(216)-IMPORTANT NOTES FOR REDEMPTION OF DEBENTURES

Important Notes for Redemption of Debentures

• The profit or loss on redemption of debentures, disclosed in the debenture redemption account, is the difference between the price paid on redemption and the nominal value. As the price paid on redemption includes accrued debenture interest, an adjustment made debiting debentures interest account and crediting debentures redemption account with the accrued interest. The amount of such interest, having being paid out of sinking fund cash, must be reimbursed thereto out of general cash, and reinvested.
• If debentures are purchased or redeemed when they are ex-interest, the price paid will exclude interest from the date of purchase to the interest payment date; an adjustment can be made debiting debenture redemption account and crediting debenture interest account with interest on the debentures purchased or redeemed from the date of purchase to the interest payment date; general cash will be debited and sinking fund cash credited.
• No purpose is served by apportioning the proceeds of sale of the investments between capital and income, as both the interest earned and any profit or loss on realization of the investments must be transferred to the sinking fund account.
• An amount equal to the nominal amount of the debenture stock cancelled has been transferred from the sinking fund account to general reserved, as the assets representing it are now part of the general asset and are not include in the sinking fund investment account.
• The discount allowed on the issue should be written off as soon as possible. The discount allowed on the issue of cancelled stock must be written off, as the debentures are no longer outstanding. As, however, the general reserve is available, it has been thought advisable to write off the whole discount against it immediately.

(215)-REDEMPTION OF DEBENTURES

Redemption of Debentures

Debentures may be irredeemable; but this unusual, except in companies formed under special act of parliament.

Debentures may be redeemed either at the end of a given period or by annual drawings. The trust deed, or if there is no trust deed, then the debentures themselves, will contain provision for redemption and will unusually stipulate the establishment of a sinking fund for repayment out of profits.

Alternatively a company may take out of a sinking fund policy with an insurance company for the amount of debentures.

A company which has redeemed debentures to reissue them, either by reissuing the same debentures, or by issuing other debentures in lieu; unless provision, express or implied, is contained in the articles or the conditions of issue, or unless the company has, by passing a resolution, or by some other act, shown its intention that the debentures shall be cancelled. Where a company has redeemed debentures, every balance sheet must show particulars of debentures that may be reissued. On reissue the debentures must be stamped as an original issue; they retain, however, the same priorities as the original debentures.

The company can purchase its own debentures; when debentures are purchased at below the issued price a capital profit will result from the purchase. Strict accounting demands appropriate adjustments for accurate interest included the purchase price. In practice this would frequently be ignored.

(214)-DEBENTURE ISSUES

Debenture Issues

Debentures issued at a premium

When debentures are issued at a premium, debenture account is credited with the nominal amount and debenture premium account with the premium. Debenture premium account can be shown in the balance sheet as a revenue reserve. The companies act does not specify the uses of the debenture premium account.

Debenture issued at a discount

Debenture can be issued at a discount, but must be redeemed at par or a premium; since a capital profit (which is subject to tax) is made on redemption, a lower rate of interest can be paid than if the debentures were issued at their redeemable price.

Where debentures are issued at a discount, cash is debited with the net sum received and discount on debentures account being credited with the full nominal value of the debentures, at which value they must appear as a liability in the balance sheet. The discount on debentures, or so much as has not been written off, must be shown separately in the balance sheet.

The discount on the issue is, in effect, deferred interest, and should accordingly be written off over the period having the use of the money raised by the debentures, unless a sinking fund is created to accumulate the full redemption price, including the discount. Where the debentures are to be redeemed by annual drawings, the discount should be written off by proportionately reducing installments, since each succeeding year has the use of a reducing amount of principal.

Debentures repayable at a premium

These debentures will stand in the balance sheet as a liability at their nominal amount, with a note of the amount at which they are repayable, any discount or premium on issue being treated as described above.

If a sinking fund is raised to provide for repayment, it should include provision for the payment of the premium on redemption. If no sinking fund is created, the premium should be provided for out of profits over the period of the debentures.

Debentures may even be issued at a discount and repayable at a premium.

(213)-DEBENTURES OF A COMPANY

Debentures of a Company

A debenture is a written acknowledgement of a debt by a company, usually under seal and generally containing provision for payment of interest and repayment of capital; a simple or naked debenture carries no charge on assets; a secured debenture carries either a fixed charge on a specific asset or a floating charge an all or some of the assets. All form of loan stock is debentures.

A fixed charge is a mortgage on specific assets, under which the company losses the right to deal with the assets charged, except with the consent of the mortgagee. A floating is not a mortgage at all, since the charge is such that so long as the company continues to carry on its business and observe the terms of the charge, the directors are entitled to deal in any way they please in the ordinary course of business with the assets of the company, and may even make specific charges on property which, subject to the terms of the floating charge given, will have priority to the floating charge. The floating charge is a charge on a class of assets, present and future, which in the ordinary course of business is charging from time to time, and attaches to the priority included therein in priority to the general liabilities of the company. The floating charge hovers over or “floats” with the assets, until some event happens which crystallizes or fixes the charge.
A company may take more than one issue of debentures; issues subsequent to the first may rank on an equal footing with the original issue, or may confer a charge, subject to and following the first, according to whether the original debentures contained clauses allowing or forbidding subsequent on an equal footing issues. Where the debentures carry different priorities, they are usually designated first debentures, second debentures etc-a higher rate of interest usually being payable on those of lower rank to compensate for the lower degree of security.

A company can issue debentures within the limits of its borrowing powers, as set out in its memorandum and/or articles of association. A trading company’s borrowing powers are implied unless there are provisions to the contrary in the memorandum or articles.

Interest at the agreed rate is payable on the debentures whether the company makes profits or not, since the charge given covers both principle and interest. Income tax is deductible from the interest payable.

In liquidation, the debenture holders are entitled to the proceeds of their securities, if any, otherwise they rank equally with the unsecured creditors; if the proceeds of a security are insufficient to repay the debentures, the debenture holders rank as unsecured creditors for the balance still due to them.

The entries in the books of a company for an issue of debentures are similar to those on an issue of shares, installment accounts being debited with the various installments as they become due, and debentures account credited. If debentures are issued to the vendor as part of the consideration for a business acquired by the company, the vendors’ account is debited and the debentures account credited. The appropriate entry must also be made in the register of charges kept by the company.

(212)-RESERVES AND PROVISIONS

Reserves and Provisions

Reserves

The term reserves may include the following:

• Reserves created by means of appropriation from profit and loss account.
  

The reserves referred to below be voluntary reserves, the amounts transferred are at the discretion of the directors. These reserves may include following:

1. General reserve
2. Fixed asset replacement reserve
3. Stock replacement reserve
4. Debenture reserve
   

There is no legal restriction on the use of any of these reserves to pay a dividend to the shareholders. However, the fact that a particular company has any of these reserves implies that the directors wish funds to be kept within the business for a future purpose rather than be distributed as dividend.

• Share premium account
• Revaluation reserve
• Capital redemption reserve
• Merger reserve
• Reserves provided for by the articles of association
  

Provisions

The term is defined by companies act and includes:

• Provision for depreciation or diminution in value of assets-this includes provision for depreciation, stock and doubtful debts. Such provisions are deducted from the asset heading to which they relate.
• Provisions for liabilities or charges-amounts retained as reasonably necessary for the purpose of providing for any liability or loss which is either:

1. Likely to be incurred, or
2. Certain to be incurred but uncertain as to amount or date on which it will arise.
   

This includes provisions for redundancy and reorganization, repairs and maintenance, warranty expenditure and deferred taxation.

(211)-ISSUE OF SHARES

Issue of Shares

Whenever an allotment of shares is made, an entry should be made in the journal, debiting an application and allotment account with the amount payable on application and allotment in respect of the shares so allotted, and crediting share capital account. If more than one class of capital is being issued, separate accounts must be opened in the ledger for each class.

Similar entries must be made debiting the vendor or other persons, and crediting share capital account, in respect of all shares issued for a consideration other than cash.

When calls are made, an entry must be made debiting call account and crediting share capital account with the total amount due in respect of all call.

Shares issued at a premium

A company may issue shares at a premium, for an amount in excess of their nominal value. Such an issue might be made by a successful company which has paid high dividends on its existing capital and where shares, as a result, already stand at a premium on the market. When shares are issued at a premium, whether for cash or otherwise, the premium must be credited to an account called “the share premium account” unless the manager reserve provisions of the companies act. The amount credited to share premium account can only be applied as follows:

1. Subject to the conformation of the court, in a scheme for reduction of capital, as if it were paid-up share capital of the company;
2. In paying up unissued shares of the company to be issued to the members as fully paid bonus shares;
3. In writing off preliminary expenses or the expenses of, or commission paid or discount allowed on, any issue of shares or debentures of the company;
4. In providing for the premium payable on the redemption of the company.
   

The premium is usually payable with the installment due on allotment, and where this is so, the journal entry for allotment must show the amount payable for the premium, which must be credited direct to the share premium account, only the proportion of the amount due representing a payment on account of the nominal value of the shares being credited to share capital account.

(210)-SHARE CAPITAL OF A COMPANY

Share Capital of a Company

The most common class of share capital is ordinary shares which carry votes. In principle a company may have more than one class of shares, including:

• Voting ordinary shares which carry the right to vote on all matters and to participate in surplus profits or surplus assets on liquidation.
• Non-voting ordinary shares which have similar rights as for above except that the ability to vote is restricted.
• Preference shares, provided that there are profits available for distribution.
  

Two further points are relevant:

1. Preference shares are deemed to be cumulative unless they are designated as non-cumulative. Cumulative means that should a company be unable to pay preference dividend in a particular year, the entitlement is carried forward as a memorandum note outside the double entry system. Should available profits arise in a subsequent year, such arrears of preference dividends must be paid in priority to ordinary dividends.
2. Participating preference shares are a special type of share. They may have a prior entitlement to a fixed amount of dividend, and then a further entitlement, once ordinary shareholders have received a particular amount.
   

• Deferred or founders’ shares-such shares carry votes but shareholders are not entitled to dividends until holders of ordinary shares have received a specified dividend. Such shares are fairly rare.