Redemption of Preference Shares and Debentures

Redemption of Preference Shares

Shares for which the amount should be repayable after the expiry of a specified
period are called redeemable preference shares. The Articles of the company
should permit such redemption. The redemption is carried out either at premium or
at face value. A company cannot return its share capital to the shareholders without
the permission of the court of law.
Provision of the companies Act:
The following are the important provisions of Sec 80 Companies Act 1956,
relating to issue and redemption of redeemable preference shares.
 A company limited by shares, may if authorized by its Articles of
Association, issue of preference shares which are liable to be redeemed
as per terms of the issue.
 Shares cannot be redeemed unless they are fully paid up.
 Shares can be redeemed either out of the profits of the company which
would otherwise be available for dividend or out of the proceeds of a
fresh issue of shares made for the purpose of redemption.
 If any premium is payable on redemption of preference shares, such
premium has to be provided out of the profits of the company or out of
the Securities Premium Account.
 When such shares are redeemed out of profits a sum equal to the nominal
amount of the shares so redeemed must be transferred out of the profits
of the company which would otherwise be available for dividend to a
reserve account called Capital Redemption Reserve Account.
 Capital Redemption reserve can be utilised to issue fully paid bonus
shares to the equity shareholders.
 Redemption of preference shares by a company shall not be take as
reduction of its Authorized capital.

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Procedures for redemption of preference shares:
 Only fully paid shares can be redeemable. If the shares are partly paid up,
then it should be converted into fully paid and then redemption is made.
 The premium required for redemption is to be paid from share premium
account only. The share premium account may be in liability side of the
balance sheet or raised at the time of fresh issue of equity shares at a
premium.
 If the premium account is not sufficient for redemption then the balance
amount may be paid out of profit and loss account.
 The refund of capital amount should be made from fresh issue of equity
share capital, profit and loss account and or general reserve account in
balance sheet.
 The fresh issue of equity shares may be at face value or at premium value
or at discount value.
 Before taking an amount from profit and loss account and general
reserve, an amount equal to the same should be transferred to capital
redemption reserve.
 Redemption should not be made from issue of debentures or sale of any
investments.
Capital Redemption Reserve:
A limited company may issue redeemable preference shares if
it’s Articles of Association provide. Thus, these preference shares are liable
for redemption within a period not exceeding twenty years from the date of issue.
A company cannot issue irredeemable preference shares. Also, a company can
redeem only fully paid-up preference shares out of the profits available for
dividend or out of the proceeds of a fresh issue of shares for redemption. Hence,
the preference shares are redeemed from the capital reserve account created for the
purpose of the redemption.

Capital Redemption Reserve Account:

When the company proposes to redeem the preference shares out of

the profits, it transfers an amount equal to the nominal value of the redeemable
preference shares to the Capital Redemption Reserve A/c out of the profits of the
company.

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 Also, in this case, the provisions relating to the reduction of share capital
shall apply. The company can also use the Capital Redemption Reserve to issue the
fully paid-up bonus shares.

Difference between share and Debenture:

Basis Shares Debentures

Nature It is the part of the owned capital It is a part of the borrowed
funds.
Status Shareholders are the owners of the Debenture holders are the
company. creditors of the company.
Returns A shareholder gets dividend out of A debenture holder gets
profits and cannot be claimed by him interest even if there are losses.
till declared by the company.
Repayment Amount of equity share capital is not They are redeemed on the due
returned during the lifetime of the date.
company.
Charge No charge is created on assets of the A charge fixed of floating is
company when it issues shares. created on company’s assets
when debentures are issued.
Voting Rights Shareholders enjoy voting rights. Debenture holders do not enjoy
any voting rights.
Convertibility Shares cannot be convertible. Debenture can be converted
into equity shares.
Restriction There are legal restrictions on the There is no legal restriction on
purchase of its own shares. purchase of its own debentures.
Winding up Share capital is returned after all At the time of winding up
claims are met. debenture holders are repaid
after the payment to the
shareholders is made.
Types of preference shares:
1. Convertible Preference Shares: Convertible preference shares are those shares
that can be easily converted into equity shares.

2. Non-Convertible Preference Shares: Non-Convertible preference shares are

those shares that cannot be converted into equity shares.

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3. Redeemable Preference Shares: Redeemable preference shares are those
shares that can be repurchased or redeemed by the issuing company at a fixed rate
and date. These types of shares help the company by providing a cushion during
times of inflation.

4. Non-Redeemable Preference Shares: Non-redeemable preference shares are

those shares that cannot be redeemed or repurchased by the issuing company at a
fixed date. Non-redeemable preference shares help companies by acting as a
lifesaver during times of inflation.

5. Participating Preference Shares: Participating preference shares help

shareholders demand a part in the company’s surplus profit at the time of the
company’s liquidation after the dividends have been paid to other shareholders.
However, these shareholders receive fixed dividends and get part of the surplus
profit of the company along with equity shareholders.

6. Non-Participating Preference Shares: These shares do not benefit the

shareholders the additional option of earning dividends from the surplus profits
earned by the company, but they receive fixed dividends offered by the company.

7. Cumulative Preference Shares: Cumulative preference shares are those type of

shares that gives shareholders the right to enjoy cumulative dividend payout by the
company even if they are not making any profit.
These dividends will be counted as arrears in years when the company is not
earning profit and will be paid on a cumulative basis the next year when the
business generates pro

8. Non - Cumulative Preference Shares: Non - Cumulative Preference Shares do

not collect dividends in the form of arrears. In the case of these types of shares, the
dividend payout takes place from the profits made by the company in the current
year. So if a company does not make any profit in a single year, then the
shareholders will not receive any dividends for that year. Also, they cannot claim
dividends in any future profit or year.

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 9. Adjustable Preference Shares: In the case of adjustable preference
shares, the dividend rate is not fixed and is influenced by current market
rates.
Methods of Redemption
There are three methods of redemption of preference shares. They are:
(a) Redemption out of fresh issue of shares.
(b) Redemption out of Profits.
(c) Redemption partly out of fresh issue and partly out of profit.

Accounting Procedure
For solving problems, the following procedure is to be followed:

Redemption out of fresh issue of shares.

1. First see whether the redeemable preference shares are fully paid up or
partly paid up.
If they are partly paid up, pass the following journal entries to make them fully paid.
(a) Preference Share Final Call A/c Dr

To Preference Share Capital A/c

(b) Bank A/c Dr.
To Preference Share Final Call A/c

2. Make journal entry for fresh issue of shares when company issues new
shares:
(a) At Par
Bank A/c Dr.
To Share Capital A/c
(b) At Premium
Bank A/c Dr.
To Share Capital A/c
To Security Premium A/c
(c) At Discount
Bank A/c Dr.
Discount on Issue of Share A/c Dr.
5
To Share Capital A/c
 3. Write journal entry for redemption of preference shares

(a) When Redemption is at Par

Redeemable Preference Share Capital A/c Dr.
To Preference Shareholders A/c
(For transferring the capital to preference shareholders)

Preference Shareholders A/c Dr

To Bank A/c
(For paying the amount due to preference shareholders)
(b) When Redemption is at Premium
Security Premium A/c / Profit and Loss A/c Dr.
To Premium on Redemption of Preference Shares A/c /
(For providing premium on redemption out of security premium or profit and loss)

Redeemable Preference Share Capital A/c Dr.

Premium on Redemption of Preference Share A/c Dr.
To Preference Shareholders A/c
(For transferring the capital and premium to preference shareholders)

Preference Shareholders A/c Dr.

To Bank A/c
(For paying the amount due to preference shareholders)
Note: If the preference shares are redeemed at a premium, such premium on redemption is
provided out of Security Premium Account (existing or fresh issue) or Profit and Loss or
General Reserve.

Minimum fresh issue of shares:

At the time of redemption of preference shares, some companies may decide to utilize all the
permissible reserves for the redemption and make new issue of shares for any balance amount
required. The intention is to minimize the new issue of shares. Such minimum new issue may
be made at par, at premium and at discount

Formula:
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Minimum new issue to be made = [Face value redeemable preference share + Premium payable
on redemption – Securities premium in balance sheet – revenue reserve in balance sheet] x
100 / 100 + Premium % on new issue (or) 100 – Discount % on new issue

Illustration 1 (Fresh Issue of Shares at Par and Redemption, at Par)

A Ltd had 10,000, 8% redeemable preference shares of Rs. 100 each, fully paid up. The
company decided to redeem these preference shares at par by issue of sufficient number of
equity shares of Rs. 10 each fully paid at par. Write journal entries in the books of the
company.

Solution
Face value of share to be redeemed (10,000 x 100) = 10,00,000
Proceeds per new share = Rs. 10
No.of shares to be issued = 10,00,000 = 1,00,000 shares
10

Illustration 2 (Fresh Issue of Shares at Premium and Redemption at Par)

B Ltd had 3,000, 9% preference shares of f 200 each fully paid up. The company decided to
redeem these preference shares at par, by issue of sufficient number of ordinary shares of Rs.
25 each at a premium of Rs. 2 per share as fully paid. Write journal entries in the books of the
company.

Solution
Value of shares to be redeemed (3,000 x 200) = 6,00,000
Proceeds per new share = Rs. 25
No.of shares to be issued = 6,00,000 = 24,000 shares
25
Illustration 3 (Fresh Issue of Shares at Discount and Redemption at Par)
C Ltd had 9000, 8% Redeemable Preference Shares of 20 each, fully paid up. The company
decided to redeem these shares by issue of sufficient No. of equity shares of Rs.10 each fully
paid at 10% discount. Pass necessary journal entries in company’s book.

Solution
Value of shares to be redeemed (9,000 x 20) = Rs. 1,80,000
When shares are issued at discount, the proceeds must be sufficient to cover the face value of
preference shares to be redeemed, i.e., Rs. 1,80,000.
Proceeds per new share = 10 -10% = Rs. 9
No.of Shares = Rs. 1,80,000 = 20,000 shares
9
or
1,80,000 x 100 = 2,00,000 = 20,000 shares
9 90 10
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Illustration 4 (Issue of Fresh Equity Shares)
Ahuja Company Ltd. had 5,000, 8% Redeemable Preference Shares of Rs. 100 each, fully paid
up. The company decided to redeem these preference shares at par by the issue of sufficient
number of equity shares of ₹10 each fully paid up at par. You are required to pass necessary
Journal Entries including cash transactions in the books of the company.
Solution

Date Particulars Dr. (₹) Cr. (₹)

Bank A/c Dr. 5,00,000
To Equity Share Capital A/c 5,00,000
(Being the issue of 50,000 Equity Shares of ₹10 each at par
for the purpose of redemption of preference shares)
8% Redeemable Preference Share Capital A/c To Dr. 5,00,000
Preference Shareholders A/c 5,00,000
(Being the amount payable on redemption of preference
shares transferred to Preference Shareholders Account) Dr. 5,00,000
Preference Shareholders A/c
To Bank A/c 5,00,000
(Being the amount paid on redemption of preference shares)
Illustration 5 (Issue of Fresh Equity Shares)
A Ltd. had 10,000, 10% Redeemable Preference Shares of ₹ 100 each, fully paid up. The
company decided to redeem these preference shares at par, by issue of sufficient number of
equity shares of ₹ 10 each at a premium of ₹ 2 per share as fully paid up. You are required to
pass necessary Journal Entries including cash transactions in the books of the company.

Solution

Date Particulars Dr. (₹) Cr. (₹)

Bank A/c Dr. 12,00,000
To Equity Share Capital A/c 10,00,000
2,00,000
To Securities Premium A/c
(Being the issue of 1,00,000 Equity Shares of ₹ 10 each
at a premium of ₹ 2 per share)
10% Redeemable Preference Share Capital A/c To Dr. 10,00,000
Preference Shareholders A/c 10,00,000

(Being the amount payable on redemption of preference

shares transferred to Preference Shareholders A/c)
Preference Shareholders A/c To Dr. 10,00,000
Bank A/c 10,00,000

(Being the amount paid on redemption

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Note: Amount required for redemption is ₹ 10,00,000. Therefore, face value of equity shares
to be issued for this purpose must be equal to ₹ 10,00,000. Premium received on new issue
cannot be used to finance the redemption.

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Illustration 6 (Issue of Fresh Equity Shares)
S India Ltd. had 9,000 10% redeemable Preference Shares of ₹ 10 each, fully paid up. The
company decided to redeem these preference shares at par by the issue of sufficient number of
equity shares of ₹ 9 each fully paid up.
You are required to pass necessary Journal Entries including cash transactions in the books of
the company.
Solution
In the books of S India Limited Journal
Date Particulars Dr. (₹) Cr. (₹)
Bank A/c Dr. 90,000
To Equity Share Capital A/c 90,000
(Being the issue of 10,000 Equity Shares of ₹9 each at par)
10% Redeemable Preference Shares Capital A/c Dr. 90,000
To Preference Shareholders A/c 90,000
(Being the amount payable on redemption of preference
shares transferred to Preference Shareholders A/c)
Preference Shareholders A/c To Dr. 90,000
Bank A/c 90,000
(Being the amount paid on redemption of preference shares)

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Redemption out of Profits
Redeemable preference shares can be redeemed out of the divisible profits. Divisible profits for
dividend. The examples of divisible or undistributed profits include general reserve, reserve
fund, dividend equalisation reserve, investment fluctuation reserve, insurance fund, workmen's
compensation fund, workmen's accident fund, debenture redemption reserve, reserve for
contingencies, any other revenue reserve, profit and loss account balance etc.
In the case of shares so redeemed should be transferred from divisible profits to Capital
Redemption Reserve Account.

Reasons for Creating CRR

CRR is created for the following reasons:
1) Capital maintenance: The important purpose of creating CRR is to maintain the
capital intact. By creating CRR, it is possible to protect capital structure and
components of capital as it is. If much variation is taking place in components and
volume of capital, business activities would be reduced. This causes dissatisfaction
among shareholders.
2) Safeguard of creditors: The other reason for creating CRR is to protect the interest
of creditors. If CRR is not created, the directors may distribute the entire amount of
profits by way of dividend. This will adversely affect the interest of creditors.
Note: For calculating CRR, the premium on redemption and security premium are totally
ignored.

Accounting Treatment
The following journal entries are required to be passed the books of the company.

1. When Shares are Redeemed at Par

(a) On transfer to Capital Redemption Reserve A/c
Profit and Loss A/c / General Reserve A/c Dr.
To Capital Redemption Reserve A/c

(b) On the redemption of shares

Preference Share Capital A/c Dr.
To Preference Shareholders A/c

(c) On Payment to Preference Shareholders

Preference Shareholders A/c Dr.
To Bank A/c
Note: First see whether the preference shares are fully paid up or partly paid up. If the shares
are partly paid up they must be made fully paid up. The journal entries have already been
given.
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2. When Shares are Redeemed at Premium
(a) Transfer to Capital Redemption Reserve A/c from divisible profits.
Profit and Loss A/c / General Reserve A/c Dr.
To Capital Redemption Reserve A/c
(b) On providing Premium Payable on Redemption
Security Premium A/c / Profit & Loss A/c / Capital Reserve A/c Dr.
To Premium on Redemption A/c
(c) On making money due to preference shareholders
Preference Share Capital A/c Dr.
Premium on Redemption A/c Dr.
To Preference Shareholders A/c
(d) On payment to Shareholders
Preference Shareholders A/c Dr.
To Bank A/c
Illustration 7 (Redemption out of Profits)
The Balance Sheet of Y Ltd. as on 31st March, 2018 is as follows:
Particulars ₹
EQUITY AND LIABILITIES
1. Shareholders’ funds
a) Share capital 2,90,000
48,000
b) Reserves and Surplus
2. Current liabilities 56,500
Trade Payables Total 3,94,500

ASSETS
1. Fixed Assets 3,45,000
18,500
Tangible asset
Non-current investments
31,000
2. Current Assets
3,94,500
Total
Cash and cash equivalents (bank)
The share capital of the company consists of ₹50 each equity shares of ₹2,25,000 and ₹100
each Preference shares of ₹65,000(issued on 1.4.2016). Reserves and Surplus comprises Profit
and Loss Account only.
In order to facilitate the redemption of preference shares at a premium of 10%, the Company
decided:
a) to sell all the investments for ₹15,000.
b) to finance part of redemption from company funds, subject to, leaving a bank balance
of ₹12,000. 12
 c) to issue minimum equity share of ₹50 each at a premium of ₹10 per share to raise the
balance of funds required.
You are required to pass: The necessary Journal Entries to record the above transactions and
prepare the balance sheet as on completion of the above transactions.

Solution

Date Particulars Dr. (₹) Cr. (₹)

Bank A/c Dr. 37,500
To Share Application A/c 37,500
(For application money received on 625 shares @ ₹ 60
per share)
Share Application A/c Dr. 37,500
To Equity Share Capital A/c To 31,250
Securities Premium A/c 6,250
(For disposition of application money received)
Preference Share Capital A/c Dr. 65,000
Premium on Redemption of Preference Shares A/c Dr. 6,500
To Preference Shareholders A/c 71,500
(For amount payable on redemption of preference shares)

Profit and Loss A/c Dr. 6,500

To Premium on Redemption of Preference
Shares A/c (For writing off premium on redemption 6,500
out of profits)
Bank A/c Dr. 15,000
Profit and Loss A/c (loss on sale) A/c Dr. 3,500
To Investment A/c 18,500
(For sale of investments at a loss of ₹ 3,500)
Profit and Loss A/c Dr. 33,750
To Capital Redemption Reserve A/c 33,750
(For transfer to CRR out of divisible profits an amount
equivalent to excess of nominal value of preference shares
over proceeds (face value of equity shares) i.e., ₹ 65,000 -
₹ 31,250)
Preference Shareholders A/c To Dr. 71,500
Bank A/c 71,500
(For payment of preference shareholders)

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 Journal
Balance Sheet (after redemption)
Date Particulars Notes No. (₹)

EQUITY AND LIABILITIES

1. Shareholders’ funds
a) Share capital 1 2,56,250
b) Reserves and Surplus Current
2 44,250
liabilities
2. Trade Payables
56,500
Total 3,57,000

ASSETS
1. Fixed Assets Tangible asset Current Assets
Cash and cash equivalents (bank) 3,45,000

2.
Total 3 12,000
3,57,000

Notes to accounts

₹
1. Share Capital
Equity share capital (2,25,000 + 31,250) 2,56,250
2. Reserves and Surplus
Capital Redemption Reserve 33,750
Profit and Loss Account (48,000 – 6,500 – 3,500 – 33,750) 4,250
Security Premium 6,250
44,250
3. Cash and cash equivalents
Balances with banks (31,000 + 37,500 +15,000 – 71,500) 12,000

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 Working Note:
Calculation of Number of Shares: ₹
Amount payable on redemption 71,500
Less: Sale price of investment (15,000)
56,500
Less: Available bank balance (31,000 - 12,000) (19,000)
Funds from fresh issue 37,500
No. of shares = 37,500/60=625 shares
Illustration 8 (Capitalisation of Undistributed Profits)
The following are the extracts from the Balance Sheet of ABC Ltd. as on 31st December, 2018.

Share capital: 40,000 Equity shares of ₹10 each fully paid – ₹4,00,000; 1,000 10% Redeemable
preference shares of ₹100 each fully paid – ₹1,00,000.

Reserve & Surplus: Capital reserve – ₹50,000; Securities premium – ₹50,000; General reserve –
₹75,000; Profit and Loss Account – ₹35,000
On 1st January 2019, the Board of Directors decided to redeem the preference shares at par by
utilisation of reserve. You are required to pass necessary Journal Entries including cash
transactions in the books of the company.
Solution
Journal Entries in the books of ABC Limited

Date Particulars Dr. (₹) Cr. (₹)

2019
Jan 1 10% Redeemable Preference Share Capital A/c Dr. 1,00,000
To Preference Shareholders A/c 1,00,000
(Being the amount payable on redemption transferred to
Preference Shareholders Account)
Preference Shareholders A/c To Dr. 1,00,000
Bank A/c 1,00,000
(Being the amount paid on redemption of preference
shares)
General Reserve A/c Dr. 75,000
Profit & Loss A/c Dr. 25,000
To Capital Redemption Reserve A/c 1,00,000
(Being the amount transferred to Capital Redemption
Reserve Account as per the requirement of the Act)

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Note: Securities premium and capital reserve cannot be utilised for transfer to Capital
Redemption Reserve.

Illustration 9 (Capitalisation of Undistributed Profits)

B Limited had 3,000, 12% Redeemable Preference Shares of ₹100 each, fully paid up. The
company had to redeem these shares at a premium of 10%.
It was decided by the company to issue the following:
i) 25,000 Equity Shares of ₹10 each at par,
ii) 1,000 14% Debentures of ₹100 each.
The issue was fully subscribed and all amounts were received in full .The payment was duly
made. The company had sufficient profits. Show Journal Entries in the books of the company.
Solution
Journal Entries in the books of B Limited
Date Particulars Dr. (₹) Cr. (₹)
Bank A/c Dr. 2,50,000
To Equity Share Capital A/c 2,50,000
(Being the issue of 25,000 equity shares of ₹ 10 each at par)
Bank A/c Dr. 1,00,000
To 14% Debenture A/c 1,00,000
(Being the issue of 1,000 Debentures of ₹ 100 each)
12% Redeemable Preference Share Capital A/c Dr. 3,00,000
Premium on Redemption of Preference Shares A/c Dr. 30,000
To Preference Shareholders A/c 3,30,000
(Being the amount payable on redemption transferred to
Preference Shareholders Account)
Preference Shareholders A/c To Dr. 3,30,000
Bank A/c 3,30,000
(Being the amount paid on redemption of preference shares)

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 Profit & Loss A/c Dr. 30,000
To Premium on Redemption of Preference Shares
A/c 30,000
(Being the adjustment of premium on redemption against
Profits & Loss Account)
Profit & Loss Dr. 50,000
To Capital Redemption Reserve A/c 50,000
(Being the amount transferred to Capital Redemption
Reserve Account as per the requirement of the Act)
Working Note:
Amount to be transferred to Capital Redemption Reserve Account
Face value of shares to be redeemed ₹ 3,00,000
Less: Proceeds from new issue (₹ 2,50,000)
Total Balance ₹ 50,000

Redemption of Partly Paid up Shares

If the preference shares are partly paid, they will have to be made fully paid before redemption.
The journal entries have already been given.
In case there are two categories of redeemable preference shares (one fully paid \and another
partly paid) and there is no instruction regarding redemption, only fully /paid preference shares
may be redeemed.
Sometimes there are calls in arrears in case of redeemable preference shares. In. such a case, it
is necessary to follow the instructions given in the question. If nothing is mentioned in the
question, there are two options. They are:
(a) Preference shares having calls in arrears should not be redeemed,
(b) It is presumed that calls in arrears are collected and all the preference shares are
redeemed.

Illustration 10 (Partly Paid up Shares)

The Balance Sheet of ABC Ltd. as at 31st December, 2018 inter alia includes the following:
₹ 50,000, 8% Preference Shares of ₹100 each, ₹70 paid up 35,00,000
1,00,000 Equity Shares of ₹100 each fully paid up 1,00,00,000
Securities Premium 5,00,000
Capital Redemption Reserve 20,00,000
General Reserve 50,00,000

Under the terms of their issue, the preference shares are redeemable on 31st March, 2019 at 5%
premium. In order to finance the redemption, the company makes a rights issue of 50,000
equity shares of ₹100 each at ₹ 110 per share, ₹ 20 being payable on application, ₹ 35 (including
premium) on allotment and the balance on 1st January, 2020. The issue was fully subscribed
and allotment made on 1st March, 2019. The money due on allotment were received by 31st
March, 2019. The preference shares were redeemed 17 after fulfilling the necessary conditions of
Section 55 of the Companies Act, 2013.
You are asked to pass the necessary Journal Entries and show the relevant extracts from the
balance sheet as on 31st March, 2019 with the corresponding figures as on 31st December,
2018.
Solution
Journal Entries in the books of ABC Ltd.
Date Particulars Dr. (₹) Cr. (₹)
8% Preference Share Final Call A/c Dr. 15,00,000
To 8% Preference Share Capital A/c 15,00,000
(For final call made on preference shares @ ₹ 30 each to
make them fully paid up)
Bank A/c Dr. 15,00,000
To 8% Preference Share Final Call A/c 15,00,000
(For receipt of final call money on preference shares)
Bank A/c Dr. 10,00,000
To Equity Share Application A/c 10,00,000
(For receipt of application money on 50,000 equity shares
@ ₹ 20 per share)
Equity Share Application A/c To Dr. 10,00,000
Equity Share Capital A/c 10,00,000
(For capitalisation of application money received)
Equity Share Allotment A/c Dr. 17,50,000
To Equity Share Capital A/c To 12,50,000
Securities Premium A/c 5,00,000
(For allotment money due on 50,000 equity shares @ ₹ 35
per share including a premium of ₹ 10 per share)
Bank A/c Dr. 17,50,000
To Equity Share Allotment A/c 17,50,000
(For receipt of allotment money on equity shares)
8% Preference Share Capital A/c Dr. 50,00,000
Premium on Redemption of Preference Shares A/c Dr. 2,50,000
To Preference Shareholders A/c 52,50,000
(For amount payable to preference shareholders on
redemption at 5% premium)
General Reserve A/c Dr. 2,50,000
To Premium on Redemption A/c 2,50,000
(For writing off premium on redemption of preference
shares)
General Reserve A/c Dr. 27,50,000
To Capital Redemption Reserve A/c 27,50,000
(For transfer of CRR the amount not covered by the
proceeds of fresh issue of equity shares i.e., 50,00,000 -
10,00,000 - 12,50,000) 18
 Preference Shareholders A/c Dr. 52,50,000
To Bank A/c 52,50,000
(For amount paid to preference shareholders)
Balance Sheet (extracts)
Particulars Notes No. As at 31.3.2019 (₹) As at 31.12.2018
(₹)
EQUITY AND LIABILITIES
1. Shareholders’ funds
a) Share capital 1 1,22,50,000 1,35,00,000
b) Reserves and Surplus 2 77,50,000 75,00,000
Notes to accounts
Particulars As at As at
31.3.2019 31.12.2018
1. Share Capital
Issued, Subscribed and Paid up:
1,00,000 Equity shares of ₹100 each fully paid up 1,00,00,000 1,00,00,000

50,000 Equity shares of ₹ 100 each ₹ 45 paid up 22,50,000 -

50,000, 8% Preference shares of ₹ 100 each, 35,00,000

₹ 70 called up
1,22,50,000 1,35,00,000
2. Reserves and Surplus
Capital Redemption Reserve 47,50,000 20,00,000
Securities Premium (5,00,000 + 5,00,000) 10,00,000 5,00,000
General Reserve 20,00,000 50,00,000
77,50,000 75,00,000

Note: Amount received (excluding premium) on fresh issue of shares till the date of redemption should be
considered for calculation of proceeds of fresh issue of shares. Thus, proceeds of fresh issue of shares are ₹
22,50,000 (₹10,00,000 application money plus ₹ 12,50,000 received on allotment towards share capital).

19
Debentures:
Debenture is an important source of raising funds by a company as a
company requires large number of funds to finance its new projects or for its
expansion. Debenture is a written instrument acknowledging a debt taken under the
common seal of the company. It contains terms and collections of contract as
regard the payment of interest and redemption of the principal.
Types of debentures:
1. Security point of view:
(a) Simple or naked or unsecured debentures: These are those debentures
that have no security. The holders of such debentures are treated as unsecured
creditors at the time of winding up of the company.
(b) Secured debenture: These are the debentures that are secured against
the particular assets of the company. If the company is unable to repay the amount
of debentures, than the debenture holders can realize their dues from the assets
mortgaged with them.
2. Tenure point of view:
(a) Redeemable debentures: These are those debentures that will be repaid
by the company at the end of the specified period during the existence of the
company.
(b) Irredeemable debenture: These are those debentures which ar not to be
repaid during the lifetime of the company.

3. Mode point of view:

(a) Convertible debentures: These are those debentures which can be
converted into the equity shares on the option of the debenture holders.
(b) Non Convertible debentures: These are those debentures which cannot
be converted into the equity shares on the option of the debenture holders.
4. Registration point of view:

20
 (a) Registered debenture: These are the debentures in which the
details of the debenture holders are registered in the register of the
company. These debentures cannot be transferred from one debenture
holders to another.
(b) Bearer debenture: These are those debentures which can be
transferred by way of delivery and the company does not keep any record
of the debenture holder.
Methods of redemption of debentures:
Repayment or discharge of liability on account of debentures is
called redemption of debentures. The method of debenture redemption
adopted determines to a very large extent the actual accounting for
redemption as well as the marshalling of resources for the same.
1) By Payment in Lumpsum
Under payment in lumpsum method, at maturity or at the expiry of a
specified period of debenture the payment of entire debenture is made in
one lot or even before the expiry of the specified period.
2) By Payment in Instalments
Under payment in instalments method, the payment of specified portion
of debenture is made in instalments at specified intervals.

3) Purchase of Debentures in Open Market

Debentures sometimes are purchased in open market; where there is a
Debenture Redemption Reserve out of the reserve and, if there is none, as
a general investment; the Debenture Investment Account or Own
Debenture Account is debited.

Accounting Treatment
1. When debentures are redeemed at par
Debentures A/c Dr
To Debenture holders A/c
(Amount due to debenture holders)
21
Debenture holders A/c Dr.
To Bank A/c
(Payment to debenture holders)
2. When debentures are redeemed at premium
Debentures A/c Dr.
Premium on Redemption A/c Dr.
To Debenture holders A/c
(Amount due to debenture holders, including premium)

Securities Premium Reserve / General Reserve/ P/L Dr.

To Premium on Redemption A/c
(Premium on redemption provided out of securities premium reserve or
general reserve or P/L)
Debenture holders A/c Dr
To Bank A/c
(Payment due to debenture holders)
3. When debentures are redeemed at discount

Debentures A/c Dr.

To Debenture holders A/c
To Capital Reserve A/c
(Amount due to debenture holders on redemption after deducting the
discount)
Debenture holders A/c
To Bank A/c
(Payment due to debenture holders)
Redemption out of Profits
Debenture Redemption Reserve 22

A company issuing debentures is required to create a debenture

redemption reserve account out of the profits available for distribution of
dividend and amounts credited to such account cannot be utilised by the
company except for redemption of debentures. Such an arrangement
would ensure that the company will have sufficient liquid funds for the
redemption of debentures at the time they should fall due for payment.
An appropriate amount is transferred from profits every year to Debenture
Redemption Reserve and its investment is termed as Debenture
Redemption Reserve Investment. These investment

23
earn certain amount of income i.e. interest which is reinvested together
with the fixed appropriated amount for the purpose in subsequent years.
In last year, the interest earned and the appropriated fixed amount are not
invested. In fact, at this stage the Debenture Redemption Reserve
Investments are encashed and the amount so obtained is used for the
redemption of debentures. Any profit or loss made on the encashment of
Debenture Redemption investments is also transferred to Debenture
Redemption Reserve Account.

Liability of the Company to Create Debenture Redemption Reserve

Section 71 of the Companies Act 2013 covers the requirement of creating
a debenture redemption reserve account. Section 71 states as follows:
(1) Where a company issues debentures under this section, it should
create a debenture redemption reserve account out of its profits
which are available for distribution of dividend every year until
such debentures are redeemed.
(2) The amounts credited to the debenture redemption reserve should
not be utitlised by the company except for the purpose aforesaid.
(3) The company should pay interest and redeem the debentures in
accordance with the terms and conditions of their issue.
(4) Where a company fails to redeem the debentures on the date of
maturity or fails to pay the interest on debentures when they fall
due, the Tribunal may, on the application of any or all the holders of
debentures or debenture trustee and, after hearing the parties
concerned, direct, by order, the company to redeem the debentures
forthwith by the payment of principal and interest due thereon.

Journal Entries
The necessary journal entries passed in the books of a company are given
below:
1. At the end of First Year

(a) For setting aside the fixed amount of profit for redemption
Profit and Loss A/c Dr. 24
To Debenture Redemption Reserve A/c
 (b) For investing the amount set aside for redemption
Debenture Redemption Reserve Investment A/c Dr.
To Bank A/c
2. At the end of second year and subsequent years other than last
year
(a) For receipt of interest on Debenture Redemption Reserve
Investments
Bank A/c Dr.
To Interest on Debenture Redemption Reserve Investment A/c
(b) For transfer of Interest on Debenture Redemption Reserve
Investment (DRRI) to Debenture Redemption Reserve
Account
Interest on Debenture Redemption Reserve Investment A/c Dr.
To Debenture Redemption Reserve A/c
(c) For setting aside the fixed amount of profit for redemption
Profit and Loss A/c Dr.
To Debenture Redemption Reserve A/c
(d) For investments of the amount set aside for redemption and
the interest earned on DRRI
Debenture Redemption Reserve Investment A/c Dr.
To Bank A/c
3. At the end of last year

(a) For receipt of interest

Bank A/c Dr.
To Interest on Debenture Redemption Reserve Investment A/c
(b) For transfer of interest on Debenture Redemption Reserve
Investment to Debenture Redemption Reserve Investment
A/c
Interest on Debenture Redemption Reserve
25 Investment A/c Dr.
To Debenture Redemption Reserve A/c
 (c) For setting aside the fixed amount of profit for redemption
Profit and Loss A/c Dr.
To Debenture Redemption Reserve A/c
(d) For encashment of Debenture Redemption Reserve
Investments
Bank A/c Dr.
To Debenture Redemption Reserve Investment A/c
(e) For the transfer of profit/loss on realisation of Debenture
Redemption Reserve Investments
(i) In case of Profit
Debenture Redemption Reserve Investment A/c Dr.
To Debenture Redemption Reserve A/c Or
(ii) In case of Loss
Debenture Redemption Reserve A/c Dr.
To Debenture Redemption Reserve Investment A/c
(f) For amount due to debenture holders on redemption
Debenture A/c Dr.
To Debenture holder A/c
(g) For payment to debenture holders
Debenture holders A/c Dr.
To Bank A/c

Balance in Debenture Redemption Reserve (DRR)

The balance to the credit of Debenture Redemption Reserve, may in
certain circumstances may either be more or less as compared to the
amount of debentures which are proposed to be redeemed.
 If it is in excess, the amount is transferred to the Capital Reserve, on
the assumption that it is a capital profit
26
received on the appreciation
in the value of investments or settlement of liability for a lesser
amount that what was usually payable.
  On the other hand, if it is short, the deficit is made up by the transfer from
Profit and Loss Account. The balance in the account, equal to the amount of
debentures redeemed is subsequently transferred to General Reserve.

If the debentures are purchased within the interest period, the price would be
inclusive of interest provided these are purchased “cum interest”; but if purchased
“ex Interest”, the interest to the date of purchase would be payable to the seller in
addition. In order to adjust the effect thereof the amount of interest accrued till the
date of purchase, if paid, is debited to the Interest Account against which the
interest for the whole period will be credited. Thus, in result, a balance in the
Account would be left, equal to the interest for the period the debentures were held
by the company.

Modes of Redemption
1. By Conversion
When debentures are redeemed (by conversion) at par on maturity and new shares/
debentures are issued at par:
a) Debentures A/c (old) Dr. (with nominal value)
To Debenture holders A/c
(Transfer of debentures (to close) to debenture holders)
b) Debenture holders A/c Dr.
To New Debentures A/c/ Share Capital A/c
(Issue of new debentures or shares at par)
No. of new shares/debentures to be issued = Amount payable/ Issue price per
share or debenture
Q.1.A Ltd. issued 60,000, 8% debentures of Rs. 100 each redeemable after 4 years
by converting them into equity shares of Rs. 10 each. Record journal entries for
issue and redemption of debentures. Ignore entries for payment of interest.

27
When debentures are redeemed (by conversion) at premium on maturity and new
shares/ debentures are issued at par:
Debentures A/c Dr.
Premium on Redemption of Debentures A/c Dr.
To Debenture Holders A/c
(Amount due to debenture holders and premium due)
b) Debenture holders A/c Dr.
To New Debentures A/c / Share Capital A/c
(Issue of new debentures or shares at par)
Q.2. X Ltd. had issued 2,000, 8% debentures of Rs. 100 each at par and
redeemable at 10% premium by converting debentures into equity shares of Rs. 10
each at par. Write journal entries for conversion.
28
When debentures are redeemed (by conversion) at par at maturity and new shares/
debentures are issued at premium.
a) Debentures A/c Dr.
To Debenture Holders A/c
(Amount due to debenture holders)
b) Debentures holders A/c Dr.
To New Debentures A/c / Share Capital A/c
To Securities Premium Reserve A/c
(Issue of new debentures or shares at premium)
Q.3. X Ltd. issued 80,000, 9% debentures of Rs. 100 each at a premium of 5%
on April 1, 2018 redeemable at par by conversion of debentures into shares of Rs.
20 each at a premium of Rs. 5 per share on March 31, 2020. Record necessary
journal entries for issue and redemption of debentures.

29
When debentures are redeemed (by conversion) at premium at maturity and new
shares/ debentures are issued at premium

Debentures A/c Dr.

Premium on Redemption of Debentures
To Debenture Holders A/c
(Amount due to debenture holders)

b) Debentures holders A/c Dr.

To New Debentures A/c / Share Capital A/c
To Securities Premium Reserve A/c
(Issue of new debentures or shares at premium)
When debentures are redeemed (by conversion) at par at maturity and new
debentures are issued at discount
a) Debentures A/c Dr.
To Debenture Holders A/c
(Amount due to debenture holders)
b) Debentures holders A/c Dr.
Discount on issue of debentures A/c Dr.
To New Debentures A/c / Share Capital A/c
(Issue of new debentures at discount)
When debentures originally issued at discount are redeemed by conversion
a. Conversion before maturity: When debentures originally issued at discount are
converted/ redeemed before maturity, the number of shares or debentures to be
issued are calculated on the basis of net proceeds (after deducting the discount
from the face value)

30
i. Redeemable at par by conversion into shares before maturity
a) Debentures A/c Dr.
To Discount on issue of debentures A/c (discount not yet written off)
To Statement of Profit and Loss (discount already written off)
To Debenture Holders A/c (net amount due)
(Amount due to debenture holders)
b) Debentures holders A/c Dr.
To New Debentures A/c / Share Capital A/c
(Issue of new debentures or shares at par)
c) Debenture holders A/c Dr.
To Debentures/ Share Capital A/c
To Securities Premium A/c
(Issue of shares or debentures at premium)
ii. Redeemable at premium by conversion into shares before maturity
a) Debentures A/c Dr.
Premium on Redemption of Debentures A/c Dr. (redemption premium
payable)
To Discount on issue of debentures A/c (discount not yet written off)
To Statement of Profit and Loss (discount already written off)
To Debenture Holders A/c (net amount due)
(Amount due to debenture holders)
b) Debentures holders A/c Dr.
To New Debentures A/c / Share Capital A/c
(Issue of new debentures or shares at par)
c) Debenture holders A/c Dr.
31
 To Debentures/ Share Capital A/c
To Securities Premium A/c
(Issue of shares or debentures at premium)
b. Conversion of Debentures on Maturity: If debentures issued at discount are
converted into shares or debentures on maturity, then it is converted on the basis of
the face value or nominal value and not at its net proceeds. The discount on issue
of debentures has already been written off.

2. Purchase of Debentures in the Open Market

A company can buy Its own debentures if it is authorised by its Articles. A
company purchases its own debentures from the open market when the price of
debentures falls below the face value or redemption price. It can be done in two
ways;
a. Immediate Cancellation
b. Own Investment
Redemption by purchase of debenture has the following advantages:
1. The purchase is made when the market price of the debenture is the lowest.
Hence, less amount is spent for their redemption (profit on cancellation or on
redemption).
2. This reduces the interest burden.
3. This avoids to pay premium on redemption.

Purchase of Debentures for Immediate Cancellation

A company may purchase its debentures for the purpose of immediate
cancellation. This results in reduction of debenture liability to the extent of par
value of debentures cancelled.
Accounting Treatment
(a) When Debentures are purchased at par
Debentures A/c Dr. (with nominal value)
32
To Bank A/c
(b) When Debentures are purchased at a discount
Debentures A/c \ Dr. (with nominal value)
To Bank A/c (with purchase price)
To Profit on Purchase (or Redemption) of Deb. A/c (profit on purchase)
(c) When Debentures are purchased at a premium
Debentures A/c Dr. (Nominal Value)
Loss on Redemption of Debentures Dr. (Difference in face value and market
price)
To Bank A/c.
Purchased as Own Investment
Own Debentures A/c Dr. (Cost of debentures)
To Bank A/c (Amount paid)
Cum-interest Quotation
If the purchase price includes interest for the period from previous date of
interest to the date of purchase, it is called cum interest price. It means the price
paid by the company for the debentures includes the interest for the expired
period also.

(a) When the debentures are purchased for immediate cancellation:

Debentures A/c Dr. (Nominal value of debentures)
Interest on Debentures A/c Dr. (Interest for the expired period)
To Bank (Amount paid)
To Profit on Redemption of Debentures (Profit on redemption)

(b) When the debentures are purchased for holding as investment:

Own Debentures A/c Dr. (Cost of debentures)
33
Interest on Debentures A/c Dr. (Interest for the expired period)
To Bank A/c (Amount paid)

(c). When own debentures purchased for investment are cancelled in future
Debentures A/c Dr (Nominal value)
To Own Debentures A/c (Price paid minus Interest)
To Profit on Redemption of Debentures (Balance)

Ex-interest Quotation
If the purchase price excludes the interest for the expired period, it is called Ex-
interest Price. This means that the purchase price of debentures does not include
the interest for the expired period. This further means that the purchaser
(company) has to pay, in addition, the interest for the expired period
(a) When debentures are purchased for immediate cancellation
Debentures A/c Dr. (Nominal value of debentures)
Interest on Debentures A/c Dr. (Interest for the expired period)
To Bank A/c (Total amount paid, i.e., cost of debentures + interest)
To Profit on Redemption of Debentures (Balancing figure)

(b) When debentures are purchased as investment

Own Debentures A/c Dr. (Cost of debentures, i.e., Price paid)
Interest on Debentures A/c Dr. (Interest for the expired period)
To Bank A/c (Total)

(c) When own debentures purchased for investment are cancelled in future
Debentures A/c Dr (Nominal Value)

34
To Own Debentures A/c (Cost, i.e., Price Paid)
To Profit on Redemption of Debentures (Balance)

35