Redemption of Debentures 1 Redemption of debenture Redeemable

Redemption of Debentures 1

Redemption of debenture Redeemable debenture will be redeemed on or before a specified date which is stated clearly in the terms of the issue of debentures 2

In order to provide the funds to finance the redemption of debentures, the company may use the money from the following resources: (I) The balance of existing cash and bank account (II) The money received from the fresh issue of shares (III)or debentures for the purpose of the redemption 3

Debenture Redemption Reserve If the company is unable to redeem its debentures by issuing new shares to raise necessary funds, the company should create Debenture Redemption Reserve account for redeeming the debentures Equal to the cash used in redemption might be voluntarily transferred to a debenture redemption reserve fund from profit and loss account as a matter of financial prudence The debenture redemption reserve is then identified as not being available for dividend distribution The voluntary appropriation of profit to “Debenture Redemption Reserve” ensures that the resources of the company are not disadvantageously reduced 4

Premium on Redemption of Debentures Redeemed price of debentures - Par value of Debentures = Premium on Redemption An amount equals “Premium on Redemption” will be transferred from Share Premium account to Debenture Redemption account If it is not covered by Share Premium account, the balance will be transferred from Profit and Loss account 5

Discount on Redemption of Debentures Par value of Debentures - Redeemed price of debentures = Discount on Redemption An amount equals “Discount on Redemption” will be transferred from to Debenture Redemption account to Reserve or Profit and loss account 6

Redemption of Debentures without a Sinking Fund 7

Summary of Procedures Out of distributable profits Out of the proceeds of new issue 1. Declaration of redemption Dr. Debentures Cr. Debenture Redemption 2. Transfer of distributable profit to debenture redemption reserve Dr. Profit and Loss Appropriation Cr. Debenture Redemption Reserve 2. (a) New shares issued at premium Dr. Bank Cr. Share Capital Cr. Share Premium (b) Transfer to redemption reserve Dr. Profit and Loss Appropriation Cr. Debenture Redemption Reserve 8

Out of distributable profit/proceeds of new issue 3. Redemption at a premium a) if the debentures were originally issued at a premium Dr. Share/Debenture Premium Cr. Debenture Redemption b) if the debentures were not issued at a premium Dr. Profit and Loss Appropriation Cr. Debenture Redemption c) if the current balance of premium or the premium received on debentures originally issued is less than the premium on redemption Dr. Share/Debenture Premium Dr. Profit and Loss Appropriation Cr. Debenture Redemption 9

Out of distributable profit/proceeds of new issue 4. Redemption at a discount Dr. Debenture Redemption Cr. Debenture Redemption Reserve / General Reserve 5. Redemption of debentures Dr. Debenture Redemption Cr. Bank 10

Example 1 11

Example 1 $1, 000 debentures were redeemed at par A new issue of $1, 000 ordinary shares at par Dr. 1. Bank Ordinary Shares Being issue of ordinary shares 1000 2. Debentures Debenture Redemption Being declaration of redemption 1000 3. Debenture Redemption Bank Being redemption of debentures 1000 Cr. 1000 12

Example 2 $1, 000 debentures were redeemed at par with no new issue of shares Dr. 1. Debentures Debenture Redemption Being declaration of redemption 1000 2. Profit and Loss Appropriation Debenture Redemption Reserve Being transfer to debenture redemption reserve 1000 3. Debenture Redemption Bank Being redemption of debentures 1000 Cr. 1000 13

Example 3 $1, 000 debentures were redeemed at par Redemption was partly provided for out of the proceeds of a new issue of 800 ordinary shares at par Dr. 1. 2. Bank Ordinary Shares Being issue of ordinary shares 2. Profit and Loss Appropriation Debenture Redemption Reserve Cr. 800 200 Being transfer to debenture redemption reserve 3. Debentures Debenture Redemption Being declaration of redemption 4. Debenture Redemption Bank Being redemption of debentures 1000 14

Example 4 $1, 000 debentures were redeemed at a premium of 20% with no new issue of shares Dr. 1. Debentures Debenture Redemption Being declaration of redemption 2. Profit and Loss Appropriation Debenture Redemption Reserve Cr. 800 1000 Being transfer to debenture redemption reserve 3. Profit and Loss Appropriation Debenture Redemption Being premium on redemption 200 4. Debenture Redemption Bank Being redemption of debentures 1200 15

Example 5 Case 1 16

Example 5 $1, 000 debentures, issued at a premium of 5% Redeemed at a premium of 20% Case 1: 1, 200 $1 ordinary shares at par These balances may not be the same, as some funds may have been used up in the bonus issue and redemption Balance before new issue Premium on new issue Balance after new issue Less: Amount transferred to the redemption account (should be the lower of the balance after the new issue or the original premium on the issue) Balance after redemption 1000*5%=50 Case 1 $ 10 10 10 17

Dr. Debentures Debenture Redemption Being redemption of debentures 1000 Bank Ordinary Share 1200 Being issue of ordinary shares Share Premium Profit and loss Debenture Redemption (1000*20%) Being premium on redemption Debenture Redemption Bank (1000*1. 2) Being amount paid on redemption Cr. 1000 1200 10 190 200 1200 18

Example 5 Case 2 19

Example 5 $1, 000 debentures, issued at a premium of 5% Redeemed at a premium of 20% Case 2: 1, 000 $1 ordinary shares at a 10% premium These balances may not be the same, as some funds may have been used up in the bonus issue Case 2 and redemption $ Balance before new issue Premium on new issue Balance after new issue Less: Amount transferred to the redemption account (should be the lower of the balance after the new issue or the original premium on the issue) Balance after redemption 50 100 150 1000*0. 1 50 1000*5%=50 20

Dr. Debentures Debenture Redemption Being redemption of debentures Bank Ordinary Share Premium (1000*0. 1) Being issue of ordinary shares Share Premium Profit & Loss Appropriation Debenture Redemption Cr. 1000 1100 100 50 150 200 Being premium on redemption Debenture Redemption Bank Being amount paid on redemption 1200 21

Example 5 Case 3 22

Example 5 $1, 000 debentures, issued at a premium of 5% Redeemed at a premium of 20% Case 3: 800 $1 ordinary shares at a 20% premium These balances may not be the same, as some funds may have been used up in the bonus issue Case 3 and redemption $ Balance before new issue Premium on new issue Balance after new issue Less: Amount transferred to the redemption account (should be the lower of the balance after the new issue or the original premium on the issue) Balance after redemption 50 60 210 800*0. 2 50 160 1000*5%=50 23

Dr. Debentures Debenture Redemption Being redemption of debentures Bank Ordinary Share Premium Being issue of ordinary shares Profit & Loss Appropriation (1000 -800*1. 2) Debenture Redemption Res. Being part of redemption not covered by new issue Share Premium Profit & Loss Appropriation Debenture Redemption Being premium on redemption Debenture Redemption Bank Being amount paid on redemption Cr. 1000 960 800 160 40 40 50 150 200 1200 24

Redemption of Debenture by a Sinking Fund 25

Descriptions Book-keeping Entries Set aside an annual appropriation to the Sinking Fund. The same amount out of cash or bank will be invested in a specific investment under ‘Sinking Fund Investment Account’ to provide sufficient funds for the debenture redemption. Dr. Profit and Loss Account Cr. Sinking Fund Any interest or dividend income received from Sinking Fund Investment Dr. Sinking Fund Cash/Bank Cr. Sinking Fund Dr. Sinking Fund Cash/Bank Cr. Cash/Bank Dr. Sinking Fund Investment Cr. Sinking Fund Cash/Bank Re-investment of income received Dr. Sinking Fund Investment (except in the last few months Cr. Sinking Fund Cash before the redemption) 26

Descriptions Book-keeping Entries Disposal of Sinking Fund Investment Dr. Sinking Fund Cash/Bank Cr. Sinking Fund Investment Profit on disposal of Sinking Fund Investment or Dr. Sinking Fund Investment Cr. Sinking Fund Loss on disposal of Sinking Fund Investment Dr. Sinking Fund Cr. Sinking Fund Investment Transfer the amount of Debentures to be redeemed to Debenture Redemption Account Dr. Debentures Cr. Debenture Redemption Payment on Debenture Redemption Dr. Debenture Redemption Cr. Sinking Fund Cash/Bank 27

Descriptions Premium on Redemption “Profit on Redemption” will be transferred from Redemption Account to “Sinking Fund Account” OR Discount on Redemption “Loss on Redemption” will be transferred from Redemption Account to “Sinking Fund Account” Book-keeping Entries Dr. Debenture Redemption Cr. Sinking Fund. Dr. Sinking Fund Cr. Debenture Redemption Transfer of the nominal value of Dr. Sinking Fund the debentures redeemed at every Cr. Debenture Redemption Reserve redemption and the balance of the OR sinking fund at the final General Capital Reserve redemption to the general reserve 28

Example 29

Pacific Ltd. Issued $1, 000 12% debentures at par on 1 January 1987. These were redeemable at a premium of 10% on 31 December 1997. A sinking fund account was Created by the annual appropriation of profits. Investments were made to provide Cash to redeem the debentures. All investment income must be reinvested, except for The final year of redemption. The following balances were extracted from the books at 1 January 1997: 12% Debentures Sinking Fund Investment Sinking Fund Cash 1, 000 800, 000 100, 000 During 1997, the following transactions took place: Jan 1 Investment income of $10, 000 was received Jan 30 Six month’s interest was paid on the debentures July 1 Investment costing $400, 000 was sold for $450, 000 to provide funds for the redemption of some debentures. The company redeemed $400, 000 debentures at a discount of 5% Dec 1 All remaining investments were sold for $600, 000 Dec 31 The remaining debentures were redeemed at a premium of 10% and the outstanding interest was paid. 30

Sinking Fund Cash Jan 1 Bal b/f 100, 000 July 1 Jan 1 Sinking Fund 10, 000 July 1 Sinking Fund Invest. Dec 31 ment 450, 000 Dec 1 Sinking Fund Investment 600, 000 July 1 12% Debentures Debenture Redempt. Jan. 1 ion 400, 000 Dec 31 Debenture Redemption (400000*0. 95) 380, 000 Debenture Redemption (1600000*1. 1) 660, 000 Bal b/f 1, 000 600, 000 1, 000, 000 31

Sinking Fund July 1 General Reserve 400, 000 Jan 1 (par value) Dec 31 Debenture Redemption 60, 000 July 1 (discount) July 1 Dec 31 General Reserve 620, 000 Dec 1 Bal. B/f 800, 000 Sinking Fund Cash 10, 000 Sinking Fund Investment 50, 000 (profit) Debenture Redemption 20, 000 ( premium) Sinking Fund Investment 200, 000 1, 080, 000 Sinking Fund Investment July 1 Bal b/f July 1 Sinking Fund: profit on sales (450000 -400000) Dec 1 Sinking fund: profit on sales (660000 -400000) 800000 July 1 Sinking fund cash Dec 1 Sinking fund cash 450000 600000 50000 200000 11050000 32

Debenture Redemption July 1 Sinking fund cash July 1 Sinking fund: profit 380000 July 1 12% Debenture 20000 400000 Dec 31 Sinking fund cash 660000 400000 Dec 31 12% Debenture Dec 31 Sinking fund: discount 600000 660000 Debenture interest June 30 Bank (1000000*12%*1/2) Dec 31 Bank (600000*12%*1/2) 60000 Dec 31 Profit and loss 96000 36000 96000 33