1. Issue of Debentures

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Meaning and Definition

Meaning: The issue of debentures is the process by which a company offers debt instruments to investors to raise long-term capital.

Definitions:

Accounting Perspective: A document issued by a company acknowledging a debt, containing terms regarding repayment and interest rates.
Financial Perspective: A long-term debt instrument representing a contractual obligation to pay interest and principal.

Modes of Issue

Companies use different methods to issue debt depending on their needs:

A. Based on Price Relationship

At Par: Issue Price = Face Value.
At Premium: Issue Price > Face Value (Extra amount is "Securities Premium").
At Discount: Issue Price < Face Value (Difference is "Discount on Issue").

B. Other Modes

Consideration other than Cash: Issuing debentures to vendors in exchange for assets like machinery or land.
Collateral Security: Issuing debentures as a "secondary" guarantee to a bank to secure a primary loan.

Summary Table: Modes of Issue

Method	Price vs. Face Value	Impact on Company
At Par	Price = Face Value	No extra gain or loss
At Premium	Price > Face Value	Increases Securities Premium Account
At Discount	Price < Face Value	Creates a loss/discount to be written off
Other than Cash	N/A	Acquires assets without using cash
Collateral Security	N/A	Provides extra security for bank loans

Note: To follow the principle of Prudence, any loss from discounts must be "written off" using Securities Premium or General Reserves.

2. Redemption of Debentures

Redemption refers to the repayment of the principal amount and closing the debt obligation.

📘 Learn the Methods of Redemption

Methods of Repayment

Redemption by Payment: Paying the amount due (either at Par or at a promised Premium).
Redemption by Conversion: Converting debt into new equity shares (saves cash).
Redemption by Purchase in Open Market: Buying back debentures from the stock exchange (can lead to profit).
Redemption by Own Debentures: Direct buy-back from holders.
Sinking Fund Method: Setting aside annual profits into a dedicated fund to ensure liquidity for repayment.

Comparison of Redemption Methods

Method	Primary Resource Used	Benefit
By Payment	Cash/Bank	Simple and direct
By Conversion	Equity Shares	Saves cash; increases capital
Open Market	Cash/Market Price	Potential for profit if price is low
Sinking Fund	Accumulated Profits	Ensures liquidity and prevents crisis

3. Numerical Problems

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Problem 1: Issue at Discount

XYZ Ltd. issued 1,000, 10-year debentures of 100 Rupees each at a discount of 5 percent. Pass the journal entries.

1. When money is received:
Bank A/c ............................ Dr. 95,000
   To Debenture Application & Allotment A/c ...... 95,000

2. When debentures are allotted:
Debenture Application & Allotment A/c ... Dr. 95,000
Discount on Issue of Debentures A/c ... Dr. 5,000
   To 10% Debentures A/c ......................... 1,00,000

Problem 2: Sinking Fund Calculation

A company wants to redeem 5,00,000 Rupees of debentures after 5 years. They deposit 80,000 Rupees at the end of each year with 10% annual interest. Calculate the fund value at the end of Year 2.

* End of Year 1:
Deposit: 80,000 | Interest: 0 | Total: 80,000

* End of Year 2:
Opening Balance: 80,000
Interest (10% of 80,000): 8,000
New Deposit: 80,000
Total Fund at end of Year 2: 1,68,000 Rupees

4. Case Study: Nexus Manufacturing Ltd.

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Nexus Manufacturing Ltd. wanted to expand its production in 2020 by investing 50,00,000 Rupees. To avoid diluting ownership, they issued 5,000, 9% debentures of 1,000 Rupees each at a 5% discount.

To secure a bank loan for working capital, they used debentures as collateral security. To prepare for 2025 redemption, they adopted the Sinking Fund Method, transferring 15,00,000 Rupees annually into government bonds.

In 2024, they noticed market prices dropped to 920 Rupees, so they performed a Purchase in Open Market to reduce debt cost. This strategic approach ensured financial stability during expansion.

Multiple Choice Questions

📝 Practice MCQs

When debentures are issued at a premium, the premium is credited to:
A) General Reserve | B) Securities Premium Account | C) Profit and Loss Account | D) Capital Reserve
Answer: B
Debentures are ________ of a company:
A) Owners | B) Creditors | C) Assets | D) Shareholders
Answer: B
Issue of debentures as collateral security means:
A) Issuing for cash | B) Secondary guarantee for a loan | C) Issuing to buy assets | D) None
Answer: B
Redemption by conversion means:
A) Paying cash | B) Buying from market | C) Converting debt into equity | D) Canceling debentures
Answer: C
A Sinking Fund is used for:
A) Increasing profits | B) Paying dividends | C) Gradually accumulating funds for redemption | D) Buying machinery
Answer: C

Exam-Oriented Questions with Answers

📊 Important Questions

Q: Distinguish between Issue at Par and Issue at Premium.
A: At Par means issue price equals face value. At Premium means issue price is higher, creating a surplus in Securities Premium Account.
Q: What is the purpose of a Sinking Fund?
A: To ensure sufficient liquid cash is available for redemption, preventing sudden financial crises.
Q: Why is "Discount on Issue of Debentures" written off?
A: To comply with the prudence principle, ensuring profits are not overstated by ignoring the immediate loss.
Q: Explain "Redemption by Conversion".
A: It is a method where debt is exchanged for equity shares, saving the company from immediate cash outflow.

Revision Notes & Memory Tricks

⚡ Quick Revision

Modes of Issue (P.D.P): Par (Equal), Discount (Lower), Premium (Higher).
Debenture vs. Share: Debenture = Lender (Interest); Share = Owner (Dividend).
Collateral Security: The "Backup" guarantee for a bank loan.
Redemption: The process of paying back the debt.

Mnemonic for Redemption Methods: "Please Convert Our Stock Soon"
(Payment, Conversion, Open Market, Sinking Fund, Self-purchase/Own Debentures)