Redemption of Debentures — Notes

Redemption of debentures is the repayment of the amount due to the debentureholders, which discharges the company's liability.

• Methods in the ISC 2027 syllabus: (a) in one lump sum at the end of the stated period, at par or at a premium; (b) in annual instalments by draw of lots (concepts only).
• Sources: out of capital (no profit kept back), partly out of profits (the statutory reserve) or wholly out of profits (a reserve equal to the face value redeemed).
• Safeguards: the Debenture Redemption Reserve (profit kept back) and the Debenture Redemption Investment (money set aside).

Not in the ISC 2027 syllabus: calculation of ex-interest and cum-interest prices, and numerical problems on redemption by draw of lots.

Section 71(4), Companies Act, 2013: a company issuing debentures creates a Debenture Redemption Reserve out of profits available for payment of dividend; the amount credited may be used only for redeeming debentures.

Rule 18(7), as amended in 2019:

• Other unlisted companies: reserve of at least 10% of the value of outstanding debentures.
• Not required: listed companies; All India Financial Institutions and banking companies; unlisted NBFCs and housing finance companies (HFCs) for privately placed debentures.

Entry: Surplus, i.e., Balance in Statement of Profit and Loss Dr. To Debenture Redemption Reserve A/c.

Further transfer = 10% × outstanding debentures − balance already in the reserve (nil if already enough).

Rule 18(7): on or before 30 April each year, a listed company or an unlisted company (other than the exempt classes) must invest or deposit at least 15% of the debentures maturing during the year ending on the next 31 March.

• Permitted forms: deposits with a scheduled bank free from any charge or lien; unencumbered securities of the Central or a State Government; unencumbered trust securities and notified bonds under the Indian Trusts Act, 1882.
• Use: only for redeeming the debentures maturing that year; it must never fall below 15% of them.

Entries: made: Debenture Redemption Investment A/c Dr. To Bank A/c; encashed: Bank A/c Dr. To Debenture Redemption Investment A/c, Interest on Debenture Redemption Investment A/c; interest closed: Interest on Debenture Redemption Investment A/c Dr. To Statement of Profit and Loss.

Exempt from both: banking companies, All India Financial Institutions regulated by the Reserve Bank of India, and unlisted NBFCs and HFCs for privately placed debentures.

The reserve keeps profit back (equity side); the investment puts money aside (assets side). One does not replace the other.

• Out of capital: no profit is transferred to a reserve; the funds paid out are not replaced by retained profit. Open only to a company exempt from the reserve (for example a listed company, which still makes the 15% investment).
• Partly out of profits: the statutory reserve (10% of outstanding debentures) is kept; after redemption it goes to General Reserve.
• Wholly out of profits: an amount equal to the face value redeemed is kept in the reserve before redemption: further transfer = face value − reserve already held. After redemption it goes to General Reserve, so resources equal to the debt repaid stay in the business.

Entries: Surplus, i.e., Balance in Statement of Profit and Loss Dr. To Debenture Redemption Reserve A/c (before); Debenture Redemption Reserve A/c Dr. To General Reserve A/c (after).

Order of entries for the year of redemption

1. Transfer to reserve (if it is short of the minimum).
2. Investment made by 30 April.
3. Investment encashed with interest on maturity.
4. Debentures A/c Dr. To Debentureholders' A/c (amount due).
5. Debentureholders' A/c Dr. To Bank A/c (payment).
6. Debenture Redemption Reserve A/c Dr. To General Reserve A/c.
7. Interest on the investment closed to the Statement of Profit and Loss.

Check: Debentures, Debentureholders, the investment and the reserve all close at nil; the bank changes by interest earned − amount repaid.

When debentures are redeemable at a premium, the premium is credited to Premium on Redemption of Debentures A/c at issue (with Loss on Issue debited; chapter 7). On maturity:

Debentures A/c Dr., Premium on Redemption of Debentures A/c Dr. To Debentureholders' A/c (face value + premium); then Debentureholders' A/c Dr. To Bank A/c.

Schedule III Part I: Debenture Redemption Reserve and General Reserve under Reserves and Surplus; the investment under current investments; debentures due within 12 months as current maturities under short-term borrowings; premium on redemption under other long-term liabilities (current in the final year).

• A fixed part of the issue is redeemed each year; the debenture numbers to be repaid are chosen by draw of lots.
• Holders whose debentures are drawn are repaid in full; the rest continue to earn interest until drawn.
• Reserve: the 10% minimum is built before redemption begins and transferred to General Reserve after the last instalment.
• Investment: by 30 April of each year, at least 15% of that year’s instalment is invested; it is encashed for that instalment and made again for the next.