the investments were sold: the 5% State

Development loans at 90, the 6% National Defence Bond at par, the

7% Plan Progress Loan at 115 and 7 ½ % Central Securities at 120. On

30/9/2001 the debentures of Rs.300000 were redeemed at a premium

of 2 ½ %. On the very same day 8% Moon landing Investments of

Rs.100000 were purchased at a premium of 3%. Annual contribution

for redemption was Rs.50000.Ignore interest.

Prepare the following Accounts:

Debenture Stock, Sinking fund, Sinking Fund Investments.

Redemption of Debentures by Conversion Method:-

Under this method company gives option to Debenture holders to
convert the amount of Debentures at par or at premium into either,
Equity or Preference shares or New Debentures at par, premium or

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even discount. Debenture holders not opting for these options are
paid off in cash.

Problem 6

Beeta Ltd. had issued 5000, 12% Debentures of Rs. 100 each
redeemable on 31/12/2001 at a premium of 5%. The company offered
three options to Debenture holders as follows:

i. 4% Preference Shares of Rs.10 at Rs.12.
ii. 15% Debentures of Rs.100 at par.
iii. Redemption in cash.

The options were accepted as under:

i. Option (i) by holders of 1500 Debentures
ii. Option (ii) by holders of 1500 Debentures
iii. Option (iii) by holders of 2000 Debentures.

The redemption was carried out by the company. Show Journal Entries.

Problem 7

Enron Ltd. gave notice of its intension to redeem its outstanding
Rs.600000, 8% Debentures at Rs.103 and offered the holders the
following options:

a) 10% Preference Shares of Rs.20 each at Rs.25.
b) 9% Debentures at Rs.96.
c) To have their holdings redeemed for cash.

i. The holders of Rs.180000 Debentures accepted proposal (a)
ii. The holders of Rs.240000 Debentures accepted proposal (b)
iii. The remaining debenture holders accepted proposal (c)

Pass necessary journal entries in the books of Enron Ltd.

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