Issue and Redemption of Debentures
Corporate Accounting Notes
B.Com 2nd and 4th Sem CBCS Pattern
Part B: ISSUE
AND REDEMPTION OF DEBENTURES
Q. What do
you mean by debentures? What are its features?
Q.
Distinguish between shares and debentures. State SEBI guidelines for issue of debentures.
Q. How a debenture can be redeemed? State its various methods.
Q. Write
short notes on:
Ø Debt Capital 2014
Ø Debenture Trust Deed 2018
Ø Sinking Fund and Redemption of debentures by sinking fund
method. 2014, 2016, 2019
Ø Convertible Debentures 2017
Ø Open Market Operation
Ø Cum Dividend and Ex-dividend
Ø Debenture redemption reserve
Ø Types of Debentures 2017
Ø Treatment of Discount on issue of shares and Loss on issue of
debenture 2013
Q. Practical Problems:
a) Debentures: Sinking fund method (2011, 2012, 2018)
b) Conversion method
c) Issue of debentures with redemption option (2015, 2019) and
d) Preparation of discount or loss on issue of debentures
account (2013).
Part
– B: Issue and Redemption of Debentures
Meaning of Debentures
According to
Sec. 2 (30) of the companies Act, 2013, debentures include “debenture
stock, bonds and any other securities of a company evidencing a debt, whether
constituting a charge on the assets of the company or not.”
Debentures are
debt instruments issued by a joint stock company. Amounts collected by way of
debentures form part of the loan capital of a company. They are repayable after
a fixed period. Debenture holders get interest on their debentures. They are
creditors of the company. They do not get dividend. Only shareholders get
dividend.
The
characteristics of debentures can be summarised as follows:
a) Debentures are debt instruments.
b) They generally carry fixed rate of interest.
c) They are normally repayable at the end of a fixed
period. Repayment of debenture or cancellation of debenture liability in the
books of the company is known as redemption of debentures.
d) They can be issued at par, premium or at discount
depending on the reputation of the company.
e) They can either be placed privately or offered for
public subscription.
f) They may or may not be listed in the stock exchange.
g) If offered for public subscription, they should be
rated by a credit rating agency approved by SEBI, prior to listing.
h) Interest is payable on debentures at a fixed rate
irrespective of the profit earned by the business.
i) Debentures may be issued with or without the security
of assets of the company.
j) In the event of winding up of the company the
debenture holders are treated as creditors and given priority in repayment of
their money.
k) Debenture holders normally do not have representation in the Board of the company.
Types of Debentures
Types
of Debentures: Debentures are classified as follows:
1.
On the Basis of Repayment
a. Redeemable Debentures: These
debentures are paid off or redeemed after the prescribed period.
b. Irredeemable or Perpetual
Debentures: These debentures are permanent debentures of a company. They are
paid back only in the event of winding up of a company.
2.
On the Basis of Transferability
a. Registered Debentures: These are
debentures for which the company maintains record of debenture holders.
b. Bearer Debentures: These debentures
are transferable by mere delivery. There is no need or registration of transfer
with the company.
3.
On the Basis of Security
a. Simple Debentures: These are
debentures not secured by any asset of the company.
b. Mortgage Debentures: Mortgage
debentures are issued on the security of certain assets of the company.
4.
On the basis of Conversion
a. Convertible Debentures: These
debentures are issued with an option to debenture holders to convert them fully
or partly into shares after a fixed period. Where only a part of the debenture
amount is convertible into equity shares, such debentures are known as ‘partly
convertible debentures’. When full amount of convertible into equity shares,
such debentures are known as ‘fully convertible debentures.’
b. Non-Convertible Debentures: These
are debentures issued without conversion option.
5.
On the Basis of Pre-Mature Redemption Rights:
a. Debenture with “Call” option: A
callable debenture is one in which the issuing company has the option of
redeeming the security before the specified redemption date at a pre-determined
price.
b. Debenture with “Put” option: This
is a debenture in which the holder has the option of getting it redeemed before
maturity.
6.
On the Basis of Coupon Rate (interest rate)
a. Fixed Rate Debentures: Most of the
time debentures are issued with a prefixed rate interest. These debentures are
called fixed interest debentures
b. Floating rate Debentures: Floating
rate as the names suggests keeps changing.
c. Zero Coupon Bonds: These are
debentures issued with no interest specified. They are issued at a substantial
discount to compensate the investors. These bonds are known as deep discount
bonds.
Issue of Debentures as Collateral security and Its Accounting Treatment
When
debentures are issued as security in addition to any other security against a
loan or bank overdraft such an issue of debentures is known as issue
of debentures as collateral security. The use of such an issue is that
if the company does not repay the loan and the interest and the main security
is not sufficient, the bank will be entitled to sell the debentures in the
market or the bank may keep the debentures with it. If the company repays the
loan, the bank will return the debentures issued as collateral security to the
company.
Debenture
issued as Collateral security can be dealt in two ways:
First Method: No entry needs to be passed in the books of the company
because debentures are issued only as a collateral security. Debentures become
alive only when loan is not repaid. The fact of such an issue of debentures
must be clearly stated in the Balance Sheet by way of a note under the loan and
debentures as shown below:
Balance Sheet of --- Co. Ltd. As on---
|
Liabilities |
Rs. |
Assets |
Rs. |
|
Secured Loans Bank Loan (secured by issuing 6,000 12%
Debentures of Rs. 100 each) |
5,00,000 |
Second Method: Alternatively, the following entry may be passed in books of
the company:
|
Date |
Particulars |
L.F. |
Debit Rs. |
Credit Rs. |
|
Bank A/c Dr. |
5,00,000 |
|||
|
To Bank Loan A/c |
5,00,000 |
|||
|
(For loan borrowed from bank) |
||||
|
Debentures Suspense A/c Dr. |
6,00,000 |
|||
|
To 12% Debentures A/c |
6,00,000 |
|||
|
(For 6,000 Debentures of Rs. 100 each
issued as collateral security) |
Balance Sheet of --- Co. Ltd. as on---
|
Liabilities |
Rs. |
Assets |
Rs. |
|
Secured Loans |
Miscellaneous Expenditures |
||
|
Bank Loan |
5,00,000 |
Debentures Suspense A/c |
6,00,000 |
|
12% Debentures (6,000 12% Debentures of Rs. 100 each
issued as collateral security) |
6,00,000 |
Redemption of Debentures:
Meaning of Redemption
Redemption
of debenture is the discharge of debenture liability. It can be done either by
repaying the money to debenture holders or converting the debenture into
shares. The conditions of redemption are clearly stated at the time of issue of
debenture in the prospectus. Debentures can be redeemed at par, premium or
discount as per the terms of issue. The period of maturity, redemption amount,
yield on redemption etc. will be mentioned in the prospectus. In case the non-convertible
debentures proposed to be rolled over (repayment extended for an additional
period), a compulsory option should be given to the debenture holders who wish
to withdraw from the debenture programme, as per the guidelines issued by SEBI.
Sources
of Funds for Redemption of Debentures
Redemption of debentures is an important commitment to be fulfilled by a
joint stock company. Failure to redeem debentures will disqualify the directors
of the company. Moreover, such a default will invite strict penalties and loss
of reputation. As the redemption of debentures drains a large amount of
resources, companies will make advance preparations to meet this need.
i. Redemption
of Debentures - from the proceeds of fresh issue of share capital and
debentures
ii.
Redemption of Debentures - out of accumulated profits
Methods of
Redemption of Debentures
i)
Redemption in lump-sum, at the end of stipulated period: Under this method the entire debentures are redeemed at the stipulated
date stated in the prospectus for the issue of debentures. The drawback of this
method is that the company has to arrange a large amount at the time of
redemption. Usually companies prepare well advance for the redemption of
debentures.
ii)
By Draw of Lots: Under this method the
company does not redeem all the debentures at the same time. Instead it will
call back only a portion of its debentures in the market for redemption each
year. The company select the debentures of a predetermined value, by drawing
lot and they are redeemed that year. This method of redemption reduces the
burden of redemption. Planning is relatively easy and the impact of redemption
on the finance of the company is limited.
iii)
By Open market operations: Like shares, debentures are also transferable from one person to
another. They are subject to purchase and sale in the stock exchange market.
Under this method, the company can discharge the debenture liability in full or
in part by purchasing its own debentures in the open market provided it is
authorised to do so by its articles of association. Debentures are
purchased by the company either for immediate cancellation or keeping them as
investment and cancel at a later date.
iv)
By Conversion into New Debentures or Shares:
Conversion of debentures into
shares is another method of redemption. When debentures are converted to
shares, the company does not pay money to debenture holders. Instead the
company issues share certificates in place of debentures. It may look good for
the company because there is no need of cash payment. But the company is
selling its shares. Selling shares is actually selling part of the ownership.
Debenture holders become shareholders. Creditors become owners. It is better to
pay off creditors rather than selling them part of the company. But sometimes
company agree to give some shares to make the issue of debentures more
attractive to buyers.
v) Sinking Fund method: Sinking fund is a fund into which a company sets aside money over time, in order to retire its preferred
stock, bonds or debentures. Such fund is created mainly for some specific purposes
which are:
1. To redeem or repay long term
liabilities. For example: debentures, long term loans etc.
2. To replace wasting assets. For example:
mines etc.
3. To replace an asset of depreciable
nature. For example, fixed assets.
Creation
of Sinking fund for redemption of debentures: For redemption of debentures or other long term liabilities, a fixed
amount is kept aside yearly as sinking fund for the specific purpose and the
same amount is invested in securities etc. for a specific period so that
the sufficient amount is available at the time of redemption of long term
liabilities. The amount to be set aside can be determined with the help of
Sinking fund table. The amount kept aside should not be debited to Profit and loss account but to Profit and loss appropriation
account because the same is an allocation of profit not expenditure.
Trust Deed
A company issuing
debentures by way of public issue is required to appoint trustees and execute a
trust deed. The trustees are expected to protect the interest of the debenture
holders through the powers granted by the trust deed. Debenture trust deed is a
document created by the company issuing debentures. Trust deed is prepared
before the issue of prospectus or letter of offer to the public for
subscription of debentures.
Who can be trustee? In
case of issue of debenture with maturity of more than 18 months, the issuer
shall appoint a debenture trustee which may be a scheduled bank or an insurance
company or a body corporate or a public financial institution. But, a person
who holds shares in the company or who is beneficially entitled to receive
money which is to be paid to/by the company to the debenture trusted or has
entered into any guarantee cannot appointed as a trustee.
Debenture Redemption Reserve
The company shall create a
Debenture Redemption Reserve for the purpose of redemption of debentures, in
accordance with the conditions given below;
(a) The Debenture
Redemption Reserve shall be created out of the profits of the company available
for payment of dividend;
(b) The company shall
create Debenture Redemption Reserve equivalent to at least 50% of the amount
raised through the debenture issue before debenture redemption commences
(c) Every company required
to create Debenture Redemption Reserve shall on or before the 30th day of April
in each year, invest or deposit, as the case may be, a sum which shall not be
less than 15%, of the amount of its debentures maturing during the year ending
on the 31st day of March of the next year.
(d) In case of partly
convertible debentures, Debenture Redemption Reserve shall be created in
respect of non-convertible portion of debenture issue in accordance with this
sub-rule.
(e) The amount credited to
the Debenture Redemption Reserve shall not be utilised by the company except
for the purpose of redemption of debentures.
Meaning and Treatment of “Discount on Issue of Debenture” and “Loss on Issue of Debenture”
When debentures are issued
at a price lower than its face value, then such debentures are said to be
issued as “Debentures issued at a Discount”. Discount on issue of debentures is
a Capital loss and is show in the Balance sheet on the Assets side under the
head “Miscellaneous Expenditure” till it is written off.
When debentures are
redeemable at a premium, the extra amount payable over and above the nominal
value on redemption is called “Loss on Issue of Debenture”. Again when debentures are issued at a
discount, the discount on issue of debenture is also a loss on issue of
debentures. Thus when debentures are issued at a discount and redeemable at a
premium both the losses are amalgamated under the head “Loss on Issue of
Debenture Account”. It is a Capital loss and is show in the Balance sheet on
the Assets side under the head “Miscellaneous Expenditure” till it is written
off.
The amount of debenture discount/Loss on issue of debenture
can be written off in two ways:
1. All debentures are to be redeemed after a fixed period: When the debentures
are to be redeemed after a fixed period, the amount of discount will be
distributed equally within the number of years spreaded between the
issue of debentures and their redemption. The amount of discount on
issue of debentures to be written off each year is calculated as: Amount
of discount to be written off annually = Amount of Discount / No of Years
2. Debentures are redeemed in instalments: Debentures
may also be redeemed in instalments but over a fixed period. In
that case the amount of debenture discount will be written off each year
in proportion to the amount of debentures redeemed.
Journal Entry for Writing of Discount on issue of
Debentures/Loss on issue of Debentures is:
Profit and Loss Account Dr.
To Discount on issue of Debentures Account
To Loss on Issue of Debentures Account
SEBI (Securities and Exchange Board of India) has issued
several guidelines pertaining to issue of various kinds of debentures.
Section F: Under SEBI guidelines following points are
laid down relating to issue of various kinds of debentures such as Fully
Convertible, Partially
Convertible and Non-Convertible Debentures:
(a) Issue of FCD. (Fully Convertible Debenture) having
a conversion period of more than 36 months will not be permissible, unless
conversion is made optional with “put” and “call” option.
(b) Compulsory credit rating will be required if
conversion is made for FCDs after 18 months.
(c) Premium amount on conversion and time of conversion
shall be predetermined and stated in the prospectus. The interest rate of above
mentioned debenture will be determined at the time of issue.
(d) Issues of debentures with maturity of 18 months or
less are exempted from the requirement of appointment of debenture trustee or
creating a Debentures Redemption Reserve (DRR).
(e) Any conversion in part or whole of the debenture
will be optional at the hands of the debenture holder, if the conversion takes
place at or after 18 months from the date of allotment, but before 36 months.
(f) In case of NCDs/PCDc, credit rating is compulsory
where maturity exceeds 18 months.
(g) Premium amount at the time of conversion for PCD
(Partially Convertible Debenture) shall be pre-determined and stated in the
prospectus. Maturity amount, period of redemption, on redemption for the
PCDs/NCDs shall be indicated in the prospectus.
(h) In case, the non-convertible portion of PCD/NCD one
to be rolled over with or without changes in the interest rate, a compulsory
option should be given to those debenture holders who want to withdraw and
encashed from the debenture programme.
(i) Before rollover of any NCDs or non-convertible
portion of the PCDs, fresh credit rating shall be obtained within a period of
six months prior to the due date of redemption and communicated to debenture
holders before roll over and fresh trust deed shall be made.
(j) Letter of information regarding roll over shall be
vetted by SEBI with regard to the credit rating debenture holder resolution,
option for conversion and such other items which SEBI may prescribe from time
to time.
(k) SEBI may prescribe additional disclosure
requirement from time to time after due notice.
CORPORATE ACCOUNTING CHAPTER WISE NOTES
Unit-I: Shares & Debentures
1. ISSUE OF SHARES AND SHARE CAPITAL
2. RIGHTS SHARES AND BONUS SHARES
4. REDEMPTION OF PREFERENCE SHARES
5. ISSUE AND REDEMPTION OF DEBENTURES
Unit II: Preparation of financial statements of companies
1. FINAL ACCOUNTS OF COMPANIES
2. ACCOUNTS OF BANKING COMPANIES
Unit-III: Valuations of Goodwill and Shares & Cash Flow Statement
1. VALUATIONS OF GOODWILL AND SHARES
Unit-IV: Amalgamation, External Reconstruction and Internal Reconstruction
1. AMALGAMATION AND EXTERNAL RECONSTRUCTION
2. INTERNAL RECONSTRUCTION AND CAPITAL REDUCTIONS
Unit-V: Accounts of Holding Companies