All questions of Unit 6: Redemption of Debentures for CA Foundation Exam

Explanation:

Capital Loss:
- Discount on issue of debentures represents a capital loss as it is a reduction in the value of the debentures issued by the company.

Writing off:
- This capital loss is written off over the tenure of the debentures because it is not a one-time expense but rather spread out over the period for which the debentures are outstanding.

Amortization:
- The process of writing off the discount on issue of debentures over the tenure of the debentures is known as amortization. It involves allocating a portion of the discount as an expense in each accounting period.

Matching Principle:
- This method of writing off the discount is in line with the matching principle of accounting, which requires expenses to be recognized in the same period as the revenue they help to generate.

Impact on Financial Statements:
- By spreading out the capital loss over the tenure of the debentures, the impact on the company's financial statements is more accurately reflected, as it shows the gradual reduction in the value of the debentures over time.
Therefore, the correct answer is option 'C', as the discount on issue of debentures is a capital loss to be written off over the tenure of the debentures.

• Debenture Redemption Fund Account: Profit on sale of debenture redemption fund investments in the first instance is credited to the Debenture Redemption Fund Account. This is because the purpose of the Debenture Redemption Fund is to ensure that there are enough funds available to redeem the debentures at maturity. Therefore, any profits made from the investments held in this fund are credited back to the fund itself.


• Profit and Loss Appropriation Account: The Profit and Loss Appropriation Account is used to allocate profits among various accounts such as reserves, dividends, etc. It is not directly related to the Debenture Redemption Fund investments.


• General Reserve Account: The General Reserve Account is used to set aside funds for general business purposes and is not specifically linked to the Debenture Redemption Fund investments.


• None of these: This option is incorrect as the profit on the sale of debenture redemption fund investments is credited to the Debenture Redemption Fund Account in the first instance.

Understanding Debenture Premium
A debenture premium arises when a company issues debentures at a price higher than their face value. This premium can be utilized for specific purposes, but there are restrictions on its use.
Why Dividends Cannot Be Paid from Debenture Premium
1. Nature of Premium:
- The debenture premium is considered a capital profit, not a revenue profit.
- It reflects the additional amount investors are willing to pay over the nominal value of the debentures, primarily due to the perceived creditworthiness of the company.
2. Legal Restrictions:
- According to company laws, debenture premiums are not classified as profits generated from business operations.
- Dividends, on the other hand, can only be paid out of profits earned by the company. Since debenture premiums do not fall under this category, they cannot be used for dividend distribution.
3. Financial Prudence:
- Using capital reserves for paying dividends is generally viewed as financially imprudent.
- It could lead to liquidity issues and may affect the company’s ability to meet its obligations, particularly if it relies on capital funds for operational liquidity.
Permissible Uses of Debenture Premium
Debenture premiums can be used for the following purposes:
- Write Off Discounts:
- They can be utilized to write off any discount on the issue of shares or debentures.
- Redemption Premiums:
- The premium can be applied to write off the premium on redemption of shares or debentures.
- Capital Losses:
- It may also be used to write off capital losses, ensuring that the company maintains its capital integrity.
In conclusion, while debenture premiums have specific applications, paying dividends is not one of them due to the nature of capital reserves and legal guidelines.

• Definition of Own Debentures: Own debentures are those debentures of the company which the company purchases from the market and keeps them as investments. This means that the company buys its own debentures as an investment option.


• Company Allotment: Own debentures are not allotted to promoters or directors. They are purchased from the market, which distinguishes them from debentures allotted to promoters or directors.


• Investment Purpose: Companies may choose to invest in their own debentures for various reasons, such as generating additional income through interest payments or holding them as part of their investment portfolio.


• Legal Considerations: Companies need to ensure that the purchase of their own debentures complies with legal regulations and does not violate any laws related to investments or corporate actions.

By following these guidelines, you can easily understand the concept of own debentures and how companies utilize them as part of their investment strategy.

• Excess value of Purchase consideration: This refers to the amount paid for a business over and above the net assets acquired.


• Crediting to Goodwill: The excess value is credited to Goodwill in the books of accounts.


• Goodwill: Goodwill represents the reputation, customer base, brand value, and other intangible assets of a business that are not separately identifiable.


• Classification: Goodwill is classified as a Capital Reserve as it is not available for distribution as dividends.


• Capital Reserve: Capital reserves are created out of capital profits and cannot be distributed as dividends to shareholders.

By crediting the excess value to Goodwill, the company recognizes the intangible value it has acquired through the purchase of the business. This helps in presenting a true and fair view of the financial position of the company to its stakeholders.

• Debentures Redemption Fund: This fund is created to redeem debentures when they are due.


• Transfer of Balance: When all the debentures are redeemed, the balance in the debentures redemption fund account is transferred to another account.


• General Reserve: The balance in the debentures redemption fund account is usually transferred to the general reserve.


• Capital Reserve: Sometimes, the balance may be transferred to the capital reserve if there is a specific provision for it.


• Profits and Loss Appropriation Account: In some cases, the balance may also be transferred to the profits and loss appropriation account.


• All of the Above: While all the options are possible, the most common practice is to transfer the balance to the general reserve.

• Profit and loss appropriation a/c: This account is used to distribute profits among shareholders. It is not the correct place to transfer profit on cancellation of own debentures.


• Debenture redemption reserve: This reserve is created to ensure that funds are available for the redemption of debentures. Profit on cancellation of own debentures is not transferred here.


• Capital reserve: Profit on cancellation of own debentures is transferred to capital reserve. Capital reserve is a reserve that is created from the profits earned by a company, but cannot be distributed as dividends.


• General reserve: General reserve is a reserve created out of profits of a company, which is not specifically earmarked for any particular purpose. It is not the correct place to transfer profit on cancellation of own debentures.

• Excess value of net assets: This refers to the situation where the total value of the net assets acquired in a business purchase exceeds the purchase consideration paid for those assets.


• Capital reserve: When there is excess value of net assets over purchase consideration, this amount is credited to capital reserve. Capital reserve is a type of reserve that is created out of capital profits and cannot be distributed as dividends to shareholders.


• General reserve: General reserve is created out of retained earnings or profits of the business and is used for various purposes like expansion, diversification, or meeting unexpected contingencies.


• Vendors' account: Vendors' account is used to record the amounts payable to the vendors from whom the assets were purchased.


• Goodwill: Goodwill represents the reputation, brand value, customer loyalty, etc. of a business that is not directly attributable to any specific asset and is recorded as an intangible asset on the balance sheet.

Therefore, in the given scenario, when there is an excess value of net assets over purchase consideration at the time of purchase of a business, it is credited to Capital reserve. This helps in maintaining transparency in the financial statements and ensures that the excess value is appropriately accounted for in the books of accounts.

• Transfer of balance: The balance of sinking fund investment account after the realisation of investments is transferred to the sinking fund account.

• Purpose of sinking fund: Sinking fund is created to ensure that funds are available for the repayment of debentures or other long-term liabilities when they become due.

• Realisation of investments: When the investments made from the sinking fund are realised, the resulting amount is transferred back to the sinking fund account.

• Utilisation of sinking fund: The sinking fund is used to ensure that the company has sufficient funds to meet its long-term financial obligations.

• Conclusion: Therefore, the correct answer is option C: Sinking fund account, as the balance of sinking fund investment account is transferred back to the sinking fund account after the realisation of investments.