Issue of Debentures: Meaning, Expenses and Writing Off Discount

In this article we will discuss about the Issue of Debentures:- 1. Meaning of Issue of Debentures 2. Expenses on Issue of Debentures Account 3. Debenture Redemption Reserve 4. Collateral Security 5. Writing Off Discount.

Contents:

  1. Meaning of Issue of Debentures
  2. Expenses on Issue of Debentures Account
  3. Debenture Redemption Reserve
  4. Issue of Debentures as a Collateral Security
  5. Writing Off Discount etc. on Issue of Debentures



1. Meaning of Issue of Debentures:

Debentures are issued in the same manner in which shares are issued. The company issues a prospectus inviting applications along with a sum of money called application money. After scrutiny, the Board of Directors makes allotment of debentures.

If the entire sum of money has not been asked for along with applications another sum of money called, allotment money may be asked for. Subsequently there may be a few calls even. But mostly, the entire amount is received on application or on application and allotment.

Entries for issue of debentures are similar to those passed for issue of shares, only the names of the accounts are changed. There are Debenture Applications Account, Debenture Allotment Account (or Debenture Applications and Allotment Account), Debenture First Call Account, Debenture Second Call Account, Debenture Third and Final Call Account, etc.

Instead of crediting Share Capital Account, Debentures Account is credited.

On receipt of the allotment money, bank will be debited and the Debentures Allotment Account credited.

It is usual to prefix “Debentures” with the rate of interest. Thus, if the rate of interest is 14 per cent, the name given will be “14% Debentures”.

Premium on Issue of Debentures Account and Discount on Issue of Debentures Account take place of Securities Premium Account and Discount on Issue of Shares Account respectively.

Like shares, debentures may be issued at par, at a premium or at a discount. But the law does not lay down any maximum limit for discount on issue of debentures. The sanction of the Company Law Board is also not needed.

Debentures are invariably redeemable. They may be redeemable at par or at a premium. Redemption of debentures at a premium means that the company pays to the debenture-holders, at the time of redemption, a sum higher than the face value of debentures held by them.

If a company issues debentures on the condition that it would redeem them at a premium, this additional liability should be recorded in a separate account called ‘Premium on Redemption of Debentures Account’ and shown along with the liability ‘Debentures’ in the balance sheet.

As debentures can be issued at par, at a premium or at a discount and can be redeemable at par or at a premium, there are a number of possible cases of entries to be passed at the time of issue of debentures.

Summarised entries for typical cases are given below:

The name of Share Premium has been changed to Securities Premium. Debentures are also securities. Hence, premium on issue of debentures can logically be credited to Securities Premium Account. Then, restrictions on the use of premium on issue of shares will be applicable to the use of premium on issue of debentures also.

Premium on Redemption of Debentures must be distinguished from Premium on Issue of Shares; the former is a liability to be shown along with Debentures under the heading Long-term Borrowings while the latter is a capital profit to be shown under Reserves and Surplus.

Alternatively, discount allowed on issue of debentures as well as the amount of premium payable on redemption may be debited to Loss on Issue of Debentures Account, in which case the journal entry will be as follows:




2. Expenses on Issue of Debentures Account:

Discount on Issue of Debentures Account and Loss on Issue of Debentures Account may be transferred to Cost of Issue of Debentures Account by means of the following journal entry:

Cost of Issue of Debentures Account Dr

To Expenses on Issue of Debentures Account

To Discount on Issue of Debentures Account

To Loss on Issue of Debentures Account

Cost of Issue of Debentures Account, Expenses on Issue of Debentures Account, Discount on Issue of Debentures Account and Loss on Issue of Debentures Account represent capital losses and their balances are shown as a deduction from Reserves and Surplus in the balance sheet.

According to the provisions of the Companies Act, the amount of such a loss need not be written off. But sound principles of accountancy demand that the loss should be gradually and suitably written off over the life span of debentures in respect of which the loss has been incurred. Alternatively, the loss may be wholly or partly be transferred to Securities Premium Account.

Premium on Issue of Debentures Account represents a capital profit and should be transferred to Capital Reserve. Premium on Redemption of Debentures Account is a personal account. At the time of redemption of debentures, Premium on Redemption of Debentures Account is transferred to Sundry Debenture-holders Account.

Illustration 1:

White Ltd. issues 10,000 12% Secured Debentures of Rs. 100 each. Give journal entries if the Debentures are redeemable at par and are issued (i) at par, (ii) at a discount of 2 per cent and (iii) at a premium of 3 per cent.

Also show the entries which will be made if the Debentures are redeemable at a premium of 5 per cent and are issued (i) at par and (ii) at a discount of 2 per cent.

Also show in each case, how the figures will appear in the balance sheet.

Debentures may be issued for consideration other than cash. Such an issue may be made at par, at a premium or at a discount. When a company takes over a running business, very frequently it discharges a part of the consideration in the form of its debentures.

Illustration 2:

Pee Co. Limited took over certain fixed assets for Rs. 3,15,000 from the liquidator of Tee Limited which was being wound up and allotted 3,000 13% Debentures at a premium of 5% to the liquidator to satisfy the consideration.




3. Debenture Redemption Reserve:

As per SEBI guidelines, in case of issue of debentures with maturity of more than 18 months, debenture redemption reserve has to be created.

The following points are also noteworthy:

(i) A moratorium up to the date of commercial production can be provided for creation of the debenture redemption reserve in respect of debentures raised for project finance.

(ii) The debenture redemption reserve may be created either in equal installments for the remaining period or with higher amounts if profits permit.

(iii) In the case of partly convertible debentures, debenture redemption reserve should be created in respect of non-convertible portion of debenture issue on the same lines as applicable for fully non-convertible debenture issue.

In respect of non-convertible issues by new companies, the creation of debenture redemption reserve should commence from the year the company earns profits for the remaining life of debentures.

(iv) Company should create DRR equivalent to 50% of the amount of debenture issue before debenture redemption commences. Withdrawal from DRR is permissible only after 10% of the debenture liability has been actually redeemed by the company.

(v) Debenture redemption reserve will be treated as a part of General Reserve for consideration of bonus issue proposals.

The entry for creation of debenture redemption reserve will be as follows:

Profit and Loss Appropriation Account Dr. with the amount of the installment

To Debenture Redemption Reserve

Illustration 3:

On 1st April 2008, a company issued 1,000 14% debentures of Rs 1,000 each at Rs 950. Terms of issue provided that beginning with April 2010, Rs 50,000 of debentures should be redeemed, either by drawings at par or by purchase in the market every year. The expenses of the issue amounted to Rs 8,000 which were written off in 2008-09.

The company wrote off Rs 10,000 from the Discount on issue of Debentures every year. In 2010-11, the debentures to be redeemed were repaid at the end of the year by draw of lots. In 2011-2012, the company purchased for cancellation 50 debentures at the ruling price of Rs 980 on 31st March, 2012, the expenses being Rs 500.

Interest is payable yearly. Every year, an appropriate amount was also credited to Debenture Redemption Reserve. Ignore income tax.

Give journal entries and the balance sheet (as far as it relates to debentures) on 31st March, 2012.




4. Issue of Debentures as a Collateral Security:

A company may issue debentures in favour of a lender of money as a collateral (subsidiary or secondary) security for a loan raised by it. The debentures remain dormant with the lender unless and until the company makes a default in the repayment of the loan for whose security the debentures have been issued. No entry need be passed for issue of such debentures.

However, if an entry is desired, the following entry may be passed:

Debentures Suspense Account Dr

  To Debentures Account

Face value of debentures issued by way of collateral security.

In the balance sheet, both Debentures Account and Debentures Suspense Account will appear on the Liabilities side, Debentures Suspense Account being deducted from Debentures Account.

It may be shown as follows:

Illustration 4:

Kalpana Ltd. raised a bank loan of Rs 2,50,000 and issued by way of a collateral security, 250 14% Debentures of Rs 1,000 each. The company further issued to public 8,000 12% Debentures of Rs 100 each at a discount of 2% payable as to Rs 50 on application and the balance on allotment.

The issue was underwritten by M/s Ajanta Underwriters for a commission of 1 % of nominal value of debentures underwritten. The whole of the issue was subscribed to by the members of the public. The company paid the underwriting commission in the form of its 12% Debentures of Rs 100 each issued at par. Pass journal entries for the above mentioned transactions and draw the balance sheet of the Kalpana Ltd.




5. Writing Off Discount etc. on Issue of Debentures:

A company is not legally bound to write off discount or loss or expenses on issue of debentures (cost of issue of debentures). But prudence demands that such amounts should be gradually written off by transfer to Profit & Loss Account on some reasonable basis.

If the debentures are redeemable at the end of a certain period, say ten years, it will be reasonable to write off one-tenth of the cost of issue of debentures every year.

If the debentures are to be repaid by installments, the amount to be written off each year should be in proportion to the amount outstanding against debentures because that represents the benefit which the company reaps from the issue of debentures.

Suppose, a company issues debentures for Rs 10,00,000 and redeems at the end of each year debentures of Rs 1,00,000. Then, the total cost of issue of debentures should be written off in ten years in the ratio of 10:9:8:7:6:5:4:3:2:1. If debentures remain outstanding only for a part of a year, the amount to be written off at the end of that year should be proportionately reduced.

Illustration 5:

Vaishali Co. Limited closes its books of accounts every year on 31st March. On 1st May, 1999 it issues 8% Debentures of the face value of Rs 5,00,000 at a discount of 3%. Expenses of issue amount to Rs 3,000.

Calculate the amounts of the cost of Issue of Debentures to be written off in different accounting years in each one of the following cases:

(a) All the debentures will be redeemed after 10 years on 1st May, 2009.

(b) Every year debentures of the face value of Rs 1,00,000 will be redeemed; the first redemption taking place on 1st May, 2000.

(c) Debentures will be redeemed in five equal yearly installments of Rs 1,00,000 each, the first installment being payable on 1st May, 2003.

Solution:

Discount allowed on issue of debentures = 3/100 x Rs 5,00,000 = Rs 15,000

Expenses on issue of debentures = Rs 3,000

Total cost of issue of debentures to be written off= Rs 15,000 + Rs 3,000 = Rs 18,000

(a) As debentures will be redeemed after 10 years, one-tenth of the total cost of issue of debentures should be written off for every completed year.

But in the accounting year 1999-2000, debentures remain outstanding for 11 months only (i.e., from 1st May, 1999 to 31st March, 2000). Hence, amount to be written off in accounting year 1999- 2000 = Rs 18,000 x 1/10 x 11/12 = Rs 1,650 The amount to be written off in each one of the next nine accounting years = Rs 18,000 x 1/10 = Rs 1,800

In the accounting year 2009-10, debentures remain outstanding for only 1 month (i.e. from 1st April, 2009 to 1st May, 2009). Hence, amount to be written off in accounting year 2009-10 = Rs 18,000 x 1/10 x 1/12 = Rs 150.

(b) Debentures of Rs 1,00,000 are redeemed after each completed year. Hence, during the years 1999-2000,2000-01,2001 -02,2002-03 and 2003-04 debentures of the face value of Rs 5 lakh, Rs 4 lakh, Rs 3 lakh, Rs 2 lakh and Rs 1 lakh respectively remain outstanding.

Cost of issue of debentures should be written off in the ratio of 5 : 4 : 3 :2 : 1. Total of the ratios = 5 + 4 + 3 + 2+1 = 15. Cost of issue of debentures to be written off for the period between 1st May, 1999 and 1st May, 2000 = Rs 18,000 x 5/15 = Rs 6,000.

But in accounting year 1999-2000, debentures of Rs 5 lakhs remain outstanding only for 11 months (i.e. from 1st May, 1999 to 31st March, 2000). Hence, amount to be written off in 1999-2000 = Rs 18,000 x 5/15 x 11/12 =Rs 5,500.

In the accounting year 2000-01, debentures of Rs 5,00,000 remain outstanding for 1 month and those of Rs 4,00,000 remain outstanding for 11 months.

Hence, amount to be written off in the accounting year 2000-01 = Rs (18,000 x 5/15 x 1/12) + Rs (18,000 x 4/15 x 11/12) = Rs 500 + Rs 4,400 = Rs 4,900

Applying similar reasoning, we can calculate the amounts to be written off in other years as follows:

Amount to be written off in 2001-02

= Rs (18,000 x 4/15 x 1/12) + Rs (18,000 x 3/15 x 11/12)

= Rs 400+ 3,300 = Rs 3,700

Amount to be written off in 2002-03

= Rs (18,000 x 3/15 x 1/12) + Rs (18,000 x 2/15 x 11/12)

= Rs 300+Rs 2,200 = Rs 2,500

Amount to be written off in 2003-04

= Rs (18,000 x 2/15 x 1/12) + Rs (18,000 x 1/15 x 11/12)

= Rs 200 + Rs 1,100=Rs 1,300

Amount to be written off in 2004-05

= Rs 18,000 x 1/15 x 1/12 = Rs 100.

(c) During the first four complete years, debentures of Rs 5 lakh remain outstanding and during the next four complete years debentures of Rs 4 lakh, Rs 3 lakh, Rs 2 lakh and Rs 1 lakh respectively remain outstanding. Hence, ratio in which the cost of issue of debentures should be written off for eight complete years = 5:5:5:5:4:3:2:1. Total of ratios = 5 + 5 + 5 + 5+ 4 + 3 + 2+1= 30.

Amount to be written off in accounting year 1999-2000 (for 11 months from 1st May, 1999 to 31st March, 2000)

= Rs 18,000 x 5/30 x 11/12 = Rs 2,750.

In each of the accounting years of2000-01, 2001-02 and 2002-03 the amount to be written off

= Rs 18,000 x 5/30 = Rs 3,000.

Amount to be written off in 2003-04

= Rs (18,000 x 5/30 x 1/12) + Rs (18,000 x 4/30 x 11/12)

= Rs 250 + Rs 2,200 = Rs 2,450

Amount to be written off in 2004-05

= Rs (18,000 x 4/30 x 1/12) + Rs (18,000 x 3/30 x 11/12)

= Rs 200 + Rs 1,650 = Rs 1,850.

Amount to be written off in 2005-06

= I (18,000 X 3/30 X 1/12) + Rs (18,000 x 2/30 x 11/12)

= Rs 150 +Rs 1,100=Rs 1,250.

Amount to be written off in 2006-07

= Rs (18,000 x 2/30 x 1/12) + Rs (18,000 x 1/30 x 11/12)

= Rs 100 + Rs 550 = Rs 650.

Amount to be written off in 2007-08

= Rs 18,000 x 1/30 x 1/12 = Rs 50.


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