UNIT III

Redemption of Debentures

3.1   Redemption of Debentures

Repayment of debt securities

The Companies Act of 1956 does not lay down strict guidelines or conditions for the repayment of bonds. Regardless of this, this debt instrument is redeemable without exception and the process is normally carried out in accordance with the conditions specified in a prospectus formulated during the issuance.

As a rule, such conditions must be in accordance with the issuing company. Nevertheless, in order to successfully execute it, investors need to obtain more information and should not limit it to the repayment of bonds. 

It follows an in-depth look into this concept that can help shed light on how debt securities are redeemed.

What is the repayment of bonds?

Typically, it can be described as the process of repaying bonds issued by an entity to its debtors. In other words, it is the process of repaying the principal amount to debtors.

It is a remarkable transaction for most companies as the amount required for repayment is quite substantial. 

As soon as bonds are redeemed, the issuing company unloads its share of liability and takes it off the balance sheet. As a result, companies build up a robust provision from their profits and accumulate capital for the recovery of bonds.

As a rule, the repayment terms are specified in the promissory note certificate. In particular, the approach behind the repayment of bonds can be understood by looking at these following notes –

• Bonds can be redeemed at either premium or par.
• Repayment means- repayment of the number of bonds to debtors.
• All Redemption conditions are listed in the prospectus of a company that initiates an invitation to issue bonds.

Methods of repayment of debt securities

Different companies may choose different methods of repayment of bonds. These following are some popular ways to do this:

1.  Lump sum payment to a preceding date

This unique method is considered one of the simplest redemption options. According to this method, debtors receive the promised sum on the preceding date.

If the bonds are not redeemed with a discount or premium, the lump sum, calculated by the sum of the net present value of all bonds, will be paid on the pre-specified or maturity date specified in the bond agreement. The issuing company may decide to pay off the amount of the bond before its due date. Since companies know in advance when to pay for the bond, they are better positioned to streamline it.

The accounting treatment of the repayment of debt securities in this method is specified below

2.     Payment in annual rate

This method is considered to be similar to the redemption process of a temporary loan. According to this method, companies pay a portion of the capital of a bond to the holders each year until their due date. Total liability is divided by the number of investment years and the result is paid out each year.

3.     Debenture redemption reserve

This is also called a sinking fund. Essentially, it is a reserve that is built up by accumulating at least 25% of the face value of the bond each year until maturity. The main objective of this reserve is to protect the interests of debtors. Under the Indian Companies Act of 1956, companies issuing bonds are required to form this reserve before the maturity date of a particular bond.

4.     Call and put option

Some companies issue bonds with both calls and put options for repayment. Typically, the call option allows companies to purchase their bonds either before or on the maturity date at a predetermined price. The put option, on the other hand, allows debtors to claim the right to sell the bond back to the company either before or on the due date at an agreed price.

5.     Conversion into shares

This particular method is directed against convertible bonds. Such bonds include a clause allowing holders to convert their shares into common shares of the company. It is at this point of conversion that the entire liability of debt securities is discharged.

6.     You buy from the open market

Companies can also buy bonds from an open market if their shares are traded on a regulated exchange. It saves you the effort of being subject to administrative documents. In addition, bonds are often traded at a discount on the market. In turn, it allows individuals to lower the payout and helps retain more revenue.

Regardless of this, investors and issuers must weigh the advantages and disadvantages of their repayment in the prevailing market condition before repaying bonds. In addition, one should be clear about their purpose of repayment of these debt securities and research in detail about their prospects.

3.2 Introduction : Provisions of Section 71 (1) and (4) of the Companies Act,2013

Meaning

Debenture is the most important instrument and method for increasing the company's loan capital. A bond is such as a loan certificate or loan bond that demonstrates the fact that the company has to pay a certain amount with interest and although the money raised from the bonds becomes part of the company's capital structure, it does not become share capital.

Section 2 (30) of the businesses Act, 2013 defines inclusive debenture as "debenture" includes debentures, bonds or other instruments of a corporation that establish a debt, whether or not it is a burden on the company's assets.

The authority to issue bonds may be exercised on behalf of the company as a Board Meeting pursuant to Section 179 (3) of the Companies Act 2013. Further, Section 71 of the Companies Act, 2013 deals with the provisions relating to the issue of bonds, together with the penalties for non-compliance with them, which may be summarized as follows:

1. A company may issue bonds with the option to convert all or part of these bonds into shares at the time of redemption. Provided that the issue of bonds with the option to convert these bonds into shares is approved by a special resolution of the shareholders at a duly convened annual general meeting of the company.
2. Companies may issue secured and unsecured bonds. Secured bonds may be issued by an entity under the prescribed conditions. The company cannot issue bonds that do not protect voting rights.
3. The company creates a debenture repayment reserve account from the profits of the company available for the payment of the dividend, and the amount credited to this account is not used by the company with the exception of the repayment of debentures.
4. The company may not issue a prospectus or make an offer or invitation to the public or its members for more than five hundred to subscribe for its bonds unless it has appointed one or more bond trustees prior to such issue or offer.
5. A debt trustee shall take measures to protect the interests of debtors and remedy their complaints in accordance with the rules that may be prescribed.
6. Any provision contained in a trust deed to secure the issuance of bonds, or in a contract with debtors secured by a trust deed, shall be void to the extent that it would result in a trustee being exempted from it, or exempting him from liability for breaches of trust, unless he demonstrates the degree of care and duty of care required of him as a trustee, taking into account the provisions of the trust deed that confer upon him power, authority or discretion; Provided that the liability of the debtor trustee is subject to the exceptions that may be agreed upon by the majority of debtors holding at least three-quarters of the total debt securities in a meeting held for this purpose.
7. A company pays interest and redeems the bonds in accordance with the terms of its issue.
8. If, at any time, the debt trustee concludes that the company's assets are insufficient or likely not to be sufficient to pay the principal when it becomes due, the debt trustee may file an application with the court, and the court, after hearing the company and any other person interested in the matter, May, by order, impose such restrictions on the formation of further liabilities of the company that the court deems necessary in the interest of the debtors.
9. If a company does not redeem the bonds on the due date or does not pay the interest on the bonds on the due date, the court May, at the request of one or all debtors or debt trustees and after hearing the parties concerned, request the company to redeem the bonds immediately against payment of the capital and interest due thereon.
10. If a default is made in accordance with the order of the court under this Section, any officer of the company who is in default will be punished with a custodial sentence for a term that may extend up to three years or with a fine not less than two lakh rupees, but which may extend up to five lakh rupees, or with both.
11. A contract with the company to receive and pay bonds of the company may be enforced by a decree for certain services.
12. And finally, the central government may prescribe the procedure for securing the issuance of bonds, the form of the promissory note, the procedure for debtor holders to examine the trust deed and obtain copies of it, the necessary reserves for the repayment of bonds and such other matters.

(Share Capital and Debentures) Rules, 2014 ("2014 Rules"), which prescribes certain conditions to be met by a corporation for issuing secured bonds, provides " rule 18 of the businesses "

The company may not issue secured bonds unless it meets the following conditions, namely:-

• Secured bonds may be issued provided that the date of their repayment does not exceed ten years from the date of issue. Provided that a company setting up infrastructure projects can issue secured bonds for a period of more than ten but not more than thirty years;
• Such issuance of debt securities is secured by the creation of a levy on the company's real estate or assets with a value sufficient for the repayment of the amount of the debt securities and interest due;
• the Company shall appoint a debt trustee prior to the issue of the prospectus or the letter of offer to subscribe to its bonds and shall issue a debt deed to protect the interests of the debtors no later than sixty days after the bonds have been allotted; and
• the security for the Bonds by a levy or mortgage will be paid to the debtor trustee on-

• any specific movable property of the company (not in the nature of pledge); or
• any specific property, wherever situate, or have an interest in it.

PROCEDURE FOR ISSUING BONDS UNDER THE COMPANIES ACT, 2013

[Applicable provisions: articles 56, 72 of the businesses Act, 2013 pursuant to rules 18 and 19 of the businesses Rules (share capital and bonds), 2014]:

1. Call and hold a board meeting and decide which types of bond are issued by the company.
2. If the company decides to issue secured bonds, the company must comply with the conditions set out in Rule 18 of the companies (Share Capital & Debentures) Rules, 2014.
3. In the case of the appointment of a debt trustee, approval is obtained from a Sebi-registered debt trustee, who is proposed to be appointed. If bonds to be issued are collateralized bonds, a bond certificate in form no. SH-12 or as close as possible shall be executed by the company for the benefit of Debenture Trustees within sixty days of the allocation of Debentures.
4. Resolutions adopted at the board meeting for

a)     approval of the offer letter for the private placement in form no. PAS-4 and application forms (in the case of private placement of bonds)

b)    Debenture Trustee Agreement and appointment of a Debenture Trustee (in the case of secured bonds only) should be approved ;

c)     appointment of an expert for valuation (in the case of private placement of bonds);

d)    to approve the increase in lending powers, if necessary;

e)     to approve the preparation of fees for the assets of the company;

f)       to approve the promissory note agreement;

g)    to set the date, date and time for the Extraordinary General Meeting of shareholders.

5.     Draft of the following should be prepared 

1. Agreement of Debenture Subscription;
2.  the private placement should provide the  offer letter  in form PAS-4 and application forms;
3. records of a private placement offer in form PAS-5;
4. Debenture Trustee Agreement;
5.  mortgage agreement to prepare fees for the company's assets.

6.     Issue notices of the extraordinary general meeting together with the statement of reasons.

7.     Hold an extraordinary general meeting and adopt a special resolution to issue convertible bonds and to increase the company's borrowing and to authorize the executive board to incur a charge on the company's assets.

8.     File Form No. PAS-4 and PAS-5 in the form not. Transmit GNL – 2 with the Registrar of Companies.

9.     File offer letter in form no. MGT-14 with the Registrar of companies.

3.3 Creation and investment of DRR including The Companies (Share Capital and Debentures) Rules 2014,

Issue of debt securities [under Section 71 &  company rules rule 18   (share    capital & debt securities), 2014]

The bonds issued by an entity are a confirmation that the entity has borrowed an amount of money from the public that it promises to repay at a later date. Debtors are therefore creditors of the company. A bond does not carry voting rights, financing by it does not dilute shareholder control over management. The issue of bonds is appropriate in the situation where sales and earnings are relatively stable.

The majority of the bonds come with a fixed interest rate and these interest must be paid before dividends are paid to shareholders. In the US, most debt securities are unsecured, but elsewhere debt securities are usually secured by the borrower's assets.When we talk about the classification of debt securities in terms of their repayment modes, the same can be divided into two modes:

• Convertible bonds - these can be converted into corporate holdings and this option is in the hands of the holder of the bonds.
• Non-convertible debentures - non-convertible debentures have no option to convert into shares and will be repaid after the specified period(s). They are usually listed on the stock exchanges and any investor with a demat account can invest in them. Furthermore, the NCD can be classified into secured and unsecured.

Now the governing sections and rules prescribed in the Companies Act 2013 must be taken into account when issuing bonds,:

• Section 2 (30)
• Section 71
• Section 179(3)
• Section 180, Paragraph 1, Letter C)

Through these articles we will discuss the detailed process for issuing bonds and the same can be completed as follows:

1. Convene and hold a Board meeting and this Board meeting:

Determine the type of bond to be issued after the debt securities have been resolved.The draft offer letter should be accepted to be placed privately in the form no PAS 4 in the debentures subscription agreement

A draft offer for a private placement should also be approved for form no. PAS 5

The appointment of the trustee for the bond should also be resolved if the bond is secured in nature

The executive board should be authorized to invest the burden on the company's assets in the form of CHG-9 in respect of secured bonds.

Open a separate bank account to receive subscription money to continue issuing CCDs.

The Extraordinary General Meeting of shareholders should be dealt with in accordance with Section 180(1) (C) if the borrowing of the board of Directors is increased.Notice of the extraordinary general meeting together with the reasons

Pursuant to Section 42, the board of directors should be authorized to open a separate account for the proposed issue.

2.     Call The Extraordinary General Meeting

To examine and approve the increase of the Executive Board mandates with a special resolution. MGT-14 must be submitted within 30 days from the date of adoption of a special decision.Letter of approval to be sent to shareholders

The application format attached to the offer letter should be used by the applicant to request the allocation of securities by paying the application fee.

Decision on the allocation of CCDs

The offer letter should be submitted to ROC by completing Form PAS-4 and PAS-5 as an attachment together with GNL-2.Approval for the submission of form PAS-3

Approval for submission of the form FC-GPR in the case of a foreign subscriber is involved.

3.     The Board meeting should be convened, to approve the following ;

Pursuant to Section 42(6), bonds should be issued within 60 days of the date of receipt of the funds. CHG-9 should be filed within 30 days from the date of special settlement (if the company has issued secured debentures)

Return to the allotment for the PAS to be submitted 3 within thirty days from the date of allotment with list of allottees, board resolution for allotment, evaluation report, copy of special resolution passed.

Debenture trust deed draft will be approved at Secured Debentures. (if the company has issued secured bonds).Debenture certificate to be issued.

4.     Items of note in the appointment of Debenture Trustee or Trustees (if the company has not issued secured debentures).

Debenture trustees must be appointed before the issue of the letter, but not later than 60 days after the allotment. Debenture trustee should obtain Written consent

5.     A trust deed in form no SH. 12 or as close as possible shall be executed by the company issuing bonds in favour of the bond trustees within three months of the closing of the issue or offer (if the company has issued secured bonds).

6.     the company must comply with the Debenture Redemption Reserve (DRR) requirements and the investment or deposit of the amount in respect of debt securities maturing during the year ended December 31, 2018.

7.     Reserve for debt securities is formed from profits of the company that are available for the distribution of the dividend;

For unlisted companies with the exception of all Indian financial institutions and banking companies, the adequacy of the redemption reserve for debt securities is ten percent of the value of the outstanding debt securities.

NOTE: RULE 18 APPLIES ONLY TO SECURED BONDS

IN SHORT, THE PROVISIONS BELOW MUST BE COMPLIED WITH IN THE EVENT OF ISSUANCE OF BONDS:

• Call for Board meeting
•  letter in form of  PAS-4 Draft offer (letter for private placement)
• Creation of the PAS-5 form (recording of a private placement)
• the registered valuer prepared the valuation report

Changes to company rules (share capital and debt securities), 2014 22. August 2019

On August 16, 2019, the Ministry of Corporate Affairs ("MCA") notified companies (share capital and debt securities) Amendment Rules, 2019 ("the amended rules") to make certain changes to the Companies (share capital and debt securities) Rules, 2014 ("the existing rules") in respect of shares with different voting rights, issuance of ESOPs by start-up companies and maintenance of Debenture Redemption Reserves ("DRR") by several classes of companies.

The most important highlights of the report [1] are summarised below.

Amendment of Rule 4-shares with different rights:

• The existing rules allow the issue of shares with different rights on condition that the shares with different rights may not exceed 26% of the total equity of the company paid out after the issue at any time. This upper limit will now be changed to 74% of the total voting rights, including voting rights for shares with different rights, at any time.
• In addition, under the amended rules, the requirement of a track record of distributable profits over the past three years for the issue of shares with different rights has been abolished.

Amendment of Rule 5-Certificate of shares (if shares are not in DEMAT form):

Under the existing rules, the directors were allowed to sign a share certificate by various means, such as facsimile signature, etc. However, according to the amended rules, the secretary of the company is also permitted to sign the share certificate in a similar manner.

   Change of Rule 12 - issue of Employee Stock Options:

• According to the existing rules, the start-up companies were allowed to issue ESOPs to "employees", as mentioned below, up to the period of "five years" from the date of their establishment or registration:
• An individual  belonging to the group of  promoter, or A promoter
• A director who directly or indirectly holds more than ten percent of the outstanding shares of the company, either himself or through his relative or through a corporation.
• Under the revised rules, start-up companies may issue ESOPs to such employees for a period of "ten years" from the date of their establishment or registration.

The definition of start-up companies has also been expanded to include the following:

• A company that is a private company or registered partnership company or registered Limited Partnership Company for a period of up to ten years from its formation / registration; and
• With a turnover of up to INR 100 crores for each of the financial years since the establishment / registration ; and
• Company works towards innovation, development or improvement of products or processes or services or when it is a scalable business model with a high potential to create jobs or wealth.
• Provided that a company formed by splitting or reconstructing an existing company is not considered a "start-up".

   Amendment to rule 18-debt securities:

   According to the amended rules, the requirement to create DRR by certain business classes has been abolished. The summary of the changes in the DRR provisions and the comparison of the changed rules with the existing rules are given in the table under:

• Sr. Nr.
• Class of companies
• According to the existing rules
• According to the amended rules

1. All Indian financial institutions regulated by the Reserve Bank of India (RBI) and banking companies

• Public Issue:

• No disaster preparedness required

• Private Problem:

• No disaster preparedness required

• DRR provisions as provided in the existing rules 

2.     Other Financial Institutions According To § 2 (72) Companies Act, 2013

•            DRR provisions apply to NBFCs registered with the RBI
•            DRR provisions as provided in the existing rules

3.     For listed companies (with the exception of all Indian financial institutions and banking companies, as stated in serial number 1 Above)

a)     All listed NBFCs and listed HFCs

• Public Issue:DRR amounted to 25% of the value of the outstanding bonds issued by public issue

• Private Problem:No disaster preparedness required

• Public Issue:No disaster preparedness required

b)    Other listed companies

• Public Issue:DRR amounted to 25% of the value of the outstanding bonds

• Private Problem:DRR amounted to 25% of the value of the outstanding bonds

• Public Issue:No disaster preparedness required

• Private Problem:No disaster preparedness required

4.     For unlisted companies (excluding all Indian financial institutions and banking companies as per serial number 1 Above))

a)     All listed NBFCs and Unlisted HFCs

• Public issue [according to Sebi (issuance and listing of debt securities) Regulations, 2008]:
• DRR amounted to 25% of the value of the outstanding bonds

b)    Other unlisted companies

• Public issue [according to Sebi (issuance and listing of debt securities) Regulations, 2008]:
• DRR amounted to 25% of the value of the outstanding bonds

• Private Problem:

• DRR amounted to 25% of the value of the outstanding bonds
• DRR is 10% of the value of the outstanding bonds

In addition, each company required to establish a DRR had to invest or deposit, in accordance with applicable rules, at least 15% of the amount of its debt securities maturing during the year ending March 31 of the following year in a separate fund recognised as a Debenture Reserve Fund ("DRF") on or before April 30 of each year.

However, under the revised rules, only certain types of companies need to invest or deposit this amount. The list of such companies that need to invest in DRF is as  follows:

1. All listed NBFCs registered with the Reserve Bank of India;
2. All listed HFCs registered with the National Housing Board;
3. All other listed companies (except all Indian financial institutions, banking companies and other financial institutions) and
4. All unlisted companies that are not NBFCs and HFCs

   BDO comments:

The amended rules have provided the necessary clarity on the limitation of voting

rights up to which a company can issue shares with different voting rights.

In addition, the change has expanded not only the types of companies that now

qualify for the start-ups category, but also a relaxation for such start-ups by

increasing the sales limit and the period of years up to which they can be considered as start-ups.

The amendment also abolished the requirement to create DRR for listed companies

and also lowered the DRR threshold for unlisted companies. On the other hand, the

amended rules make it mandatory for listed companies to invest in DRF, although

DRR is not applicable to them. In addition, it would have been helpful if clarity had

been provided regarding the DRR requirements for unlisted NBFCs and unlisted

HFCs in the case of public debt issuance.

The amendments contained in the application shall enter into force from 16 June

2018.

3.4 The methods of writing-off discount/loss on issue of debentures; Terms of issue of debentures

Meaning of depreciation discount

The loss or discount on the issuance of debt securities is usually a capital loss or a notional asset and must therefore be written off during the term of the debt securities. The amount of the loss or discount on the issuance of debt securities shall not be written off in the year of issue, as the benefit of the debt securities would accumulate with the company until they are repaid or repaid.

The loss or discount, therefore considered as a capital loss. The discount can either be charged to Securities Premium A/c or written off over three to five years through the income statement in accordance with guidelines published by ICAI (the Institute of Chartered Accountants of India).

If there are no capital gains or if the capital gains are not sufficient, the amount of such a loss or discount can be written off each year by passing on the magazine entry below to the revenue gain :

• Income statement Dr.
• Discount / loss on issuance of bonds a / c
• (Discount / losses on issuance of debt securities written off)

Some of the methods used to treat the discount in the issuance of debentures are the following:

The discount on the bond issue is a capital loss. It will appear on the asset side of the balance sheet until it is written off. It is desirable that it be cancelled as soon as possible. Discount in issuance of debentures, as it is a loss of capital nature, it can be amortized in two ways.

First method:

In this case, the total amount of discount on obligations is distributed equally over the life of the obligations. Assume that the bonds are issued at a discount to be redeemed after five years. The amount of the discount will be divided by five and the amount thus obtained will be charged to the profit and loss account for five years. This method is followed when the bonds are redeemed at the end of a specified period.

Second method:

In this method, the discount is cancelled each year in proportion to the amount of debentures used each year. This method is followed when the bonds are exchanged each year by notification and lottery.

The accounting entry to cancel the discount is as follows:

Profit and Loss a/c                                                                                                   Dr.

TO discount on debenture a/c

Journal entry example:

Problem 1:

X Co. Ltd. issues Rs. 1, 00,000 debentures on January 1, 2012, with a 10 percent discount. Calculate the amount of discount that will be cancelled each year in each of the following cases:

1.  Obligations will be repaid after four years.
2.  The company redeems Rs. 25,000 debentures each year by drawing starting on December 31, 2012.

Solution:

1. The company will reimburse obligations after 4 years. Therefore, the discount amount to be cancelled each year will be Rs. 10,000 / 4 or Rs. 2,500.

2. The company redeems debentures worth Rs. 25,000 every year. Therefore, the discount will be amortized proportionally.

It is calculated as follows:

Problem 2:

One company issued bonds for the face value of Rs. 1, 00,000 with a discount of 6%. The obligations were repaid by annual drafts of Rs. 20,000. How would you calculate the discount on debentures? Show the discount account in the company's general ledger for the duration of the obligations.

Solution:

The discount of obligations can be amortized in two ways:

(a) Likewise during the life of the obligations. Since the obligations are for five years, each year one fifth of the discount can be taken to the profit and loss account.

(b) In proportion to the amount used. Since in this case the redemption plan is given, it is possible to cancel the discount in the proportion of the amount used.

If done then it will be cancelled as in:

The debenture discount in the second case will appear as under:

Debenture Discount

Problem 3

AB Ltd. bought assets worth Rs. 6, 80,000 and assumed liabilities of Rs. 80,000. It was accepted to pay the purchase price of Rs. 6.40,000 through the issuance of debentures valued at Rs. 4.40,000 of Rs. 100 each with a 10% premium and cash balance. Record the transaction in the books of the buying company.

Solution:

NB: No of Debentures = Rs 4,40,000 / Rs, 100 + Rs. 10 = 4,000 Debentures

Therefore, premium = 4,000 x Rs. 100 x 10% = Rs. 40,000

Problem 4:

You must approve the journal entries for the issuance of the following obligations:

(a) 120 10% Rs. 1,000 bonds are issued at a 5% discount and are repayable at par.

(b) Others 150 7% Rs. 1,000 bonds are issued with a 5% discount and refundable with a 10% premium.

(c) Plus 80 9% Rs. 1,000 bonds are issued with a 5% premium.

(d) In addition, another 400 8% Rs. 100 bonds are issued as collateral against a loan of Rs. 40,000. (ICWA Inter)

Solution:

                                                               Journal Entries                                                      Dr.     Cr.

Problem 5:

B.K. Ltd. issued at Rs 1, 00,000 10% to 95% bond. Subscriptions are paid up to Rs 20,000 on application and balance on assignment. The cost of the issue is 500 rupees.

Show the journal entries and the Company Balance Sheet.

Solution:

                                                               Journal Entries                                                      Dr.     Cr.

Balance Sheet of B.K. Ltd.

Problem 6:

On a company's balance sheet, the discount on obligations shows a debit balance of 15,000 rupees. Every year 5,000 rupees is charged to the profit and loss account. How will the discount on the liability account appear at the end of the first year and the second year on the company's balance sheet?

Solution:

Balance Sheet (First Year)

Problem 7:

One Company issued Rs 2.00,000 Bonds at 10% of Rs 100 each at par, repayable at the end of 5 years with a 5% premium. Regarding the deed of trust, a sinking fund would be created in order to accumulate sufficient funds for this purpose. Investments were made with a 5% interest received at the end of each year. All investments, including reinvestments of interest received, were made at the end of the year. All investments were sold in the fifth year for Rs 1, 63,805.

You must show journal entries and general ledger accounts for 5 years.

Note:

Rs 2, 71462 invested at the end of each year at 5% compounded interest will amount to Rs 15 at the end of 5 years.

The calculation can be done to the nearest rupee.

Solution:

Amount required for the redemption of debentures:

(a)  Nominal value of debentures = Rs 2,00,000

(b) Premium on redemption at5% = Rs 10,000

                                                       = Rs 2,10,000

When the amount required id Rs 15, annual instalment= Rs 2.71462

When the amount required is Rs 2,10,000, annual instalment

= 2,10,000 × 2.71462/15 = Rs. 38,005 (approximate)

(Without Narration)

                                                                                                               Dr.             Cr

Problem 8:

On January 1, 1993, a company issued 10,000 bonds at 6% of Rs 100 each, repayable at par after 15 years. The terms of the issue, however, established that the debentures could be exchanged with 6 months' notice at any time after 5 years with a premium of 4%, either through payment in cash or through the allocation of preferred shares and / or other obligations in accordance with the option of the bondholders.

On April 1, 2004, the company informed the bondholders to repay the bonds on October 1, 2004, either by cash payment or by allocating 8% of preferred shares of Rs 100 each to Rs 130 per share or 7% of second bonds from Rs 100 each to Rs 96 per bond.

Holders of 4,000 debentures accepted the offer of 8% preferred shares, holders of 4,800 debentures accepted the offer of 7% of 2nd Debenture and the remainder demanded cash. Provide journal entries that record the previous redemption.

Solution

                                                   Journal Entries                                Dr.             Cr.

Terms of issue of debentures

Meaning:

The debentures are issued in the same way as the shares are issued. The company issues a prospectus that invites applications along with a sum of money called application money. After the scrutiny, the Board of Directors makes the assignment of obligations.

If the full sum of money has not been requested along with the applications, another requested sum of money, the allocation money, may be requested. Later there may even be some calls. But above all, the full amount is received by application or by application and award.

The transactions  for the issuance of debentures are same to those approved for the issuance of shares, only the names of the accounts are changed. There is an Obligation Requests Account, a Obligation Assignment Account (or a Request Account and an Obligation Assignment), a First Call Obligation Account, a Second Call Obligation Account, a Third and Last Call Account obligations, etc.

Instead of crediting the capital account, the obligation account is credited.

The amount on application which are rejected will be refunded. The entry, therefore, is:

Debenture Application Account    Dr.    application money on rejected

To Bank                                                                  applications

Likes share, surplus application money on partially accepted application will be transferred to Debentures Allotments. Thus –

Debentur Applications Account          Dr.     surplus application money on

To Debentures Allotment Account         partially accepted applications

The amount due to allotment of debentures is journalised as:

Debentures Allotment Account             Dr.           gross amount due to allotment.

To Debentures

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

Upon receipt of the assignment money, the bank will be debited and the Obligation Assignment Account will be credited.

It is customary to put “Obligations” before the interest rate. Thus, if the interest rate is 14 percent, the name given will be "Obligations at 14%."

The premium in the issuance of the bond account and the discount in the issue of the bond account take place in the securities premium account and the discount in the issue of the share account, respectively.

Like stocks, bonds can be issued at par, at a premium, or at a discount. But the law does not establish any maximum discount limit in the issuance of obligations. Nor is the approval of the Company Law Board necessary.

Obligations are invariably redeemable. They can be exchanged at par or with a premium. The exchange of debentures with a premium means that the company pays the holders of debentures, at the time of exchange, a sum greater than the face value of the debentures they hold.

If a company issues debentures on the condition that it repays them with a premium, this additional liability must be recorded in a separate account called "Debt Reimbursement Premium Account" and shown together with the liability "Debentures" on the balance sheet.

Since the debentures can be issued at par, at a premium, or at a discount and can be redeemed at par or at a premium, there are several possible cases of entries that must be approved at the time of issuance of the debentures.

Summary entries for typical cases are given below:

(a)  Journal Entries (Debentures Issued at Par)

(b)  Journal Entries (Debentures issued at Premium)

When issue price of debentures is more than the face value of debentures they ar said to be issued at premium.

Generally, premium money is collected alongwith allotment money. As already said, procedure for issue of debentures is the same as tht for issue of shres. Therefore, only the journal entry relating to premium is given below:

(c)  Journal Entries (Debentures issued at Discount)

Only the journal entries relating to disount is given below:

The name Issue Premium has been changed to Securities Premium. Obligations are also securities. Therefore, the premium in the issuance of debentures, logically, can be credited to the Securities Premium Account. Then, the restrictions on the use of the premium in the issuance of shares will also apply to the use of the premium in the issuance of debentures.

The Bonds Redemption Premium must be distinguished from the Share Issue Premium; The first is a liability that is shown together with the Obligations in the Long-term Loans item, while the second is a capital gain that is shown in Reserves and Surpluses.

Alternatively, the discount allowed in the issuance of debentures, as well as the amount of the premium payable in the reimbursement, can be charged to the Loss Account in the Issuance of Debentures, in which case the journal entry will be as follows:

2. Expenses of issuance of the bond account:

The discount in the issuance of the debenture account and the loss in the issuance of the debenture account can be transferred to the cost account of issuance of debentures through the following journal entry:

Cost of issuing the debt account Dr

                 To the costs of issuing the bond account

                 To a discount on the issuance of an obligation account

                 To Loss due to issuance of bond account

The cost of issuing the bond account, the cost of issuing the bond account, the discount on the bond account issue and the loss on the bond account issue represent capital losses and their balances are shown as a deduction from reserves and balance sheet surplus.

In accordance with the provisions of the Public Limited Companies Law, it is not necessary to amortize the amount of said loss. But sound accounting principles require that the loss be gradually and appropriately amortized over the useful life of the obligations in respect of which the loss has been incurred. Alternatively, the loss can be transferred in whole or in part to the Securities Premium Account.

The premium on issuance of the bond account represents a capital gain and must be transferred to Capital Reserve. The Premium account in exchange of obligations is a personal account. At the time of the redemption of obligations, the premium of the account of redemption of obligations is transferred to the account of holders of various obligations.

Problem 9:

White Ltd. issues 10,000 secured bonds at 12% Rs. 100 each. Indicate journal entries if the Notes can be exchanged at par and are issued (i) at par, (ii) with a 2 percent discount and (iii) with a 3 percent premium. Also indicate the entries that will be made if the Notes are redeemable with a premium of 5 percent and are issued (i) at par and (ii) with a discount of 2 percent. Also indicate in each case how the figures will appear on the balance sheet.

Solution:

                                                   Journal Entries                                Dr.             Cr.

Balance Sheet

(i)                Debentures issued at par and redeemable at per

Notes:                                                                                                                                    RS

1. Long term Borrowings

12% Debentures                                                                                                 10,00,000

2.     Cash and Cash equivalence

Balance with Bank                                                                                           10,00,000

(ii)             Debenture issued at a discount and redeemable at per

Notes:

1. Reserve and Surplus  

Discount on Issue of Debentures                                                                                    (20,000)  

2.     Long term Borrowings

12% Debentures                                                                                                                         10,000

3.     Cash and Cash Equivalents

Balance with Bank                                                                                                                         9,80,000       

(iii)          Debentures issued as premium and redeemable at par

Notes:

1. Reserve and Surplus  

Securities Premium Account                                                                                            (30,000)  

2.     Long term Borrowings

12% Debentures                                                                                                                         10,00,000

3.     Cash and Cash Equivalents

Balance with Bank                                                                                                                         10,30,000       

(iv)           Debentures issued at par and redeemable at a premium of 5%

Notes:

1. Reserve and Surplus  

Loss on Issue of Debentures                                                                                                   (30,000)  

2.     Long term Borrowings

12% Debentures                                                                                                                         10,00,000

Premium on Redemption of Debentures                                                                                 50,000

                                                                                                                                                         10,50,000      

3.     Cash and Cash Equivalents

Balance with Bank                                                                                                                  10,00,000

(v)              Debentures issued at a discount and redeemable at a premium

Notes:

1. Reserve and Surplus  

Loss on Issue of Debentures                                                                                                   (70,000)  

2.     Long term Borrowings

12% Debentures                                                                                                                         10,00,000

Premium on Redemption of Debentures                                                                                 50,000

                                                                                                                                                         10,50,000      

3.     Cash and Cash Equivalents

Balance with Bank                                                                                                                  9,80,000

The bonds can be issued in exchange for a consideration other than cash. This issue can be done at par, with a premium or with a discount. When a company takes over a running business, it very often discharges part of the consideration in the form of obligations.

Problem 10:

Pee Co. Limited took over certain fixed assets for Rs. 3.15,000 from the liquidator of Tee Limited that was being liquidated and assigned 3,000 obligations of 13% with a premium of 5% to the liquidator to satisfy the consideration.

The company then issued a prospectus inviting the public to subscribe 10,000 12% Dentures of Rs100 each at a discount of 12%, payable as follows:-                                                  Rs

With application                                                                                                                     35

On allotment                                                                                                                          23

On first and final call                                                                                                             40

Applications were received for 9,000 debentures only. All the application were accepts. In course of time the call was also made. All the money’s were duly received.

Prepare the Cash Book and the Journal.

Solution:

Dr.                                                            Cash Book (Bank Columns Only)                                                  Cr.

                                                                                     Journal                                                    Dr.          Cr.

3. Reserve for the exchange of obligations:

In accordance with SEBI guidelines, in the event of issuance of debentures with a maturity of more than 18 months, a debenture redemption reserve must be created.

The following points are also worth noting:

(i) A moratorium may be established until the date of commercial production for the creation of the reserve for the reimbursement of obligations with respect to the obligations obtained for the financing of projects.

(ii) The reserve for the exchange of obligations can be created in equal instalments for the remaining period or with higher amounts if the earnings allow it.

(iii) In the case of partially convertible bonds, the bond reimbursement reserve must be created with respect to the non-convertible part of the bond issue on the same lines that apply for the issue of fully non-convertible bonds.

With respect to the non-convertible issues of new companies, the creation of the reserve for the reimbursement of obligations must begin from the year in which the company obtains benefits for the remaining life of the obligations.

(iv) The company must create a disaster risk reduction equivalent to 50% of the amount of the debenture issue before the debenture swap begins. Withdrawal of RRD is allowed only after the company has redeemed 10% of the liability.

(v) The reserve for the exchange of obligations will be treated as part of the General Reserve for the consideration of bond issuance proposals.

The entry for creating the debenture exchange reservation will be as follows:

Profit and loss appropriation account Dr. with the amount of the fee

                                    To reserve for the exchange of obligations

Problem 11:

On April 1, 2008, a company issued 1,000 debentures at 14% of 1,000 rupees each at 950 rupees. The issuance conditions stipulated that as of April 2010, 50,000 rupees of bonds should be exchanged, either by drawing at par or by buying in the market year. Expenses for the issue amounted to Rs 8,000 which was cancelled in 2008-09.

The company cancelled Rs 10,000 of the bond issue discount each year. In 2010-11, the obligations to be exchanged were reimbursed at the end of the year by lottery. In 2011-2012, the company purchased 50 bonds for cancellation at the prevailing price of Rs 980 on March 31, 2012, with expenses being Rs 500.

Interest is paid annually. Each year, an appropriate amount was also credited to the Reserve for the exchange of obligations. Ignore the income tax.

Provide the journal entries and balance sheet (as it relates to obligations) as of March 31, 2012.

Solution:

                                                                                                    Journal                                        Dr.     Cr

Balance Sheet as on March 31, 2012

(Items relating to debentures only)

Notes:

1. Reserve and Surplus                                                                                                  

Debentures Redemption Reserve                                                                             9,00,000                                                                                                                                             

General Reserve                                                                                                              1,00,000

Discount on issue of Debentures                                                                                 (10,000)

                                                                                                                                             9,90,000

2.     Long term borrowings

900 14% Debentures @ Rs 7,000 each                                                                       9,00,000                                                           

4. Issuance of obligations as collateral guarantee:

A company can issue obligations in favour of a money lender as collateral (subsidiary or secondary) of a loan obtained by it. The obligations remain dormant with the lender unless and until the company defaults on the loan for which the obligations have been issued. It is not necessary to approve any entry for the issuance of such bonds.

However, if an input is desired, the following input can be passed:

Debentures Suspense Account Dr

                            To the obligation account

Nominal value of the bonds issued as guarantee.

On the balance sheet, both the Obligation Account and the Obligation Suspension Account will appear on the P side

Balance Sheet

Debentures

Less: debentures Suspense Account

When the loan is repaid, the above entry is reversed as follows:

Debentures Suspense Account                                              Dr

To Debentures Account

Problem 12:

Kalpana Ltd. obtained a bank loan of 2.50,000 rupees and issued 250 bonds of 14% of 1,000 rupees as collateral. In addition, the company issued to the public 8,000 12% bonds of Rs 100 each with a 2% discount payable on Rs 50 on application and balance on award.

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

Notes:                                                                                  Rs                                                                 Rs            

Working Notes:-

Dr.                                                                Cash Book (Bank Column Only)                                Cr.

Dr.                                                                12% Debenture Account                                                Cr.               

5. Cancellation of discounts, etc. in the issuance of obligations:

A company is not legally obliged to cancel discounts or losses or expenses in the issuance of debentures (cost of issuing debentures). But prudence requires that such amounts be gradually written off by transfer to the Profit and Loss Account on a reasonable basis.

If the debentures are exchangeable at the end of a specified period, say ten years, it will be reasonable to pay off one-tenth of the cost of issuing the debentures each year.

If the obligations must be repaid in instalments, the amount to be paid each year must be proportional to the amount pending payment of the obligations, since it represents the benefit that the company obtains from the issuance of obligations.

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

Problem 13:

Vaishali Co. Limited closes its books of accounts every year on March 31st. On May 1, 1999, it issues 8% bonds for a nominal value of Rs 5,000,000 with a 3% discount. The issuance costs amount to Rs 3,000.  Calculate the amounts of the cost of Issuance of Obligations to be derecognized in different accounting years in each of the following cases:

(a) All obligations will be repaid after 10 years on May 1, 2009.

(b) Obligations of a face value of Rs 1.00,000 shall be repaid each year; the first repayment took place on May 1, 2000.

(c) Obligations will be repaid in five equal annual instalments of Rs 100,000 each, the first instalment being payable on May 1, 2003.

Solution:

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

Bond issue expenses = Rs 3,000

Total cost of issuing bonds to be cancelled = 15,000 rupees + 3,000 rupees = 18,000 rupees

(a) Since the debentures will be redeemed after 10 years, one-tenth of the total cost of issuing the debentures must be amortized for each full year.

But in the 1999-2000 accounting year, the bonds remain outstanding for only 11 months (that is, from May 1, 1999 to March 31, 2000). Therefore, the 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 of the next nine accounting years = Rs 18,000 x 1/10 = 1,800 rupees

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

(b) Obligations of Rs 1, 00,000 are repaid after each full year. Therefore, 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 pending.

The cost of issuing the debentures must be amortized in a ratio of 5: 4: 3: 2: 1. Total of the proportions = 5 + 4 + 3 + 2 + 1 = 15. Cost of issuing the debentures to be amortized in the period between May 1, 1999 and May 1, 2000 = Rs 18,000 x 5/15 = Rs 6,000.

But in accounting year 1999-2000, the obligations of Rs 5 lakh remain in circulation for only 11 months (i.e. from May 1, 1999 to March 31, 2000). Therefore, the amount to write off in 1999-2000 = 18,000 rupees x 5/15 x 11/12 = 5,500 rupees.

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

Therefore, the amount to be written off in 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

3.5 Methods of redemption of debentures: By payment in lump sum and by payment in instalments (excluding from by purchase in open market), Conversion.

What is the redemption of obligations?

The exchange of debentures refers to the payment of the amount of debentures by the company. When the debentures are recovered, the liability is discharged on account of the debentures. To put it in other words, the amount of capital required for the repayment of obligations is large, and therefore economic enterprises make an adequate provision of profits and accumulate capital to claim obligations.

Meaning of the exchange of obligations

It means the reimbursement of the number of debentures to the holders of debentures.

• The bonds can be redeemed at par or at a premium.
• The terms and conditions of redemption are generally given in the prospectus that invites applications for the issuance of obligations.

There are 4 ways to claim the obligations. Namely:

1. Lump sum payment
2. Instalment payment
3. Buy on the open market
4. By conversion into shares or new obligations

1. Lump sum payment: The Company claims the obligations by paying the fund in a lump sum (round sum) to the bondholders during their maturity according to the terms and conditions of issue.
2. Payment in instalments: under this method, the exchange of debentures is generally paid in instalments on the particular date during the time the obligations are located. The total amount of the liability is divided by the total number of years. This should be noted that the authentic recoverable debentures are recognized by the sources of extraction of the required number of lots of the outstanding debentures for payment.
3. Buying in the open market: when a company buys its own obligations in order to cancel them, such act of buying and cancelling the obligations includes the exchange of the obligations through the purchase in the open market.
4. Conversion into shares or new obligations: a company can reclaim its obligations by transforming them into a new class of obligations or shares. If bondholders find the offer useful, they can exercise their right to transform their debentures into a new class of debentures or shares. These new shares or obligations can circulate at a premium, at a discount or at par. It should be noted that this method is applicable only to convertible bonds.

1. Refund of obligations in lump sum upon maturity:

In this case, the obligations are exchanged in a single payment at the end of the stipulated period.

The basic accounting entries for the reimbursement of obligations are:

The bonds can be exchanged at par, with a premium or with a discount. When the bonds are exchanged at par, the two previous entries are passed. When the bonds are exchanged with a premium, the following accounting entries are passed.

Debentures a/c                              Dr.  (with face value of debentures to be redeemed)

Premium on redemption of debenture a/c  Dr.(with premium payable on redemption)

To debenture holders a/c

It should be noted here that the "premium in the exchange of a / c debentures" may have been opened and paid at the time of issuance of debentures. If so, the premium payable on the debenture exchange should only be transferred to the account of the debenture holders based on the first entry. If it has not been opened before, it will be loaded now and then closed by transferring it to the a/ c securities premium or profit and loss account.

Bonds can be redeemed at a discount, although this is an unrealistic situation and is not found in practice.

However, in such a case the following inputs are passed:

Debentures a/c                         Dr.           (with the face value of debentures redeemed)

To debenture holders                               (with the amount payable)

To profit on redemption of debentures (with discount on redemption)

The benefit of the bond redemption is a capital benefit. It is used to cancel the discount on the issuance of debentures / shares; otherwise, it will be transferred to the capital reserve. The bonds can be exchanged with capital or with earnings. Prudent companies arrange for the swap of bonds early on. They separate a certain sum of money from earnings each year and invest an equivalent amount in first-class securities so that the necessary funds are available for the debt swap at the appropriate time.

To invest funds out of business, the business can use either of the following two methods:

(a)  Sinking fund method / Obligation sinking fund method

(b) Insurance policy method

(a) Sinking fund method / Obligation sinking fund method:

According to this method, each year, the company reserves a certain part of the earnings and credits the same to the bond redemption fund. To raise the necessary funds at the time of repayment, invest them in first-class securities. Interest earned on investments is also reversed when the obligations are due for repayment; the investments are sold and the proceeds of the sale are used to redeem the bonds.

Following transactions are:

The above two entries are passed in the first yea. At the end of second year and subsquent tears, the following entries will be passed:

Accounting for last year are as follows:

4. Last year's entry for the purchase of investments will not be approved as investments will not be purchased.

Instead, the entry for the sale of investments and the repayment of obligations will be approved, which are the following:

For the loss on the sale of investments, the reverse entry will be passed. In the exchange of obligations, the following entries will be approved.

The credit balance in DRF a / c will be transferred to the general reserve account. It should be noted here that the proceeds from investment sales that were previously transferred to the DRF account will be transferred to the DRF capital reserve, these events are recorded using the following accounting entry.

(b) Insurance policy method:

Under this method, instead of buying investments, the company takes out an insurance policy for an amount that would be adequate for the exchange of debentures.

The accounting entries, under these methods, are the following:

First year and beyond (including last year)

In the last year, when the amount of the policy is made and the obligations are exchanged, the following accounting entries are passed.

2.     Amortization of Obligations by instalment payment:

In this method of redemption of Debentures, the amount is reimbursed to the holders of debentures in instalments on the specified date (which are agreed in advance at the time of issuance of Debentures), during the life of the obligations. To calculate the amount of the instalment, the total amount payable to the bondholders is divided by the total number of years.

Repayment of obligations through instalment payment - Journal entries

1 If redeemed with profit:

a) Profit and loss statement A / c Dr.

                    To reserve for exchange of A / c obligations

   (DRR being transferred to P&L A / c)

 b) Obligations A / c Dr.

                         To holders of A / c obligations

(Amount payable to bondholders)

Problem 14:

Show through journal entries how you will record the following numbers.

Also show how they will appear on their respective balance sheets:

(a) A Ltd. issues 5,000 bonds at 10% Rs. 1,000 each with a 5% discount redeemable at the end of 5 years at par.

(b) B Ltd. issues 5000 bonds at 11% Rs. 100 each with a 5% premium redeemable at the end of 5 years at par.

(c) C Ltd. issues 5000 bonds at 12% Rs. 100 each with a 5% discount redeemable at the end of 5 years with a 5% premium.

(d) D Ltd. issues 5,000 bonds at 13% Rs. 100 each with a 5% premium redeemable at the end of 5 years with a 5% premium.

Solution:

(a)                                                                   In the Books of A Ltd.

Journal Entries

Balance Sheet of A Ltd.

(as on…)

(b)                                                                   In the Books of B Ltd.

Journal Entries

Balance Sheet of B Ltd.

(as on…)

(c )                                                              In the Books of C Ltd.                                                         

Journal Entries

Balance Sheet of C Ltd.

(d ) In the Book of D Ltd,

Journal Entries

Balance Sheet of D Ltd.

(as at…)

Illustration 4:

X Co. Ltd. issued 10 percent bonds for Rs. 6,00,000 on January 1, 2012. These bonds had to be exchanged after four years from the date of issue, that is, December 31, 2015. The company decided to create a bond redemption fund for this purpose and bought investment gain interest @ 5 percent per year Sinking fund tables show that .232012 invested annually at 5% equals Re 1 in four years.

On the expiration date, the investment was sold for Rs. 4, 40,000 and debentures were exchanged. Pass the journal entries required to record the above transactions for 4 years. Also, prepare the necessary accounts. The bank balance before redemption on the due date was Rs. 2, 45,000.

Solution:

The annual investment (without interest) required is

6, 00,000 x .232012 = 1, 39,207.20

10% Debenture a/c

10% Debenture a/c

Debenture redemption fund a/c

Debenture Redemption Fund Investment a/c