Accountancy · Ch 6 — Issue and Redemption of Debentures
Redemption by Purchase in Open Market
Redemption by Purchase in Open Market
When a company buys back its own debentures from the stock market (or any open market) and immediately cancels them, this is called redemption by purchase in the open market. The key advantage is flexibility: the company can redeem debentures whenever it has surplus cash, and it can often buy them at a discount (below face value), saving money.
Accounting for Purchase at a Discount
If the company buys its debentures at a price below their face value (a discount), the difference between the face value and the purchase price is a profit. This profit is not an operating income — it arises from the company's own financial instruments — so it is transferred to Capital Reserve (a reserve not available for dividend distribution).
Journal Entry 1 — Purchase and cancellation (when bought at a discount):
| Date | Particulars | L.F. | Debit (₹) | Credit (₹) |
|---|---|---|---|---|
| Debentures A/c (Face Value) | Dr. | [Face Value] | ||
| To Bank A/c (Actual cost) | [Purchase Price] | |||
| To Profit on Redemption of Debentures A/c (Discount) | [Face Value – Purchase Price] | |||
| (Being own debentures purchased from open market and cancelled) |
Journal Entry 2 — Transfer of profit to Capital Reserve:
| Date | Particulars | L.F. | Debit (₹) | Credit (₹) |
|---|---|---|---|---|
| Profit on Redemption of Debentures A/c | Dr. | [Profit amount] | ||
| To Capital Reserve A/c | [Profit amount] | |||
| (Being profit on redemption transferred to capital reserve) |
Why debit Debentures A/c with the face value?
The Debentures A/c is a liability account. When debentures are cancelled, we reduce the liability by its full face value. The credit to Bank is the actual cash paid. The balancing figure (the discount) is the profit.
Accounting for Purchase at a Premium
If the company buys its debentures at a price above the face value (a premium), the excess is a loss. This loss is debited to Loss on Redemption of Debentures A/c and then transferred to the Statement of Profit and Loss (i.e., it reduces the profit for the year).
Journal Entry 1 — Purchase and cancellation (when bought at a premium):
| Date | Particulars | L.F. | Debit (₹) | Credit (₹) |
|---|---|---|---|---|
| Debentures A/c (Face Value) | Dr. | [Face Value] | ||
| Loss on Redemption of Debentures A/c (Premium) | Dr. | [Purchase Price – Face Value] | ||
| To Bank A/c (Actual cost) | [Purchase Price] | |||
| (Being own debentures purchased from open market and cancelled) |
Journal Entry 2 — Transfer of loss to Statement of Profit and Loss:
| Date | Particulars | L.F. | Debit (₹) | Credit (₹) |
|---|---|---|---|---|
| Statement of Profit and Loss A/c | Dr. | [Loss amount] | ||
| To Loss on Redemption of Debentures A/c | [Loss amount] | |||
| (Being loss on redemption charged to profit and loss) |
Alternative Two-Step Method
The textbook also shows an alternative where the purchase and cancellation are recorded in two separate entries: …