Issue and Redemption of Debentures

The full picture

When a company needs large amounts of money for expansion or new machinery, it cannot always rely on its owners alone. One major option is to borrow from the public by issuing debentures. A debenture is a certificate of debt: the company promises to pay the holder a fixed rate of interest (called the coupon) every year and to repay the principal on a fixed future date. Unlike shareholders, debenture holders are not owners — they are creditors. This means they have a legal right to receive interest before shareholders get any dividend, and in a winding-up their claims are settled before those of equity and preference shareholders (though secured creditors, government dues, and employee wages rank above unsecured debenture holders).

Debentures can be issued at three different prices. When issued at par, the company receives exactly the face value (say ₹100 for a ₹100 debenture). When issued at a discount (say ₹95), the company receives less than face value but must still repay ₹100 at maturity — the ₹5 shortfall is a financing cost recorded as 'Discount on Issue of Debentures' (a debit balance, contra to the debenture liability). When issued at a premium (say ₹105), the company receives more than face value but repays only ₹100 — the ₹5 gain is credited to Securities Premium Reserve. This distinction matters for the balance sheet: debentures are always shown at their redemption value, not the cash received.

Recording the issue is straightforward once you know the rule: debit Bank for cash received, debit Discount on Debentures for any shortfall, and credit the Debentures account at full face (redemption) value. If issued at premium, credit both Debentures (at face value) and Securities Premium Reserve (for the extra amount). Every year, two things flow through the Profit and Loss account as Finance Costs: the interest actually paid to holders (coupon rate × face value) and the amortisation of any discount. Under the Straight-Line Method (SLM), the discount is spread equally over the debenture's life — so if ₹2 lakh of discount covers 5 years, you charge ₹40,000 each year.

Here is something many students get wrong about the Straight-Line Method: the annual rupee charge is the same every year (coupon + fixed amortisation), but the effective interest rate actually falls each year. Why? Because the carrying amount of the debenture rises each year as the discount balance shrinks. You are dividing the same fixed rupee charge by a larger and larger denominator — so the rate must fall. A constant effective interest rate across all years is the property of the Effective Interest Rate (EIR) method, which is used in advanced accounting standards. For Plus Two exams, SLM is the standard method.

Redemption is the repayment of the debenture principal at maturity. The simplest method is a lump-sum payment on the maturity date: debit Debentures and credit Bank for the full face value. By that date, all discount must be fully amortised, so no further adjustment is needed. Companies may also redeem in instalments through a sinking fund, where a fixed amount is invested each year in safe securities (like government bonds) so that the accumulated fund equals the redemption amount at maturity. This protects debenture holders and ensures the company has the cash ready when the time comes. Serial redemption — paying off different tranches in different years — is another approach used when a company wants to reduce its debt burden gradually.

On the balance sheet, debentures appear under Non-Current Liabilities. Show them at their face value with any unamortised discount deducted (or any unamortised premium added) to arrive at the net carrying amount. This two-line presentation is informative: it reveals both the company's full repayment obligation and the deferred financing cost still to be charged in future years. Interest accrued but not yet paid appears separately under Current Liabilities as 'Interest Accrued on Debentures'.

An Indian example

Imagine Kerala Infrastructure Investment Fund Board (KIIFB) issues ₹500 crore worth of 8% debentures at ₹97 (a ₹3 discount) to fund a coastal highway project, redeemable after 10 years. The board's accountant records: Bank Dr ₹485 crore, Discount on Debentures Dr ₹15 crore, Debentures Cr ₹500 crore. Every year, KIIFB pays ₹40 crore interest to holders (8% of ₹500 crore) and also charges ₹1.5 crore of discount amortisation to Finance Costs (₹15 crore over 10 years). The balance sheet shows the debentures at ₹500 crore less the unamortised discount balance, which starts at ₹15 crore and shrinks by ₹1.5 crore each year. After 10 years the discount is fully written off and KIIFB repays all ₹500 crore to the holders in one lump sum. A student reading KIIFB's annual report can now trace every one of these figures.

Common misconceptions to watch for

• Shares and debentures can both be issued at a discount — this is wrong. Under Section 53 of the Companies Act 2013, a company cannot issue shares at a discount (except sweat equity in limited cases). Debentures, however, are debt instruments and can legally be issued below face value; the discount is then amortised as a finance cost over the debenture's life.
• The balance sheet should show debentures at the price the company actually received (issue price) — this is incorrect. The liability is always recorded at the redemption value, which is what the company is legally obligated to repay. Any discount is shown as a separate deduction and any premium as a separate addition, giving readers the net carrying amount.
• Under the Straight-Line Method, the effective interest rate stays the same every year — this is a common mix-up. SLM fixes the annual rupee charge (coupon plus equal discount instalment), but the carrying amount of the debenture grows each year as the discount is written off. Dividing the same fixed charge by a rising carrying amount gives a falling effective rate. A constant effective rate is the feature of the Effective Interest Rate (EIR) method, not SLM.