Terms of Issue of Debentures

When a company issues debentures, the terms of issue specify not only the price at which debentures are sold to investors but also the price at which the company will redeem (repay) them at maturity. Redemption means the discharge of the liability on account of debentures by repaying the debenture holders. Debentures can be redeemed either at par (i.e., at their face value) or at a premium (i.e., at a price higher than face value).

Depending on the combination of issue price and redemption price, six common situations arise in practice. For each, the accounting treatment differs because the company may receive more or less than the face value at issue, and may have to pay more than the face value at redemption.

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The Six Situations

1. Issued at par and redeemable at par – No gain or loss at issue or redemption.
2. Issued at discount and redeemable at par – The company receives less than face value; the discount is a loss at the time of issue.
3. Issued at a premium and redeemable at par – The company receives more than face value; the premium is a gain (credited to Securities Premium Reserve).
4. Issued at par and redeemable at a premium – The company must pay extra at redemption; that extra is a loss at the time of issue.
5. Issued at a discount and redeemable at a premium – Both a discount on issue and a premium on redemption exist; the total loss is the sum of the two.
6. Issued at a premium and redeemable at a premium – The premium on issue partly offsets the premium on redemption; the net loss is only the premium on redemption (since the issue premium is credited separately).

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Accounting Treatment – The Core Logic

The journal entries for all six cases follow a consistent pattern. The key accounts involved are:

• Bank A/c – Debited with the actual cash received from applicants.
• Debenture Application & Allotment A/c – A temporary account used to record application money; it is closed by transfer to the Debentures A/c and other relevant accounts.
• Debentures A/c – Credited with the nominal (face) value of the debentures issued. This is the liability that will eventually be repaid.
• Discount on Issue of Debentures A/c – Debited when debentures are issued at a discount (i.e., the company receives less than face value). This is a loss and is written off over the life of the debentures.
• Securities Premium Reserve A/c – Credited when debentures are issued at a premium (i.e., the company receives more than face value). This is a capital reserve.
• Loss on Issue of Debentures A/c – Debited when debentures are redeemable at a premium. The amount debited equals the premium payable on redemption. If there is also a discount on issue, the total loss debited to this account is the sum of the discount and the redemption premium.
• Premium on Redemption of Debentures A/c – Credited with the amount of premium payable at redemption. This is a liability (a provision) shown under Non-current liabilities – Long-term Borrowings until the debentures are redeemed.

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Journal Entries for Each Situation

1. Issue at par and redeemable at par

2. Issue at a discount and redeemable at par

3. Issue at a premium and redeemable at par

4. Issue at par and redeemable at a premium

5. Issue at a discount and redeemable at a premium

6. Issue at a premium and redeemable at a premium