Debenture Redemption by Instalments: Draw of Lots Explained

Debenture Redemption

Redemption of debentures occurs when a company eliminates its debt to debenture holders by paying off the holders in total. Ordinarily, debentures are repaid at the end of a particular time set when the debentures are issued. The terms of the debenture issuance specify the date of redemption. Before the redemption date, debentures may be redeemed via a lottery or open market acquisition. The debentures may be cancelled or converted into equity shares after the market acquisition.

What are Instalments by Draw of Lots?

To better plan for cash flow, some companies use a revenue recognition strategy called the instalment method, which delays the recording of gross profit on a sale until the owner receives payment from the customer. Using the instalment approach, income is progressively recorded as payments are accepted.

The instalment method is often utilised when a client has been granted authorisation to pay an invoice in periodic payments spread over several years. There is a high possibility that the seller will be unable to collect the entire amount due in some instances. Due to the potential for loss, the company prefers not to record the whole debt amount at the transaction's time. The organisation may reduce this risk by using the instalment method of revenue recognition.

Aspects Influencing Redemption

The following are important considerations at the time of Redemption of Debentures:

Time - The date by which the debentures must be redeemed is the most critical factor. The company must specify debentures' terms of validity at the time of issuance. The debenture holder receives a certificate that specifies the debenture's maturity date and other terms.

Amount - To calculate the redemption amount owed to the holder, we need to make some educated guesses at that moment. The payments consist of both the principal and interest owed.

Source - The redemption amount and how it is repaid are also crucial factors. Therefore, redemption options will vary significantly based on urgency and practicality.

The redemption process will go more smoothly if the organisation has planned and made the necessary preparations.

Debenture Issuance and Redemption Procedures

Redemption of Debentures

Step 1: A Need for Long-Term Funding

The availability of funds in the debenture redemption reserve account is crucial to the effective running of the organisation. For this reason, they must have access to long-term capital to invest in the company's future.

Step 2: Debentures are Issued to Generate Funds

Businesses raise capital through issuing debentures, both convertible and nonconvertible. The corporation then gives Debenture Certificates. Debenture issuance and redemption details are included on the certificate.

Step 3: The Payment Deadline

Debentures are issued for a certain period and will mature on that date. After this period ends, the business promptly redeems all outstanding debentures. The debenture certificate will provide the redemption date for the holder's use.

Step 4: Redeeming Resources

The firm investigates potential debenture redemption channels if needed. In other words, whether the corporation would spend its cash on hand or issue new shares or debt.

Step 5: Redeeming Techniques

For the sake of salvation, this is the most critical step. The best option for the organisation would be one that would not compromise its current financial standing. The four options for redeeming debentures mentioned above are the most common ones.

Illustration

On 01/01/2019, ABK Limited issued 12,000 Debentures for $100 each, with a maturity date of 01/01/2022. However, the corporation wants to redeem the debenture ahead of the redemption date. Therefore, find a way for the corporation to redeem the debentures three years early, beginning on January 1, 2020.

Solution:

The debenture may be redeemed in three equal instalments by the corporation, either via a random drawing or by acquiring the debentures on the open market and cancelling them. How do you Figure Out the Payment Amount?

An Instalment Payment Amount = Debentures Issued / Number of Years

Debentures issued = 12000

Period = 3 Years

Instalment Amount = Rs. 12,000 divided by 3 = 4,000/-

To effectively redeem all debentures, the corporation must annually purchase 4,000 debentures at market price.

Conclusion

Debentures provide long-term company funding. After a specified time, the money must be returned. The debenture holder's investment is redeemed. The firm must choose redemption suppliers and methods carefully.

Debenture payments are expensive. The corporation must plan the redemption at issue. The instalment method is better than accrual accounting if a business expects periodic payments over several years. The accrual basis method records all sales revenue from the first transaction without accounting for delayed payments.