The Hindu Business Line : Double-entry for debenture deals

DEBENTURES, secured or unsecured, are one of the sources of funds for an entity. Both public and private limited companies can issue debentures. They can be convertible, non-convertible, or even a hybrid, that is, partly convertible and partly redeemable.

One of the options for a company to redeem its debentures is to buy them in the stock market and cancel them. When a company buys debentures, they are to be held as investments until cancelled. They are disclosed as "own debentures" under the head "Investments". The following entry is passed:

Own debentures A/c. Dr

To Bank.

(Being own debentures purchased)

Companies Act requires that the face value of the debentures acquired to be disclosed alongside the balance-sheet. Since they are held as investments, requirements of AS 13 have to be complied with. AS 13 requires these investments to be classified as current or long-term investments. As defined in AS 13, a `current investment' is one that by its very nature readily realisable and intended to be held for no more than one year from the date on which such investment is made. A `long-term investment' is that which is other than a `current investment'.

The board resolution to acquire own debentures provides a clue as to whether these instruments constitute a current or a long-term investment. If the board resolution states that they are to be cancelled immediately on acquiring, the `Own Debentures Account' is to be debited with the consideration paid as and when acquired. Once the process is complete, these debentures are to be cancelled immediately and the question of treating them as current or long-term investments does not arise.

But if the board resolution states that these debentures are to be held indefinitely or to be considered for cancellation when the remaining debentures are to be redeemed, these become long-term investments. The disclosure norms as per AS 13, as applicable to long-term investments, should be complied with.

If the resolution provides for reconsidering the cancellation at the next/subsequent board meetings, these debentures would be current investments.

AS 13 requires the cash flows to be divided in to operating, financing and investing activities. Accordingly, the acquiring of these own debentures constitutes an investing activity and should be disclosed as such.

These debentures can be acquired cum- or ex-interest. When the purchase consideration is inclusive of the interest for the broken period, it is said to be cum-interest. The interest component should be calculated and debited to `Interest A/c'. and only the balance debited to `Own Debentures A/c'.

If, on the other hand, the consideration paid is only towards debentures and do not cover the interest, the entire consideration should be debited to `Own Debentures A/c'. In such a case, the company pays extra for interest. For example: A company has 12 per cent debentures of Rs 100 each, interest payable on January and July 1 each year. The company purchases on April 1, 100 debentures @ 102 cum-interest and on August 1, 50 debentures @ 98 ex-interest.

The accounting will be:

For the purchase on April 1:

Total debentures purchased — 100

Consideration paid per debenture — Rs 102

Interest on debenture from January 1 to April 1 (three months) — Rs 3.

Cost of each debenture (Rs 102 less Rs 3) — Rs 99.

The accounting entry would be:

Own debentures A/c. — Dr. 9,900

Interest on debentures — Dr. 300

To Bank — 10,200

(Being purchase of 100 debentures @ 102 cum interest)

For the purchase on August 1:

Total debentures purchased — 50

Consideration paid per debenture — Rs 98

Interest on debenture from July1 to August 1 (one month) — Re 1.

Consideration per debenture (Rs 98 plus Re 1) — Rs 99.

Own debentures A/c. — Dr. 4,900

Interest on debentures — Dr. 50

To Bank — 4,950

(Being purchase of 50 debentures @ 98 ex-interest)

It can be observed that interest has been deducted from the consideration in the case of cum-interest purchase and added to the price in the case of ex-interest purchase.

Whatever the terms of purchase, these own debentures should be disclosed at cost price in the financial statements and the face value indicated alongside. The company has two options for own debentures:

1. They can be disposed off in the stock exchanges at market rate

2. They can be cancelled.

The entry for disposal:

Bank A/c. Dr.

To Own debentures

(Being the amount realised on sale of own debentures)

The Debentures Account will not come in the picture at all.

The entry for cancellation:

Own Debentures A/c. Dr. (Face value of debentures cancelled)

To Own Debentures

If the debentures are disposed off, the balance in the `Own Debentures A/c' represents the profit or loss on disposal of investments. The cash flow from the sale of such own debentures would be an investing activity whereas redemption of debentures a financing activity.

Since these `own debentures' fall within the definition of a capital asset, any resultant profit on sale of these own debentures would be subject to capital gains under the Income-Tax Act. Depending on their period for which they are held, they may constitute a long- or a short-term capital gain.

When `own debentures' are cancelled, no cash flow is involved. Therefore, the question of it being a financing or investing activity does not arise.

Upon cancellation of `own debentures', any difference between the face value of the debentures and the cost price of `own debentures' represents profit or loss on cancellation. In compliance with the requirements of AS 13, such profits should be transferred to the Profit and Loss A/c. Such a profit or loss should be recognised only on cancellation or sale, as the case may be, but not on purchase.

Section 205 of the Companies Act permits usage of the current year profits (irrespective of its nature whether capital or revenue) for declaring dividends.

Since the profits/losses on such sale or cancellation of debentures are transferred to the Profit and Loss A/c, the balance in the Profit and Loss A/c after recording these profits/losses should be considered for declaring the dividends.

If the debentures are to be redeemed at a premium, a Proportionate Premium Account' also should be debited along with the `Debentures Account'.

Any loss on issue of debentures representing the proportionate value of debentures redeemed should also be written off to the `Profit and Loss Account'.

As long as the debentures are held without cancellation or disposal, the company will be saving on the interest payable. Interest on `Debentures A/c' should, however, be debited on the total value of debentures including `own debentures'. Care should be taken to exclude the interest already paid to the earlier owner of debentures at the time of purchase of debentures.

The `Bank Account' is to be credited to the extent of cash actually paid. So much of the amount representing interest on `Own Debentures' should be credited to an account titled `Interest on Own Debentures A/c'. This amount should be disclosed in the financial statements as any other income on investments.

Netting off such interest on `own debentures' against `Interest on Debentures Account' may not be proper because the interest on debentures is not an investing activity whereas the income from interest on own debentures is investing activity.

Once the debentures are cancelled, the liability of the company to pay interest stands decreased proportionately.