CORPORATE ACCOUNTING DEBENTURES ISSUE OF DEBENTURES REDEMPTION OF

CORPORATE ACCOUNTING DEBENTURES � � � ISSUE OF DEBENTURES REDEMPTION OF DEBENTURES UNDERWRTING

What is a Debenture? Meaning : Debenture is an ‘instrument’ in writing for a ‘fixed period’ given by a company acknowledging the liability for total amount received as a result of issue of debenture and agreeing thereby to pay the money raised after the expiry of stipulated period at a certain rate of interest. � Need for issue of debentures : A company for its extension & development may require to raise funds without increasing its share capital so, a may invite the public by open declaration to lend money for a fixed period at a ‘declared rate’ to be paid on such money. �

� In law, a debenture is a document that either creates a debt or acknowledges it. In corporate finance, the term is used for a medium- to longterm debt instrument used by large companies to borrow money. In some countries the term is used interchangeably with bond, loan, stock or note. � Debentures are generally freely transferable by the debenture holder. Debenture holders have no rights to vote in the company's general meetings of shareholders, but they may have separate meetings or votes e. g. on changes to the rights attached to the debentures. The interest paid to them is a charge against profit in the company's financial statements.

Types of Debentures Debenture can be classified as under: 1. � � � From security point of view: - Secured or Mortgage debentures : These are the debentures that are secured by a charge on the assets of the company. These are also called mortgage debentures. The holder’s secured debentures have the right to recover their principal amount with unpaid amount of interest on such debentures out of the asset s mortgaged by the company. In India, debentures must be secured.

Secured debentures can be of two types : � (a) First mortgage debentures : The holders of such deb entures have a first claim on the assets charged. � b) Second mortgage debentures : The holders of such debentures have a second claim on the assets charged. ii. Unsecured debentures: Debentures which do not carry a ny security with regard to the principal amount or unpaid interest are called unsecured debentures. These are called simple debentures. 2) On the basis of redemption: (i) Redeemable debentures : These are the debentures which are issued for a fixed period. The principal amount of such debe nture is paid off to the debenture holders on the expiry of such period. These can be redeemed by annual drawings or by purchas i.

� � � ii) Non-redeemable debentures : These are the debentures which are not redeemed in the life time of the company. Such debentures are paid back only when the company goes into liquidation. On the basis of Records i) Registered debentures: These are the debentures that are registered with the company. The amount of such debentures is payable only to those debenture holders whose name appears in the register of the company. ii) Bearer debentures : These are the debentures which are not recorded in a register of the company. Such debenture s are transferrable merely by delivery. Holder of these debentures is entitled to get the interest

� � � On the basis of convertibility i) Convertible debentures : These are the debenture s that can be converted into shares of the company on the expiry of pre-decided period. The term and conditions of conversion are generally announced at the time of issue of debentures. Nonconvertible debentures : The debenture holders of su ch debentures cannot convert their debentures into shares of the company On the basis of priority First debentures : These debentures are redeemed before other debentures. Second debentures : These debentures are redeemed after the redemption of first debentures

ISSUE OF DEBENTURES � � � By issuing debentures means issue of a certificate by the comp any under its seal which is an acknowledgment of debt taken by the company. The procedure of issue of debentures by a company is similar to that of the issue of shares. A Prospectus is issued, applications are invited, and letters of allotment are issued. On rejection of applications, application money is refunded. In case of partial allotment, excess application money may be Issue of Debenture takes various forms which are as under adjusted towards subsequent calls. Debentures issued for cash Debentures issued for consideration other than cash Debentures issued as collateral security: Further, debentures may be issued

� OVER SUBSCRIPTION Company if receives applications for number of debentures that exceed the number of debentures offered for subscription, it is called over subscription. There can be following treatment of the excess application money received : � (a) The total amount of excess number of applications is refunded in case the applications are totally rejected. � (b) The amount of excess application money is totally adjusted towards amount due on allotment and calls --- in case partial allotment is made, --- the excess amount is adjusted towards sums due on allotment and rest of the � amount is refunded. �

ØISSUE OF DEBENTURES AT PREMIUM AND AT DISCOUNT Debentures are said to be issued at premium when these are issued at a value which is more than their nominal value. For example, a debenture of Rs 100 is issued at Rs 110. This excess amount o f Rs 10 is the amount of premium. The premium on the issue of debentures is credited to the Securities Premium A/c as per section 78 of the Companies Act, 1956. ØISSUE OF DEBENTURES AT DISCOUNT When debentures are issued at less than their nominal value they are said to be issued at discount. For example, debenture of Rs 100 each is issued at Rs 90 per debenture. Companies Act, 1956 has not laid down any conditions for the issue of debentures at a discount as have been laid down in case of issue of shares at discount. However, there should be provision for issue of such debentures in the Articles of Association of the Company.

ISSUE OF DEBENTURES FOR CONSIDERATION OTHER THAN CASH When a company purchases some assets and issues debentures as a payment for the purchase, to the vendors it is known as issue of debentures for consideration other than cash. Debentures can be issued to vendors at par, at premium and at discount

� � ISSUE OF DEBENTURES AS COLLATERAL SECURITY Collateral security means security given in addition to the principal security. It is a subsidiary or secondary security. Whenever a company takes loan from bank or any financial institution it may issue its debentures as secondary security which is in addition to the principal security. Such an issue of debentures is known as ‘issue of debentures as collateral security’. The lender will have a right over such debentures only when company fails to pay the loan amount and the principal security is exhausted. In case the need to exercise this right does not arise debentures will be returned back to the company. No interest is paid on the debentures issued as collateral security because company pays interest on loan.

In the accounting books of the company issue of debentures as collateral security can be credited in two ways. (i) No journal entry to be made in the books of accounts of the company : Debentures are issued as collateral security. A note of this fact is given on the liability side of the balance sheet under the heading Secured Loans and Advances. (ii) Entry to be made in the books of account the company A journal entry is made on the issue of debentures as a collateral security, Debentures suspense A/c is debited because no cash is received for such issue.

Accounting treatment of debentures � � A – Issue of Debenture ‘at Par’ When company receives application money of debentures 1 st journal Entry Bank account Debit Debenture Application Account Credit � 2 nd Journal Entry When company accepts the applications Debenture Application Account Debit Debenture Account Credit � 3 rd Journal Entry When Allotment money of debenture due Debenture Allotment Account Debit Debenture Account Credit

� 4 th Journal Entry When Allotment money of debenture received Bank Account Debit Debenture Allotment Account Credit � 5 th Journal Entry When Call money of debenture is payable Debenture Calls Account Debit Debenture Account Credit � 6 th Journal Entry When Call money of debenture is received Bank Account Debit Debenture Calls Account Credit

B- When Company issue of debenture ‘at premium’ If premium is receivable with application money 1 st Journal Entry When amount of application received with premium Bank Account Debit Debenture Application account Credit

� 2 nd Journal Entry Debenture Application Account Debit Debenture Account Credit Security premium Account credit If premium receivable on allotment then Debenture Allotment account debit Debenture Account Credit Security Premium Account Credit And allotment money received with premium Bank account Debit Debenture Allotment Account Credit When Debenture Issued At discount Debenture Allotment Account Debit Discount on Issue of Debenture Account Debit Debenture Allotment Account Credit When discounted amount of debenture is received Bank Account Debit Debenture Allotment Account Credit

� Illustration : � On July 1, 2007 sports Ltd. , issued 10, 000, 12 percent debentures of Rs. 10 each at 95 per cent, repayable on June 30, 2013 at par. Rs. 6 per debenture was payable on application and the balance on allotment. Interest was payable on full nominal amount as from september 1, 2007. � Applications were received for 15000 debentures. All allotments were made proportionately , over subscriptions being applied to the balance due on allotment, which took place on August 31, 2007. All sums due on allotment were received by September 14, 2007. Assuming that the discount is to be written off evenly over the whole period, you are required to draft journal entries to record : (a) the issue of debentures , and (b) the charges to profit and loss account for the year ended June 30, 2008.

PARTICULARS BANK A/C L. F DEBIT 90, 000 TO DEBENTURES APPLICATION A/C DEBENTURE APPLICATION A/C 90, 000 TO DEBENTURE A/C TO DEBENTURE ALLOTMENT A/C DISCOUNT ON DEBENTURES A/C 60, 000 35, 000 TO DEBENTURES A/C BANK A/C TO DEBENTURE ALLOTMENT CREDIT 40, 000 5, 000

PARTICULARS PROFIT AND LOSS A/C L. F DEBIT 500 TO DISCOUNT ON ISSUE OF DEBENTURES PROFIT AND LOSS A/C TO INTEREST ON DEBENTURES A/C CREDIT 500 10, 000

UNDERWRITING Underwriting is an agreement, entered into by a company with a financial agency, in order to ensure that the public will subscribe for the entire issue of shares or debentures made by the company. The financial agency is known as the underwriter and it agrees to buy that part of the company issues which are not subscribed to by the public in consideration of a specified underwriting commission.

UNDERWRITING AGREEMENT The underwriting agreement, among others, must provide for the period during which the agreement is in force, the amount of underwriting obligations, the period within which the underwriter has to subscribe to the issue after being intimated by the issuer, the amount of commission and details of arrangements, if any, made by the underwriter for fulfilling the underwriting obligations. The underwriting commission may not exceed 5 percent on shares and 2. 5 percent in case of debentures. Underwriters get their commission irrespective of whether they have to buy a single security or not.

BENEFITS OF UNDERWRITING Underwriting has become very important in recent years with the growth of the corporate sector. It provides several benefits to a company: - ØIt relieves the company of the risk and uncertainty of marketing the securities. ØUnderwriters have an intimate and specialised knowledge of the capital market. They offer valuable advice to the issuing company in the preparation of the prospectus, time of floatation and the price of securities, etc. They also provide publicity service to the companies which have entered into underwriting agreements with them.

ØIt helps in financing of new enterprises and in the expansion of the existing projects. ØIt builds up investors' confidence in the issue of securities. The association of well-known underwriters lends prestige to the company and the investors feel that the issue is sound enough for profitable investment. Also, the securities underwritten by reputed underwriters receive better response from the public. ØThe issuing company is assured of the availability of funds. Important projects are not delayed for want of funds. ØIt facilitates the geographical dispersal of securities because generally, the underwriters maintain contacts with investors throughout the country.

TYPES OF UNDERWRITINGS � � COMPLETE UNDERWRITING: If the whole issue of debentures of a company is underwritten, it is called complete underwriting. In such a case the whole issue is underwritten either by an individual/ institution agreeing to take the entire risk or by a number of firms or institutions each agreeing to take the risk to a limited extent. PARTIAL UNDERWRITING: If part of issue of debentures of a company is underwritten, it is said to be partial underwriting. In such a case the part of the issue is underwritten either by an individual/ institution or by a number of firms or institutions each agreeing to take risk to a limited extent.

ØSyndicate Underwriting: - is one in which, two or more agencies or underwriters jointly underwrite an issue of securities. Such an arrangement is entered into when the total issue is beyond the resources of one underwriter or when he does not want to block up large amount of funds in one issue. ØSub-Underwriting: - is one in which an underwriter gets a part of the issue further underwritten by another agency. This is done to diffuse the risk involved in underwriting. The name of every under-writer is mentioned in the prospectus along with the amount of securities underwritten by him.

ØFirm Underwriting: - is one in which the underwriters apply for a block of securities. Under it, the underwriters agree to take up and pay for this block of securities as ordinary subscribers in addition to their commitment as underwriters. The underwriter need not take up the whole of the securities underwritten by him. For example, if the underwriter has underwritten the entire issue of 5 lakh shares offered by a company and has in addition applied for 1 lakh shares for firm allotment. If the public subscribes to the entire issue, the underwriter would be allotted 1 lakh shares even though he is not required to take up any of the shares.

TYPES OF UNDERWRITERS Underwriting of capital issues has become very popular due to the development of the capital market and special financial institutions. The lead taken by public financial institutions has encouraged banks, insurance companies and stock brokers to underwrite on a regular basis. The various types of underwriters differ in their approach and attitude towards underwriting: - ØDevelopment banks like IFCI, ICICI and IDBI: - they follow an entirely objective approach. They stress upon the long-term viability of the enterprise rather than immediate profitability of the capital issue. They attempt to encourage public response to new issues of securities.

ØInstitutional investors like LIC and AXIS: - their underwriting policy is governed by their investment policy. ØFinancial and development corporations: - they also follow an objective policy while underwriting capital issues. ØInvestment and insurance companies and stockbrokers: - they put primary emphasis on the short term prospects of the issuing company as they cannot afford to block large amount of money for long periods of time.

To act as an underwriter, a certificate of registration must be obtained from Securities and Exchange Board of India (SEBI). The certificate is granted by SEBI under the Securities and Exchanges Board of India (Underwriters) Regulations, 1993. These regulations deal primarily with issues such as registration, capital adequacy, obligation and responsibilities of the underwriters. Under it, an underwriter is required to enter into a valid agreement with the issuer entity and the said agreement among other things should define the allocation of duties and responsibilities between him and the issuer entity. These regulations have ben further amended by the Securities and Exchange Board of India (Underwriters) (Amendment) Regulations, 2006.

MARKED APPLICATION Marked application is the term which is used in underwriting of debentures. Marked application means all those application which is received by company and a mark will show on each application which identify a specific underwriter's sale. Suppose, A has sell XYZ's company's 20000 share applications. Now, when company gets 20, 000 share applications, it application will show A's identity. So, A underwriter's liability will deduct with 20000 shares. ( It is assumed that each shareholder send one application for buying one share).

If company has also contracted with B underwriter and he underwrote 10, 000 shares and company receives the application of 5000 shares in which mark shows the identity that it was sold by B. So, B underwriter's liability will decrease with 5000 shares. So, mark on application or marked application is very important for calculating the net liability of underwriter.

UNMARKED APPLICATION In underwriting of debentures Unmarked application is totally opposite of marked application. In these applications, there is no any sign which shows the identity of any specific underwriter who has sold it. So, all these application's no. of shares are totalled by company and for reducing the liability of each underwriter, these total unmarked application shares are distributed among all the underwriters in their gross liability ratio and then deduct from gross liability of each underwriter. You can study the statement preparation for calculating the net liability of underwriter.

ACCOUNTING TREATMENT In the books of company, you will pass following journal entries. 1. When company gets money from public for selling shares under the contract of underwriting. Bank account Dr. XXXX Share capital Account Cr. XXXX 2. When underwriter takes the liability of unsold shares Underwriter's account Dr. XXXX Share Capital Account Cr. XXXX

3. When underwriting commission will due Underwriting Commission Account Dr. XXXX Underwriter's Account Cr. XXXX 4. When Underwriter deduct his commission and send net amount of takeover shares Bank Account Dr. XXXX Underwriter Account ( Total receivable amount on takeover shares by underwriter - Underwriter's commission) Cr. XXXX

UNDERWRITING ACCOUNT Underwriting account is important account which is made by underwriter for calculating the net profit or loss from underwriting business. In this account’s debit side, he shows all his expenses relating to underwriting and in the credit side of this account, he shows his underwriting and sub underwriting commission and any other profit from underwriting business. Net difference between debit and credit of underwriting account will be his profit or loss which will be shown as balancing figure.

UNDERWRITING COMMISSION Underwriting commission is payment which is given by company to underwriters for their services of underwriting. Actually, contract of underwriting is same as the contract of insurance. Company gives maximum 5% commission to underwriter for selling his shares. Underwriter will take the risk of takeover the shares which will not be subscribed by public.

ØThe underwriting commission is paid only in accordance with the Section 76 of the Companies Act, 1956. The statutory regulations and other obligations regarding the commission are: -The underwriting commission should be paid only with the acceptance of the article of association of the company ·The underwriting commission should be paid in accordance with the rules and regulations as prescribed by the Government.

In case of shares, the amount or rate of commission which is not offered to the public should be disclosed in the statement in lieu of prospectus. ·The number of underwriters and their proposition should be indicated in the statement. ·An underwriting agreement copy should be submitted to the Registrar of Companies at the time of delivery of the prospectus.

The Central Government has prescribed the following rates of underwriting commission: P/S On Amounts in developing on the underwriter On amounts subscribed by the Public 2. 5% (a) Equality shares b) Preference shares/convertible and nonconvertible debentures For amounts upto Rs. 5 lakhs 2. 5% For amount in excess of Rs. 5 lakhs 2% 1. 5% 1%

LIABILTY OF UNDERWRITERS For calculating underwriter's net liability, you have to understand marked application, unmarked application and firm underwriting. STEPS: ØFirst of all we deduct all unmarked application of shareholders because with this liability of underwriters will decrease. ØThen, you will deduct all marked application of shareholders because with this liability of underwriters will also decrease. ØThen, you will deduct all the number of shares which will be taken under firm underwriting contract. .

ØNow balance amount will show the number of shares which will be taken under the contract. If there is any negative number, then these will be adjusted with other underwriters in gross liability ratio. ØAfter this adjustment, balance number will show as net liability of underwriters.

EXAMPLE 1 � A company issues 50, 000 shares of Rs. 10 each at par. The whole issue has been underwritten by X & Co. for a commission of 4%. The company received applications only for 47, 000 shares. All the applications were accepted. Give the journal entries to record the above transactions.

PARTICULARS BANK A/C …DR L. F DEBIT 4, 70, 000 TO DEBEBTURES A/C X & CO. A/C …DR 4, 70, 000 30, 000 TO DEBENTURES A/C COMMISSION ON ISSUE OF DEBENTURES A/C . . DR TO X & CO. A/C CREDIT 30, 000 20, 000

PARTICULARS BANK A/C …. DR TO X & CO. L. F DEBIT CREDIT 10, 000

EXAMPLE 2 A ltd. Issued 1, 000 equity shares. The whole of the issue was underwritten as follows; X – 40%; Y – 30%; Z – 30% Applications for 80, 000 shares were received in all, out of which applications for 20, 000 shares had the stamp of X, those for 10, 000 shares that of Y, and 20, 000 shares that of Z. the remaining applications for 30, 000 shares did not bear any stamp. Show the liability of the underwriter

SOLUTION PARTICULARS GROSS LIABILTY LESS: MARKED APPLICATIONS LESS: MAEKED APPLICATIONS ( IN THE RATIO OF GROSS LIABILITIES ; 40: 30 ) NET LIABILTY X 40% SHARES Y 30% SHARES Z 30% TOTAL 100% SHARES 40, 000 20, 000 30, 000 10, 000 30, 000 20, 000 1, 000 50, 000 20, 000 10, 000 50, 000 12, 000 9, 000 30, 000 8, 000 1, 000 20, 000 11, 000