Tag: Financial Statements

Management Notes

Issue of Debentures

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Company debenture is one of the important sources of finance for large companies, in addition to equity stocks, bank loans, and bonds. Companies need to follow certain procedures for issue of debentures to raise money. There are several ways of issuing a debenture viz. at a par, premium or discount and even for consideration other than cash.

Issue of Debentures

The procedure of issuing debentures by a company is similar to the one followed while issuing equity stocks. The company starts by releasing a prospectus declaring the debenture issuance. The interested investors, then, apply for the same. The company may need the entire amount while applying for the debentures or may ask for installments to be paid while submitting the application, on allotment of debentures or on various calls by the company. The company can issue debentures at a par, at a premium or at a discount as explained below.

Different ways for issuing of Debenture

Once the company invites the applications and the investors apply for the debentures, the company can issue debentures in one of the following ways:

Issue of Debenture at par

When the issue price of the debenture is equal to its face value, the debenture is said to be issued at par. When a debenture is issued at par, the long-term borrowings in the liabilities section of the balance sheet equals the cash in the assets side of the balance sheet. Thus, no further adjustment is required to balance the assets and the liabilities of the company. The company can collect the whole amount in one installment i.e on an application or in two installments i.e. on an application and subsequent allotment. However, there might be a scenario in which money is collected in more than two installments i.e. on an application, on an allotment and at various calls by the company.

Issue of debenture at discount

The debenture is said to be issued at a discount when the issue price is below its nominal value. Let us take an example – a Rs. 100 debenture is issued at Rs. 90, then Rs.10 is the discount amount. In such a scenario, the liabilities and the assets sides of the balance sheet do not match. Thus, the discount on debentures’ issuance is noted as a capital loss and is charged to ‘Securities Premium Account’ and is reflected as an asset. The discount can be written off later.

Issue of Debenture At Premium

When the price of the debenture is more than its nominal value, it is said to be issued at a premium. For example, a Rs. 100 debenture is issued for Rs.105 and Rs.5 is the premium amount. Again, assets and liabilities do not match in such situation. Therefore, the premium amount is credited to Securities Premium Account and is reflected under ‘Reserves and Surpluses’ on the liabilities side of the balance sheet.

The Issue of Debenture as Collateral

The debentures can be issued as a collateral security to the lenders. This happens when the lenders insist on additional assets as security in addition to the primary security. The additional assets may be used if the complete amount of loan cannot be realized from the sale of the primary security. Therefore, the companies tend to issue debentures to the lenders in addition to some other physical assets already pledged. The lenders may redeem or sell the debentures on the open market if the primary assets do not pay for the complete loan.

Issue of Debenture for Consideration Other Than Cash

Debentures can also be issued for consideration other than cash. Generally, companies follow this route with their vendors. So, instead of paying the cash for the assets purchased from the vendor, the companies issue debentures for consideration other than cash. In this case, also, the debentures can be issued at a par, premium or discount and are accounted for in the similar fashion.

Over Subscription

The company invites the investors to subscribe to its debenture issue. However, it may happen that the applications received for the debentures may be more than the original number of debentures offered. This scenario is referred to as oversubscription. In the case of over-subscription, a company cannot allocate more debentures than it had originally planned to issue. So, the company refunds the money to the applicants to whom debentures are not allotted. However, the excess money received from applicants who are allocated debentures is not refunded. The same money is used towards allotment adjustment and the subsequent calls to be made.

Management Notes

Valuation of Preference Shares

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Preference Shares are a type of share capital that provides shareholders a preferential right over equity shareholders in two key aspects: (1) Receiving dividends at a fixed rate before equity shareholders, and (2) Repayment of capital during winding up of the company. They usually do not carry voting rights, except in special cases. Preference shares may be cumulative, non-cumulative, redeemable, or convertible. They are considered a hybrid security, combining features of both equity and debt, offering stability to investors and flexible financing to companies.

Valuation of Preference Shares:

Valuation depends on whether preference shares are irredeemable or redeemable.

A. Irredeemable Preference Shares

  • These shares have no maturity date; holders get a fixed dividend forever.

  • Value is calculated as the present value of perpetual dividends.

Formula:

Value of Irredeemable Preference Share = Annual Preference Dividend / Required Rate of Return

B. Redeemable Preference Shares

  • These shares are repayable after a fixed period (say 5 or 10 years).

  • Value is based on the present value of dividends for n years plus present value of redemption value.

Formula:

Need of  Valuation of Preference Shares:

  • Investment Decision-Making

Valuation of preference shares helps investors decide whether to buy, hold, or sell such securities. Since preference shareholders receive fixed dividends and priority over equity shareholders, knowing the fair value ensures they do not overpay or undervalue their investment. By comparing the intrinsic value with the market price, investors can judge potential returns and risks. This process builds confidence in investment decisions, especially for risk-averse investors who prefer stable returns rather than uncertain equity dividends.

  • Corporate Financing Decisions

Companies issue preference shares as a source of capital, combining features of both debt and equity. Before issuing or redeeming such shares, firms must know their value to ensure cost-effective financing. Valuation helps management compare preference shares with other funding sources like debentures or equity. It also influences dividend payout policies and redemption strategies. Thus, correct valuation ensures balanced capital structure, reduces financing costs, and maintains investor trust, which is essential for smooth business operations and long-term sustainability.

  • Regulatory and Legal Requirements

Valuation of preference shares becomes necessary during mergers, acquisitions, liquidation, or restructuring of a company. Laws and accounting standards often require that shareholders, including preference shareholders, receive fair value for their holdings. Accurate valuation ensures compliance with statutory provisions and prevents disputes among stakeholders. It also helps in calculating compensation payable to preference shareholders when the company decides to redeem or convert their shares. Thus, valuation ensures transparency, fairness, and legal compliance in corporate financial transactions and governance.

  • Redemption and Conversion Decisions

Preference shares are often redeemable after a fixed period or convertible into equity shares. In both cases, valuation plays a vital role. For redemption, it helps determine the repayment amount and its impact on company finances. For conversion, valuation ensures fair exchange ratios between preference and equity shares, avoiding shareholder conflicts. This process safeguards the interests of both the company and investors. Therefore, proper valuation ensures smooth redemption or conversion, maintains fairness, and supports effective long-term financial planning.

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