What is Redemption of Debentures?
What is Debenture and Redemption of Debenture?
First, what is a debenture? a debenture is a form or structure designed for long-term debt or loans that corporations or firms use to accept to borrow money from the public. It is common for debentures to remain unsecured even when borrowers have pledged to repay the loan in full after the term has expired. In India, like in many other countries, the loan is often collateralised by the company's or firm's secured assets. In the United States, however, they are still not protected.
Debentures are redeemed when the holder settles all outstanding obligations and loans owed to the debenture holder or the lender that provided the loan. It includes the parties' agreed-upon terms and conditions for the loan or debt repayment.
The term "redemption of debentures" describes how a corporation pays back loaned money to its creditors after maturity. The obligation is cancelled when the debt on the debenture account is paid in full.
What Does DRR (Debenture Redemption Reserve) Mean?
Defining the Term Debenture Redemption Reserve
A debenture redemption Reserve is a clause stating that any corporation, firm, or organisation in the nation that issues debentures is needed to establish a redeeming service of the debenture to demonstrate an attempt to assure the return of borrowed money.
Companies that issue debentures in India must set aside funds for debenture redemption well before the debenture's maturity date, as required by the Indian Companies Act of 1956. To issue debentures under this Act, a company must have a minimum of 25 percent of the face value represented by the debentures.
For Example, On April 1, 2022, ABC Pvt Ltd. issued Rs. 20 lakhs in debentures with a maturity date of March 1, 2025. In this case, ABC Pvt. Ltd. is required by the Companies Act to set aside Rs. 5 lakhs (or 25% of the debenture's face value) as a debenture redemption reserve by the debenture's maturity date.
After issuing a debenture, companies are not obligated to immediately set aside money for the redemption reserve. Instead, they may put a sufficient sum into the DDR account each year until maturity.
Redemption Reserve Methods
Debentures can be redeemed in several different ways. For bookkeeping purposes, each approach is handled differently. It is possible to place these methods into the following buckets:
Lump-sum Method
After the maturity term, the corporation will make a single redemption payment in full to the holder of the debenture. The principal amount and maturity date will be agreed upon during debenture issuance. Since the corporation knows the maturity date, it can plan accordingly. In addition, this debenture amount received in lump sum includes the cash held in the debenture's redemption reserve account.
Instalment Method
In this form of debenture redemption, the borrowed funds are repaid in a series of payments, either regularly or irregularly, depending on the rescue of the debenture above.
Purchasing Method
Market participants are eager to buy the debentures these corporations and organisations issued. They may also be terminated instantly, allowing the corporation to extend the debenture's term until its repayment is within its means.
In addition, the corporation may increase its income by purchasing debentures on the open market at a discount, which reduces the total redemption payment.
Conversion Method
Conversion to a different debenture or stock in the issuing firm is an additional perk of redeemable debentures. As part of the debenture's issuing process, the holder is informed of the terms and circumstances under which the debenture may be converted.
Convertible debentures are the word used to describe this kind of debt instrument. At par, at a discount, or at a specified premium, the company can issue new equity shares in exchange for such debentures or issue new debentures.
A company can redeem its debentures by at least 15% of its face value during the investment year if the firm is investing in designated securities under Rule 18 (7) of the Companies Share Capital and Debenture Rules 2014. This must be completed by April 30 of the maturity year. Finally, businesses must remember that the DRR account may be established at any Indian bank recognised by the Reserve Bank of India.
Case Study
Show the example of Redemption of Debentures Journal Entries.
On March 31, 2002, X Co. Ltd. paid Rs. 97 for its own 9% debentures with a nominal value of Rs. 40,000. Input the transaction into the company's accounting system. If the price quoted is:
(i) Cum-interest
(ii) Ex-interest.
The company pays debtor interest twice a year, on June 30 and December 31.
Solution:
Conclusion
The functioning of debentures in an organisation is made possible by the procedures of issuing new debentures and redeeming existing ones. Therefore, discharging an organisation's debt burden of debentures is meant as "debenture redemption." One of the many methods for redeeming debentures is to make a one-time payment in the form of a lump amount. Other methods are also available. In this scenario, debenture holders get the guaranteed amount on the date that has been predetermined.
FAQs on Redemption of Debentures
1. What is Redemption of Debentures?
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?
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?
The various methods of Redeeming Debentures are payment in lump-sum, payment in instalments, conversion of debentures and purchase of debentures in the market.
4. What methods are usually used for the Redemption of Debentures?
Redemption of Debentures is the format of terms and conditions between the lender and borrower about the repayment of the loan or funds that a company or firm has borrowed from the debenture holders after the expiry of the tenure. The borrower is bound to follow the terms and conditions mentioned in the debenture redemption form. In case of any violation of the terms mentioned there in the format the company will be treated as a defaulter. The methods of redemption of the debt can be as follows:
Paying back in lump sum amount at at time
Paying back in easy instalments
Purchasing the debentures in the open market.
5. What is the usual time given to Redeem the debenture?
Debts and loans are usually redeemed back with cash or sometimes converted into some other forms after the completion of the tenure. This tenure can range to a fixed number of years or after a certain number of years as promised earlier by giving a specified notice. They can also be redeemed by drawing the funds annually. The tenure should not exceed more than ten years from the issue of the debenture. However in certain special cases the tenure can be extended but not beyond 30 years. The special cases which can be considered for late redemption are as follows:
Company is setting up big projects on infrastructure.
Company having the permission from the Ministry, Department of Central Government or Reserve Bank of India.
6. What is the necessity for creating a debenture redemption reserve?
Debenture redemption reserve is a separate account other than the debenture account which ensures the debenture holder that the company has substantial funds for the redemption of debenture after the expiry of the tenure when the company is still not able to repay the debt. This is usually created with 25% of the actual loan borrowed. This is required to distribute the dividend annually until the debentures are cleared. The company is not permitted to use this amount in debenture redemption reserve at any time. When a company could not repay back the debenture amount even after completion of its tenure, the tribunal can order the company to repay back the principal amount along with the interest and in that case this reserve comes in play and helps in the repayment.
7. How many types of debentures are present?
Debentures are the format of loans taken by companies from public funds. The type of these formats can be mainly of four types. They are as follows:
They can be secured or unsecured based on the agreement. In India they are mainly of the secured type.
Registered or bearer type
The debenture can be convertible or non-convertible in its form based on its conversion or non conversion to equity shares.
First and second type depending upon whether the first debenture has been redeemed or not.
8. What advantages do debentures give?
Debentures are so popular because of the huge advantages it brings with itself. They are:
It assures the investor a fixed income with no or low risk.
Financing through debentures does not reduce the autonomy of equity held by shareholders because voting rights are not guaranteed in a debenture.
A company may not provide assets earned through profits into a debenture.
Thus debenture is an appropriate solution when income and sales are stable.
9. What exactly does it mean to redeem debentures by a single lump-sum payment?
The total amount of debenture payments obtained in one transaction; redemption of debentures in lump sum refers to the process by which the total amount of debentures is paid to the holders of debentures in a single lump payment either on the day of maturity or even before the date of maturity. During the maturity hereof, the company will redeem the debentures by making a single, lump-sum payment to the holders of the redemption of debentures will result in following the terms and circumstances of issuance.
10. What does the term "irredeemable debentures" mean?
Irredeemable debentures are deeds of trust in which the principal investment amount cannot be recouped throughout the organisation's existence. When using irredeemable debentures, the borrower does not need to identify a certain term or amount during which the principle would be restored.
This eliminates the requirement for the borrower to plan. This is because these debentures are exempt from being redeemed. The issuance of debentures that cannot be redeemed is far less frequent than the issuance of debentures that can be saved.
11. What do you understand by the term "redeemable debentures"?
If there is a predetermined period for the return of either the principle or the interest, then such debentures are regarded as being redeemable. On this day, right up to the time when the stores shut their doors for the day, there are two ways that they may be redeemed:
Lump-sum
Instalments
These are some instances of how one might redeem themselves. Furthermore, the holder of the debenture is the one who is responsible for the redemption of the securities, which must take place at either the face value or a premium above the face value.