What is redemption of debenture ? Discuss the various methods of redemption of debenture.

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What is redemption of debenture ? Discuss the various methods of redemption of debenture.

 Meaning- The repayment of the amount of debentures to the debenture holders is referred to as redemption of debentures.  It denotes the principal amount as well as the interest due to debenture holders.  In other words, it refers to the discharge of debenture liability in accordance with the terms of issuance.

Journal entries at the time of redemption of debentures: 

Redemption of Debentures at Par 

(a) Debentures A/C                                                         Dr 
                To Debentureholders’ A/C
(Being debentures due for redemption) 


(b) Debentureholders’A/C                                             Dr 
                   To Bank A/C 
(Being amount paid on redemption) 


Redemption of Debentures at Premium 
(a)   Debentures A/C                                                        Dr 
        Premium on Redemption of Debentures A/C         Dr 
                    To Debentureholders’A/C 
(Being debentures due for redemption at premium)


 (b) Debentureholders’A/C Dr 
                    To Bank A/C
(Being amount paid on redemption)

Methods of Redemption of Debenture-

1. Redemption out of profits- The redemption of debentures from profits entails transferring to DRR an amount equal to the face value of the debentures redeemed. As a result, a portion of the company's profits are withheld from distribution to shareholders.

Accounting entries in this case are as follows:

The debenture redemption reserve account is shown on the balance sheet's liabilities side. With each redemption, the balance in the Debenture Redemption Reserve a/c grows. When all debentures have been redeemed, the DRR is closed by transferring the remaining balance to general reserve.

2. Redemption out of capital- Under this method, the company may sell some fixed assets and use the proceeds to redeem debentures. It is, however, a very unusual source of finance and is rarely used. The company may once again use its working capital to redeem the debentures. This has a negative impact on the company's working capital. In either case, the company's assets are reduced. However, due to the legal provisions governing the creation of DRR, redemption of debentures solely for capital is not possible. The basic entries for debenture redemption are passed in this case.

3. Redemption of Debentures by conversion- When a debenture holder can convert his or her debentures into shares or new debentures after a specified period of time has passed, this is referred to as redemption of debentures by conversion. There is no need to keep the Debenture Redemption Reserve because the company does not need to pay any funds for the redemption (DRR). New shares or debentures may be issued at par, at a premium, or at a discount.

4. Redemption of Debenture out of provisions- It is possible that the company will make provision for the redemption of debentures from the funds set aside in the advance. The provision can be made in two ways using this method:

(a) Insurance Policy Method

(b) Sinking Fund Method 

(a) Insurance Policy Method- This method entails taking out an insurance policy for the amount required to pay off the debentures at the end of the fixed period. The premium is paid to the insurance company either annually or biannually. The policy matures when the specified period expires, and the insurance company repays the insured amount to the company. Thus, the debentures are redeemed with the proceeds received from the insurance company.

(b) Sinking Fund Method- A sinking fund is a fund created by a charge against or appropriation of profits represented by specific investments, and it is created for a specific purpose.

Conclusion-

All these are the method/sources of redemption of debenture.

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