Hello! Welcome back. In our previous lesson, we covered how to account for the ongoing interest payments a company makes to its debenture holders. We've now looked at the beginning (issue) and the middle (interest) of a debenture's life. It's time to address the end: paying back the principal amount.
This lesson focuses on the final stage of the debenture lifecycle: Redemption. We will cover how to record journal entries for the redemption of debentures by lump sum payment and by purchase in the open market for cancellation. These are two of the most common methods you'll encounter in your CBSE syllabus, and understanding them is key to mastering this chapter.
1. Redemption by Lump Sum Payment
This is the most straightforward method of redemption. As the name suggests, the company repays the entire outstanding debenture amount to the holders in a single transaction on the date of maturity.
The accounting process follows a clear, logical sequence of four steps. Let's first look at the core journal entries for making the amount due and paying it, as outlined in your textbook.
Acompany raises its capital by means of issue of
Your NCERT textbook clearly lays out the fundamental journal entries for making the redemption amount due to debenture holders and then settling the payment.
Please read the section titled '2.12 Redemption by Payment in Lump Sum'. Focus on the template journal entries shown under points 1 (for redemption at par) and 2 (for redemption at premium). This will form the core of our understanding.
As you saw, the core entries are simple. However, the full process involves a few more crucial steps related to legal compliances we've touched upon before, such as using the funds set aside in the Debenture Redemption Investment (DRI) and closing the Debenture Redemption Reserve (DRR) after redemption is complete.
This video walks through the complete, practical sequence of events.
#3 Redemption of Debentures - Lumpsum Method - Problem 1 - By Saheb Academy - CA INTER
Let's see the full process in action. This video solves a problem demonstrating the complete sequence for a lump sum redemption, from arranging funds to the final closure of reserves.
Watch the video from 11:22 to 16:14. Pay close attention to the chronological order of the journal entries: Making Amount Due (11:22): The liability is transferred from 'Debentures A/c' to 'Debenture Holders A/c'. Encashing DRI (12:48): The investment is sold to generate cash for the payment. Final Payment (13:50): The debenture holders are paid, and the liability is cleared. Transfer of DRR (14:46): With redemption complete, the special reserve (DRR) is transferred to the General Reserve.
To summarize, the complete process for lump sum redemption involves these four key journal entries:
-
For encashing Debenture Redemption Investment (DRI):
- Bank A/c Dr.
- To Debenture Redemption Investment A/c
-
For making the redemption amount due to debenture holders:
- (%) Debentures A/c Dr. [With Face Value]
- Premium on Redemption of Debentures A/c Dr. [If any]
- To Debenture Holders A/c
-
For making the payment to debenture holders:
- Debenture Holders A/c Dr.
- To Bank A/c
-
For transferring DRR balance to General Reserve (after redemption):
- Debenture Redemption Reserve A/c Dr.
- To General Reserve A/c
2. Redemption by Purchase in the Open Market
Instead of waiting for the maturity date, a company can choose to buy back its own debentures from the stock market and cancel them. This constitutes redemption.
Why would a company do this? The primary motivation is financial advantage. If a company's debentures, with a face value of ₹100, are trading on the market for ₹95, the company can buy them back at a lower price and cancel its ₹100 liability, making a profit of ₹5 per debenture.
This short video explains the business logic behind this strategy.
#11 Redemption of Debentures - Purchase in Open Market - By Saheb Academy - CA INTER
Let's explore why a company would opt to buy its own debentures from the market instead of waiting for maturity. This video explains the strategic and financial reasoning.
Watch from 01:20 to 05:20. Focus on understanding why this method is a 'golden opportunity' for a company, especially when its debentures are trading at a price lower than their face value.
The accounting for this method is focused on recognizing the cancellation of the liability and the resulting profit or loss.
Acompany raises its capital by means of issue of
The journal entries for open market purchases are quite direct. Your textbook provides a clear example of how to record the transaction and account for the profit.
Read the section '2.13 Redemption by Purchase in Open Market' and carefully review 'Illustration 28'. Notice the two key entries: one for the purchase and immediate cancellation, and the second for transferring the profit to Capital Reserve.
As highlighted in the textbook, the accounting treatment for immediate cancellation is as follows:
1. On purchasing own debentures for cancellation (at a discount):
- (%) Debentures A/c Dr. [With Face Value]
- To Bank A/c [With Purchase Price]
- To Profit on Redemption of Debentures A/c [The difference]
The profit on redemption is a capital profit, not a revenue profit from regular business operations. Therefore, it is transferred to a capital account.
2. On transferring the profit on redemption:
- Profit on Redemption of Debentures A/c Dr.
- To Capital Reserve A/c
If debentures are purchased at a price higher than the face value, the company incurs a loss, which is debited to 'Loss on Redemption of Debentures A/c' and written off against the Statement of Profit and Loss.
Test your understanding!
A company purchases 1,000 of its own 9% Debentures, each with a face value of ₹100, from the open market at ₹98 per debenture for immediate cancellation. What is the journal entry to record this transaction and what is the amount of profit transferred to Capital Reserve?
Show answer
- Face Value of Debentures Cancelled: 1,000 debentures × ₹100 = ₹1,00,000
- Amount Paid: 1,000 debentures × ₹98 = ₹98,000
- Profit on Redemption: ₹1,00,000 - ₹98,000 = ₹2,000
Journal Entry for Purchase & Cancellation:
9% Debentures A/c Dr. 1,00,000
To Bank A/c 98,000
To Profit on Redemption of Debentures A/c 2,000
(Being 1,000 own debentures purchased and cancelled)
Journal Entry for Transfer of Profit:
Profit on Redemption of Debentures A/c Dr. 2,000
To Capital Reserve A/c 2,000
(Being profit on redemption transferred to Capital Reserve)
A Note on Ex-Interest and Cum-Interest Purchase
When buying debentures between interest payment dates, the price quoted can be ex-interest (price of the security only) or cum-interest (price includes accrued interest). While this is an important concept in advanced accounting, for your Grade 12 CBSE exams, you can generally assume the price given is the ex-interest purchase price unless explicitly stated otherwise. Your profit/loss calculation will simply be the difference between the face value and this purchase price.
Conclusion
Great job! You have now learned the accounting treatment for two major methods of debenture redemption.
Key Takeaways:
- Lump Sum Redemption: A planned repayment at maturity. The accounting process involves encashing DRI, making the amount due to holders, paying them, and finally transferring the DRR to General Reserve.
- Open Market Purchase: An opportunistic redemption to take advantage of low market prices. The key is to cancel the debenture liability (at face value) against the cash paid (at market price) and recognize the difference.
- Profit on Redemption: This is a capital profit and is transferred to the Capital Reserve.
- Loss on Redemption: This is a capital loss and is written off against the Statement of Profit and Loss.
Preview of the Next Lesson:
In this lesson, we saw the practical application of DRR and DRI (encashing DRI, transferring DRR). In our next lesson, we will take a step back and do a deep dive into the theory behind these concepts. We will explain the legal requirements and detailed accounting for Debenture Redemption Reserve (DRR) and Debenture Redemption Investment (DRI) as per the Companies Act, 2013.