Debenture Accounting
Interest On Debentures
Interest on debentures is a fixed percentage of the face value of the debentures and is payable periodically (usually half-yearly or annually), irrespective of the company's profits. Debenture interest is a charge against profits, not an appropriation of profits (like dividends).
This means interest must be paid even if the company incurs losses. The interest paid is a legitimate business expense and is deductible for tax purposes, thereby reducing the company's tax liability.
Companies issuing debentures are required to deduct Tax Deducted at Source (TDS) on the interest payable to resident debenture holders if the interest amount exceeds a specified limit in a financial year. The rate of TDS is as prescribed by the income tax laws (currently 10% for individuals/HUFs in most cases if PAN is provided).
Accounting Treatment
Accounting for debenture interest involves making the interest due, paying the interest, and transferring the interest expense to the Statement of Profit and Loss.
Assume a company has issued 1,000, 10% Debentures of ₹100 each (total face value ₹1,00,000). Interest is payable half-yearly on 30th September and 31st March. We'll assume a full year's interest for simplicity in example entries, but the principle applies to half-yearly payments.
Annual Interest Amount = $1,00,000 \times 10\% = ₹10,000$.
Half-yearly Interest Amount = $₹10,000 / 2 = ₹5,000$.
1. On Interest Becoming Due
When the interest is due (e.g., at the end of the accounting period or half-year), the company incurs an expense. It also becomes liable to pay this amount to debenture holders and the tax authority (TDS).
Debit 'Debenture Interest Account' (Expense).
Credit 'Debenture holders Account' (Liability to holders).
Credit 'TDS Payable Account' (Liability to government).
Assume annual interest ₹10,000 and TDS @ 10%. Interest payable to holders = ₹9,000; TDS payable = ₹1,000.
$ \begin{array}{|l|l|r|} \hline \textbf{Date} & \textbf{Particulars} & \textbf{Amount (₹)} \\ \hline & \text{Debenture Interest A/c Dr.} & 10,000 \\ & \hspace{10mm} \text{To Debenture holders A/c} & 9,000 \\ & \hspace{10mm} \text{To TDS Payable A/c} & 1,000 \\ & \text{(Being interest due on 10% Debentures, deducting TDS)} & \\ \hline \end{array} $
2. On Payment of Interest to Debenture holders and TDS to Government
Debit 'Debenture holders Account' (Liability paid).
Debit 'TDS Payable Account' (Liability paid).
Credit 'Bank Account' (Cash paid).
$ \begin{array}{|l|l|r|} \hline \textbf{Date} & \textbf{Particulars} & \textbf{Amount (₹)} \\ \hline & \text{Debenture holders A/c Dr.} & 9,000 \\ & \text{TDS Payable A/c Dr.} & 1,000 \\ & \hspace{10mm} \text{To Bank A/c} & 10,000 \\ & \text{(Being interest paid to debenture holders and TDS paid to government)} & \\ \hline \end{array} $
3. On Transfer of Debenture Interest to Statement of Profit & Loss
At the end of the financial year, the total debenture interest expense is transferred to the Statement of Profit and Loss (Debit side).
Debit 'Statement of Profit and Loss' (or Profit and Loss Account).
Credit 'Debenture Interest Account' (Expense closed).
$ \begin{array}{|l|l|l|} \hline \textbf{Date} & \textbf{Particulars} & \textbf{Amount (₹)} \\ \hline & \text{Statement of Profit and Loss Dr.} & 10,000 \\ & \hspace{10mm} \text{To Debenture Interest A/c} & 10,000 \\ & \text{(Being debenture interest transferred to Statement of Profit and Loss)} & \\ \hline \end{array} $
TDS Payable Account is a liability and will be shown in the Balance Sheet until paid to the government.
Writing Off Discount/Loss On Issue Of Debentures
The Discount on Issue of Debentures and the Loss on Issue of Debentures (which includes discount on issue and premium payable on redemption) are capital losses or expenses incurred at the time of issuing debentures. These amounts are typically written off over the life of the debentures.
The amount is usually written off from:
- Securities Premium Account (if available).
- Capital Reserve Account (if available).
- Statement of Profit and Loss (from revenue profits).
The amount to be written off each year can be calculated using the straight-line method or the fluctuating instalment method.
Straight-Line Method:
The total amount of discount/loss is spread equally over the useful life of the debentures.
Annual amount to be written off = $\frac{\text{Total Discount/Loss}}{\text{Number of years till redemption}}$
This method is suitable when the debentures are to be redeemed in a lump sum at maturity.
Fluctuating Instalment Method:
This method is used when debentures are redeemed in instalments. The amount of discount/loss written off each year is in proportion to the debentures outstanding at the beginning of that year.
Annual amount to be written off = Total Discount/Loss $\times \frac{\text{Face value of debentures outstanding at the beginning of the year}}{\text{Total face value of debentures issued}}$
Accounting Treatment:
The amount written off each year is debited to the Statement of Profit and Loss (or first to Securities Premium/Capital Reserve if available) and credited to 'Discount on Issue of Debentures Account' or 'Loss on Issue of Debentures Account'.
Assume a company issued 1,000 debentures of ₹100 each at a discount of ₹5 (Total discount ₹5,000), redeemable after 5 years in a lump sum. Using the straight-line method, annual write-off = $₹5,000 / 5 = ₹1,000$.
Journal Entry for Writing Off Discount/Loss
Assuming write-off is from Statement of Profit and Loss:
$ \begin{array}{|l|l|l|} \hline \textbf{Date} & \textbf{Particulars} & \textbf{Amount (₹)} \\ \hline & \text{Statement of Profit and Loss Dr.} & 1,000 \\ & \hspace{10mm} \text{To Discount on Issue of Debentures A/c} & 1,000 \\ & \text{(Being discount on issue of debentures written off)} & \\ \hline \end{array} $
If using Securities Premium first:
$ \begin{array}{|l|l|l|} \hline \textbf{Date} & \textbf{Particulars} & \textbf{Amount (₹)} \\ \hline & \text{Securities Premium A/c Dr.} & 1,000 \\ & \hspace{10mm} \text{To Discount on Issue of Debentures A/c} & 1,000 \\ & \text{(Being discount on issue of debentures written off from Securities Premium)} & \\ \hline \end{array} $
The remaining balance in the 'Discount on Issue of Debentures' or 'Loss on Issue of Debentures' account is shown as an asset in the Balance Sheet until fully written off.
Redemption Of Debentures
Redemption of debentures means the repayment of the principal amount of debentures to the debenture holders. It is the discharge of the loan liability represented by the debentures.
Debentures can be redeemed at par or at a premium as per the terms of issue. Redemption at a premium results in a loss for the company, which is usually accounted for at the time of issue (as 'Loss on Issue of Debentures' and 'Premium on Redemption of Debentures').
Companies Act, 2013, requires companies to create a Debenture Redemption Reserve (DRR) out of profits available for dividend before proceeding with the redemption of debentures. The purpose of DRR is to ensure that sufficient funds are available for repayment of debentures on maturity and to protect the interests of debenture holders. Rules regarding the percentage of DRR and investment of the amount vary based on the type of company (listed/unlisted, financial institution/other) and the type of debentures.
Also, companies are required to invest or deposit a certain percentage of the amount of debentures maturing during the financial year ending 31st March of the next year into specified securities or accounts. This is known as Debenture Redemption Investment (DRI).
Common methods of redemption are:
Redemption By Payment In Lump Sum
Under this method, the entire amount of debentures is repaid on a specific maturity date.
Accounting Treatment:
Assume a company redeems 1,000, 10% Debentures of ₹100 each (₹1,00,000 face value) which were issued at par and are redeemable at par.
1. For making the amount due to Debenture holders:
Debit the '10% Debentures Account' (to close the liability).
Credit 'Debenture holders Account' (Liability to pay cash).
$ \begin{array}{|l|l|l|} \hline \textbf{Date} & \textbf{Particulars} & \textbf{Amount (₹)} \\ \hline & \text{10% Debentures A/c Dr.} & 1,00,000 \\ & \hspace{10mm} \text{To Debenture holders A/c} & 1,00,000 \\ & \text{(Being amount due to debenture holders for redemption at par)} & \\ \hline \end{array} $
If redeemable at premium (e.g., 10% premium, ₹10 extra per debenture), the Premium on Redemption of Debentures Account (which was credited at the time of issue) is also debited to close it.
$ \begin{array}{|l|l|r|} \hline \textbf{Date} & \textbf{Particulars} & \textbf{Amount (₹)} \\ \hline & \text{10% Debentures A/c Dr.} & 1,00,000 \\ & \text{Premium on Redemption of Debentures A/c Dr.} & 10,000 \\ & \hspace{10mm} \text{To Debenture holders A/c} & 1,10,000 \\ & \text{(Being amount due to debenture holders for redemption at 10% premium)} & \\ \hline \end{array} $
Calculation of Premium on Redemption: $1,000 \times ₹10 = ₹10,000$.
2. On Payment to Debenture holders:
Debit 'Debenture holders Account' (Liability paid).
Credit 'Bank Account' (Cash paid).
$ \begin{array}{|l|l|l|} \hline \textbf{Date} & \textbf{Particulars} & \textbf{Amount (₹)} \\ \hline & \text{Debenture holders A/c Dr.} & \text{(Amount due)} \\ & \hspace{10mm} \text{To Bank A/c} & \text{(Amount paid)} \\ & \text{(Being debenture redemption amount paid)} & \\ \hline \end{array} $
Along with redemption, the balance in DRR corresponding to the debentures redeemed is transferred to General Reserve.
3. On Transfer of DRR to General Reserve:
$ \begin{array}{|l|l|l|} \hline \textbf{Date} & \textbf{Particulars} & \textbf{Amount (₹)} \\ \hline & \text{Debenture Redemption Reserve A/c Dr.} & \text{Required DRR amount} \\ & \hspace{10mm} \text{To General Reserve A/c} & \text{Required DRR amount} \\ & \text{(Being DRR on redeemed debentures transferred to General Reserve)} & \\ \hline \end{array} $
Any specific investment (DRI) made for redemption must also be encashed before making payment to debenture holders. The entry for encashing investment would be Bank A/c Dr. to Debenture Redemption Investment A/c.
Redemption By Payment In Instalments (Draw of Lots)
Under this method, a certain proportion of debentures is redeemed every year (or at fixed intervals) by drawing lots. A 'Debenture Redemption Fund' or 'Sinking Fund' method might also be used to accumulate funds for this purpose (though DRR/DRI is now mandatory).
Accounting Treatment:
Entries for making debentures due and paying them are similar to the lump sum method, but they are passed only for the number of debentures redeemed in that specific instalment. The balance in the Debentures Account reduces each year.
Assume ₹20,000 nominal value of debentures is redeemed each year (out of ₹1,00,000 total). In the first year, the entry for making due (if redeemable at par) would be:
$ \begin{array}{|l|l|l|} \hline \textbf{Date} & \textbf{Particulars} & \textbf{Amount (₹)} \\ \hline & \text{10% Debentures A/c Dr.} & 20,000 \\ & \hspace{10mm} \text{To Debenture holders A/c} & 20,000 \\ & \text{(Being instalment amount due to debenture holders)} & \\ \hline \end{array} $
Payment entry follows this. DRR transfer to General Reserve is done proportionately for the nominal value redeemed.
Accounting for DRR and DRI must be done annually as per rules, even when redemption is by instalments.
Redemption By Purchase In Open Market
A company may purchase its own debentures from the open market for the purpose of cancellation, provided its Articles of Association permit. This is often done when the market price of the debentures is less than their face value (i.e., trading at a discount).
Purchasing debentures at a price lower than the face value results in a profit on redemption. Purchasing at a price higher than face value results in a loss on redemption.
When debentures are purchased in the open market, they can be purchased either:
- For immediate cancellation: The purchased debentures are cancelled straight away.
- As investments (Own Debentures): The purchased debentures are held by the company as its own investments. No interest is paid on these debentures. These can be cancelled later or resold in the market.
Accounting Treatment for Purchase for Immediate Cancellation
Assume a company purchases its own 10% Debentures of ₹1,000 nominal value (10 debentures of ₹100 each) from the market for ₹9,800 (at a discount).
Face Value of debentures purchased = $10 \times ₹100 = ₹1,000$.
Purchase Price = ₹9,800.
Profit on Redemption = ₹1,000 (Face Value) - ₹980 (Purchase Price per debenture ₹9,800/10 = ₹98) = ₹20 per debenture. Total Profit = ₹200.
Journal Entry for Purchase and Cancellation:
Debit '10% Debentures Account' with the Face Value of debentures purchased.
Debit 'Interest on Debentures Account' for any accrued interest paid to the seller (if applicable). Market prices usually include accrued interest, which needs to be adjusted.
Credit 'Bank Account' with the cash paid.
Credit 'Profit on Redemption of Debentures Account' (Capital Gain) with the difference between Face Value and Purchase Price (excluding interest).
$ \begin{array}{|l|l|r|} \hline \textbf{Date} & \textbf{Particulars} & \textbf{Amount (₹)} \\ \hline & \text{10% Debentures A/c Dr.} & 1,000 \\ & \hspace{10mm} \text{To Bank A/c} & 980 \\ & \hspace{10mm} \text{To Profit on Redemption of Debentures A/c} & 20 \\ & \text{(Being 10 debentures purchased for cancellation at ₹98 each)} & \\ \hline \end{array} $
The Profit on Redemption of Debentures is a capital profit and is transferred to Capital Reserve.
Journal Entry for Transfer of Profit:
$ \begin{array}{|l|l|l|} \hline \textbf{Date} & \textbf{Particulars} & \textbf{Amount (₹)} \\ \hline & \text{Profit on Redemption of Debentures A/c Dr.} & 20 \\ & \hspace{10mm} \text{To Capital Reserve A/c} & 20 \\ & \text{(Being profit on redemption of debentures transferred to Capital Reserve)} & \\ \hline \end{array} $
If the purchase price is higher than the face value, the difference is a loss on redemption, debited to Loss on Redemption of Debentures Account (a capital loss). This loss is written off against Capital Reserve or Statement of Profit and Loss.
Purchase in the open market also requires compliance with DRR and DRI rules, although the specific application might differ based on regulations.
Redemption By Conversion
Conversion of debentures into shares or other securities is a method of redemption where the company does not have to repay cash. This method is applicable only to Convertible Debentures as per the terms of their issue.
The conversion ratio and terms are decided at the time of issue. Conversion can be into equity shares at par, premium, or sometimes even discount (though less common for conversion) relative to their market value or a predetermined conversion price.
Accounting Treatment:
When debentures are converted, the liability for debentures is extinguished, and Share Capital and/or Securities Premium accounts are credited for the value of shares issued.
Assume 1,000, 10% Convertible Debentures of ₹100 each are converted into equity shares of ₹10 each at a conversion price of ₹10 per share (i.e., at par). The face value of debentures is ₹1,00,000.
Number of equity shares to be issued = $\frac{\text{Face Value of Debentures}}{\text{Conversion Price per Share}} = \frac{₹1,00,000}{₹10} = 10,000$ shares.
Journal Entry for Conversion into Equity Shares at Par:
$ \begin{array}{|l|l|l|} \hline \textbf{Date} & \textbf{Particulars} & \textbf{Amount (₹)} \\ \hline & \text{10% Convertible Debentures A/c Dr.} & 1,00,000 \\ & \hspace{10mm} \text{To Share Capital A/c} & 1,00,000 \\ & \text{(Being 1,000 debentures of ₹100 each converted into 10,000 equity shares of ₹10 each at par)} & \\ \hline \end{array} $
If converted into equity shares at a premium (e.g., conversion price ₹12 per share), the excess goes to Securities Premium.
Number of equity shares to be issued = $\frac{₹1,00,000}{₹12} \approx 8,333.33$. Assuming for simplicity, the conversion terms resulted in 8,000 shares.
Number of equity shares issued = 8,000 shares.
Face value of 8,000 shares = $8,000 \times ₹10 = ₹80,000$.
Premium on conversion = Value of debentures converted - Face value of shares issued = $₹1,00,000 - ₹80,000 = ₹20,000$. Or, Premium per share = ₹12 - ₹10 = ₹2. Total Premium = $8,000 \times ₹2 = ₹16,000$. (Note: Discrepancy arises if total value converted is not exactly divisible by conversion price. The total value of debentures is debited, and equivalent value in shares issued is credited to Capital/Premium).
Let's recalculate based on value: Total value of debentures extinguished = ₹1,00,000. This value is converted into shares. Conversion price is ₹12. Face value of share is ₹10. So, for every ₹12 of debenture value, ₹10 is Capital and ₹2 is Premium.
Total Capital part = ₹1,00,000 $\times \frac{₹10}{₹12} \approx ₹83,333.33$
Total Premium part = ₹1,00,000 $\times \frac{₹2}{₹12} \approx ₹16,666.67$
Assuming conversion into a round number of shares at a specific price:
Assume 1,000 debentures (₹1,00,000 face value) are converted into 8,000 shares of ₹10 face value at a conversion price of ₹12.5 per share. Total value of shares issued = $8,000 \times ₹12.5 = ₹1,00,000$.
Share Capital = $8,000 \times ₹10 = ₹80,000$.
Securities Premium = $8,000 \times ₹2.5 = ₹20,000$.
Journal Entry for Redemption by Conversion at Premium:
$ \begin{array}{|l|l|r|} \hline \textbf{Date} & \textbf{Particulars} & \textbf{Amount (₹)} \\ \hline & \text{10% Convertible Debentures A/c Dr.} & 1,00,000 \\ & \hspace{10mm} \text{To Share Capital A/c} & 80,000 \\ & \hspace{10mm} \text{To Securities Premium A/c} & 20,000 \\ & \text{(Being 1,000 debentures converted into 8,000 equity shares of ₹10 each at ₹12.5)} & \\ \hline \end{array} $
DRR requirements might be different for convertible debentures compared to non-convertible ones, depending on regulations.