Q.C. Ltd. has outstanding 11,00,000, 10% debentures of ₹200 each, on April 1, 2017. The Board of Directors have decided to purchase 20% of own debentures for cancellation at ₹200 each. Record necessary entries for the same.

Let’s start with something you already know from everyday life. Suppose you borrow ₹1,000 from a friend and promise to pay it back after one year. But when the year ends, you don’t just return ₹1,000 — you also pay an extra ₹50 as a “thank you” for the favour. That extra ₹50 is like a premium — an amount above the face value.

Now replace your friend with a company, and the loan with a redeemable preference share or a debenture. When a company issues these, it promises to repay the holder at a future date. Sometimes, the company agrees to repay more than the face value — say, a ₹100 share is repaid at ₹110. That extra ₹10 is the premium on redemption.

Why does a company offer a premium on redemption?

It’s not generosity. A company offers a premium to make its shares or debentures more attractive to investors. If the market interest rate is high, investors won’t buy a low-coupon debenture unless they know they’ll get a bonus at redemption. The premium is the sweetener.

From the company’s side, this premium is a cost — an extra outflow of cash when the instrument is redeemed. And like any cost, it must be accounted for properly.

The accounting treatment — the core rule

The premium on redemption is not a loss that hits the Profit & Loss account directly. Instead, it is adjusted against the company’s reserves and surplus — specifically, the Securities Premium Reserve (if available) or the General Reserve / Retained Earnings.

Here’s the precise journal entry when the premium is paid at the time of redemption:

Then, when the actual payment is made:

| | Premium on Redemption of Debentures/Preference Shares A/c … Dr. | xxx | |

| | To Bank A/c | | xxx |

| | (Being the premium paid to debenture/shareholders) | | |

Which account is debited and which is credited — the logic

• Debit the reserve account (Securities Premium Reserve first, then General Reserve, then any other free reserve). Why? Because the company is using its accumulated profits (reserves) to meet this extra cost — it’s not a business expense like salary or rent.
• Credit a temporary liability account called “Premium on Redemption of … A/c”. This shows that the company owes this premium to the holders. Later, when paid, that liability is cleared by crediting Bank.

Where does this appear in the financial statements?

In the Balance Sheet, before redemption, the “Premium on Redemption of … A/c” appears under Current Liabilities (or as a separate item under Non-Current Liabilities if the redemption is due after one year). After payment, it disappears.

In the Notes to Accounts, the movement in reserves (like Securities Premium Reserve) will show the amount used for premium on redemption as a deduction.

A small format — as per NCERT style

The NCERT textbook (Class 12, Part 2, Chapter on Redemption of Debentures) shows a statement of premium on redemption when debentures are redeemed at a premium. Here’s a simplified version:

This statement is used to compute the total cash needed. The premium amount (₹10,000) is then provided for by debiting Securities Premium Reserve or General Reserve.

The key takeaway for your exam

• Premium on redemption = extra amount paid above face value when redeeming shares/debentures.
• It is not a revenue expense — it is adjusted against reserves (Securities Premium Reserve first, then General Reserve).
• Journal entry: Debit Reserve, Credit Premium on Redemption A/c (liability). Then debit that liability, credit Bank when paid.
• In the Balance Sheet, the unpaid premium appears as a liability.

Remember: the premium is a cost of raising finance, but it’s settled from past profits (reserves), not from current year’s profit. That’s the conceptual heart.