NCERT Solution: Issue and Redemption of Debentures- 1 | Accountancy Class 12 - Commerce PDF Download

Short Answer Questions

Q1: What is meant by a Debenture?
Ans: A debenture is a written certificate issued by a company that acknowledges a long-term borrowing. It contains a contract specifying the repayment of the principal after a fixed period and the payment of interest at stated intervals (commonly half-yearly). A debenture does not confer ownership rights like shares; it is a form of loan capital raised by the company to meet its long-term finance requirements.

Q2: What does a Bearer Debenture mean?
Ans: Bearer debentures are transferable instruments payable to whoever holds (possesses) the physical debenture certificate. The company does not record the names of holders in its register. Interest is claimed by presenting the attached interest coupons at the specified bank or paying office. Transfer takes place simply by delivery of the certificate.

Q3: State the meaning of 'Debentures issued as a Collateral Security'.
Ans: Collateral security means additional or secondary security given along with a primary security. When a company borrows from a bank or financial institution, it may issue debentures to the lender as collateral in addition to the primary security. These debentures do not carry interest for the lender while held as collateral. If the company defaults, the lender first realises the primary security; if that is insufficient, the collateral debentures may be realised to recover the remaining amount.

Q4: What is meant by 'Issue of debentures for Consideration other than Cash'?
Ans: When a company acquires an asset (for example, from a supplier) and instead of paying cash issues debentures as consideration, this is called issue of debentures for consideration other than cash. It defers cash outflow for the purchaser while giving the vendor a return in the form of interest. Debentures issued in this manner may be at par, at a premium, or at a discount.
Accounting treatment for Issue of Debentures for Consideration other than Cash 

Q5: What is meant by Issue of debenture at discount and redeemable at premium?
Ans: When debentures are issued at a price lower than their face (par) value but are later redeemed at a price higher than the face value, the situation is called issue at discount and redeemable at premium. The overall loss equals the redemption amount paid less the cash actually received on issue.
Example: A 10% debenture of Rs 1,000 is issued at 5% discount and is redeemed at 10% premium.

Total loss = Payment made at redemption - Amount received on issue of debenture
1,100 - 950 = Rs 150

Q6: What is 'Capital Reserve'?
Ans: Capital Reserve is a reserve created from capital profits - gains that arise from non-operating or non-recurring transactions rather than from normal business operations. Examples include premium on issue of shares or debentures, profit on sale of fixed assets, profit on reissue of forfeited shares and profit prior to incorporation. Capital reserve is not available for distribution as dividend; it is generally used to meet capital losses or to issue bonus shares.

Q7: What is meant by an 'Irredeemable Debenture'?
Ans: Irredeemable debentures (also called perpetual debentures) are debentures that have no fixed date of redemption and are repayable only on the company's winding up. They thus carry an indefinite life. In present practice in India, companies do not issue irredeemable debentures.

Q8: What is a 'Convertible Debenture'?
Ans: Convertible debentures are debentures that can be converted into equity shares after a specified period or on specified terms. They are of two kinds:
i. Fully Convertible Debentures - the entire principal amount is convertible into equity shares. No Debenture Redemption Reserve (DRR) is required for such debentures.
ii. Partly Convertible Debentures - only a part of the principal is convertible into shares; the non-convertible portion remains as debt and DRR is required only for that non-convertible part.

Q9: What is meant by 'Mortgaged Debentures'?
Ans: Mortgaged debentures are debentures secured by the company's assets. If debentures are secured against a specific asset the security is a fixed charge; if secured against all or fluctuating assets it is a floating charge. If the company defaults on interest or principal, debenture holders with security have the right to realise the secured assets to recover their dues.

Q10: What is discount on issue of debentures?
Ans: When debentures are issued at a price below their face value, they are said to be issued at discount. The difference between face value and issue price is a capital loss. As per Revised Schedule VI of the Companies Act, discount on issue of debentures is disclosed in the Notes to Accounts as follows:
1. Amount to be written off within 12 months of the balance sheet date - shown under Other Current Assets.
2. Amount to be written off after 12 months - shown under Other Non-Current Assets.

Q11: What is meant by 'Premium on Redemption of Debentures'?
Ans: When debentures are redeemed at a price higher than their face value they are redeemed at a premium. The difference between redemption price and face value is treated as a capital loss and is written off over time until redemption. In the balance sheet this premium on redemption is shown in the Notes to Accounts under Other Long-term Liabilities, and the final balance appears under Non-Current Liabilities on the Equity and Liabilities side.
Accounting Treatment for Premium on Redemption on Debentures:

Q12: How are debentures different from shares? Give two points.
Ans: 

Additional explanation:
- Nature: Shares represent ownership (equity) in the company; debentures represent a loan (debt).
- Returns: Shareholders may receive dividends depending on profits; debenture holders receive fixed interest irrespective of profits.

Q13: What is meant by redemption of debentures?
Ans: Redemption of debentures means repayment of the principal amount to debenture holders in accordance with the terms of issue. Redemption discharges the liability created by issue of debentures. Debentures may be redeemed at par, at premium, or at discount (though redemption at discount is rare). Redemption can be financed from profits, by fresh issues of debentures or shares, or from existing cash resources. Methods of redemption include:

1. In lump sum at maturity.
2. In instalments (sometimes by draw of lots at the end of each year).
3. By purchase in the open market when market price is below face value.
4. By conversion into equity shares or into new debentures.

Q14: Can the company purchase its own debentures?
Ans: Yes, a company may purchase its own debentures only if its Articles of Association authorise such purchase. Purchases from the open market are allowed under that authority. Main reasons for purchase are:
1. Immediate cancellation of high-cost debt when interest on existing debentures is above current market rates.
2. Investment motive - to buy at a low price and sell later at a profit.
The company may buy its own debentures either at a discount or at a premium for cancellation; the relevant journal entries are recorded accordingly.

Q15: What is meant by redemption of debentures by conversion?
Ans: Redemption by conversion occurs when debenture holders are given the option to convert their debentures into equity shares or into new debentures as per terms specified at issue. Because no cash payment is required for redemption in such conversion, no Debenture Redemption Reserve (DRR) is necessary. Shares or new debentures issued on conversion may be issued at par, premium, or discount. The issue price of shares on conversion should not exceed the amount originally received from the debentures.

Q16: How would you deal with 'Premium on Redemption of Debentures'?
Ans: When debentures are redeemed at a premium, the excess of redemption price over face value is treated as a capital loss and written off over the life of the debentures (or up to redemption). In financial statements the premium on redemption is disclosed in the Notes to Accounts under Other Long-term Liabilities, with the final amount appearing in Non-Current Liabilities on the Balance Sheet.
Accounting Treatment for Premium on Redemption on Debentures:

Q17: What is meant by redemption of debentures by 'Purchase in the Open Market?
Ans: Redemption by purchase in the open market means the company buys its own debentures from the market (subject to Articles of Association authorisation). Reasons include cancelling debt where the interest burden is high relative to market rates, or for investment profit. Purchased debentures may be cancelled; appropriate journal entries are passed depending on whether purchase was at discount or premium. This method gives flexibility to manage the company's debt cost.

Long Answer Questions

Q1: Explain the different types of debentures?
Ans: Debentures are instruments of long-term borrowing issued by companies. They are classified as follows.
1. On the Basis of Security
a. Secured (Mortgaged) Debentures - backed by specific assets of the company. If the company defaults, holders can realise the secured assets.
b. Unsecured Debentures - carry no security and holders rank as general creditors; these are less common.
2. On the Basis of Tenure
a. Redeemable Debentures - repayable after a specified period; redemption may be in lump sum or instalments and at par or premium.
b. Irredeemable (Perpetual) Debentures - have no fixed redemption date and are repayable only on winding up; nowadays these are generally not issued in India.
3. On the Basis of Mode of Redemption
a. Convertible Debentures - convertible into equity shares after a defined period:
  i. Fully Convertible - entire amount converts into shares (no DRR needed).
  ii. Partly Convertible - only part converts; DRR required for the non-convertible portion.
b. Non-Convertible Debentures - cannot be converted into shares; they remain as debt.
4. On the Basis of Coupon Rate
a. Zero Coupon Debentures - issued without periodic interest; issued at deep discount and redeemed at face value; the difference acts as implied interest.
b. Fixed (or Specific) Coupon Debentures - carry a specified fixed or floating interest rate.
5. On the Basis of Registration
a. Registered Debentures - the company records the names and addresses of holders in a register.
b. Bearer Debentures - transferable by delivery; interest is claimed by presenting coupons.
These classifications help companies and investors to understand rights, security, convertibility and repayment terms.

Q2: Distinguish between a debenture and a share. Why is debenture known as loan capital? Explain.
Ans:

Key distinguishing points include ownership vs. lending, return type, voting rights, and claim on assets. A debenture is termed loan capital because it represents borrowed funds repayable by the company after a stated period. Interest paid on debentures is an expense for the company and is deductible for tax purposes, and the obligation to pay interest and repay principal makes debentures resemble a loan rather than capital contributed by owners.

Q3: Describe the meaning of 'Debenture Issued as Collateral Securities'. What accounting treatment is given to the issue of debentures in the books of accounts?
Ans: The collateral issue of debentures is the practice of issuing debentures to a lender as an additional security over and above the primary security given for a loan. These debentures are not entitled to interest while held as collateral. If the borrower defaults, the lender realises the primary security first and may then realise the collateral debentures if needed to cover the outstanding debt.
Accounting Treatment:
There are two approaches to record debentures issued as collateral security:
1. No Journal Entry
- No accounting entry is passed because no immediate liability arises in cash terms. As per Revised Schedule VI, the fact and amount of debentures issued as collateral are disclosed in the Notes to Accounts under Long-Term Borrowings. The related loan amount received in cash appears in the Notes to Accounts for cash and cash equivalents. Example provided below illustrates disclosure.

2. By Making Entry
- Some companies record a memorandum or a Debentures Suspense Account entry to reflect that debentures have been issued as collateral. Journal entries on issue and relevant disclosures are then made; in the Notes to Accounts the debentures issued as collateral may be shown net of Debentures Suspense. This method recognises the obligation more explicitly in the company's books.

Q4: Explain the different terms for the issue of debentures with reference to their redemption.
Ans: The terms of issue and redemption can be combined as permutations of par, premium and discount. Common combinations are:
1. Issue at Par, Redeemable at Par.
2. Issue at Premium, Redeemable at Par.
3. Issue at Discount, Redeemable at Par.
4. Issue at Par, Redeemable at Premium.
5. Issue at Premium, Redeemable at Premium.
6. Issue at Discount, Redeemable at Premium.
For each situation appropriate journal entries are passed when debentures are issued and on redemption. Sample journal entries for these six cases are illustrated below.

1. Issue at Par and Redeemable at Par- 

2. Issue at Premium and Redeemable at Par-

3. Issue at Discount and Redeemable at Par-

4. Issue at Par and Redeemable at Premium-

5. Issued at Premium and Redemption at Premium-

6. Issue of Discount and Redemption at Premium-

Q6: Differentiate between redemption of debentures out of capital and out of profits.
Ans: Redemption Out of Capital
When debentures are redeemed using the company's capital without using profits, it is called redemption out of capital. Since this reduces the company's capital base, regulatory guidelines generally restrict or prevent full redemption from capital alone. Under SEBI and company law provisions it is usually not permissible to redeem all debentures purely out of capital; certain exemptions apply (see below). No transfer to Debenture Redemption Reserve (DRR) is made when redemption is wholly out of capital.
Redemption Out of Profits
When redemption is financed out of profits, the company first appropriates profits to create a Debenture Redemption Reserve (DRR) before redemption. SEBI guidelines require an amount equal to 50% of debentures issued to be transferred to DRR before starting redemption for debentures with maturity over 18 months. The DRR appears under Reserves and Surplus in the Notes to Accounts, and when debentures are finally redeemed the DRR balance may be transferred to General Reserve.

Q7: Explain the guidelines of SEBI for creating Debenture Redemption Reserve.
Ans: Main SEBI guidelines for Debenture Redemption Reserve (DRR):
1. DRR must be created for debentures having maturity of more than 18 months.
2. An amount equal to 50% of debentures issued should be transferred to DRR before starting redemption.
3. DRR applies only to Non-Convertible Debentures and to the non-convertible portion of partly convertible debentures.
4. Withdrawal from DRR is permitted only after at least 10% of the debentures have been redeemed.
Exemptions: infrastructure companies and companies issuing debentures with maturity up to 18 months are exempted from DRR creation.

Q8: Can a company purchase its own debentures in the open market? Explain.
Ans: Yes, provided the company's Articles of Association authorise such purchases. Purchase of its own debentures from the market may be done to cancel debt where the interest rate is unfavourable or for investment/profit motives. The company may buy at discount or premium; appropriate journal entries are passed depending on whether the purchase is for cancellation at discount or at premium.

2. If Debentures are Purchased at Premium for Cancellation

Q9: What is meant by conversion of debentures? Describe the method of such a conversion.
Ans: Conversion of debentures means exchanging debentures for equity shares (or new debentures) according to conversion terms set out at the time of issue. Because conversion requires no cash payment, there is no need to create a Debenture Redemption Reserve for amounts redeemed by conversion. If conversion is exercised, the share issue price must be equal to or less than the amount originally received against those debentures. The accounting entries record cancellation of the debenture liability and issue of shares or new debentures as applicable.