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Lesson 53

Debenture Redemption Entries

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Hello! Welcome to our lesson on accounting for debentures.

In our previous lessons, we explored the different reasons a company might issue debentures—for cash, to purchase assets, or as collateral security. We recorded the journal entries for these events assuming the debentures would be repaid at their face value. Today, we will add an important layer of complexity.

This lesson is designed to help you master the learning outcome: to record journal entries for the issue of debentures with redemption terms (e.g., issued at a discount, redeemable at a premium).

We will explore how the promise a company makes about the future repayment (redemption) of a debenture can significantly change the accounting entries we make today at the time of issue. This involves a key accounting principle you may remember: the Prudence (or Conservatism) Concept, which states that we should anticipate and provide for all known future losses.

The Six Scenarios of Issue and Redemption

When a company issues debentures, there are two key financial events: the issue and the redemption.

  • Issue: Can be at Par, Premium, or Discount.
  • Redemption: Is typically at Par or Premium.

Combining these possibilities gives us six potential scenarios. We will see that the accounting gets interesting only when redemption is at a premium, as this creates a future loss for the company that we must account for at the time of issue.

Let's start by understanding the fundamental logic.

Issue of Debentures from Redemption Point of View | All cases Covered | Class 12 Accounts Debentures

This video by CA Hardik Manchanda provides an excellent conceptual foundation. It explains why a future premium on redemption is considered a loss and a liability that must be recorded today, citing the Prudence Concept.

Watch the segments from 01:49 to 05:51 and from 15:53 to 25:07. Focus on understanding why the premium on redemption is treated as a loss that needs to be recorded at the time of issue. Pay close attention to the introduction of the two key accounts: 'Loss on Issue of Debentures' and 'Premium on Redemption of Debentures'.

As explained in the video, when debentures are to be redeemed at a premium, we must recognize this future obligation immediately. This introduces two new accounts into our issue entry:

  1. Premium on Redemption of Debentures A/c: This is a liability account. It is credited to represent the extra amount the company has promised to pay back to the debenture holders over and above the face value. It is shown under 'Non-Current Liabilities' in the Balance Sheet.
  2. Loss on Issue of Debentures A/c: This is a capital loss account. It is debited with the same amount as the premium on redemption. It represents the loss the company will incur by paying back more than the face value. This loss is recorded immediately due to the Prudence Concept.

A Systematic Walkthrough of All Six Cases

Now that you understand the underlying principle, let's go through all six scenarios systematically. The first three are a review of what happens when redemption is at par, while the last three apply our new concept.

Issue of Debentures | Class 12 | Part 3 | Concepts and Questions

This video by Rajat Arora provides a clear, step-by-step walkthrough of all six cases, with journal entries and calculations for each. It's a perfect way to see all the scenarios in action.

Watch from 14:03 to 35:11. The video is structured perfectly to cover our topic. Pay special attention to cases 4, 5, and 6, which are the most important and are marked as 'special' in the video.

Let's summarize the journal entries for all six cases. We'll assume the issue and allotment money is received in a lump sum for simplicity.

Group 1: Redeemable at Par (No Future Loss)

These cases don't involve a premium on redemption, so the entries are straightforward.

Case 1: Issued at Par, Redeemable at Par

  • (Issue: ₹100, Redemption: ₹100)
    • Bank A/c Dr.
    • To Debenture Application & Allotment A/c
    • Debenture Application & Allotment A/c Dr.
    • To % Debentures A/c

Case 2: Issued at Premium, Redeemable at Par

  • (Issue: ₹105, Redemption: ₹100)
    • Bank A/c Dr.
    • To Debenture Application & Allotment A/c
    • Debenture Application & Allotment A/c Dr.
    • To % Debentures A/c
    • To Securities Premium Reserve A/c

Case 3: Issued at Discount, Redeemable at Par

  • (Issue: ₹95, Redemption: ₹100)
    • Bank A/c Dr.
    • To Debenture Application & Allotment A/c
    • Debenture Application & Allotment A/c Dr.
    • Discount on Issue of Debentures A/c Dr.
    • To % Debentures A/c

Group 2: Redeemable at Premium (Anticipated Future Loss)

These are the crucial cases where we apply the Prudence Concept.

Case 4: Issued at Par, Redeemable at Premium

  • (Issue: ₹100, Redemption: ₹105)
    • Bank A/c Dr.
    • To Debenture Application & Allotment A/c
    • Debenture Application & Allotment A/c Dr.
    • Loss on Issue of Debentures A/c Dr. (with premium on redemption, ₹5)
    • To % Debentures A/c
    • To Premium on Redemption of Debentures A/c (with premium on redemption, ₹5)

Case 5: Issued at Premium, Redeemable at Premium

  • (Issue: ₹110, Redemption: ₹105)
    • Bank A/c Dr.
    • To Debenture Application & Allotment A/c
    • Debenture Application & Allotment A/c Dr.
    • Loss on Issue of Debentures A/c Dr. (with premium on redemption, ₹5)
    • To % Debentures A/c
    • To Securities Premium Reserve A/c (with premium on issue, ₹10)
    • To Premium on Redemption of Debentures A/c (with premium on redemption, ₹5)

Case 6: Issued at Discount, Redeemable at Premium

  • (Issue: ₹95, Redemption: ₹105)
    • Bank A/c Dr.
    • To Debenture Application & Allotment A/c
    • Debenture Application & Allotment A/c Dr.
    • Loss on Issue of Debentures A/c Dr. (with discount ₹5 + redemption premium ₹5 = ₹10)
    • To % Debentures A/c
    • To Premium on Redemption of Debentures A/c (with premium on redemption, ₹5)

Notice in Case 6, both the discount on issue and the loss from the premium on redemption are debited to a single account: Loss on Issue of Debentures A/c. This is because both items are capital losses of a similar nature.

To reinforce these concepts, you should refer to your NCERT textbook, which provides a concise summary and clear illustrations.

Issue and Redemption of Debentures

The NCERT textbook provides an authoritative summary of all six scenarios, along with a comprehensive illustration showing the journal entries for each case. This is an essential resource for your exam preparation.

Read Section 2.8, 'Terms of Issue of Debentures'. Then, carefully study Illustration 15, which presents the journal entries for all six cases. This will solidify your understanding of the patterns.

Test your understanding!

A company issues 1,000, 9% Debentures of ₹100 each at a discount of 10%, redeemable at a premium of 5%. What will be the journal entry for the allotment of debentures?

Show answer

Here's the breakdown:

  • Face Value: ₹100
  • Issue Price: ₹100 - 10% discount = ₹90
  • Redemption Price: ₹100 + 5% premium = ₹105
  • Discount on Issue per debenture: ₹10
  • Premium on Redemption per debenture: ₹5
  • Total Loss per debenture: ₹10 (discount) + ₹5 (redemption premium) = ₹15

The journal entry for 1,000 debentures will be:

Particulars Debit (₹) Credit (₹)
Debenture Application & Allotment A/c Dr. 90,000
Loss on Issue of Debentures A/c Dr. 15,000
     To 9% Debentures A/c 1,00,000
     To Premium on Redemption of Debentures A/c 5,000
(Being allotment of 1,000 debentures issued at a discount and redeemable at a premium)

Conclusion

In this lesson, you've learned a crucial aspect of accounting for debentures. By applying the Prudence Concept, you can now correctly record the issue of debentures while anticipating the financial impact of their future redemption terms.

Key Takeaways:

  • When debentures are redeemable at a premium, this represents a future, known loss for the company.
  • This loss must be recorded at the time of issue by debiting Loss on Issue of Debentures A/c and creating a liability by crediting Premium on Redemption of Debentures A/c.
  • The amount of loss due to discount on issue is also a capital loss and is typically combined with the loss on redemption into the single Loss on Issue of Debentures A/c.
  • If debentures are redeemable at par, no special entry for redemption is needed at the time of issue.

Preview of the Next Lesson:
Now that we have a solid understanding of the entries at the time of issue, our next lesson will focus on the ongoing life of the debentures. We will learn how to account for the interest paid on debentures, including the important legal requirement of handling Tax Deducted at Source (TDS).