Debentures: Issue, Types, Accounting & Redemption

TAKEAWAYS:

• Debentures are long-term borrowings by companies (like loans) but issued to the public instead of banks.
• They can be secured (backed by assets) or unsecured (based on company reputation).
• Issue at par, premium, or discount affects accounting entries and profit/loss.
• Redemption can be at par, premium, or discount, with sinking funds or purchase in the open market.
• Interest on debentures is a financial expense, reducing taxable profit.
• NEB exams test journal entries, ledger postings, and calculations of issue/redemption values.

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What Are Debentures?

Debentures are long-term debt instruments issued by companies to raise capital. Unlike shares, debentures represent loans—the company promises to repay the principal amount plus interest at a fixed rate.

Key Features:

• No ownership: Holders are creditors, not owners.
• Fixed interest: Interest is paid periodically (usually annually or half-yearly).
• Repayment: Principal is repaid after a fixed period (e.g., 5, 10, or 15 years).
• Transferable: Can be sold in the market like shares.

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Types of Debentures

Debentures can be classified based on security, convertibility, and repayment method.

1. Secured vs. Unsecured Debentures

2. Convertible vs. Non-Convertible Debentures

3. Redeemable vs. Irredeemable Debentures

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Issue of Debentures

Companies issue debentures at par, premium, or discount. The accounting treatment differs based on the issue price.

1. Issue at Par (Face Value)

• Definition: Issued at the face value (e.g., ₹100 per debenture).
• Journal Entry:

  Bank A/c           Dr. 100,000
      To 10% Debentures A/c       100,000
  

2. Issue at Premium

• Definition: Issued above face value (e.g., ₹120 for a ₹100 debenture).
• Premium Account: Treated as deferred revenue (not profit).
• Journal Entry:

  Bank A/c           Dr. 120,000
      To 10% Debentures A/c       100,000
      To Securities Premium A/c   20,000
  

3. Issue at Discount

• Definition: Issued below face value (e.g., ₹90 for a ₹100 debenture).
• Discount Account: Treated as financial expense (increases cost).
• Journal Entry:

  Bank A/c           Dr. 90,000
      Discount on Debentures A/c Dr. 10,000
      To 10% Debentures A/c       100,000
  

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Interest on Debentures

• Fixed Rate: Interest is calculated on the face value, not the issue price.
• Accounting Treatment:
  • Debit: Interest on Debentures A/c (expense).
  • Credit: Interest Payable A/c (liability) or Bank A/c (if paid).

Example: If ₹100,000 debentures are issued at 10% interest:

Interest on Debentures A/c Dr. 10,000
    To Interest Payable A/c       10,000

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Redemption of Debentures

Debentures can be redeemed in three ways:

1. Redemption at Par

• Definition: Repaid at face value (no premium/discount).
• Journal Entry:

  10% Debentures A/c       Dr. 100,000
      To Bank A/c                   100,000
  

2. Redemption at Premium

• Definition: Repaid above face value (e.g., ₹110 for ₹100).
• Premium Account: Treated as financial expense (reduces profit).
• Journal Entry:

  10% Debentures A/c       Dr. 100,000
      Premium on Redemption A/c Dr. 10,000
      To Bank A/c                   110,000
  

3. Redemption at Discount

• Definition: Repaid below face value (e.g., ₹90 for ₹100).
• Discount Account: Treated as financial income (increases profit).
• Journal Entry:

  10% Debentures A/c       Dr. 100,000
      To Discount on Redemption A/c 10,000
      To Bank A/c                   90,000
  

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Methods of Redemption

1. Purchase in the Open Market

• Company buys back debentures from the market at current market price.
• Advantage: Flexible; no fixed repayment date.
• Disadvantage: Market price may fluctuate.

2. Sinking Fund Method

• Company sets aside periodic amounts in a sinking fund to repay debentures.
• Advantage: Ensures repayment; reduces risk.
• Disadvantage: Requires disciplined savings.

3. Conversion into Shares

• Convertible debentures can be exchanged for equity shares.
• Advantage: Reduces debt; no cash outflow.
• Disadvantage: Dilutes ownership.

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Solved Example: Issue and Redemption of Debentures

Problem: A company issues 1,000 debentures of ₹100 each at a 10% premium, repayable after 5 years. Interest is paid annually at 12%. After 3 years, the company redeems 500 debentures at a 5% premium.

Solution:

1. Issue of Debentures:

   Bank A/c           Dr. 110,000 (1,000 × ₹110)
       To 12% Debentures A/c       100,000
       To Securities Premium A/c   10,000
   

2. Interest for Year 1:

   Interest on Debentures A/c Dr. 12,000 (1,000 × ₹100 × 12%)
       To Interest Payable A/c       12,000
   

3. Redemption After 3 Years:

   • Premium on Redemption: 5% of ₹50,000 (500 × ₹100) = ₹2,500.

   12% Debentures A/c       Dr. 50,000
       Premium on Redemption A/c Dr. 2,500
       To Bank A/c                   52,500
   

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NEB-Style Questions

Short Answer (5 marks)

1. What is the difference between secured and unsecured debentures? Give one example of each.

Long Answer (10 marks)

2. Explain the journal entries for:
   • Issue of ₹50,000 debentures at a 5% discount.
   • Payment of first year’s interest at 10%.
   • Redemption of half the debentures at a 10% premium after 3 years.

Practical (15 marks)

3. From the following transactions, prepare the ledger accounts for debentures:
   • Issued 2,000 debentures of ₹100 each at a 15% premium.
   • Paid first year’s interest at 12%.
   • Redeemed 1,000 debentures at ₹105 after 2 years.

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Exam Tips

1. Memorize Journal Entries: NEB often asks for issue/redemption entries—practice them daily.
2. Premium/Discount Handling:
   • Issue Premium: Credit to Securities Premium A/c (not profit).
   • Redemption Premium: Debit to Premium on Redemption A/c (expense).
3. Interest Calculation: Always calculate on face value, not issue price.
4. Methods of Redemption: Know open market, sinking fund, and conversion—explain advantages/disadvantages.
5. Numerical Problems: Show step-by-step calculations (e.g., premium/discount amounts).

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