Redemption of debentures means the repayment of the amount of debentures to the debenture holders on or before the maturity date. Debentures may be redeemed at par, at a premium, or at a discount, and the redemption may take place either in a lump sum at the end of the term or in instalments over a period of time. The terms of redemption are specified in the debenture deed and the prospectus.
Under the Companies Act, 2013, a company must create a Debenture Redemption Reserve (DRR) out of its profits before it redeems its debentures. The purpose of the DRR is to ensure that the company accumulates adequate profits for the repayment of debentures rather than distributing all profits as dividends. The amount of the DRR is prescribed by the law, and the company must also invest a specified amount in specified securities.
The accounting for the redemption of debentures involves the payment to debenture holders, the treatment of premium on redemption, the writing off of any loss on issue, the creation and utilisation of the Debenture Redemption Reserve, and the disposal of the Debenture Redemption Reserve after redemption. The methods of redemption include redemption in instalments by draw of lots, redemption by purchase in the open market, and conversion of debentures into shares.
Debentures can be redeemed from the proceeds of a fresh issue of shares or debentures, or out of the accumulated profits of the company. When debentures are redeemed out of profits, an equivalent amount is transferred to the Debenture Redemption Reserve so that the company does not distribute the profits meant for redemption as dividends.
The redemption may be at par, at a premium (where the redemption price is higher than the face value), or at a discount (rarely, where the redemption price is lower than the face value).
The company may redeem the whole of the debentures at once after the expiry of the term. This is the simplest method and involves paying the debenture holders the redemption amount at maturity.
Under this method, a part of the debentures is redeemed each year by drawing lots. The debentures are chosen by lot and redeemed at the face value. The remaining debentures continue to carry interest until their turn for redemption.
The company may purchase its own debentures from the open market. If the market price is favourable, the company buys the debentures and cancels them. The difference between the purchase price and the nominal value is treated as a gain or loss. The gain is transferred to the Capital Reserve Account.
Debentures may be redeemed by converting them into equity shares or new debentures. This is done at the option of the company or the holder, and the old debentures are cancelled on conversion.
According to the Companies (Share Capital and Debentures) Rules, 2014, a company must create a DRR out of its profits available for dividend before the redemption of debentures. The DRR is created by a transfer from the profit and loss account:
Profit and Loss Appropriation A/c Dr.
To Debenture Redemption Reserve A/c
The DRR is shown as a reserve under Shareholders' Funds in the Balance Sheet. After the redemption of the debentures, the DRR may be transferred back to the General Reserve.
The company must also invest a prescribed percentage of the nominal value of the debentures outstanding in specified securities (such as unencumbered securities of the central or state governments) before the date of redemption, and the investment must be utilised for the payment of the redemption amount.
$$\text{Debenture Holders' A/c} = \text{Number of Debentures} \times \text{Face Value}$$
Debentures A/c Dr.
To Debenture Holders' A/c
Debenture Holders' A/c Dr.
To Bank A/c
When debentures are redeemed at a premium, the premium on redemption is a loss for the company and is debited to a Premium on Redemption of Debentures Account:
Debentures A/c Dr.
Premium on Redemption of Debentures A/c Dr.
To Debenture Holders' A/c
Debenture Holders' A/c Dr.
To Bank A/c
The premium on redemption is written off against the Debenture Redemption Reserve or Securities Premium Account.
When the company buys its debentures in the open market at a price below the face value:
$$\text{Gain on Redemption} = \text{Nominal Value} - \text{Purchase Price}$$
The gain is transferred to the Capital Reserve Account.
If debentures are redeemed out of capital, no DRR is created. If they are redeemed out of profits, the DRR must be created. Redemption out of profits ensures that the company retains an amount equal to the profits used for redemption, so that the working capital is not depleted.
| Method | Description |
|---|---|
| Lump sum | All debentures redeemed at maturity |
| Draw of lots | Part redeemed each year by lot |
| Purchase in open market | Company buys and cancels its debentures |
| Conversion | Debentures converted into shares |
| Event | Entry |
|---|---|
| Redemption at par | Debentures A/c Dr. To Debenture Holders' A/c; then payment to Bank |
| Premium on redemption | Premium on Redemption A/c Dr. along with Debentures A/c |
| DRR created | P&L Appropriation A/c Dr. To DRR A/c |
| DRR after redemption | DRR A/c Dr. To General Reserve A/c |
| Basis | At Par | At Premium |
|---|---|---|
| Redemption price | Face value | Higher than face value |
| Loss to company | None | Premium on redemption |
| Journal entry | Debentures A/c Dr. | Debentures + Premium A/c Dr. |
The redemption of debentures is the final stage in the life of debentures and requires careful accounting to ensure that the company's obligations are settled correctly. The creation of the Debenture Redemption Reserve and the investment in specified securities safeguard the interests of debenture holders by ensuring that profits are retained for repayment. The various methods of redemption, namely lump sum, draw of lots, purchase in the open market, and conversion, each have their own accounting treatment. Understanding the difference between redemption at par and at premium, and the treatment of the premium and discount, completes the accounting for debentures from issue to redemption.