Redemption of Debentures

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Debentures are a type of debt instrument utilised by companies and firms to borrow funds from the public at large. As per the agreements of the contract of this loan, debentures holders are repaid the principal amount after the tenor expires.

Such a process of settling the liability of an organisation is termed as Redemption of Debentures. The mechanism behind the redeeming process of debentures depends upon each type of debenture and their terms of repayment of funds to the holders.

What do you Mean by Redemption of Debentures?

Redemption of Debentures is defined as the settlement of borrowed funds by a company or a firm to their debenture holders after the date of maturity. After the funds are repaid, the liability on the debenture account is discharged. 

To have a more fundamental understanding of the Redemption of Debentures Meaning : 

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What is Debenture Redemption Reserve (DRR)?

A debenture redemption Reserve can be referred to as a provision which states that any company, firm or enterprise in the country which issues debentures are required to open a redeeming service of the debenture to show an effort to ensure repayment of borrowed funds. 

As per the Indian Companies Act of 1956, all companies who issue a debenture need to create a debenture redemption reserve before the maturity date of a specific debenture. According to this Act, companies need to represent at least 25% of the face value of the issued debentures.

For example, let’s say that a company ABC Pvt Ltd. issues Rs. 20 lakhs in debentures on the 1st of April of 2020 with a maturity date of March 2025. Here, as per the companies act, ABC Pvt Ltd. needs to assemble 25% of Rs. 20 lakhs as debenture redemption reserve before the maturity date of the debenture. 

Companies are not required to arrange funds for the debenture redemption reserve just after issuing the debenture. They are allowed to credit funds into the DDR account by an adequate amount each year until the maturity date.

Methods of Redemption Reserve

There are several methods by which the redemption of debentures can take place. Each method follows a unique accounting treatment. These approaches can be classified under the following categories :

  • Payment in lump-sum on the debenture’s maturity.

  • Payment in instalments after the maturity date.

  • Redemption through the purchase of the debenture on the market.

  • Redemption through the conversion of debentures into new debentures or equity shares.

For a clear understanding, check a tabular representation : 

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a. Payment in Lump-Sum on the Debenture’s Maturity

In such cases, the debenture is redeemed by the company in a lump-sum amount as a one-time payment at the end of the maturity period. The amount, as well as the maturity date, will be as per the terms discussed during the issuance of the debenture.

As the company is aware of the date of maturity, they can prepare their finances in advance. This one-time payment of such a lump-sum amount also includes the funds set aside in the debenture’s redemption reserve account.

b. Payment in Installments after the Maturity Date of the Debenture

In this method of redemption of debentures, repayment of the borrowed funds takes place through a series of instalments in a regular or irregular fashion as per the terms of the conditions of the redemption of the said debenture.

c. Redemption Through the Purchase of the Debenture on the Market

In this case, companies and firms are willing to purchase their debentures on the market. They can also choose to cancel them immediately; in such a way, the company can prolong the maturity of the debenture until the payment is suitable for its financial capabilities.

Moreover, if the purchase of the debentures on the open market is made at a discount, the company can avail the opportunity of lowering the overall redemption payment, thereby improving the overall business revenue.

d. Redemption Through the Conversion of Debentures

Redeemable Debentures also offer the facility of conversion into a new type of debenture or an equity share of the concerned company. The terms and conditions of the conversion of such a debenture are addressed to the holder during the issuance of the debenture.

This kind of debenture is termed as convertible debentures. Such debentures are converted to new debentures, or equity shares can be issued by the company at par, for discount and even at a specified premium.

According to Rule 18(7) of the Companies Share Capital and Debenture Rules 2014 at least 15% of the face value of the debenture amount is to be redeemed during the year the company is making investments in specified securities. This is required to be done within the 30th of April of the maturity year.

Finally, companies should also keep in mind that the DRR account is required to be opened in any financial institution of the country which is authorised by the Reserve Bank of India.

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FAQ (Frequently Asked Questions)

1. What is Redemption of Debentures?

A. Redemption of Debentures is the form of repayment of the borrowed funds of a company or a firm to its debenture holders on maturity.

2. What is a Debenture Redemption Reserve?

A. As an effort to ensure the debenture holders that the repayment of borrowed funds is on course, companies are required to set aside 25% of the outstanding debenture amount on a separate account, known as the debenture redemption reserve, before the maturity date.

3. What are the Various Methods of Redemption of Debentures?

A. The various methods of Redeeming Debentures are payment in lump-sum, payment in instalments, conversion of debentures and purchase of debentures in the market.