Blog

Class 12 Accountancy Chapter 2 – Issue And Redemption Of Debentures

Short Questions for NCERT Accountancy Solutions Part 2 Class 12 Chapter 2

1. What is meant by a Debenture?

Debenture is derived from the Latin word “debere” which translates to borrow. Debentures are not backed by any collaterals. These are issued by governments and corporations to raise funds or capital for long term borrowing.

2. What does a Bearer Debenture mean?

When records are not maintained for debenture and holders and the debenture can be transferred by delivery, such debentures are known as Bearer Debenture. These debentures are issued physically on paper and are payable to bearer of the debenture. These are also called as unregistered debentures.

3. State the meaning of ‘Debentures issued as a Collateral Security’.

Collateral security refers to an additional layer of security over and above the primary security. It is seen in case of company taking a loan from a financial institution, in such cases, company issues debentures which are additional security or collateral security. The money lender will not be receiving any interest on these debentures. In case the company defaults in making payment and the primary security is not sufficient to cover the debt, then debentures can be used for recovering the amount.

4. What is meant by ‘Issue of debentures for Consideration other than Cash’?

A company purchases any asset from its vendors or suppliers and issues debentures to them instead of paying in cash. This process is known as issue of debenture for consideration other than cash. It helps both the seller and purchaser as the seller gets interest on debentures issued and the purchaser do not need to arrange cash immediately. Debentures are issued at par, premium or at a discounted rate to the seller.

 

5. What is meant by ‘Issue of debenture at discount and redeemable at premium?

It may happen that due to challenging market conditions a company has to raise funds from market by issuing debenture below its par value and to attract investor interest has to offer redeemable value higher than its par value, this is termed as issue of debenture at discount and redeemable at premium. The difference that is generated due to such arrangement is treated as loss on issue of debenture.

6. What is ‘Capital Reserve’?

The reserve that is created from the capital profits is called as Capital Reserve, these are profits that is obtained from activities that are different than the normal business activities. Examples of such activities are: profit obtained from reissuing of debentures, premium on issue of share and debenture, profit redemption on debenture, profits obtained from sale of fixed asset etc. These can be used to issue bonus shares but cannot be used for paying dividend. The capital reserve is used to meet future capital losses.

7. What is meant by an ‘Irredeemable Debenture’?

Debentures that are not redeemable by a company during its life time are called irredeemable debentures. These debentures are only payable at the time of winding up of the company. Also called as perpetual debentures because of indefinite life span. These type of debentures are not issued in India.

8. What is a ‘Convertible Debenture’?

Debentures that can be converted to equity shares after a specified time is called as Convertible Debenture. The time at which it can be converted to equity shares is mentioned when the debentures are issued. There are two types:

1. Partly convertible debentures: In this only a part of debenture is eligible to be converted into equity shares.

2. Fully convertible debentures: In this all of the debenture can convert to equity shares.

9. What is meant by ‘Mortgaged Debentures’?

Debentures that are secured against the asset/assets of a company are called as Mortgaged debentures. These are also called as secure debentures. There are two types:

1. Fixed Charge: Debentures secured against a specific asset or the firm of the computer

2. Floating Charge: Debentures secured against all assets of a company

10. What is discount on issue of debentures?

Debentures which are issued at a value less than its face value (nominal value) is said to be issued at discount. There is no restriction on companies for issuing debentures on discount.

11. What is meant by ‘Premium on Redemption of Debentures’?

Debenture redeemed at premium refers to the situation where Debentures are redeemed at a price which is more than its face value or nominal value. The difference between the redeemed price and face value of debenture is regarded as a capital loss and hence needs to be written off. The premium obtained on redemption of debenture is shown on liabilities side of balance sheet.

12. How are debentures different from shares? Give two points.

 

13. Name the head under which ‘discount on issue of debentures’ appears in the Balance Sheet of a company.

Discount on issue of debentures is treated as a capital loss. As per the revised schedule VI of the Companies Act, it should be shown on the Asset side of balance sheet under “Miscellaneous Expenditures” heading until it is written off.

14. What is meant by redemption of debentures?

It refers to the repayment of debentures by the company to the debenture holders. In this process debenture holders get payment for the debentures they were issued and the repayment is made as per terms and conditions determined at the time of debenture issue. It may be redeemable at par, discount or premium. Redemption takes place from profits or from a fresh batch of debentures. Following methods are used in redeeming debentures:

1. By conversion into equity shares and new debentures

2. By annual drawing in instalments

3. By purchasing debentures in an open market

4. Lump sum payment on maturity date

5. Utilizing call or put option

15. Can the company purchase its own debentures?

Yes, it is possible if a company which is authorised by its Article of Association is able to purchase its own debentures. The debentures are purchased to serve the following purpose:

1. As a source of investment which can be sold at a higher price on a later date to earn more profit

2. To cancel debenture liabilities if the debenture rate is higher than the rate of interest in market.

16. What is meant by redemption of debentures by conversion?

The situation where a debenture holder is able to convert existing debentures into equity shares or new debentures after the expiry of the existing debentures time period is known as redemption of debentures by conversion.

17. How would you deal with ‘Premium on Redemption of Debentures’?

Debentures which are redeemed for a price which is more than its par value or nominal value is known as debentures redeemed at premium. The difference between the par value (face value) and the price at which it is redeemed is known as capital loss and this will be written off till debentures are redeemed. It is shown on the liabilities part of Balance Sheet till debentures are redeemed. The accounting treatment can be represented as:

18. What is meant by ‘Redemption out of Capital?

It refers to the condition when the debentures are redeemed from the capital without utilising the profits for redemption. Such a condition results in no profit being transferred to the Debenture Redemption Reserve, a reserve that needs to be created as debentures cannot be redeemed entirely from the capital. SEBI has issued guidelines for the redemption of debenture by creating Debenture Redemption reserve. However, there are some industries that are exempted from creating a reserve and they are:

1. Companies that issue debentures with maturity of 18 months

2. Companies involved in infrastructure sector like maintenance, construction, business development activities

19. What is meant by redemption of debentures by ‘Purchase in the Open Market’?

Redemption of debentures by purchase in open market refers to the condition when a company is authorised by its Article of Association to be able to purchase its own debentures. The debentures are purchased to serve the following purpose:

1. As a source of investment which can be sold at a higher price on a later date to earn more profit

2. To cancel debenture liabilities if the debenture rate is higher than the rate of interest in market.

20. Under which head is the ‘Debenture Redemption Reserve’ shown in the Balance Sheet?

The Debenture Redemption Reserve (DRR) is shown on balance sheet under header Reserves and Surplus as per the revised Schedule VI of the Company Act.

Long Questions for NCERT Accountancy Solutions Part 2 Class 12 Chapter 2

1. Explain the different types of debentures?

Debenture refers to a long term instrument that companies use to borrow money from the market. It is the acknowledgement of a debt that is taken by a company. There are many types of debentures based on the nature which are:

1. Based on tenure

i. Redeemable Debenture: Debentures that have a specific date of redemption that is mentioned on the certificate and the company is bound to pay the person/persons holding the debenture, the principal amount on that date.

ii. Perpetual/Irredeemable Debenture: Debentures that do not mention a specific date for redemption. The only way these can be redeemed is when the company is liquidated.

2. Based on Convertibility

i. Convertible Debenture: Those type of debentures that have the flexibility to convert into equity shares. The terms and conditions governing the conversion are clearly mentioned at the time of issue of debenture.

ii. Non-Convertible Debenture: These are debentures that do not have any special features and are not converted into equity shares.

3. Based on Security

i. Mortgage Debenture: A type of debenture that is backed by some asset or assets and such asset can be used to recover funds in case

ii. Naked Debenture: Debenture that is issued basing solely on the basis of credibility of the issuer.

4. Based on Priority

i. First Debenture: Also known as preferred debenture. These debentures are the first to be paid in case of winding up of a company.

ii. Second Debenture: These are ordinary debenture and are paid after the first debenture.

5. Based on registration:

i. Registered Debenture: Debentures that are registered with the age, name, address etc. are added and to the debenture.

ii. Bearer Debenture: These debenture are transferred by delivery to the new holder.

2. Distinguish between a debenture and a share. Why is debenture known as loan capital? Explain.

 

Debentures are also called as long term debts. A company issues debentures for getting funding for achieving growth in the long term. Interest needs to be paid on those loans. This interest is an expense for the business and is deducted as per applicable tax laws. Hence, debentures are known as loan capital.

3. Describe the meaning of ‘Debenture Issued as Collateral Securities’. What accounting treatment is given to the issue of debentures in the books of accounts?

Collateral security refers to an additional layer of security over and above the primary security. It is seen in case of company taking a loan from a financial institution, in such cases, company issues debentures which are additional security or collateral security. The money lender will not be receiving any interest on these debentures. In case the company defaults in making payment and the primary security is not sufficient to cover the debt, then debentures can be used for recovering the amount.

Treatment of Debentures:

Debentures when issued for the first time by a company are not active and to make it active an accounting entry is required to be passed

For creating accounting record Debenture Suspense A/C is debited and debenture account is credited. Debentures are represented in liabilities side and Debenture suspense A/c is shown on credit side. When the debt is paid off by the business debenture account is debited and debenture suspense account gets credited.

4. How is ‘Discount on Issue of Debentures’ treated in the books of accounts? How will you deal with the ‘discount in issue of debentures’ when the debentures are to be redeemed in instalments?

Debentures which are issued at a value less than its face value (nominal value) is said to be issued at discount. There is no restriction on companies for issuing debentures on discount.

The following treatment is done when discount is applied on issue of debentures

There are two methods that are applicable when debentures are redeemed in installments.

1. Fixed Installment Method: Also known as equal installment method. This method is used when debentures are redeemed in lump sum and after a specific time period. In this method an equal amount of discount or loss is written off till the debenture is not paid off. The formulae used to calculate the discount amount is given below

2. Variable Instalment Method: This method is also known as Fluctuating or Reducing Instalment Method or Proportion Method. In this method debentures are paid in annual drawings or instalments. The amount of discount that is written off every year should be in proportion to debentures that are outstanding at the beginning of each year. Therefore the amount of discount will vary each year, and it will be more in the initial years and will subsequently reduce at the end of redemption.

5. Explain the different terms for the issue of debentures with reference to their redemption.

Debentures can be issued in three ways: at par, premium and at discount while the debentures can be redeemed only at par and at premium. The following combinations can be discussed:

1. Issued at Par and Redeemable at Par: This is the condition when debentures are issued and redeemed at their par value or face value. The following entries can be seen

2. Issued at Premium and Redeemable at Par: A situation where debenture is issued at premium and is redeemable at par. Issuing debentures at premium is gain, so it is credited.

3. Issue at Discount and Redeemable at Par: The situation in which debenture is issued at a discount and is redeemable at par. Discount being a loss is recorded as a debit entry.

4. Issue at Par and Redeemable at Premium: Here the share is issued at par and is redeemable at premium. The following entries are recorded

5. Issued at Premium and Redemption at Premium: In this situation both the issue and redemption of the debenture is at premium. It will give rise to following entries

6. Issue of Discount and Redemption at Premium: When debentures are issued at discount and redeemable at premium. The following entries can be recorded

6. Differentiate between redemption of debentures out of capital and out of profits.

Redemption of Debentures Out of Capital

It refers to the condition when the debentures are redeemed from the capital without utilising the profits for redemption. Such a condition results in no profit being transferred to the Debenture Redemption Reserve, a reserve that needs to be created as debentures cannot be redeemed entirely from the capital. SEBI has issued guidelines for the redemption of debenture by creating Debenture Redemption reserve. However, there are some industries that are exempted from creating a reserve and they are:

1. Companies that issue debentures with maturity of 18 months

2. Companies involved in infrastructure sector like maintenance, construction, business development activities

Redemption of Debenture Out of Profits

Debentures when redeemed out of profit does not utilize capital for redemption. It is mandatory to create a DRR before redeeming debenture. This rule has been created by SEBI (Securities and Exchange Board of India) and as per that a company should transfer an amount equal to 50% of debentures issued, to DRR before redeeming the debentures. Profit gets transferred to DRR from Profit and Loss Appropriation Account. This reduces the total profit and therefore this process is called Redemption of Debenture out of profits. DRR is shown under Reserve and Surplus section of Liabilities part of balance sheet. After all debentures are redeemed a DRR account is closed by transferring it to general reserve.

7. Explain the guidelines of SEBI for creating Debenture Redemption Reserve.

These points need to be followed while creating Debenture Redemption Reserve (DRR):

1. DRR needs to be created for companies whose issue debenture with maturity of more than 18 months.

2. For partly convertible debentures, DRR needs to be created for non-convertible portion of debenture in the same way as is done for fully non-convertible debenture issue.

3. Company should create DRR equivalent to 50% of debenture issue before debenture redemption commences.

4. Withdrawal from DRR is permissible only after 10% on the debenture liability has been actually redeemed by the company.

As per SEBI’s guidelines the following type of companies will be exempted from creating DRR:

1. Company issuing debentures with a maturity up to 18 months.

2. Companies involved in infrastructure sector like maintenance, construction, business development activities

8. Describe the steps for creating Sinking Fund for redemption of debentures.

Following steps are involved:

1. Calculate the amount from profit that needs to be set aside every year with information obtained from Sinking Fund Table.

2. This amount that is set aside every year in Step 1 is transferred to a Debenture Redemption Fund (Sinking Fund) by debiting P & L Appropriation Account.

3. The instalment hence determined is invested to obtain amount essential for redeeming the debenture by debiting the DRF (Debenture Redemption Fund).

4. The interest on the amount thus invested will be received on bi-annual or annual basis.

5. The total investment which includes investment and the interest is re-invested in the following year.

6. Repeat the steps of transferring and investing till the last instalment which will be debited from P & L appropriation account.

7. The investment is sold off at the year of redemption

8. The profit/loss that is obtained from the sale of investment is transferred appropriately by debiting/crediting Debenture Redemption Fund (DRF) investment account to the DRF Account.

9. Payment is processed for the holders of debenture

10. The balance remaining, if any, from the DRF Account is transferred to the General Reserve.

9. Can a company purchase its own debentures in the open market? Explain.

Redemption of debentures by purchase in open market refers to the condition when a company is authorised by its Article of Association to be able to purchase its own debentures. The debentures are purchased to serve the following purpose:

1. As a source of investment which can be sold at a higher price on a later date to earn more profit

2. To cancel debenture liabilities if the debenture rate is higher than the rate of interest in market.

10. What is meant by conversion of debentures? Describe the method of such a conversion.

The situation where a debenture holder is able to convert existing debentures into equity shares or new debentures after the expiry of the existing debentures time period is known as redemption of debentures by conversion. The issue price of shares must be equal to or less than the amount that is received from debentures, this should be kept in mind by debenture holder when exercising the conversion option.

Debentures that can be converted to equity shares after a specified time is called as Convertible Debenture. The time at which it can be converted to equity shares is mentioned when the debentures are issued. There are two types:

1. Partly convertible debentures: In this only a part of debenture is eligible to be converted into equity shares.

2. Fully convertible debentures: In this all of the debenture can convert to equity shares.

Following treatment is provided for the conversion:

Numerical Questions for NCERT Accountancy Solutions Part 2 Class 12 Chapter 2

1. G.Ltd. issued 75, 00,000, 6% Debenture of ₹ 50 each at par payable ₹ 15 on application and ₹ 35 on allotment, redeemable at par after 7 years from the date of issue of debenture. Record necessary entries in the books of Company.

The solution for this question is as follows:

2. Y.Ltd. issued 2,000, 6% Debentures of ₹ 100 each payable as follows: ₹ 25 on application; ₹ 50 on allotment and ₹ 25 on First and Final call.

The solution for this question is as follows:

3. A Ltd. issued 10,000, 10% Debentures of ₹ 100 each at a premium of 5% payable as follows:

₹ 10 on Application;

₹ 20 along with premium on allotment and balance on First and Final call. Record necessary Journal Entries.

The solution for this question is as follows:

4. A. Ltd. issued 90,00,000, 9% Debenture of ₹ 50 each at a discount of 8%, redeemable at par any time after 9 years. Record necessary entries in the books of A. Ltd.

The solution for this question is as follows

5. A. Ltd. issued 4,000, 9% Debentures of ₹ 100 each on the following terms:

₹ 20 on Application;

₹ 20 on Allotment;

₹ 30 on First call; and

₹ 30 on Final call.

The public applied for 4,800 Debentures. Applications for 3,600 Debentures were accepted in full. Applications for 800 Debentures were allotted 400 Debentures and applications for 400 Debentures were rejected.

The solution for this question is as follows:

 

6. T. Ltd. offered 2,00,000, 8% debenture of ₹ 500 each on June 30, 2014 at a premium of 10% payable as ₹ 200 on application (including premium) and balance on allotment, redeemable at par after 8 years. But application are received for 3, 00,000 debentures and the allotment is made on pro-rata basis. All the money due on application and allotment is received. Record necessary entries regarding issue of debentures.

The solution for this question is as follows:

7. X.Ltd. invites application for the issue of 10,000, 14% debentures of ₹ 100 each payable as to ₹ 20 on application, ₹ 60 on allotment and the balance on call. The company receives applications for 13,500 debentures, out of which applications for 8,000 debentures are allotted in full, 5,000 only 40% and the remaining rejected. The surplus money on partially allotted applications is utilised towards allotment. All the sums due are duly received.

The solution for this question is as follows:

8. R.Ltd. offered 20, 00,000, and 10% Debenture of ₹ 200 each at a discount of 7% redeemable at premium of 8% after 9 years. Record necessary entries in the books of R. Ltd.

The solution for this question is as follows:

9. M.Ltd. took over assets of ₹ 9, 00, 00,000 and liabilities of ₹ 70, 00,000 of S.Ltd. and issued 8%Debenture of ₹ 100 each. Record necessary entries in the books of M. Ltd.

The solution for this question is as follows:

10. B.Ltd. purchased assets of the book value of ₹ 4, 00,000 and took over the liability of ₹ 50,000 from Mohan Bros. It was agreed that the purchase consideration, settled at ₹, 3, 80,000, be paid by issuing debentures of ₹ 100 each.

What Journal entries will be made in the following three cases, if debentures are issued: (a) at par; (b) at discount; (c) at premium of 10%? It was agreed that any fraction of debentures be paid in cash.

The solution for this question is as follows:

 

Case (a)

 

Case (b)

Case (c)

11. X.Ltd. purchased a Machinery from Y for an agreed purchase consideration of ₹ 4, 40,000 to be satisfied by the issue of 12% debentures of ₹ 100 each at a premium of ₹ 10 per debenture. Journalise the transactions.

The solution for this question is as follows

12. X.Ltd. issued 15,000, 10% debentures of ₹ 100 each. Give journal entries and the Balance Sheet in each of the following cases:

(i) The debentures are issued at a premium of 10%;

(ii) The debentures are issued at a discount of 5%;

(iii) The debentures are issued as a collateral security to bank against a loan of ₹ 12, 00,000; and

(iv) The debentures are issued to a supplier of machinery costing ₹ 13, 50,000.

The solution for this question is as follows:

(i)

ACCOUNT NOTES

(ii)

ACCOUNT NOTES

(iii) No entry will be passed for issuing debentures as a collateral security

ACCOUNT NOTES

Alternative Method

ACCOUNT NOTES

(iv)

ACCOUNT NOTES

13. Journalise the following:

(i) A debenture issued at ₹ 95, repayable at ₹ 100;

(ii) A debenture issued at ₹ 95, repayable at ₹ 105; and

(iii) A debenture issued at ₹ 100, repayable at ₹ 105;

The face value of debenture in each of the above cases is ₹ 100.

The solution for this question is as follows:

14. A.Ltd. Issued 50, 00,000, 8% Debenture of ₹ 100 at a discount of 6% on April 01, 2009 redeemable at premium of 4% by draw of lots as under:

20, 00,000 Debentures on March, 2011

10, 00,000 Debentures on March, 2013

20, 00,000 Debentures on March, 2014

Compute the amount of discount to be written-off in each year till debentures are paid. Also prepare discount/loss on issue of debenture account.

The solution for this question is as follows:

Loss on issue of debenture = 6% (discount on issue) + 4% (premium on redemption) = 10%

15. A company issues the following debentures:

(i) 10,000, 12% debentures of ₹ 100 each at par but redeemable at premium of 5% after 5 years;

(ii) 10,000, 12% debentures of ₹ 100 each at a discount of 10% but redeemable at par after 5 years;

(iii) 5,000, 12% debentures of ₹ 1,000 each at a premium of 5% but redeemable at par after 5 years;

(iv) 1,000, 12% debentures of ₹ 100 each issued to a supplier of machinery costing ₹ 95,000. The debentures are repayable after 5 years; and

(v) 300, 12% debentures of ₹ 100 each as a collateral security to a bank which has advanced a loan of ₹ 25,000 to the company for a period of 5 years.

Pass the journal entries to record the: (a) issue of debentures; and (b) repayment of debentures after the given period.

The solution for this question is as follows

 

a) Issue of Debentures

b) Repayment of Debentures

16. A company issued debentures of the face value of ₹ 5, 00,000 at a discount of 6% on April 01, 2012. These debentures are redeemable by annual drawings of ₹, 1, 00,000 made on March 31 each year. The directors decided to write off discount based on the debentures outstanding each year.

Calculate the amount of discount to be written-off each year. Give journal entries also.

The solution for this question is as follows

Assuming that the amount of discount on issue of debentures is to be written off in 5 years.

17. A company issued 10% Debentures of the face value of ₹, 1, 20,000 at a discount of 6% on April 01, 2011. The debentures are payable by annual drawings of ₹ 40,000 commencing from the end of third year.

How will you deal with discount on debentures?

Show the discount on debentures account in the company ledger for the period of duration of debentures. Assume accounts are closed on March 31 every year.

The solution for this question is as follows

i) Working Note:

Amount of Discount on Issue of Debenture:

18. B. Ltd. issued debentures at 94% for ₹ 4, 00,000 on April 01, 2011 repayable by five equal drawings of ₹ 80,000 each. The company prepares its final accounts on March 31 every year.

Indicate the amount of discount to be written-off every accounting year assuming that the company decides to write-off the debentures discount during the life of debentures. (Amount to be written-off: 2012 ₹ 8,000; 2013 ₹ 6,400; 2014 ₹ 4,800; 2015 ₹ 2,000; 2016 ₹ 1,600).

The solution for this question is as follows:

Amount of discount to written off every year

In 2012 = ₹8,000

In 2013 = ₹6,400

In 2014 = ₹4,800

In 2015 = ₹3,200

In 2016 = ₹1,600

​

Working Notes:

Important Note: As per NCERT textbook, ₹2,000 discount has been written off in the year 2015 which is incorrect because then the total discount amounts to ₹22,800. Therefore, it should be ₹3,200. 

 

19. B. Ltd. issued 1,000, 12% debentures of ₹ 100 each on April 01, 2014 at a discount of 5% redeemable at a premium of 10%.

Give journal entries relating to the issue of debentures and debentures interest for the period ending March 31, 2015 assuming that interest is paid half yearly on September 30 and March 31 and tax deducted at source is 10%.

The solution for this question is as follows

20. What journal entries will be made in the following cases when company redeems debentures at the expiry of period by serving the notice: (a) when debentures were issued at par with a condition to redeem them at premium; (b) when debentures were issued at premium with a condition to redeem that at par; and (c) when debentures were issued at discount with a condition to redeem them at premium?

The solution for this question is as follows:

Concepts covered in this chapter –

• Meaning and definition of debentures
• Difference between Shares and Debentures
• Types of debentures
• Issue of debentures
• Over subscription
• Interest on debentures
• Sinking fund method

Conclusion