Q.Can a company purchase its own debentures in the open market? Explain.

Yes, a company can purchase its own debentures in the open market. This is a common financial practice, not a prohibition. The Companies Act, 2013, does not forbid a company from buying back its own debentures, unlike the stricter rules for buyback of shares.

The primary reasons a company does this are:

• To cancel the debt and reduce its liabilities.
• To invest surplus funds temporarily, earning interest on its own debentures (which are then held as "Investments" or "Debentures in Treasury").
• To support the market price of its debentures.
• To avail of a tax advantage if interest paid is taxable but the company can earn tax-free interest on its own debentures. …

Concept and Accounting Treatment

A debenture is a written instrument acknowledging a debt under the company's seal. It is a loan taken by the company from the public, carrying a fixed rate of interest. When a company buys back its own debentures from the open market, it is essentially repaying its debt earlier than the contracted maturity date.

The key accounting principle here is that a company cannot be its own creditor. Therefore, when it purchases its own debentures, those debentures must be either:

1. Cancelled immediately – treated as a redemption of debt.
2. Held as an investment (called "Own Debentures" or "Debentures in Treasury") – the company becomes a debtor to itself, which is not allowed under accounting standards. Hence, this treatment is generally not permitted under Indian accounting practices (as per the Companies Act and AS). The standard approach is to cancel them upon purchase.

Why the entries are prepared this way:

• When debentures are purchased, the company pays cash. So Bank account is credited (decrease in asset).
• The liability represented by the debentures is reduced. So Debentures Account is debited (decrease in liability).
• If the purchase price is less than the face value (i.e., at a discount), the difference is a gain for the company – credited to Capital Reserve (a capital profit, not available for dividends).
• If the purchase price is more than the face value (i.e., at a premium), the difference is a loss – debited to Profit and Loss Account (or Securities Premium Reserve, if available).

The journal entries follow the golden rules of accounting:

• Debentures Account (a liability) – debit when liability decreases.
• Bank Account (a real account) – credit when asset goes out.
• Capital Reserve (a nominal account representing gain) – credit when income/gain arises.

Solution: Journal Entries

Assume a company purchases 1,000 of its own 10% debentures of ₹100 each at ₹95 per debenture (i.e., at a discount of ₹5 per debenture) for immediate cancellation.

If purchased at a premium (say ₹105 per debenture):

Working Notes

Working Note 1: Calculation of Amount Payable to Bank

• Number of debentures purchased: 1,000
• Purchase price per debenture: ₹95
• Total amount paid = 1,000 × ₹95 = ₹95,000

Working Note 2: Calculation of Capital Reserve (Gain)

• Face value of debentures purchased: 1,000 × ₹100 = ₹1,00,000
• Amount paid: ₹95,000 …