NCERT Class 12 Accountancy Chapter 6 Issue and Redemption of Debentures

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NCERT Class 12 Accountancy Chapter 6 Issue and Redemption of Debentures

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Also, you can read the NCERT book online in these sections Solutions by Expert Teachers as per Central Board of Secondary Education (CBSE) Book guidelines. CBSE Class 12 Accountancy Solutions are part of All Subject Solutions. Here we have given NCERT Class 12 Accountancy Chapter 6 Issue and Redemption of Debenturesl Notes, NCERT Class 12 Accountancy Textbook Solutions for All Chapters, You can practice these here.

Chapter: 6

PART – II

Short Answer Questions: 

1. What is meant by a Debenture? 

Ans: The word ‘debenture’ has been derived from a Latin word ‘debere’ which means to borrow. Debenture is a written instrument acknowledging a debt under the common seal of the company. It contains a contract for repayment of principal after a specified period or at intervals or at the option of the company and for payment of interest at a fixed rate payable usually either half-yearly or yearly on fixed dates.

2. What does a Bearer Debenture mean?

Ans: Bearer debentures are the debentures which can be transferred by way of delivery and the company does not keep any record of the debentures Interest on debentures is paid to a person who produces the interest coupon attached to such debentures.

3. State the meaning of ‘Debentures issued as a collateral security’.

Ans: The lending institutions may insist on additional assets as collateral security so that the amount of loan can be realised in full with the help of collateral security in case the amount from the sale of principal security falls short of the loan money. In such a situation, the company may issue its own debentures to the lenders in addition to some other assets already pledged. Such an issue of debentures is known as ‘Debentures issued as Collateral Security’.

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4. What is meant by ‘Issue of debentures for consideration other than cash’?

Ans: Sometimes a company purchased assets from vendors and instead of making payment in cash issues debentures for consideration thereof. Such an issue of debentures is called debentures issued for consideration other than cash.

5. What is meant by Issue of debenture at discount and redeemable at premium?

Ans: When a debenture is issued at a price below its nominal value, it is said to be issued at a discount. For example, the issue of Rs. 100 debentures at Rs. 95, Rs. 5 being the amount of discount. The discount on issue of debentures can be written off either by debiting it to or out of Securities Premium Reserve, if any, during the lifetime of debentures. 

Debentures issued at par and redeemable at premium mean that the company will receive the total face value of the debentures and will refund the debenture with the premium at the time of redemption.

6. What is a ‘Capital Reserve’? 

Ans: A capital reserve is created from capital profit earned through sales of capital assets such as the sale of fixed assets, profit on the sale of shares. It can also serve as a cushion to absorb potential losses in the future. Capital reserves are never used to pay dividends to shareholders.

7. What is meant by an ‘Irredeemable Debenture’?

Ans: Irredeemable debentures are also known as Perpetual Debentures because the company does not give any undertaking for the repayment of money borrowed by issuing such debentures. These debentures are repayable on the winding-up of a company or on the expiry of a long period.

8. What is a ‘Convertible Debenture’? 

Ans: Shares cannot be converted into debentures whereas debentures can be converted into shares if the terms of issue so provide, and in that case these are known as convertible debentures.

9. What is meant by ‘Mortgaged Debentures’? 

Ans: Mortgage debenture are those which are secured against the fixed assets of the company. In such a case, a specific property is pledged as security. In case the company fails to pay back the principal amount of debenture or fails to meet its interest obligations on the due date.

10. What is discount on issue of debentures?

Ans: Discount or Loss on issue of debentures is a capital loss and is written-off in the year when debentures are issued. Discount or loss can be written-off from securities premium reserve [section 52(2)]. In case, capital profit do not exist or are inadequate, the amount should be written off against revenue profits of the year.

11. What is meant by ‘Premium on Redemption of Debentures’? 

Ans: Premium on redemption is a liability of a company payable in future. It is a provision and is shown under the head Non-current liabilities under subhead ‘Long-term Borrowings’ until debentures are redeemed.

12. How debentures are different from shares? Give two points. 

Ans: (i) Ownership: A ‘share’ represents ownership of the company whereas a debenture is only acknowledgement of Debt. A share is a part of the owned capital whereas a debenture is a part of borrowed capital. 

(ii) Repayment: Normally, the amount of shares is not returned during the life of the company, whereas, generally, the debentures are issued for a specified period and repayable on the expiry of that period.

13. What is meant by redemption of debentures? 

Ans: When a company issues debentures, it usually mentions the terms on which they will be redeemed on their maturity. Redemption of debentures means discharge of liability on account of debentures by repayment made to the debenture holders. Debentures can be redeemed either at par or at a premium.

14. Can the company purchase its own debentures?

Ans: Yes, A company may also purchase its own debentures with the motive of investment and sell them at higher price in future and thereby earn profit.

15. What is meant by redemption of debentures by conversion?

Ans: A company can redeem its debentures by converting them into shares or new class of debentures. If debentureholders find that the offer is beneficial to them, they can exercise their right of converting their debentures into shares or new class of debentures. These new shares or debentures can be issued at par, at a discount or at a premium. It should be noted that only the actual proceeds of debentures are to be taken into account for ascertaining the number of shares to be issued in lieu of the debentures to be converted. 

16. How would you deal with ‘Premium on Redemption of Debentures?

Ans: Premium on redemption of debentures is shown under liabilities side of the Balance Sheet, so, it is a personal account.

17. What is meant by redemption of debentures by “Purchase in Open Market”?

Ans: When a company purchases its own debentures for the purposes of cancellation, such an act of purchasing and cancelling the debentures constitutes redemption of debentures by purchase in the open market.

Long Answer Questions

1. Explain the different types of debentures?

Ans: A company may issue different kinds of debentures which can be classified as under:

(i) From the Point of view of Security:

(a) Secured Debentures: Secured debentures refer to those debentures where a charge is created on the assets of the company for the purpose of payment in case of default. The charge may be fixed or floating. A fixed charge is created on a specific asset whereas a floating charge is on the general assets of the company. The fixed charge is created against those assets which are held by a company for use in operations not meant for sale whereas floating charge involves all assets excluding those assigned to the secured creditors.

(b) Unsecured Debentures: Unsecured debentures do not have a specific charge on the assets of the company. However, a floating charge may be created on these debentures by default. Normally, these kinds of debentures are not issued.

(ii) From the Point of view of Tenure:

(a) Redeemable Debentures: Redeemable debentures are those which are payable on the expiry of the specific period either in lump sum or in Instalments during the life time of the company. Debentures can be redeemed either at par or at premium. 

(b) Irredeemable Debentures: Irredeemable debentures are also known as Perpetual Debentures because the company does not give any undertaking for the repayment of money borrowed by issuing such debentures. These debentures are repayable on the winding-up of a company or on the expiry of a long period.

(iii) From the Point of view of Convertibility:

(a) Convertible Debentures: Debentures which are convertible into equity shares or in any other security either at the option of the company or the debentureholders are called convertible debentures. These debentures are either fully convertible or partly convertible. 

(b) Non-Convertible Debentures: The debentures which cannot be converted into shares or in any other securities are called nonconvertible debentures. Most debentures issued by companies fall in this category.

(iv) From Coupon Rate Point of view:

(a) Specific Coupon Rate Debentures: These debentures are issued with a specified rate of interest, which is called the coupon rate. The specified rate may either be fixed or floating. The floating interest rate is usually tagged with the bank rate. 

(b) Zero Coupon Rate Debentures: These debentures do not carry a specific rate of interest. In order to compensate the investors, such debentures are issued at substantial discount and the difference between the nominal value and the issue price is treated as the amount of interest related to the duration of the debentures.

(v) From the view Point of Registration: 

(a) Registered Debentures: Registered debentures are those debentures in respect of which all details including names, addresses and particulars of holding of the debentureholders are entered in a register kept by the company. Such debentures can be transferred only by executing a regular transfer deed. 

(b) Bearer Debentures: Bearer debentures are the debentures which can be transferred by way of delivery and the company does not keep any record of the debentures Interest on debentures is paid to a person who produces the interest coupon attached to such debentures.

2. Distinguish between a debenture and a share. Why debenture is known as loan capital? Explain. 

Ans:

BasisDebentureShare
Ownershipwhereas a debenture is only acknowledgement of Debt. whereas a debenture is a part of borrowed capital.A ‘share’ represents ownership of the company.A share is a part of the owned capital.
ReturnWhile the return on debentures is called interest. The rate of interest on debentures is prefixed. The payment of dividend is an appropriation of profits.The return on shares is known as dividend. The rate of return on shares may vary from year to year depending upon the profits of the company.
Repaymentwhereas, generally, the debentures are issued for a specified period and repayable on the expiry of that period.Normally, the amount of shares is not returned during the life of the company.
Voting Rightswhereas debentureholders do not normally enjoy any voting right.Shareholders enjoy voting rights.
SecurityWhereas the debentures are generally secured and carry a fixed or floating charge over the assets of the company.Shares are not secured by any charge.
Convertibilitywhereas debentures can be converted into shares.Shares cannot be converted into debentures.

3. 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 procedure for the issue of debentures is the same as that for the issue of shares. The intending investors apply for debentures on the basis of the prospectus issued by the company. The company may either ask for the entire amount to be paid on application or by means of instalments on application, on allotment and on various calls. Debentures can be issued at par, at a premium or at a discount. They can also be issued for consideration other than cash or as a collateral security.

Depending upon the terms and conditions of issue and redemption of debentures, the following six situations are commonly found in practice. 

(i) Issued at par and redeemable at par.

(a) Bank A/c Dr. 

To Debenture Application & Allotment A/c 

(Receipt of application money) 

(b) Debenture Application & Allotment A/c Dr. 

To Debentures A/c

(ii) Issued at discount and redeemable at par.

(a) Bank A/c Dr. 

To Debenture Application & Allotment A/c 

(Receipt of application money) 

(b) Debenture Application & Allotment A/c Dr. 

Discount on Issue of Debentures A/c Dr. 

To Debentures A/c 

(Allotment of debentures at a discount)

(iii) Issued at a premium and redeemable at par.

(a) Bank A/c Dr. 

To Debenture Application & Allotment A/c 

(Receipt of application money) 

(b) Debenture Application & Allotment A/c Dr. 

To Debentures A/c 

To Securities Premium Reserve A/c 

(Allotment of debentures at a premium) 

(iv) Issued at par and redeemable at a premium. 

(a) Bank A/c Dr. 

To Debenture Application & Allotment A/c 

(Receipt of application money)

(v) Issued at a discount and redeemable at a premium.

Bank A/c Dr. 

To Debenture Application & Allotment A/c 

(Receipt of application money)

(vi) Issued at a premium and redeemable at a premium.

Bank A/c Dr. 

To Debenture Application & Allotment A/c 

(Receipt of application money)

4. Explain the different terms for the issue of debentures with reference to their redemption. 

Ans: When a company issues debentures, it usually mentions the terms on which they will be redeemed on their maturity. Redemption of debentures means discharge of liability on account of debentures by repayment made to the debenture holders. Debentures can be redeemed either at par or at a premium. Depending upon the terms and conditions of issue and redemption of debentures, the following six situations are commonly found in practice. 

(i) Issue at par and redeemable at par: 

(a) Bank A/c Dr. 

To Debenture Application & Allotment A/c 

(Receipt of application money) 

(b) Debenture Application & Allotment A/c Dr. 

To Debentures A/c 

(Allotment of debentures) 

(ii) Issue at a discount and redeemable at par: 

(a) Bank A/c Dr. 

To Debenture Application & Allotment A/c 

(Receipt of application money) 

(b) Debenture Application & Allotment A/c Dr. 

Discount on Issue of Debentures A/c Dr. 

To Debentures A/c 

(Allotment of debentures at a discount) 

(iii) Issue at premium and redemption at par:

(a) Bank A/c Dr. 

To Debenture Application & Allotment A/c 

(Receipt of application money) 

(b) Debenture Application & Allotment A/c Dr. 

To Debentures A/c 

To Securities Premium Reserve A/c 

(Allotment of debentures at a premium) 

(iv) Issue at par and redeemable at premium:

(a) Bank A/c Dr. 

To Debenture Application & Allotment A/c 

(Receipt of application money) 

(b) Debenture Application & Allotment A/c Dr. 

Loss on Issue of Debentures A/c Dr. 

(with premium on redemption) 

To Debentures A/c 

(with nominal value of debenture) 

To Premium on Redemption of Debenture A/c

(Allotment of debentures at par and redeemable at a premium)

(v) Issue at discount and redemption at premium: 

Bank A/c Dr. 

To Debenture Application & Allotment A/c 

(Receipt of application money) 

Debenture Application & Allotment A/c Dr. 

Loss on Issue of Debentures A/c Dr. 

(with discount on issue plus premium on redemption) 

To Debentures A/c 

(with nominal value of debenture) 

To Premium on Redemption of Debentures A/c

(Allotment of debentures at a discount and redeemable at premium) 

(vi) Issued at a premium and redeemable at premium: 

Bank A/c Dr. 

To Debenture Application & Allotment A/c 

(Receipt of application money) 

Debenture Application & Allotment A/c 

Dr. Loss on Issue of Debentures A/c Dr. 

(with premium on redemption) 

To Debentures A/c 

(with nominal value of debenture) 

To Securities Premium Reserve A/c 

(with premium on issue) 

To Premium on Redemption of Debentures A/c

(with premium on redemption) 

5. Differentiate between redemption of debentures out of capital and out of profits. 

Ans:

BasisRedemption out of capitalRedemption out of profits
MeaningWhen debentures are redeemed out of capital and no profits are utilised for redemption, then such redemption is termed as redemption out of capital.As transfer of amount (profits) to the DRR Profit and Loss Appropriation Account reduces the amount of profit available for distribution of dividend, so this redemption process is known as redemption out of profit.
DividendIt is called redemption out of profits because the transfer of profit to Debenture Redemption Reserve (DRR) reduces the amount of profit available for dividends.Preference shares can be redeemed either out of profits of the company that would otherwise be available for dividends, or out of the proceeds of a fresh issue of shares made for redemption.
Reduction of capitalIt is result in reduction of the company’s capital as the result the funds that could not used for other business activities are used to pay off debentures.The company uses its current profit which indicates a healthy financial position for company.
ApprovalIt often requires approvals and compliance with legal provisions.Approval not necessary.
Legal requirementsMany laws may restrict the redemption of debentures out of capital to protect creditors.Legal requirements typically involves in transferring amount of profits to a debenture redemption reserve redemption.

6. Explain the guidelines of SEBI for creating Debenture Redemption Reserve. 

Ans: The guidelines of SEBI for creating debenture redemption reserve are as follows:

(i) Applicability: Companies issuing debentures must create a Debenture Redemption Reserve to protect the interests of investors against the risk of default. If a reserve is not created within 12 months of issuing the debentures, the company is liable to pay a 2% interest penalty to debenture holders.

(ii) Amount to be Created: Company shall create DRR equivalent to 50% of the amount of debenture issue before debenture redemption commences. Drawl from DRR is permissible only after 10% of the debenture liability has actually been redeemed by the company.

(iii) Subscriptions: The minimum subscription for a public issue shall not be less than 75% percent of the base issue size or as may be specified by SEBI.

(iv) Investment of DRR: Debenture Redemption Reserve (DRR) is a fund maintained by companies that have issued debentures. Its purpose is to minimise the risk of default on repayment of debentures. The DRR ensures availability of funds for meeting obligations towards debenture-holders.

(v) A company shall create Debenture Redemption Reserve equivalent to at least 50% of the amount of debenture issue before starting the redemption of debenture.

(vi) Development of Securities Market: SEBI actively promotes the development of the securities market by creating a conducive environment for its growth. This involves setting policies and regulations that encourage participation and investment in the market.

7. Describe the steps for creating a Sinking Fund for redemption of debentures.  

Ans: It should be noted that only the actual proceeds of debentures are to be taken into account for ascertaining the number of shares to be issued in lieu of the debentures to be converted. If debentures were originally issued at discount, the actual amount realised from them at the time of issue would be used as the basis for computing the actual number of shares to be issued. It may be noted that this method is applicable only to convertible debentures. 

The following factors should be taken into consideration by the company at the time of redemption of debentures: 

(i) Time of redemption of debentures: Generally, debentures are redeemed on due date but a company may redeem its debentures before maturity date, if its articles provides for such. 

(ii) Sources of Redemption of debentures: A company may source its redemption of debentures either out of capital or out of profits. 

As per the Act, all India financial institutions registered by Reserve Bank of India, banking companies, NFBCs registered with Reserve bank of India, Housing Finance companies registered to the National Housing bank and the companies listed on stock exchange and unlisted companies are exempted from creating Debenture Redemption Reserve and may redeem debentures out of capital. Whereas for “other unlisted companies”, the adequacy of Debenture Redemption Reserve shall be ten percent of the value of the outstanding debentures.

8. Can a company purchase its own debentures in the open market? Explain. 

Ans: When a company purchases its own debentures in the open market for the purpose of immediate cancellation, the purchase and cancellation of such debentures are termed as redemption by purchase in the open market. The advantage of such an option is that a company can redeem the debentures at its convenience whenever it has surplus funds. Secondly, the company can purchase them when they are available in market at a discount. A company may also purchase its own debentures with the motive of investment and sell them at higher price in future and thereby earn profit.

9. What is meant by conversion of debentures? Describe the method of such a conversion. 

Ans: A convertible debenture is a type of long-term debt issued by a company that can be converted into shares of equity stock after a specified period. A company can redeem its debentures by converting them into shares or a new class of debentures. If debentureholders find that the offer is beneficial to them, they can exercise their right of converting their debentures into shares or new class of debentures. Convertible debentures are usually unsecured bonds or loans, often with no underlying collateral backing up the debt.

However companies are required to invest or deposit a sum on or before April 30 which shall not be less than 15% of the amount of debentures maturing during the year ending on March 31 of the next year in anyone or more methods of investments or deposits given below: 

(i) Deposit with any scheduled bank, free from any charge or line.

(ii) Securities of the Central Government or of any State Government.

(iii) Securities mentioned in sub clauses (a) to (d) and (ee) of section 20 of the Indian Trusts Act, 1982. 

(iv) Bonds issued by any other company which is notified under sub clause (f) of section 20 of the Indian Trusts Act, 1982.

(v) The amount invested or deposited as above shall not be used for any purpose other than for redemption of debentures maturing during the year.

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