Chapter 2 — Issue and Redemption of Debentures

Chapter 2 covers the meaning and types of debentures, distinction between debentures and shares, and journal entries for issuing debentures at par, premium, and discount. It also covers issue for consideration other than cash, issue as collateral security, six terms of issue and redemption, interest accounting, writing off discount or loss, and all four methods of redemption.

A debenture is a written instrument acknowledging a debt under the common seal of the company. The word is derived from the Latin 'debere' meaning to borrow. According to section 2(30) of the Companies Act, 2013, it includes debenture stock, bonds, and any other securities of a company whether or not they constitute a charge on the company's assets.

A share represents ownership (owned capital) whereas a debenture is an acknowledgement of debt (borrowed capital). Return on shares is called dividend and varies with profits, while return on debentures is interest at a prefixed rate payable even if no profit is earned. Shareholders have voting rights; debentureholders normally do not. Debentures are generally secured by a charge on assets; shares are not.

Debentures are classified from five points of view: security (secured or unsecured), tenure (redeemable or irredeemable/perpetual), convertibility (convertible or non-convertible), coupon rate (specific coupon rate or zero coupon rate), and registration (registered or bearer debentures).

Zero coupon rate debentures do not carry a specific rate of interest. To compensate investors, they are issued at a substantial discount, and the difference between the nominal value and the issue price is treated as the amount of interest related to the duration of the debentures.

Debentures are issued at a discount when the issue price is below the face value; for example, a Rs. 100 debenture issued at Rs. 95. Discount is debited to Discount on Issue of Debentures and written off against Securities Premium Reserve or profits. Debentures are issued at a premium when the issue price exceeds face value; the premium amount is credited to Securities Premium Reserve.

Collateral security is a subsidiary or secondary security given in addition to the primary security when a company takes a loan. When the company issues its own debentures to the lender as collateral security, it is called debentures issued as collateral security. This can be recorded either by making no accounting entry (noting it below the loan in the balance sheet) or by debiting Debenture Suspense Account and crediting Debentures Account.

When a company purchases assets from vendors and, instead of paying in cash, issues debentures as payment, it is called issue of debentures for consideration other than cash. Such debentures may be issued at par, at a premium, or at a discount, with journal entries similar to those for shares issued for non-cash consideration.

The six common combinations are: (i) issued at par and redeemable at par; (ii) issued at discount and redeemable at par; (iii) issued at premium and redeemable at par; (iv) issued at par and redeemable at premium; (v) issued at discount and redeemable at premium; (vi) issued at premium and redeemable at premium. When redeemable at premium, the premium on redemption is debited to Loss on Issue of Debentures and shown as a non-current liability.

Debentures can be redeemed by: (1) payment in lump sum at maturity; (2) payment in instalments, with specific debentures selected by draw of lots; (3) purchase in the open market for immediate cancellation; and (4) conversion into equity shares or a new class of debentures. Only convertible debentures can be redeemed by the conversion method.

Debenture Redemption Reserve is a reserve created out of profits before redeeming debentures. For 'other unlisted companies', the adequacy of DRR shall be ten percent of the value of outstanding debentures. After redemption, the DRR is transferred to General Reserve. Listed companies, banking companies, and certain financial institutions are exempted from creating DRR.

Companies are required to invest or deposit a sum on or before April 30 which shall not be less than 15% of the amount of debentures maturing during the year ending March 31 of the next year, in specified instruments such as scheduled bank deposits or government securities. The amount invested shall not be used for any purpose other than redemption of debentures maturing during that year.

When a company purchases its own debentures in the open market at a price below face value for immediate cancellation, the difference between the face value and the purchase price is treated as profit on redemption of debentures. This profit is transferred to Capital Reserve.

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