Sunday, April 19, 2015

Issue and Redemption of Debentures

Issue and Redemption of Debentures
Meaning of Debentures
According to Sec. 2 (30) of the companies Act, 2013, debentures include “debenture stock, bonds and any other securities of a company evidencing a debt, whether constituting a charge on the assets of the company or not.
Debentures are debt instruments issued by a joint stock company. Amounts collected by way of debentures form part of the loan capital of a company. They are repayable after a fixed period. Debenture holders get interest on their debentures. They are creditors of the company. They do not get dividend. Only shareholders get dividend.
The characteristics of debentures can be summarised as follows:
a)      Debentures are debt instruments.
b)      They generally carry fixed rate of interest.
c)       They are normally repayable at the end of a fixed period. Repayment of debenture or cancellation of debenture liability in the books of the company is known as redemption of debentures.
d)      They can be issued at par, premium or at discount depending on the reputation of the company.
e)      They can either be placed privately or offered for public subscription.
f)       They may or may not be listed in the stock exchange.
g)      If offered for public subscription, they should be rated by a credit rating agency approved by SEBI, prior to listing.
h)      Interest is payable on debentures at a fixed rate irrespective of the profit earned by the business.

i)        Debentures may be issued with or without the security of assets of the company.
j)        In the event of winding up of the company the debenture holders are treated as creditors and given priority in repayment of their money.
k)      Debenture holders normally do not have representation in the Board of the company.

Debentures are classified as follows:
1. On the Basis of Repayment: Redeemable Debentures and Irredeemable or Perpetual Debentures.
 2. On the Basis of Transferability: Registered Debentures and Bearer Debentures.
 3. On the Basis of Security: Simple or Naked Debentures and Mortgage Debentures.
4. On the basis of Conversion: Convertible Debentures and Non Convertible Debentures.
5. On the Basis of Pre-Mature Redemption Rights: Debenture with “Call” option and Debenture with “Put” option.
6. On the Basis of Coupon Rate (interest rate): Fixed Rate Debentures, Floating rate Debentures and Zero Coupon Bonds.

Issue of Debentures as Collateral security and Its accounting Treatment
When debentures are issued as security in addition to any other security against a loan or bank overdraft such an issue of debentures is known as issue of debentures as collateral security. The use of such an issue is that if the company does not repay the loan and the interest and the main security is not sufficient, the bank will be entitled to sell the debentures in the market or the bank may keep the debentures with it. If the company repays the loan, the bank will return the debentures issued as collateral security to the company.
Debenture issued as Collateral security can be dealt in two ways:
First Method: No entry needs to be passed in the books of the company because debentures are issued only as a collateral security. Debentures become alive only when loan is not repaid. The fact of such an issue of debentures must be clearly stated in the Balance Sheet by way of a note under the loan and debentures as shown below:
Balance Sheet of --- Co. Ltd. As on---
Secured Loans
Bank Loan
(secured by issuing 6,000 12% Debentures of Rs. 100 each)

Second Method: Alternatively, the following entry may be passed in books of the company:
Bank A/c Dr.
        To Bank Loan A/c
(For loan borrowed from bank)
Debentures Suspense A/c Dr.
        To 12% Debentures A/c
(For 6,000 Debentures of Rs. 100 each issued as collateral security)
Balance Sheet of --- Co. Ltd. as on---
Secured Loans
Miscellaneous Expenditures
Bank Loan
Debentures Suspense A/c
12% Debentures
(6,000 12% Debentures of Rs. 100 each issued as collateral security)


Redemption of Debentures:
Meaning of Redemption
Redemption of debenture is the discharge of debenture liability. It can be done either by repaying the money to debenture holders or converting the debenture into shares. The conditions of redemption are clearly stated at the time of issue of debenture in the prospectus. Debentures can be redeemed at par, premium or discount as per the terms of issue. The period of maturity, redemption amount, yield on redemption etc. will be mentioned in the prospectus. In case the non convertible debentures proposed to be rolled over (repayment extended for an additional period), a compulsory option should be given to the debenture holders who wish to withdraw from the debenture programme, as per the guidelines issued by SEBI.
Sources of Funds for Redemption of Debentures
Redemption of debentures is an important commitment to be fulfilled by a joint stock company. Failure to redeem debentures will disqualify the directors of the company. Moreover, such a default will invite strict penalties and loss of reputation. As the redemption of debentures drains a large amount of resources, companies will make advance preparations to meet this need.
i. Redemption of Debentures - from the proceeds of fresh issue of share capital and debentures
ii. Redemption of Debentures - out of accumulated profits

i) Redemption In lump-sum, at the end of stipulated period: Under this method the entire debentures are redeemed at the stipulated date stated in the prospectus for the issue of debentures. The drawback of this method is that the company has to arrange a large amount at the time of redemption. Usually companies prepare well advance for the redemption of debentures.
ii) By Draw of Lots: Under this method the company does not redeem all the debentures at the same time. Instead it will call back only a portion of its debentures in the market for redemption each year. The company select the debentures of a predetermined value, by drawing lot and they are redeemed that year. This method of redemption reduces the burden of redemption. Planning is relatively easy and the impact of redemption on the finance of the company is limited.
iii) By Purchasing in the Open Market: Debentures can be redeemed by purchasing them from the open market. If a company finds its debentures are available in the open market at cheap rate it will purchase those debentures and cancel them.
iv) By Conversion into New Debentures or Shares: Conversion of debentures into shares is another method of redemption. When debentures are converted to shares, the company does not pay money to debenture holders. Instead the company issues share certificates in place of debentures. It may look good for the company because there is no need of cash payment. But the company is selling its shares. Selling shares is actually selling part of the ownership. Debenture holders become shareholders. Creditors become owners. It is better to pay off creditors rather than selling them part of the company. But sometimes company agree to give some shares to make the issue of debentures more attractive to buyers.
Debenture Redemption Reserve
The company shall create a Debenture Redemption Reserve for the purpose of redemption of debentures, in accordance with the conditions given below;
(a) The Debenture Redemption Reserve shall be created out of the profits of the company available for payment of dividend;
(b) The company shall create Debenture Redemption Reserve equivalent to at least 50% of the amount raised through the debenture issue before debenture redemption commences
(c) Every company required to create Debenture Redemption Reserve shall on or before the 30th day of April in each year, invest or deposit, as the case may be, a sum which shall not be less than 15%,of the amount of its debentures maturing during the year ending on the 31st day of March of the next year.
d) In case of partly convertible debentures, Debenture Redemption Reserve shall be created in respect of non-convertible portion of debenture issue in accordance with this sub-rule.
(e) The amount credited to the Debenture Redemption Reserve shall not be utilised by the company except for the purpose of redemption of debentures.

Meaning and Treatment of “Discount on Issue of Debenture” and “Loss on Issue of Debenture”
When debentures are issued at a price lower than its face value, then such debentures are said to be issued as “Debentures issued at a Discount”. Discount on issue of debentures is a Capital loss and is show in the Balance sheet on the Assets side under the head “Miscellaneous Expenditure” till it is written off.
When debentures are redeemable at a premium, the extra amount payable over and above the nominal value on redemption is called “Loss on Issue of Debenture”.  Again when debentures are issued at a discount, the discount on issue of debenture is also a loss on issue of debentures. Thus when debentures are issued at a discount and redeemable at a premium both the losses are amalgamated under the head “Loss on Issue of Debenture Account”. It is a Capital loss and is show in the Balance sheet on the Assets side under the head “Miscellaneous Expenditure” till it is written off.
The amount of debenture discount/Loss on issue of debenture can be written off in two ways:
1. All debentures are to be redeemed after a fixed period: When the debentures are to be redeemed after a fixed period, the amount of discount will be distributed equally within the number of years spreaded between the issue of debentures and their redemption. The amount of discount on issue of debentures to be written off each year is calculated as: Amount of discount to be written off annually = Amount of Discount / No of Years
2. Debentures are redeemed in instalments: Debentures may also be redeemed in instalments but over a fixed period. In that case the amount of debenture discount will be written off each year in proportion to the amount of debentures redeemed.
Journal Entry for Writing of Discount on issue of Debentures/Loss on issue of Debentures is:
Profit and Loss Account                 Dr.
To Discount on issue of Debentures Account
To Loss on Issue of Debentures Account

SEBI (Securities and Exchange Board of India) has issued several guidelines pertaining to issue of various kinds of debentures.
Section F: Under SEBI guidelines following points are laid down relating to issue of various kinds of debentures such as Fully Convertible, Partially Convertible and Non-convertible Debentures:
(a) Issue of FCD. (Fully Convertible Debenture) having a conversion period of more than 36 months will not be permissible, unless conversion is made optional with “put” and “call” option.
(b) Compulsory credit rating will be required if conversion is made for FCDs after 18 months.
(c) Premium amount on conversion and time of conversion shall be predetermined and stated in the prospectus. The interest rate of above mentioned debenture will be determined at the time of issue.
(d) Issues of debentures with maturity of 18 months or less are exempted from the requirement of appointment of debenture trustee or creating a Debentures Redemption Reserve (DRR). 
(e) Any conversion in part or whole of the debenture will be optional at the hands of the debenture holder, if the conversion takes place at or after 18 months from the date of allotment, but before 36 months.
(f) In case of NCDs/PCDc, credit rating is compulsory where maturity exceeds 18 months.
(g) Premium amount at the time of conversion for PCD (Partially Convertible Debenture) shall be pre-determined and stated in the prospectus. Maturity amount, period of redemption, on redemption for the PCDs/NCDs shall be indicated in the prospectus.
(h) In case, the non-convertible portion of PCD/NCD one to be rolled over with or without changes in the interest rate, a compulsory option should be given to those debenture holders who want to withdraw and encashed from the debenture programme.
(i) Before rollover of any NCDs or non-convertible portion of the PCDs, fresh credit rating shall be obtained within a period of six months prior to the due date of redemption and communicated to debenture holders before roll over and fresh trust deed shall be made.
(j) Letter of information regarding roll over shall be vetted by SEBI with regard to the credit rating debenture holder resolution, option for conversion and such other items which SEBI may prescribe from time to time.
(k) SEBI may prescribe additional disclosure requirement from time to time after due notice.