Question

Redemption of debentures means.................

• A. Cancellation
• B. Convertion
• C. Writing off
• D. Repayment

Answer 1

Answer:

D. Repayment

• Definition: Redemption of debentures refers to the discharge of a liability by the repayment of the principal amount borrowed by a company from debenture holders.
• Accounting Treatment: It signifies the cancellation of the debenture debt, effectively reducing the company's long-term liabilities on the Balance Sheet.
• Methods of Redemption: Companies typically utilize several established methods:
  • Lump Sum Method: Repayment of the entire principal amount at the end of the specified term.
  • Installment Method (Draw of Lots): Repayment of the principal in annual installments over the life of the debenture.
  • Conversion Method: Converting debentures into equity shares or new debentures as per the agreement terms.
  • Open Market Purchase: Buying back own debentures from the secondary market to cancel them, often when market prices are lower than the face value.
• DRR Requirement: As per the Companies Act, companies issuing debentures are generally required to create a Debenture Redemption Reserve (DRR) out of profits available for dividend distribution to ensure sufficient liquidity for repayment.
• Sources of Redemption: Funds for redemption can be sourced from:
  • Fresh issue of shares or debentures.
  • Accumulated profits (Capital Redemption Reserve).
  • Sale of assets.
  • Existing cash reserves.
• Key Distinction: Redemption is distinct from Interest Payment; redemption involves the return of the face value (principal), whereas interest payments are the cost of borrowing paid periodically.