Accountancy · Ch 6 — Issue and Redemption of Debentures
From Coupon Rate Point of view
From Coupon Rate Point of view
Concept First
The coupon rate is the stated interest rate on a debenture. It determines how much periodic interest the company pays to debenture holders. From this viewpoint, debentures fall into two categories: those that carry a specific coupon rate and those that do not. The key difference lies in how the investor is compensated — either through regular interest payments or through a deep discount on the issue price.
(a) Specific Coupon Rate Debentures
These debentures are issued with a specified rate of interest, known as the coupon rate. The coupon rate can be:
- Fixed — remains constant throughout the life of the debenture.
- Floating — changes periodically, usually linked to a benchmark like the bank rate.
The company pays interest at this specified rate to debenture holders at regular intervals (typically half-yearly or annually). This is the most common type of debenture.
Accounting treatment: Interest on such debentures is calculated as:
Interest = Nominal Value × Coupon Rate × Time
The journal entry for interest payment is:
| Date | Particulars | L.F. | Debit (₹) | Credit (₹) |
|---|---|---|---|---|
| Debenture Interest A/c | Dr. | xxx | ||
| To Bank A/c | xxx | |||
| (Interest paid on debentures) |
At the end of the accounting year, the Debenture Interest account is closed by transferring it to the Statement of Profit and Loss.
(b) Zero Coupon Rate Debentures
These debentures do not carry a specific rate of interest. Instead, they are issued at a substantial discount to their nominal (face) value. The investor does not receive periodic interest payments; the return comes entirely from the difference between the issue price and the redemption value.
How the discount compensates the investor:
The difference between the nominal value and the issue price is treated as the amount of interest related to the duration of the debentures. This discount is effectively the interest cost for the company, spread over the life of the debentures.
Example: If a ₹100 zero-coupon debenture is issued at ₹80 and redeemed at ₹100 after 5 years, the ₹20 discount represents the total interest for 5 years.
Accounting treatment:
- At the time of issue: The discount is recorded as a loss.
| Date | Particulars | L.F. | Debit (₹) | Credit (₹) |
|---|---|---|---|---|
| Bank A/c | Dr. | 80 | ||
| Discount on Issue of Debentures A/c | Dr. | 20 | ||
| To Debentures A/c | 100 | |||
| (Issued 100 zero-coupon debentures at a discount) |
- Over the life of debentures: The discount is written off each year to the Statement of Profit and Loss as a finance cost. The amount written off each year is calculated by dividing the total discount by the number of years.
Annual discount amortisation = Total Discount / Life of Debentures (in years)
The journal entry each year:
| Date | Particulars | L.F. | Debit (₹) | Credit (₹) |
|---|---|---|---|---|
| Statement of Profit and Loss A/c | Dr. | 4 | ||
| To Discount on Issue of Debentures A/c | 4 | |||
| (Discount written off for the year) |