What is meant by redemption of debentures by conversion?

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Q. What is meant by redemption of debentures by conversion?

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Concept understanding — Debenture Definition

Debentures: The Company's Way of Borrowing Money

Think of a debenture like this: you need ₹5,00,000 to expand your business. Instead of asking a bank for a loan, you go to the public and say, "Lend me money, and I'll pay you interest every year. After 5 years, I'll return your full amount." Each person who lends you money gets a certificate — that certificate is a debenture.

The Precise Meaning

A debenture is a written instrument issued by a company under its common seal, acknowledging a debt. It contains a promise to repay the borrowed amount at a specified date (maturity) and to pay interest at a fixed rate at regular intervals (usually half-yearly or yearly).

Note

A debenture holder is a creditor of the company, not an owner. They have no voting rights and no share in profits — only a fixed interest payment.

Why Debentures Matter

Companies issue debentures because:

They raise large funds without diluting ownership (unlike shares)
Interest paid on debentures is a tax-deductible expense (reduces taxable profit)
Debentures are safer for investors than shares (fixed return, priority in repayment)

For investors, debentures offer:

Fixed, predictable income
Higher safety than equity shares
Priority over shareholders if the company is liquidated

Accounting Treatment

When a company issues debentures, the journal entry is:

Particulars	Debit (₹)	Credit (₹)
Bank A/c Dr.	[Amount received]
To Debentures A/c		[Face value]
To Securities Premium Reserve A/c (if issued at premium)		[Premium amount]
(Being debentures issued at premium)

Key points:

Debit Bank A/c with the actual amount received
Credit Debentures A/c with the face value (nominal value)
If issued at a premium (e.g., ₹100 debenture issued for ₹110), credit the extra ₹10 to Securities Premium Reserve A/c
If issued at a discount (e.g., ₹100 debenture issued for ₹95), debit the discount to Discount on Issue of Debentures A/c (a fictitious asset written off over the debenture's life)

Watch out

Never confuse debentures with shares. Debentures are liabilities (shown under "Non-Current Liabilities" in the Balance Sheet), while shares are equity (shown under "Shareholders' Funds").

Interest on Debentures

Interest is calculated as:

Interest = Face Value of Debentures × Rate of Interest × Time Period

For example, if a company issues ₹10,00,000 worth of 9% debentures, the annual interest is:

₹10,00,000 × 9% = ₹90,000 per year

The journal entry for interest payment:

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Redemption of Debentures by Conversion

When a company redeems debentures by conversion, it does not pay cash to the debenture holders. Instead, the company issues shares (equity or preference) or new debentures in exchange for the existing debentures. The debenture holders become shareholders or new debenture holders of the company.

This method is typically used when the company wants to reduce its debt burden without using cash. The terms of conversion — such as the number of shares per debenture and the conversion price — are specified in the original debenture trust deed.

Journal Entry for Conversion

Particulars	Debit (₹)	Credit (₹)
8% Debentures A/c (old) …Dr.	1,00,000
To Equity Share Capital A/c		80,000
To Securities Premium A/c		20,000
(Being 8% debentures of ₹1,00,000 converted into 8,000 equity shares of ₹10 each at a premium of ₹2.50 per share)

Note

The face value of the debentures being redeemed is debited to the Debentures Account. The credit goes to the Share Capital Account (at par value) and Securities Premium Account (if shares are issued at a premium). No cash flows occur.

Key Points for Exams

Aspect	Detail
Cash outflow	None

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Redemption of debentures by conversion means the company settles its debenture liability by issuing shares or other debentures to the debentureholders instead of paying cash.

Concept and Accounting Treatment

When a company needs to redeem its debentures, it can do so by converting them into equity shares, preference shares, or new debentures. This is a non-cash settlement method — the debentureholders agree to accept ownership instruments in place of repayment.

The accounting logic follows the dual aspect principle: the liability (debentures) is extinguished, and simultaneously, a new liability (share capital or new debentures) is created. The key rule is:

Debit the Debentures Account (to remove the liability) at the amount due on redemption.
Credit the Share Capital Account (or New Debentures Account) with the nominal value of the instruments issued.
If the conversion is at a premium or discount, the difference goes to Securities Premium Reserve or Discount on Issue of Debentures.

Watch out

Common Mistake

Students often forget that the conversion price may differ from the face value of debentures. Always check the terms: "conversion at par" means ₹100 debenture gets ₹100 shares; "conversion at a premium" means the debentureholder gets more shares than the face value.

Journal Entry Format

The standard journal entry for conversion is:

Particulars	Debit (₹)	Credit (₹)
10% Debentures A/c Dr.	xxx
To Equity Share Capital A/c		xxx
To Securities Premium Reserve A/c (if any)		xxx
(Being debentures converted into equity shares as per terms)

Example for Clarity

Suppose a company has ₹5,00,000, 9% debentures due for redemption. The terms allow conversion into equity shares of ₹10 each at a premium of ₹5 per share.

Working Note:

Number of shares to be issued = ₹5,00,000 ÷ ₹15 (₹10 face value + ₹5 premium) = 33,333.33 shares. Since shares cannot be fractional, the company may issue 33,333 shares and pay cash for the balance, or adjust terms. For simplicity, assume 33,334 shares are issued (rounding up).

Journal Entry:

Date	Particulars	L.F.	Debit (₹)	Credit (₹)
	9% Debentures A/c Dr.		5,00,000

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Q.What is meant by redemption of debentures by conversion?

Concept and Accounting Treatment

Journal Entry Format

Example for Clarity

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