Accounting for Issue and Redemption of Debentures
This domain tests debenture financing: issue at par, discount or premium, interest, discount or premium amortisation, debenture redemption reserve, and redemption. Debentures are long-term debt, not share capital, so the accounting treatment differs from dividends.
Core rules
- Section 71 governs debentures; interest is a charge against profit, payable whether or not the company earns profit.
- Discount on issue is amortised over the debenture life or adjusted against securities premium; it is not carried as a permanent asset.
- Premium on redemption is provided for over the life of the debentures by charging the statement of profit and loss.
- Rule 18 of the Companies (Share Capital and Debentures) Rules, 2014 requires a debenture redemption reserve of 25% of the nominal value of debentures, created out of profits and invested in specified securities, subject to exemptions for listed companies and certain prescribed classes.
- Interest accrued but unpaid is a current liability; interest paid is an expense.
Worked example
10,000 debentures of 100 each are issued at 95, redeemable at par after five years. Bank received 9,50,000; discount is 50,000. Annual amortisation is 10,000. Annual interest at 10% is 1,00,000. If redeemable at 105, the 50,000 redemption premium is provided over five years, adding 10,000 each year to the finance cost.
Traps
Treating debenture discount as an asset; ignoring premium on redemption; failing to create the debenture redemption reserve where applicable; and omitting accrued interest.
Exam focus
Journal entries at issue, year-end interest and amortisation, and redemption.