Accounting for Debentures
Debentures are long-term borrowings, and the exam tests issue, interest and redemption entries.
Issue
Debentures may be issued at par, at a premium or at a discount, and may be redeemable at a premium. When debentures are issued at a discount and redeemable at a premium, the whole loss - discount plus premium on redemption - is debited to Loss on Issue of Debentures Account, then written off against Securities Premium or Profit and Loss. Premium on redemption is a liability shown under non-current liabilities until redemption; discount on issue is never shown as an asset.
Interest
Debenture interest is a charge against profit, payable whether or not the company earns profit. Entry: Debenture Interest Dr; To Debentureholders Account (and To TDS Payable where tax is deducted at source). Interest accrues even when unpaid, so outstanding interest is a current liability. If the company holds its own debentures, no interest is paid externally on them.
Redemption
Before redeeming debentures the company must transfer the prescribed amount out of profits to a Debenture Redemption Reserve, and invest in specified securities where required. Redemption may be out of profits or out of capital. Own debentures purchased and cancelled: any profit on cancellation is transferred to Capital Reserve.
Worked example
10,000 12% debentures of ₹100 each issued at 95 and redeemable at 105. Entry: Bank Dr ₹9,50,000; Loss on Issue of Debentures Dr ₹1,00,000 (₹5 discount + ₹5 premium on redemption); To 12% Debentures ₹10,00,000; To Premium on Redemption ₹50,000.
Traps
Writing off premium on redemption as an expense of the year of issue; treating debenture interest as an appropriation like interest on capital; forgetting the Debenture Redemption Reserve when redemption is out of profits; ignoring TDS on interest.