The Companies Act, 1956 does not lay down any stringent guidelines or conditions for the redemption of debentures. Regardless, this debt instrument is invariably redeemable, and the process is usually carried out as per the terms stated in a prospectus formulated during issuance.
Typically, such terms need to be in compliance with the issuing company. Nevertheless, to carry it out successfully, investors must avail more information on the matter and should not limit it to just redemption of debentures meaning.
Following is an in-depth look into this concept that can help shed light on how debentures are redeemed.
What is Redemption of Debentures?
Typically, it can be described as the process of repaying debentures issued by a company to its debenture holders. In other words, it is the process of repaying the principal amount to debenture holders.
It is a noteworthy transaction for most companies as the amount required for redemption is quite substantial.
Once debentures are redeemed, the issuing company discharges its share of liability and takes it out from the balance sheet. Resultantly, businesses build a robust provision out of their gains and accumulate capital for reclaiming debentures.
Typically, the terms of redemption are stated in the debenture certificate. Notably, the approach behind redemption of debentures can be understood by glancing at these following pointers –
- Debentures can either be redeemed at premium or par.
- Redemption signifies – repaying the number of debentures to debenture holders.
- All terms and conditions accompanying redemption are mentioned in a company’s prospectus that initiates an invite for issuance of debentures.
Methods of Redemption of Debentures
Various companies may opt for different methods of redemption of debentures. These following are some popular ways of doing so –
1. Lump-sum payment on a prefixed date
This one-time method is considered to be among the simplest redeeming options. As per this method, debenture holders receive the promised sum on the prefixed date.
If the debentures are not redeemed at discount or premium, the lump sum amount, calculated by the summation of the principal value of all debentures, is paid out on the prefixed or maturity date that is mentioned on debenture agreement. The issuing company may decide to pay off the debenture amount before its maturity. Since companies know in advance, when they have to pay off for debenture, they are better positioned to streamline it.
The accounting treatment of redemption of debentures in this method is given below –
| S.N. | Particulars | Amount (Rs.) | Amount (Rs.) |
| 1. | Bank A/C (Dr) To Debenture Redemption Investment A/C (investment sold) | xxxx | xxxx |
| 2. | Profit and Loss Appropriation A/C (Dr) To Debenture Redemption A/C (Being amount of profit transferred) | xxxx | xxxx |
| Debenture Redemption Fund A/C (Dr) To General Reserve A/C To Capital Reserve A/C (Profit on sale of investment) | xxxxx | xxxx |
2. Payment in annual instalment
This method is considered similar to the redeeming process of a term loan. As per this method, companies pay a portion of a debenture’s principal each year to holders until its maturity date. The total liability is divided by the number of investment years, and the outcome is paid off each year.
3. Debenture redemption reserve
This is also known as the sinking fund. Essentially, it is a reserve that is built by accumulating at least 25% of the face value of debenture every year until its maturity. The main objective of this reserve is to protect the interest of debenture holders. According to the Indian Companies Act, 1956, companies that issue debentures need to create this reserve before the maturity date of a specific debenture.
4. Call and put option
Some companies issue debentures with both calls and put options for redemption. Typically, the call option enables companies to purchase their debenture either before or on the maturity date at a predetermined price. On the other hand, in the put option, debenture holders avail the right to sell the debenture back to the company at an agreed price, either before or on the maturity date.
5. Conversion into shares
This particular method is directed towards convertible debentures. Such debentures come with a clause that enables holders to convert their units into company’s ordinary equity shares. It is at that point of conversion that the total liability of debentures is discharged.
6. Buy from the open market
Companies can also purchase debentures from an open market if their units are being traded on a regulated exchange. It will save them from the hassle of being subject to administrative documentation. Furthermore, often debentures are traded at a discount in the market. In turn, it allows individuals to lower redemption payout and helps retain more revenue.
Its accounting treatment is shown in a tabular format below –
a) When purchased for a premium
| S.N. | Particulars | Amount (Rs.) | Amount (Rs.) |
| 1. | Debenture A/c (Dr) Loss on Redemption A/C (Dr) To Bank A/c | xxxx xxxx | |
| 2. | Profit & Loss A/c (Dr) To Loss on Redemption A/c | xxxx | xxxx |
b) When purchased at a discount
| S.N. | Particulars | Amount (Rs.) | Amount (Rs.) |
| 1. | Debenture A/C (Dr) To Profit on Redemption A/C (Dr) To Bank A/C | xxxx xxxx | xxxx |
| 2. | Profit on Redemption A/C (Dr) To Capital Reserve A/c | xxxx | xxxx |
Regardless, before proceeding with the redemption of debentures, both investors and issuers must weigh in the pros and cons of redeeming them in the prevailing market condition. Also, one should be clear about their purpose of redeeming these debt-instruments and research extensively on their prospect.
