Madhur Ltd. has outstanding 9% debentures of Rs. 50,00,000 redeemable at par on January 01, 2020. Debenture Re

Numerical Questions · Q20

Q. Madhur Ltd. has outstanding 9% debentures of Rs. 50,00,000 redeemable at par on January 01, 2020. Debenture Redemption Reserve of Rs. 2,00,000 on March 31, 2018 and balance of required amount of DRR was created on March 31, 2019. The company invested in specified securities (DRI) the required amount on April 01, 2019. Debentures were redeemed on the due date. Record necessary journal entries in the books of the company and also prepare the ledger accounts (ignore interest).

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Concept understanding — Premium on Redemption

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:

Journal Entry for Premium on Redemption Payable Date Particulars Dr. (₹) Cr. (₹) Securities Premium Reserve A/c \dots Dr. xxx General Reserve A/c \dots Dr. (if needed) xxx To Premium on Redemption of Debentures/Preference Shares A/c xxx (Being the premium payable on redemption provided for)

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.

Watch out

Never debit the Profit & Loss Account for premium on redemption. The NCERT textbook is clear: premium on redemption is a capital loss (or a distribution of accumulated profits), not a revenue expense. Doing otherwise would understate the year’s profit.

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. …

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We need to record the creation of the Debenture Redemption Reserve (DRR), the investment in specified securities (DRI), and the redemption of the debentures. The key rule: DRR must be at least 10% of the face value of debentures outstanding. Here, 10% of ₹50,00,000 = ₹5,00,000. The company already had ₹2,00,000 in DRR on March 31, 2018, so the additional amount required is ₹3,00,000, created on March 31, 2019. The DRI (specified securities) must be at least 15% of the face value = ₹7,50,000, invested on April 01, 2019. On redemption (January 01, 2020), the DRI is sold and the debentures are paid off.

Journal Entries in the books of Madhur Ltd.

Date	Particulars	Debit (₹)	Credit (₹)
2019 Mar 31	Statement of Profit & Loss A/c Dr. To Debenture Redemption Reserve A/c (Being additional DRR created @ 10% of ₹50,00,000 – existing ₹2,00,000)	3,00,000	3,00,000
2019 Apr 01	Debenture Redemption Investment A/c Dr. To Bank A/c (Being investment in specified securities @ 15% of ₹50,00,000)	7,50,000	7,50,000
2020 Jan 01	Bank A/c Dr. To Debenture Redemption Investment A/c (Being DRI sold on redemption date)	7,50,000	7,50,000
2020 Jan 01	9% Debentures A/c Dr. To Debentureholders A/c (Being amount due on redemption)	50,00,000	50,00,000
2020 Jan 01	Debentureholders A/c Dr. To Bank A/c (Being payment made to debentureholders)	50,00,000	50,00,000
2020 Jan 01	Debenture Redemption Reserve A/c Dr. To General Reserve A/c (Being DRR transferred to General Reserve after redemption)	5,00,000	5,00,000

Ledger Accounts

Debenture Redemption Reserve A/c

Particulars	Amount (₹)	Particulars	Amount (₹)
To General Reserve	5,00,000	By Balance b/d	2,00,000
		By Statement of P&L	3,00,000
Total	5,00,000	Total	5,00,000

Debenture Redemption Investment A/c …

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Madhur Ltd. redeems ₹50,00,000 of 9% debentures at par on Jan 1, 2020. The company creates a Debenture Redemption Reserve (DRR) of ₹5,00,000 (10% of face value) by transferring from P&L, invests ₹7,50,000 (15% of face value) in specified securities (DRI) on April 1, 2019, and redeems the debentures on due date. The DRI is then sold on or after redemption. Journal entries and ledger accounts for DRR, DRI, and debentures are required.

Concept and Accounting Treatment

When a company issues debentures, it has a liability to repay the principal on the redemption date. To ensure funds are available and to protect creditors, the Companies Act mandates two key requirements:

Debenture Redemption Reserve (DRR): The company must create a reserve out of profits (transferred from the Profit & Loss Appropriation Account) equal to at least 10% of the face value of the debentures outstanding. This reserve is a charge on profits and is created over the life of the debentures. It is shown under 'Reserves and Surplus' in the Balance Sheet. The DRR is not a fund set aside for redemption; it is a profit appropriation that restricts dividend distribution.
Debenture Redemption Investment (DRI): The company must invest an amount equal to at least 15% of the face value of the debentures in specified securities (like government bonds, bank deposits, etc.) before the redemption date. This investment is made to ensure liquidity for the actual cash payment. The DRI is held until the redemption date and then sold, with the proceeds used to pay the debenture holders.

The Journal Entry Logic:

Creating DRR: Debit Profit & Loss Appropriation A/c (reducing retained earnings) and Credit Debenture Redemption Reserve A/c (creating a statutory reserve).
Making DRI: Debit Debenture Redemption Investment A/c (an asset) and Credit Bank A/c (cash outflow).
Redemption of Debentures: Debit 9% Debentures A/c (liability extinguished) and Credit Debentureholders A/c (liability to pay). Then, Debit Debentureholders A/c and Credit Bank A/c (actual payment).
Sale of DRI: Debit Bank A/c (cash inflow) and Credit Debenture Redemption Investment A/c (asset removed). Any profit/loss on sale is transferred to the Profit & Loss A/c.
Transfer of DRR: After redemption, the DRR is no longer required. It is transferred to the General Reserve (or Retained Earnings) by debiting DRR and crediting General Reserve.

Solution: Journal Entries in the Books of Madhur Ltd.

Given Data:

Face Value of Debentures: ₹50,00,000
Redemption Date: January 01, 2020
DRR balance on March 31, 2018: ₹2,00,000
DRR created on March 31, 2019: Balance required to make DRR = 10% of ₹50,00,000 = ₹5,00,000. So, additional DRR created = ₹5,00,000 - ₹2,00,000 = ₹3,00,000.
DRI made on April 01, 2019: 15% of ₹50,00,000 = ₹7,50,000.
Redemption on Jan 01, 2020: At par.

Date	Particulars	Debit (₹)	Credit (₹)
2019 Mar 31	Profit & Loss Appropriation A/c Dr.	3,00,000
	To Debenture Redemption Reserve A/c		3,00,000
	(Being the required amount of DRR created, being 10% of ₹50,00,000 minus existing balance of ₹2,00,000)
2019 Apr 01	Debenture Redemption Investment A/c Dr.	7,50,000
	To Bank A/c		7,50,000
	(Being the investment of 15% of face value in specified securities as per Section 71(4) of Companies Act, 2013)
2020 Jan 01	9% Debentures A/c Dr.	50,00,000
	To Debentureholders A/c		50,00,000
	(Being the amount due to debentureholders on redemption)
2020 Jan 01	Debentureholders A/c Dr.	50,00,000
	To Bank A/c		50,00,000
	(Being the payment made to debentureholders)
2020 Jan 01	Bank A/c Dr.	7,50,000
	To Debenture Redemption Investment A/c		7,50,000
	(Being the specified securities sold at par on redemption date)
2020 Jan 01	Debenture Redemption Reserve A/c Dr.	5,00,000
	To General Reserve A/c		5,00,000
	(Being the DRR transferred to General Reserve after redemption)

Watch out

A common mistake is to treat the DRR as a fund that is used to pay the debentureholders. It is not. The DRR is a reserve (part of shareholders' equity). The actual cash for redemption comes from the sale of the DRI and other company funds. The DRR is simply transferred to General Reserve after redemption.

Ledger Accounts

1. Debenture Redemption Reserve Account

| :--- | ---: | :--- | ---: | …

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Particulars	Dr. (₹)	Cr. (₹)
Securities Premium Reserve A/c … Dr.	xxx
General Reserve A/c … Dr. (if needed)	xxx
To Premium on Redemption of Debentures/Preference Shares A/c		xxx
(Being the premium payable on redemption provided for)

Concept and Accounting Treatment

Solution: Journal Entries in the Books of Madhur Ltd.

Ledger Accounts

1. Debenture Redemption Reserve Account

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