Forfeiture Of Debentures
Company Accounts

Normally total face value of debenture is demanded by company in one stroke. If it is collected in installments i.e. Debenture Application, Debenture Allotment and Debentures Calls accounts there prevails every possibility that some of the debenture-holders will fail to pay the installment amount when demanded for by company. Such unpaid calls (installments) are called 'Calls in arrears'. Now, under the provisions of Companies Act, 1956 debentures cannot be forfeited by company because according to section 122 of the Companies Act 1956 debentures is a contract with a company to take up and pay for any debentures of the company may be enforced by a decree for specific performance. For the realization of calls in arrears on debentures the company can only file a suit in the court of law and can charge interest on calls-in-arrears as provided in the prospectus.

Also sometimes, few debenture-holders pay call money in advance before they are demanded by company. In such cases the amount received is credited to calls in advance account. If provided in prospectus, the company also pays interest on this amount to debenture-holders at a specified rate. Interest is always calculated for the period, the advance has been received.

Redemption of Debentures:

Simply, redemption of debentures means repayment of the amount of debentures at maturity by the company. Redemption of debentures refers to the process of discharging the liability on account of debentures in accordance with the terms of issue. There are four ways by which the debentures can be redeemed.

A Company requires large amount of money for the redemption of the debenture. Although there are no legal restrictions regarding the sources of funds to be used by the company for the redemption of debentures, the different terms of issue specified at the time of issue of debentures restrict the company's freedom about the sources to be used by it for the redemption of debentures.

These are:

  1. Payment in lump sum
  2. Payment in installments
  3. Purchase in the open market
  4. By conversion into shares or new debentures.
Redemption of Debentures And Payment Made In Lump Sum:

The company redeems the debentures by paying the amount in lump sum to the debenture holders at the maturity thereof as per the terms of issue.

Journal Entries For Redemption By Payment In Lump Sum:

When the company pays the whole amount in lump sum and when no sinking fund is maintained, it is said to be wise (not mandatory) to transfer an amount equal to the nominal value of debentures redeemed from Profit and Loss A/c to General Reserve. As a result of such transfer, profit to the extent of this amount will not be available for distribution as dividend and thus the working capital depleted as a result of redemption of debentures will be replenished. The following, journal entries are generally passed in the books of the company:

1. If The Debentures Are To Be Redeemed At Par:

(a) Debentures A/c ----------------Dr.

          To Debenture Redemption A/c

(Being the amount payable on redemption of debentures)

(b) Debenture Redemption A/c ----------Dr.

          To Bank A/c

(Being the amount paid on redemption of debentures)

2. If The Debentures Are To Be Redeemed At Premium:

(a) Debentures A/c ---------------Dr.

Profit And Loss Appropriation A/c -------Dr.

          To Debenture Redemption A/c

(Being the amount payable with premium on redemption of debentures)

(b) Debenture Redemption A/c -----------Dr.

          To Bank A/c

(Being the amount due to debenture holders on redemption paid off)

3. For Transfer To General Reserve:

Profit And Loss Appropriation A/c ---Dr.

          To General Reserve A/c

(Being equal to the face value of debentures redeemed)

Redemption of Debentures And Payment Made In Installments:

Under this method, the redemption of debentures is normally made in installments on the specified date during the tenure of the debentures. The total amount of liability on account of debenture liability is divided by the number of years.

Journal Entries For Redemption By Payment In Installments On Redemption of Debentures:

When the debentures are to be redeemed in installments, the redemption is to be made either out of profits or out of capital.

The following journal entries will be passed:

1. If Redeemed Out Of Profits:

(a) Profit And Loss Appropriation A/c--------Dr.

          To Debenture Redemption Reserve A/c

(Being the amount payable on redemption of debentures)

(b) Debentures A/C -------------Dr.

          To Debenture Redemption A/c

(Being the amount payable on redemption of debentures)

(c) Debenture Redemption A/c -------------Dr.

          To Bank A/c

(Being the amount paid on redemption of debentures)

2. If Redeemed Out Of Capital:

(A) Debentures A/C -------------Dr.

          To Debenture Redemption A/c

(Being the amount payable on redemption of debentures)

(B) Debenture Redemption A/c -------------Dr.

          To Bank A/c

(Being the amount payable on redemption of debentures)

Redemption of Debentures By Purchase In Open Market:

The process of purchasing its own debentures by the company for the purpose of cancelling the debentures is called redemption of debentures by purchase in the open market. The basic advantage is that a company can redeem the debentures at its convenience whenever it has surplus funds. Secondly, the company can purchase them when they are available in market at a discount.

When the debentures are cancelled by purchasing them from the market at a discount, the following journal entries passed:

1. On Purchase Of Our Debentures For Immediate Cancellation:

Debentures Stock A/c-------------Dr.

          To Bank A/c

          To General Reserve A/c

(Being purchase and cancellation of debentures made and the profit on cancellation transferred to General Reserve)

2. On Transfer Of Profit On Redemption:

When debentures are purchased from the market at a price below the nominal value of debentures, it is treated as profit and the amount of profit is credited to General Reserve Account.

The following journal entry will be passed:

Profit And Loss Appropriation A/c-----Dr.

          To General Reserve A/c

(Being the amount equal to the cost of debentures cancelled transferred)

In case, the debentures are purchased from the market at a price above the nominal value of debenture, the excess will be considered as loss and will be debited to General Reserve Account.

The following journal entry will be passed:

1. Debentures A/c------------Dr.

General Reserve A/c------Dr.

          To Bank A/c

(Being purchase and cancellation of debentures made and the loss on cancellation borne from General Reserve)

2. General Reserve A/c -----------Dr.

          To Profit and Loss Appropriation A/c

(Being the amount equal to the loss of debentures cancelled transferred)

Redemption of Debentures By Conversion Into Shares Or New Debentures:

A company also has the option of redeeming its debentures by converting them into shares or new class of debentures. If debenture holders find that the offer is beneficial to them, they can exercise their right of converting their debentures into shares or new class of debentures. These new shares or debentures can be issued at par, at a discount or at a premium.

Here it is to be noted that while converting the debentures into shares the actual receivables or proceeds of debentures are to be taken into account for ascertaining the number of shares to be issued. If debentures were originally issued at discount, the actual amount realized from them at the time of issue is to be considered for computing the actual number of shares to be issued.

It is also to be noted that this method is applicable only to convertible debentures.

Redemption of Debentures With Sinking Fund Method:

Sinking Fund is a fund created outside the business by investing the required amount in easily marketable securities so that it may be easily converted into cash when required. The interest received on such investment is also reinvested in the same manner. This is done to meet the requirements for redemption of debentures at the end of a specified time period.

The required amount or the amount of installment or annual contribution is calculated by referring to on Sinking Fund Table based upon the rate of return on investments and the number of years for which investments are made. The amount ascertained is then transferred from profits every year to Sinking Fund and its investment is termed as Sinking Fund Investment.

The sinking fund method is used for redemption of debentures by payment in lump sum on maturity, and the journal passed from year to year are as follows.

1. At The End Of First Year:

(a) For Annual Contribution:

Profit And Loss Appropriation A/c ------Dr.

          To Sinking Fund A/c

(Being the amount of profit to Sinking Fund Account)

(B) For Investing The Amount Annual Contribution:

Sinking Fund Investment A/C -------------Dr.

          To Bank A/c

(Being the amount of investment made)

2. At The End Of Subsequent Years:

(A) For Receipt Of Interest On Sinking Fund Investments:

Bank A/C --------Dr.

          To Interest On Sinking Fund Investment A/c

(Being the amount of interest received)

(B) For Transfer Of Interest:

Interest On Sinking Fund Investment A/C ------Dr.

          To Sinking Fund A/c

(Being the amount of interest transferred)

(C) For Annual Contribution to Sinking Fund A/c:

Profit And Loss Appropriation A/c ---------Dr.

          To Sinking Fund A/c

(Being the amount of contribution made to Sinking Fund A/c)

(D) For Investments Of The Annual Contribution And Interest:

Sinking Fund Investment A/C ------Dr.

          To Bank A/c

(Being the amount of investment made from Sinking Fund A/c)

3. At The End Of Last Year:

(a) For Encashment Of Sinking Fund Investments:

Bank A/C --------Dr.

          To Sinking Fund Investment A/c

(Being the actual amount realized on sale of investment)

(b) For Transferring Profit/Loss On sale of Investment:

In Case Of Profit:

Sinking Fund Investment A/C ----------Dr.

          To Sinking Fund A/c

(Being profit on sale of investment transferred)

In Case Of Loss:

Sinking Fund A/C --------Dr.

          To Sinking Fund Investment A/c

(Being loss on sale of investment transferred)

(c) For Amount Due To Debenture Holders On Redemption:

Debenture A/C --------Dr.

          To Debenture Redemption A/c

(Being the amount due on redemption of debentures)

(d) For Redemption Of Debentures:

Debentures Redemption A/C ---------------------Dr.

      To Bank A/c

(Being debentures redeemed)

(e) For Transfer Of Sinking Fund Account Balance To General Reserve:

Sinking Fund A/C --------Dr.

      To General Reserve A/c

(Being the balance of sinking fund transferred)

Here it is to be noted that when debentures are to redeemed at premium, Sinking Fund should be created in such a way that both the principal amount along with interest therein can be paid off out of this fund at the time of redemption.

Accounting entries at the time of redemption of debentures with premium will be:

1. For Amount Payable On Redemption:

Debentures A/c------------------------Dr.

Sinking Fund A/c ----------------------Dr.

          To Debenture Redemption A/c

(Being the amount due on redemption of debentures along with premium)

2. For Making Payment:

Debenture Redemption A/c ----------Dr.

          To Bank A/c

(Being the amount paid on redemption of debentures along with premium)