Class 12 Accountancy Chapter 6 Issue and Redemption of Debentures

Key Concept: Advanced Journal Entries, Financial Reporting

c) Dr. Application Money Account \$150,000; Cr. Debenture Allotment Account \$100,000; Cr. Bank/Cash Refund Account \$50,000

[Solution Description]

The total amount received for applications was:

$$\$150,000$$

The amount needed for allotted debentures (2,000 at \$50 each) is:

$$2,000 \times 50 = \$100,000$$

Excess amount received is:

$$\$150,000 – \$100,000 = \$50,000$$

The journal entry to record the transaction would be:

Dr. Application Money Account \$150,000

Cr. Debenture Allotment Account \$100,000

Cr. Bank/Cash Refund Account \$50,000

This reflects the refunding of the excess money to those not receiving debentures.

Key Concept: Real-world Application, Complex Issuance Scenarios

c) To enhance attractiveness to investors by lowering initial financial burden

[Solution Description]

Secured debentures imply that the debenture holders have a charge over some asset(s) of the company. Issuing at a premium means additional funds are being raised over the face value, but collecting the premium in installments serves specific strategic purposes:

1. It reduces the immediate financial burden on investors, making the debenture more attractive.

2. Manages cash flow better by not overwhelming the company’s resources through immediate high payouts.

3. Ensures that investors remain connected with the company over a longer horizon, potentially fostering loyalty and ensuring consistent capital infusion.

Thus, the main reason for choosing installment payments is to improve investor attraction by easing their initial financial commitment.

Key Concept: Strategic Decision Making, Impact Analysis

b) To keep tangible assets unencumbered for operational leverage

[Solution Description]

Companies might choose to issue debentures as collateral security instead of using tangible assets in various strategic scenarios:

1. Preservation of Asset Use: Assets remain free for operational use rather than being tied up.

2. Easier Liquidity Management: Debentures are more liquid and easier to manage compared to physical assets.

3. Cost Consideration: Lower direct costs may be associated with debentures than managing physical assets.

These strategic choices allow companies to maintain operational flexibility and financial robustness.

Key Concept: Definition Recall

c) To provide additional assurance for the repayment of a loan

[Solution Description] The primary purpose of collateral security is to provide additional assurance or guarantee to the lender by securing a loan or credit with an asset.

Key Concept: Advanced Collateral Security Concepts, Redemption Strategy

b) Employ put options for downside protection; repurchase during value dips

[Solution Description]

Hedging against market risks involves derivatives contracts, possibly using options or futures tied to interest rate movements. By leveraging these instruments, the company can offset potential losses due to interest rate changes affecting debenture value.

As for open-market purchases, timing is key: purchase when market prices are favorable, reducing total redemption cost compared to face value.

Together, these strategies protect against volatility and optimize financial outcome.

Key Concept: Exemption Entities

a) All India financial institutions

[Solution Description] According to the guidelines, All India financial institutions are typically exempted from the requirement to create a Debenture Redemption Reserve. This exemption allows them more flexibility in managing their finances.

Key Concept: Journal Entry Identification

a) Debentures A/c Dr. To Debentureholders

[Solution Description] When debentures are redeemed at par, the journal entry involves debiting the Debentures A/c and crediting the Debentureholders A/c. Therefore, the correct entry is “Debentures A/c Dr. To Debentureholders.”

Key Concept: Two Installment Adjustments

d) Debenture Allotment A/c

[Solution Description]

When the application money is transferred to allotment, the following journal entry is made: Debit “Debenture Application A/c” and Credit “Debenture Allotment A/c”. Since the total number of debentures applied and allotted are the same, we can calculate the application money as follows:

$$\text{Application Money} = 5,000 \times 40 = 200,000$$

Entry:

$\text{Debit: Debenture Application A/c } 200,000$

$\text{Credit: Debenture Allotment A/c } 200,000$

Thus, option b) is correct.

Key Concept: Real-World Application

b) Market conditions

[Solution Description] When issuing convertible debentures, a company should primarily consider market conditions as these can affect both the desirability of the debentures and the eventual conversion into equity. Favorable market conditions may lead to higher interest from investors in converting debentures into shares.

Key Concept: Types of Debentures

c) They have no coupon rate and are issued at a discount.

[Solution Description] Zero coupon debentures do not pay periodic interest, instead they are issued at a discount and redeem at face value upon maturity. The profit to the investor is the difference between their purchase price and the amount paid at redemption.

Key Concept: Calculation of Discount

c) Rs. 50,000

[Solution Description]

To calculate the total discount, we need to first determine the discount per debenture and then multiply it by the number of debentures issued.

The discount per debenture is calculated as follows:

$$\text{Discount per Debenture} = \text{Nominal Value} – \text{Issue Price} = 200 – 190 = 10 \, \text{Rs.}$$

Now, multiplying the discount per debenture by the total number of debentures gives us:

$$\text{Total Discount} = \text{Discount per Debenture} \times \text{Number of Debentures} = 10 \times 5000 = 50,000 \, \text{Rs.}$$

Key Concept: Collateral Security

c) Collateral security is used to fulfill the remaining loan obligation.

[Solution Description]

When debentures are issued as collateral security, they act as additional backup for a loan. If the main security fails to cover the debt, the collateral debentures provide the extra security needed to satisfy the lender’s claim.

Key Concept: Redemption Sources

c) From capital or profits

[Solution Description]

Generally, companies can fund the redemption of debentures from profits or capital. This flexibility allows the company to manage its financial resources effectively while complying with legal and regulatory requirements.

Key Concept: Complex Calculation, Yield Analysis

c) 5.76%

[Solution Description]

To find the yield to maturity (YTM), we use the formula:

$$P = \frac{F}{(1 + r)^n}$$

where:

– $P$ is the present value or issue price (\$600),

– $F$ is the face value (\$1,000),

– $r$ is the interest rate or yield to maturity,

– $n$ is the number of years until maturity (8 years).

Solving for $r$,

$$600 = \frac{1000}{(1 + r)^8}$$

Rearrange to solve for $r$:

$$(1 + r)^8 = \frac{1000}{600} = \frac{5}{3}$$

Now take the eighth root on both sides:

$$1 + r = \left(\frac{5}{3}\right)^{\frac{1}{8}}$$

Calculate the right side:

$$1 + r \approx 1.0576$$

Therefore,

$$r \approx 0.0576 \text{ or } 5.76%$$

Therefore, the yield to maturity is approximately 5.76%.

Key Concept: Journal Entry Analysis

c) Credit Securities Premium Account

[Solution Description]

During the conversion of debentures into shares, when shares are issued at a premium, the premium amount should be credited to “Securities Premium Account”.

Therefore, the correct journal entry would involve crediting the Securities Premium Account for the premium received from the issue.

Thus, the correct option is: Credit the Securities Premium Account.

Key Concept: Comprehensive Accounting, TDS Calculation

b) \$34,000

[Solution Description]

The nominal value of the debentures is $5,000 \times \$100 = \$500,000$. The annual interest rate is 8%, so the total interest for one year is:

$$\text{Total Interest} = 0.08 \times \$500,000 = \$40,000$$

Applying a TDS of 15%, the amount deducted as tax is:

$$\text{TDS} = 0.15 \times \$40,000 = \$6,000$$

Therefore, the net interest paid to debentureholders is:

$$\text{Net Interest} = \$40,000 – \$6,000 = \$34,000$$

Key Concept: Complex Conversion Scenario, Redemption Strategy Analysis

b) 41,667 shares

[Solution Description]

To solve this problem, we first need to determine the conversion rate based on the premium set for equity shares. The face value of an equity share is Rs.10, and with a premium of 20%, the effective price per share becomes:

$$\text{Effective Share Price} = Rs.10 + \left( \frac{20}{100} \times Rs.10 \right) = Rs.12$$

Now, calculate the total amount to be converted from debentures to shares:

$$\text{Total Debenture Value} = 5,000 \times Rs.100 = Rs.500,000$$

Using the effective share price, determine how many shares can be issued:

$$\text{Number of Shares} = \frac{Rs.500,000}{Rs.12} = 41,667 \text{ shares (rounded down to nearest whole)}$$

Therefore, the total number of equity shares to be issued is 41,667.

Key Concept: Advantage Identification

b) It allows flexibility in redemption timing

[Solution Description] An advantage of redeeming debentures by purchase in the open market is that it allows the company to redeem at its convenience and possibly at a discount, which can help in cost saving.

Key Concept: Journal Entry Sequence

a) Sundry Assets A/c Dr. To Vendor’s; Vendors Dr. To Debentures A/c

[Solution Description] The correct sequence involves two main parts: the recording of the asset acquisition and the issuance of debentures. When machinery is purchased, it increases the company’s assets, so we debit Machinery Account and credit Vendor’s Account to acknowledge the liability to the vendor. Next, since debentures are issued at par to settle this liability, we debit Vendor’s Account and credit Debenture Account. Therefore, the correct journal entry sequence is:

1. Sundry Assets A/c Dr. To Vendor’s

2. Vendors Dr. To Debentures A/c.

This choice matches option a).

Key Concept: Application of Over Subscription

b) Rs. 300,000

[Solution Description]

The company received applications for 18,000 debentures but issued only 12,000, leading to over subscription. Therefore, the company needs to refund the application money for the excess 6,000 debentures ($18,000 – 12,000$).

Refund amount = Excess debentures $\times$ Application money per debenture

$$\text{Refund amount} = 6,000 \times 50 = 300,000 \text{ Rs.}$$

Thus, the refund amount due to over subscription is Rs. 300,000.

Key Concept: Investment Requirement

b) 15%

[Solution Description] According to the syllabus, companies are required to invest or deposit at least 15% of debentures maturing during the year by April 30.

Key Concept: Application of Concepts

d) Irredeemable Debenture

[Solution Description] The company wishes to repay the debentures upon winding-up, which aligns with the characteristics of irredeemable debentures. Irredeemable debentures are also known as perpetual debentures, meaning they do not have a specific repayment date until the company winds up.

Key Concept: Repayment Impact

c) The debentures are released back to the issuer.

[Solution Description]

When a loan for which debentures have been issued as collateral security is fully repaid, these debentures become redundant in terms of securing the liability. Upon repayment:

– The lender will release the collateral, effectively nullifying the purpose of issuing them as collateral.

– Since they were just pledged and not actually sold, there is no further action needed except removing the note from records reflecting them as collateral.

Therefore, the correct understanding is that the collateral ceases to serve its purpose upon repayment.

Key Concept: Tenure Comparison

d) Redeemable debentures are repayable on expiry of a specific period.

[Solution Description] Redeemable debentures are payable at the end of a specified period, either in lump sum or installments. In contrast, irredeemable debentures are generally repayable upon winding-up or after a long unspecified duration.

Key Concept: Scenario-Based

d) Unsecured Debentures

[Solution Description] Unsecured debentures are the correct choice for this scenario because they do not have a specific charge on assets. However, they might have a floating charge by default, as opposed to secured debentures which would involve either a fixed or specific charge.

Key Concept: Journal Entry Identification

c) Both A and B

[Solution Description] The correct journal entries for redeeming debentures at par involve first debiting the Debentures account and crediting the Debentureholders account, followed by debiting the Debentureholders account and crediting the Bank account. The entries are as follows:

$$ \text{Debentures A/c Dr.}$$

$$\quad \quad \quad \quad \quad \quad \quad \quad \text{To Debentureholders}$$

$$\text{Debentureholders Dr.}$$

$$\quad \quad \quad \quad \quad \quad \quad \quad \text{To Bank A/c}$$

Key Concept: Basic Concept

c) 8%

[Solution Description] The percentage of interest on debentures issued by a company is directly mentioned in the name of the debenture itself. Hence, if a company issues 8% debentures, the percentage paid as interest is simply 8%.

Key Concept: Application of Concepts

a) Shown under Other Current Assets

[Solution Description]

If the discount on debentures is expected to be written off within 12 months, it should be classified as a current asset because it represents an expense that will be realized in the near term.

Key Concept: Journal Entry Identification

c) Securities Premium Reserve A/c

[Solution Description]

When debentures are issued at a premium, the premium amount is credited to the Securities Premium Reserve Account. This account records any extra amount received over and above the nominal value of the debentures.

Key Concept: Redemption Timing

c) On due date or before maturity if articles allow

[Solution Description] Redemption of debentures can occur on due date or before maturity if the articles allow according to the syllabus.

Key Concept: Instalment Strategy

d) \$160,000

[Solution Description] The total value of the debentures is calculated as $$8,000 \times 100 = \$800,000$$. As they are redeemed over 5 years in equal instalments, each year’s instalment is $$\frac{\$800,000}{5}$$.

Calculation:

$$\text{Annual Redemption Amount} = \frac{\$800,000}{5} = \$160,000$$

Therefore, \$160,000 worth of debentures will be redeemed each year.

Key Concept: Tenure Strategy, Real-World Application

d) To guarantee consistent availability of funds

[Solution Description] Irredeemable debentures create perpetual debt on the firm’s balance sheet, providing continuous capital without the need for repayment. This is favored when long-term stable funding supersedes short-term fluctuations, ensuring the firm is not pressured by refinancing or redemption schedules, thus maintaining steady operations.

Key Concept: Journal Entry Analysis

b) Debenture Discount Written Off Account

[Solution Description]

When writing off the discount on issue of debentures from the profit and loss account, the Profit and Loss Account is debited, and Debenture Discount Written Off Account is credited. Hence, the account credited will be the Debenture Discount Written Off Account.

Key Concept: Calculation of Sinking Fund

b) Rs. 15,762.5

[Solution Description] To calculate the total accumulation:

– Use the formula for compound interest: $A = P(1 + r)^n$

– For each year, we find the future value separately and sum them up:

$$A_1 = 5000(1+0.05)^2 = 5000 \times 1.1025 = 5512.5$$

$$A_2 = 5000(1+0.05)^1 = 5000 \times 1.05 = 5250$$

$$A_3 = 5000$$

$$\text{Total} = 5512.5 + 5250 + 5000 = 15762.5$$

So, the amount accumulated would be \$15,762.5

Key Concept: Investment for Redemption

b) 15%

[Solution Description]

According to regulatory requirements, companies are required to invest a certain percentage of the amount of debentures maturing during the year into specified securities to ensure availability of funds for redemption. This percentage is typically 15%.

Key Concept: Simple Calculation

c) Rs. 210,000

[Solution Description]

When debentures are issued at a 5% premium, the amount received can be calculated as:

$$\text{Total Amount} = \text{Face Value} + (\text{Face Value} \times \frac{5}{100})$$

Substituting the values:

$$\text{Total Amount} = 200,000 + (200,000 \times \frac{5}{100})$$

$$\text{Total Amount} = 200,000 + 10,000$$

$$\text{Total Amount} = 210,000$$

Key Concept: In-Depth Classification, Critical Analysis

b) Zero coupon debentures

[Solution Description] This problem involves understanding the characteristics of various debenture types. The firm seeks to minimize costs (deep discount), remain flexible (unsecured), and provide returns via appreciation rather than interest payments. These characteristics align with zero coupon debentures which fit all specified conditions: issued at deep discount, unsecured, and sold without periodic interest, instead appreciating over time.

Key Concept: In-Depth Conceptual Understanding, Real-World Application

d) Irredeemable Zero Coupon Rate Debentures

[Solution Description] In an economic downturn, it is prudent to choose irredeemable debentures to avoid fixed maturity commitments. Moreover, zero coupon rate debentures allow the issuer to defer interest payments, which aligns with minimizing current debt service obligations.

Key Concept: Real-world Application, Convertible Debentures

a) It avoids immediate dilution of existing shareholders’ ownership.

[Solution Description] Choosing convertible debentures allows a company to initially raise funds without immediately diluting ownership since these are debt instruments with an option to convert into equity at a later date. If converted, this can then potentially lead to dilution of ownership, but only after certain pre-defined conditions are met, typically when the company has grown and increased in value. Additionally, the interest on debentures may be cheaper than dividends paid out to shareholders.

Key Concept: TDS Calculation

b) Rs. 5,000

[Solution Description]

To calculate TDS, the given interest payment is multiplied by the TDS rate. Thus, the TDS deducted on an interest of Rs. 50,000 at 10% is $50,000 \times \frac{10}{100} = 5,000$ Rs.

Key Concept: Impact on Financial Statements

c) Increases cash/bank and increases securities premium reserve

[Solution Description]

Issuing debentures at a premium affects the company’s balance sheet in the following ways:

– Cash/Bank increases by the amount received (\$105,000 for 1,000 debentures issued at \$105).

– Non-current liabilities increase due to the creation of a Debenture liability of \$100,000.

– The Securities Premium Reserve, part of shareholders’ equity, increases by \$5,000.

Overall, both assets and liabilities + equity sides of the balance sheet increase by the premium amount.

Key Concept: Redemption at Premium

c) Rs. 1,100

[Solution Description] The redemption value is calculated as the face value plus the premium. Here, the premium is 10% of Rs. 1,000, which is Rs. 100. So, the total redemption amount = Rs. 1,000 + Rs. 100 = Rs. 1,100.

Key Concept: Calculation of Premium

c) \$52,500

[Solution Description]

When debentures are redeemed at a premium, the redemption amount includes the face value plus the premium percentage. For debentures issued at \$50,000 with a 5% premium on redemption:

$$\text{Redemption Amount} = 50,000 + (50,000 \times 0.05)$$

$$= 50,000 + 2,500$$

$$= 52,500$$

Thus, the total amount payable upon redemption is \$52,500.