Methods of Redemption of Debentures

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When a company gets loan, company issues debentures. Company gets this loan through debentures for a fixed time. After that fixed time, company will return the money of debentures to debenture holders. The refund of money to debenture holders is called redemption of debentures. Following are the various methods of redemption of debentures giving accounting treatment.

1st Method of Redemption of Debentures - Redemption Out of Profit

In this method, we repay the money of debentures out of profit. Now, understand, how is it possible? Suppose, you have estimated that you will get $ 1,00,0000 profit in march 2011 and in same month, you have to redeem $ 10,000 debentures. Now, one side, you will pay $ 10000 through your cash or bank account and other side, you will deduct same $ 10000 from your profit and loss account by making redemption reserve account. Following entry will be passed :

A) Transfer of Profit to debenture redemption reserve account

Profit and loss appropriation account Dr. 10000

Debentures Redemption account Cr. 10000

B) Redemption of Debentures

Debentures account Dr. 10000

Bank account Cr. 10000

2nd Method of Redemption of Debentures - Redemption Out of Capital

It means we directly repay the debentures out of capital. We just pass following entry after repay of debentures by cheque.

Debentures account Dr.

Bank account Cr.

This entry's effect on our capital and it will reduce by same amount. There is no need to transfer of profit to redemption reserves in this method.

3rd Method of Redemption of Debentures - Redemption by Conversion

Company can also redeem the old debentures by conversion these into new debentures or equity or pref. shares. At that time, we will pass following entry

Old Debentures account Dr.

New Debentures account Cr

or

Equity Share capital account Cr.

or

Pref. Share capital account Cr.

4th Method of Redemption of Debentures - Redemption by Buying Own Debentures

In this method, directors go to debenture market and for redemption of debentures, they have bought own debentures. For this, following entry will be passed.

Own Debenture or investment in own debentures account Dr.

Bank account Cr.

Investment in own debentures account or simply own debentures account will be shown on the assets side of the balance sheet. Debentures will continue to be shown on the liabilities side of the balance sheet. Here, it is assumed that the debentures are purchased immediately after the payment of interest.

As and when the company wants to cancel investment in own debentures, the following entry is done.

Debentures account Dr.

Loss on redemption of debentures account Dr.

Own debentures account Cr.

Profit on redemption of debentures account Cr.

5th Method of Redemption of Debentures - Redemption by Making Provision

In this method, we create provision for redemption of debentures when we issue debentures. To making provision for redemption is good method to repay the amount of debenture on the time. We keep a small amount of provision and invest in good scheme. At the time of redemption, we liquidate our provision and repay the amount of debentures, it has two sub-methods.

(A) Sinking Fund for Redemption Method

(B) Insurance Policy Method

In this method, we invest provision for redemption of debentures in insurance company, we pay premium of insurance annual. When we have to redeem the debentures, we collect all the money of insurance policy. After this, we repay the debenture amount.

Following entry will be passed in this method

First year

a) For amount of premium appropriated from profit and loss account

profit and loss account appropriated account Dr.

debenture redemption fund account Cr.

b) For amount of premium paid to insurance company

Debenture redemption fund policy account Dr.

bank account Cr.

( Note : these entries will be passed every year including the last year also )

The following entries will also be passed at the end of the specific period on realization of the policy:

a) For the amount received from insurance company

bank account Dr.

debenture redemption fund policy account Cr.

b) For the balance of debenture redemption fund policy account, excess amount received is transferred to debenture redemption fund account.

Debenture redemption fund policy account Dr.

debenture redemption fund account Cr.

c) For amount paid to debentures

debentures account Dr.

bank Cr.

d) For balance of debenture redemption fund account transferred to general reserve

debentures redemption fund account Dr

general reserve account Cr.