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Redemption of Debentures

Redemption of Debentures. 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. In order to provide the funds to finance the redemption of debentures, the company may use

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Redemption of Debentures

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  1. Redemption of Debentures

  2. 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

  3. 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 • The money received from the fresh issue of shares • or debentures for the purpose of the redemption

  4. 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

  5. Premium on Redemption of Debentures • 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 Par value of Debentures Premium on Redemption Redeemed price of debentures - =

  6. 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

  7. Redemption of Debentures without a Sinking Fund

  8. Summary of Procedures

  9. Example 1

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

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

  12. 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. Cr. • Bank 800 • Ordinary Shares 800 Being issue of ordinary shares 2. Profit and Loss Appropriation 200 Debenture Redemption Reserve 200 Being transfer to debenture redemption reserve 3. Debentures 1000 Debenture Redemption 1000 Being declaration of redemption 4. Debenture Redemption 1000 Bank 1000 Being redemption of debentures

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

  14. Example 5 Case 1

  15. 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 Case 1 $ 10 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 - 10 10 - 1000*5%=50

  16. Dr. Cr. Debentures 1000 Debenture Redemption 1000 Being redemption of debentures Bank 1200 Ordinary Share 1200 Being issue of ordinary shares Share Premium 10 Profit and loss 190 Debenture Redemption (1000*20%) 200 Being premium on redemption Debenture Redemption 1200 Bank (1000*1.2) 1200 Being amount paid on redemption

  17. Example 5 Case 2

  18. 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 and redemption Case 2 $ 50 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*0.1 100 150 50 100 1000*5%=50

  19. Dr. Cr. Debentures 1000 Debenture Redemption 1000 Being redemption of debentures Bank 1100 Ordinary Share 1000 Share Premium (1000*0.1) 100 Being issue of ordinary shares Share Premium 50 Profit & Loss Appropriation 150 Debenture Redemption 200 Being premium on redemption Debenture Redemption 1200 Bank 1200 Being amount paid on redemption

  20. Example 5 Case 3

  21. 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 and redemption Case 3 $ 50 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 60 210 800*0.2 50 160 1000*5%=50

  22. Dr. Cr. Debentures 1000 Debenture Redemption 1000 Being redemption of debentures Bank 960 Ordinary Share 800 Share Premium 160 Being issue of ordinary shares Profit & Loss Appropriation (1000-800*1.2) 40 Debenture Redemption Res. 40 Being part of redemption not covered by new issue Share Premium 50 Profit & Loss Appropriation 150 Debenture Redemption 200 Being premium on redemption Debenture Redemption 1200 Bank 1200 Being amount paid on redemption

  23. Redemption of Debenture by a Sinking Fund

  24. Example

  25. Pacific Ltd. Issued $1,000,000 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 1,000,000 Sinking Fund 800,000 Sinking Fund Investment 800,000 Sinking Fund Cash 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.

  26. Sinking Fund Cash July 1 Debenture Redemption 380,000 (400000*0.95) Jan 1 Bal b/f 100,000 Jan 1 Sinking Fund 10,000 July 1 Sinking Fund Invest- ment 450,000 Dec 31 Debenture Redemption 660,000 (1600000*1.1) Dec 1 Sinking Fund Invest- ment 600,000 12% Debentures July 1 Debenture Redempt. ion 400,000 Jan. 1 Bal b/f 1,000,000 Dec 31 Debenture Redempt- ion 600,000 1,000,000 1,000,000

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

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

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