FAA/U4 Topic 11 Redemption of Debentures
Debentures are debt instruments. Hence when their period expires, debenture holders are paid back their principal amount. This process of discharging the company’s debt is known as the redemption of debentures. Let us learn more about the various methods of redemption of debentures and their accounting treatments.
Redemption of debentures refers to the repayment of these debentures by the company to the debenture holders. So the company will discharge its liability and remove it from the balance sheet. This is a major transaction for the company since the amount of money involved tends to be quite significant.
There are a few ways in which this redemption of shares can take place. These methods all have different accounting treatment as well.
Let us take a look at the various methods of redemption of debentures.
Lump Sum Method
This method as the name suggests is a one-time payment method. Here the company will repay the whole amount in one lump sum payment to the debenture holders. The amount and the date of the payment will be according to the terms of issue.
Since the company knows the date of the repayment in advance they can plan their finances accordingly. So they make provisions to pay the debenture holders. So as per the provisions of the Companies Act and the SEBI guidelines the company has to make provisions for such a debenture. And hence the company sets up a special account known as the Debenture Redemption Reserve.
This debenture redemption reserve is a capital reserve account. It is funded by the divisible profits of each year, i.e. a portion of the profits are set aside for this purpose. This account can only be utilized for the purpose of redemption of debentures and for no other purpose.
This is also known as the drawing of lots method. Here the company will start redeeming debentures in lots or installments from one particular year as agreed by the terms of issue.
A company may opt to not pay the debenture holders at the time of redemption. Instead of that, it can convert the debentures into a new class of debentures or even equity shares. Such debentures are known as convertible debentures. Such new debentures or shares can be issued at par, premium or even discount.