by Redemption of Debentures refers to the process of repaying the principal amount to debenture holders upon maturity, as per the terms of issue. It signifies the discharge of a company’s long-term debt liability. Companies must plan for redemption carefully to avoid a significant cash outflow and ensure compliance with legal provisions, primarily the Companies Act, 2013.
Method of Redemption of Debentures
1. Lump Sum Payment Method (Payment at Maturity)
Under this method, all debentures are redeemed at once on a fixed date as stated in the terms of issue. The company repays the entire amount of debentures in a single payment either at par, premium, or discount. This method is simple and commonly used when the company has sufficient financial resources or a specific fund is created for repayment. Until the redemption date, interest continues to be paid on the outstanding debentures. The company must make proper arrangements to ensure funds are available at maturity. Accounting entries involve transferring the debenture liability to the Debentureholders’ Account and then settling it in cash. This method ensures quick settlement but may put pressure on cash resources at the time of redemption.
Example:
Company issued ₹1,00,000 10% debentures redeemable at par after 5 years.
Journal Entries:
| Date | Particulars | Debit (₹) | Credit (₹) |
|---|---|---|---|
| On Redemption | Debentures A/c Dr. | 1,00,000 | – |
| – | To Debenture holders A/c | – | 1,00,000 |
| (Being debentures due for redemption) | – | – | – |
| On Payment | Debenture holders A/c Dr. | 1,00,000 | – |
| – | To Bank A/c | – | 1,00,000 |
| (Being amount paid to debenture holders) | – | – | – |
2. Draw of Lots Method (Installment Method)
In this method, debentures are redeemed gradually in installments over a number of years by drawing lots. Each year, a portion of debentures is selected for redemption, and the holders of those debentures receive payment. This process continues until all debentures are fully redeemed. The method helps reduce the financial burden on the company since payment is spread over several years. It is suitable for large debenture issues. A Debenture Redemption Reserve (DRR) or Sinking Fund is often maintained to ensure sufficient funds are available annually. The company must maintain proper records of which debentures are redeemed to avoid confusion. This method provides financial flexibility and maintains liquidity while fulfilling redemption obligations gradually.
Example:
Out of ₹1,00,000 debentures, ₹20,000 are redeemed each year.
Journal Entries (for one year):
| Date | Particulars | Debit (₹) | Credit (₹) |
|---|---|---|---|
| On Redemption | Debentures A/c Dr. | 20,000 | – |
| – | To Debenture holders A/c | – | 20,000 |
| (Being debentures due for redemption by draw) | – | – | – |
| On Payment | Debenture holders A/c Dr. | 20,000 | – |
| – | To Bank A/c | – | 20,000 |
| (Being payment made to debenture holders) | – | – | – |
3. Purchase in the Open Market Method
In this method, a company redeems its debentures by purchasing them in the open market when they are available at a favorable price. Debentures may be bought back either at par, premium, or discount depending on market conditions. This method is advantageous when debentures are traded below their face value, allowing the company to save money on redemption. The purchased debentures are then canceled immediately after acquisition. The company must ensure compliance with the terms of issue and relevant legal provisions before repurchase. This method provides flexibility and helps manage debt efficiently. It also enhances the company’s financial image by reducing liabilities and may improve profitability by lowering future interest expenses.
Example:
Company repurchases ₹30,000 debentures for ₹28,000.
Journal Entries:
| Date | Particulars | Debit (₹) | Credit (₹) |
|---|---|---|---|
| On Purchase | Debentures A/c Dr. | 30,000 | – |
| – | To Bank A/c | – | 28,000 |
| – | To Profit on Redemption of Debentures A/c | – | 2,000 |
| (Being own debentures purchased at a discount and canceled) | – | – | – |
(If purchased at a premium, the difference is recorded as Loss on Redemption of Debentures.)
4. Redemption by Conversion Method
Under the conversion method, debenture holders are offered the option to convert their debentures into new shares or fresh debentures of another class instead of receiving cash payment. The conversion may be at par, premium, or discount as per the agreement. This method conserves the company’s cash resources since no immediate cash outflow occurs. It is often used when the company wants to strengthen its equity base or restructure its capital. Conversion terms must be clearly stated in the debenture agreement. The debentures converted are canceled, and new securities are issued in exchange. This method benefits both parties—the company saves cash, and investors may gain ownership benefits or better returns through the new securities.
Example:
₹1,00,000 10% debentures converted into 10,000 equity shares of ₹10 each.
Journal Entries:
| Date | Particulars | Debit (₹) | Credit (₹) |
|---|---|---|---|
| On Conversion | Debentures A/c Dr. | 1,00,000 | – |
| – | To Equity Share Capital A/c | – | 1,00,000 |
| (Being debentures converted into equity shares as per agreement) | – | – | – |
(If converted into new debentures, credit “New Debentures A/c” instead of “Equity Share Capital A/c.”)
5. Sinking Fund Method (Debenture Redemption Fund)
The Sinking Fund Method involves setting aside a fixed amount every year from profits to a special fund called the Debenture Redemption Fund. This amount is invested in safe securities, and the accumulated fund (plus interest) is used to redeem debentures at maturity. It ensures that the company has adequate funds for repayment without straining cash resources at once. This method is systematic and ideal for long-term debenture issues. The investments are sold at the time of redemption, and proceeds are used to pay debenture holders. Accounting entries include annual transfer to the Sinking Fund and recording interest income. This method enhances financial discipline and ensures timely redemption, safeguarding the company’s credit reputation.
Example:
Company creates a Sinking Fund and invests ₹20,000 annually. At maturity, investments worth ₹1,00,000 are sold, and debentures are redeemed.
Journal Entries:
| Date | Particulars | Debit (₹) | Credit (₹) |
|---|---|---|---|
| Every Year | Profit & Loss Appropriation A/c Dr. | 20,000 | |
| – | To Sinking Fund A/c | 20,000 | |
| (Being annual transfer to sinking fund) | – | – | – |
| On Investment | Sinking Fund Investment A/c Dr. | 20,000 | – |
| – | To Bank A/c | – | 20,000 |
| (Being investment made out of sinking fund) | – | – | – |
| On Sale of Investments | Bank A/c Dr. | 1,00,000 | |
| – | To Sinking Fund Investment A/c | – | 1,00,000 |
| (Being investment sold for redemption) | – | – | – |
| On Redemption | Debentures A/c Dr. | 1,00,000 | – |
| – | To Debentureholders A/c | – | 1,00,000 |
| On Payment | Debentureholders A/c Dr. | 1,00,000 | – |
| – | To Bank A/c | – | 1,00,000 |
| (Being redemption of debentures completed) | – | – | – |
6. Insurance Policy Method
In the insurance policy method, the company ensures the availability of funds for redemption by taking an endowment insurance policy equal to the value of debentures to be redeemed. The company pays annual premium to the insurance company for a fixed number of years. These premiums are treated as an investment and are shown as an asset in the balance sheet under the head “Insurance Policy Account.” No separate outside investments are required because the insurance company undertakes the responsibility of paying the maturity amount.
On the maturity date, the insurance company pays the sum assured to the company. The amount received is deposited in the bank and used for repayment of debentures. The difference between the total premium paid and the amount received is transferred to Profit and Loss Account. This method gives certainty and safety because funds are guaranteed at the time of redemption. It is suitable for companies that want a secure arrangement and do not wish to manage investments in securities on their own.
