Questions

Redemption Profit Calculation, Accounting

Redemption Profit Calculation | Financial Accounting Theory

Large amount is usually required for redemption of debentures. A company may adopt anyone or more of the following course in order to provide funds for redemption of debentures:

i. Redemption out of capital

ii. Redemption out of profit.

I. Redemption out of capital when the debentures are paid out of current sources of the company, it is known as redemption out of capital. It means no debenture redemption reserve is created by the company. This affects the working capital adversely as per SEBI guidelines this source can be used by the following companies.

(i) Infrastructure companies (a company wholly engaged in the business of developing maintaining and operating infrastructure facilities).

(ii) A company issuing debentures with a maturity period of not more than 18 months.

(iii) A company issue debentures in the form of private placement.

In other words the above companies are not required to create debenture redemption reserve.

II. Redemption out of profit: it means that as per SEBI guidelines an amount equal to 50% of the debentures issued should be transferred from profit & loss appropriation account to belly opened account called debentures redemption reserve account before the redemption starts. Implication of this provision is that whenever redemption of debentures is made at least an amount equal to 50 % of the debenture issued should stand to the credit of the endure redemption reserve account. This provision is applicable only in case of non-convertible debenture and non-convertible portion of partly convertible debenture. Such redemption does not affect the financial position of the company adversely company has two alternatives for investment of retained profit.

(a) Retained profit invested in its own business in such a case the following entries will be passed

(i) On transfer of profits

Profit & loss appropriation A/c Dr.

To debenture redemption reserve A/c

(ii) On redemption of debentures

(a) For the amount of debentures due

X % debentures A/c Dr.

To debenture holders A/c

(b) For payment made to debenture holders

Debenture holders A/c Dr.

To bank A/c

(iii) When all the debentures are redeemed the balance of debenture redemption reserve is transferred to general reserve.

Debenture redemption reserve A/c Dr.

To general reserve A/c

(c) Retained profit invested outside business in such a case the company sets aside a part of its profits every year and is invested in outside securities or bonds of the other business entities. For this purpose and from profits very year so as to ensure that sufficient amount accumulates in this account before redemption takes place.

The appropriate amount of sinking fund is invested in outside securities each year and the interest on these securities each year is also reinvested. The investments are sold at the time of redemption of debentures and this money is used for redeeming the debentures.

Notes:

(i) The appropriate amount (or annual contribution) will be calculated with the help of sinking fund table.

(ii) Sinking fund or debenture redemption fund will serve the purpose of debenture redemption reserve as required by the law.

The following entries will be made under sinking fund method

Entries at the end of first year

(i) For transfer of annual contribution to sinking fund.

Profit & loss appropriation A/c Dr.

To sinking fund A/c

(ii) For investment of annual contribution

Sinking fund investment A/c Dr.

To bank A/c

Entries at the end of every year (except last year)

(i) For interest received on sinking fund investment

Bank A/c Dr.

To interest on sinking fund investment A/c

(ii) For interest transferred to sinking fund

Interest on sinking fund investment A/c Dr.

To sinking fund A/c

(iii) For the transfer of annual contribution to sinking fund

Profit & loss appropriation A/c Dr.

To sinking fund A/c

(iv) For investment of annual contribution plus interest received

Sinking fund investment A/c Dr.

To bank A/c

Entries in the year of redemption

(i) For interest received on sinking fund investment

Bank A/c Dr.

To interest on sinking fund investment A/c

(ii) For interest transferred to sinking fund

Interest on sinking fund investment A/c Dr.

To sinking fund A/c

(iii) For the transfer of annual contribution to sinking fund

Profit & loss appropriation A/c

To sinking fund A/c

(iv) For the sale of sinking investment

Bank A/c Dr.

To sinking fund investment A/c

(v) (a) for profit on the sale of investment

Sinking fund investment A/c

To sinking fund A/c

(b) For loss on the sale of investment

Sinking fund investment A/c Dr.

To sinking fund investment A/c

(vi) For the redemption of debentures

(a) At par

X% debentures A/c Dr.

To debenture holders A/c

(b) At premium

X% debentures A/c

Debenture redemption premium A/c Dr.

To debenture holders A/c

(c) For payment

Debenture holders A/c Dr.

To bank A/c

For writing off the loss on account of premium redemption of debenture through sinking fund

Sinking fund A/c Dr.

To loss on issue of debentures A/c

(vii) For the transfer of balance of sinking fund

Sinking fund A/c Dr.

To capital reserve A/c (transferring of capital profits such as profit on sale of investments and gain on cancellation of own debentures)

To general reserve A/c (transferring balance of sinking fund)

Note:

(i) No entry is required for investment in the year of redemption

(ii) After redeeming all the debentures the balance of sinking fund is transferred to capital reserve and general reserve.

(iii) Loss on issue of debentures account is written of through sinking fund account as it was earlier debited while passing the issue entry.

(iv) Debenture redemption fund or debenture redemption reserve may be used in place of sinking fund.
Posted by Priti | Posted Date: 12/30/2011 5:40:04 AM




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