Key Points - Redemption of Debenture

Redemption of debentures means repayment of the due amount of debentures to the debenture holders. It may be at par or at premium.

Time of redemption : (a) At maturity : when repayment is made at the date of maturity of debentures which is determined at the time of issue of debentures. (b) Before maturity : If articles of association and terms of issue mentioned in prospectus allows, then a company can redeem its debentures before maturity date.
Redemption methods : (1) Redemption is Lump­sum :­ When redemption is made at the expiry of a specific period, as per the terms of issue. (2) Redemtion by draw of lots :­ In this method a certain proportion of debentures are redeem each year, the debenture for which repayment is to be made is selected by draw. (3) Redemtion by purchase in open market :­ if articles of association of a company authorize, it may purchase its own debentures from open market i.e. stock exchange.
Advantage of this method : 1. When market price of own debentures is low than the redeemable value.

2. Decrease the amount of interest payable to outsiders.

3. if term of issue is provided that debentures are to be redeemed at premium then such premium can be decrease.

Sometimes company can purchase the debentures at more than the redeemable value due to the following reasons: 
1. To maintain the solvency ratio.

2. To utlize the surplus money or funds which are lying idle with the company.

3. When rate of interest on debentures is more than the current market rate of interest on debentures in the industry.

4. Redemption by conversion : As per the terms of issue, convertible debentures may be covert into shares or new debentures at the option of debenture holders. This option of conversion is given to the debentureholder within specific period. In this case no need to transfer profit to Debenture Redemption Reserve Account.

Sources of Redemption of debentures.

1. Proceeds from fresh issue of share capital or debenture holders.

2. From accumulated profits.

3. Proceeds from sale of fixed assets.

4. A company may purchases its own debentures out of its surplus funds.

Two terms which are used in the redemption of debentures: 
1. Redemption out of capital : when a company not used its reserve or accumulated profit for redemption of its debentures. It is called redemption out of capital. So company using this method are not transfer it profit to DRR A/c. But as per SEBI guidelines it is necessary for a company to transfer 50% amount of nominal value of debentures to be redeemed in DRR A/c before redemption of debentures commence.

2. Redemption out of profit : Redemption out of profit means that adequate amount of profits are transferred to DRR A/c from P&L Appropriation A/c before the redemption of debenture commences. This reduce the amount available for dividends to shareholders.
NOTE : If it is mentioned in question that redemption is out of capital then
DRR should also created with 50% of the nominal value of debentures.
If it is mentioned that redemption is out of profit then DRR should be created with the 100% of the nominal value of debentures.
If nothing is mention about the source of redemption than as per SEBI guidelines

5.% of nominal value of debentures is to be transferred to DRR A/c.
If in any particular question DRR is already existed with more than 50% amount of nominal value of debentures, then in this case total 100% of nominal value of debentures is to be transferred to DRR A/c
Debenture Redemption Reserve : Debenture redemption reserve is a reserve representing retentions out of profit made for the purpose of redemption of debentures.
Amount of DRR to be created : Section 117 (c) of the Indian Companies Act 1956 requires that, an adequate amount of profit should be transferred to DRR before redemption commences. However the adequate amount is not specified by the companies Act.

SEBI has issued guidlines for the redemption of debentures whereby: 
1. An amount equivalent to 50% of the amount of debentures issue must be transferred to DRR before redemption of debentures commences.
This provision is applicable for non­convertible debentures or non­convertible part of party convertible debentures.
After all the debentures are redeemed, this account is closed by transferring to general reserve account.
Exception to the creation of DRR as per SEBI guidlines: 
1. All infrastructure companies, wholly engaged in the business related to development maintenance and operation of infrastructure facilities.

2. A company issuing debentures maturity period of not more than 18 months.

3. Debentures issued by Banking Companies.

4. Companies issuing privately placed debentures.

The above types of companies are exempted by SEBI from creating DRR. However the above types of companies can create DRR(at it option) for the redemption of debentures.
Redemption method : (1) Redemption in Lump­sum (A) Redemption at Par

Note : The infrastructure Companies are exempted from creating DRR as per SEBI guidlines. However these companies may create DRR at its option.)
Redemption Method : 2 Draw of lots

Redemption method 3 : Redemption of Debentures by Conversion : A Company may offer to the debentureholder to convert their debenture into a new class of securities like
Equity shares or preference share or new debentures. The debentureholder may accept the offer or not. If debentures are converted.
Calculation of Number of new securities to be issued
= Amount due to debentureholders/Issue Price
Issue Price = Nominal Price + Securities Premium on Issue of New Securities
Or Isse Price = Nominal Price­ Discount on Issue of New Securities.
Illustration 8 : 2000, 8% Debenture Rs.100 each issued at par redeemable at 5% premium were converted into equity share of Rs.10 each at par, Journalise.
Solution: JOURNAL
Date
Particulars
Debit
Credit

Conversion of Debentures into shares which are originally issued at a Discount: When debentures are originally issued at discount, discount on issue of debenture account is debited with the amount of discount, Discount on issue of debenture account is written off during the time period of debenture as as issue date to redemption date.
Note : By the maturity date the discount on issue of debenture account is fully written off from the Profit & Loss A/c.

(a) When conversion done after the maturity of debenture :­ The conversion is done with the full amount of debenture the discount on issue of debenture account is fully written off, so discount account is not credited on the date of conversion in maturity of debentures

If a company, convert it debentures into equity share before the maturity, then Discount in issue of debentures Account should be credited with the amount if discount which has not yet been written off and Profit & Loss Account should be credited with the amount of discount which has already written off e.g.
On 1st April 2010, X Ltd. issued 50,000, 10% Debentures of Rs.10 each at 4% discount and redeemable at par after 5 year. It offered the debentureholders option to convert their debentures in equity share of Rs.10 each after 31st March, 2012. On 1st April, 2012, 25% of debentureholders accepted & exercised their option. Give necessary journal entries at the time of converssion of debentures.