What do you mean by redemption of debentures? Explain the

What do you mean by redemption of debentures? Explain the various methods of redemption of debentures.

Ans.

REDEMPTION OF DEBENTURES

To redeem, is to pay-back’. Redemption of debenture means discharge of liability on account of debenture/bond by repayment to debenture holders. Normally, its redemption takes place on the expiry of period for which they have been issued. depending upon the terms and conditions of issue. In other words, redemption of debentures means repayment of the amount of debentures by the company. When debentures are redeemed, liability on account of debentures is discharged.

SOURCES OF FUNDS (FINANCE) FOR REDEMPTION OF DEBENTURES

Usually, a large sum of money is required for redemption of debentures. Hence, the source of redemption of the debentures must be identified. The requisite funds should be arranged to redeem debentures as per the terms of the issue of debentures. A company may collect the requisite funds for redemption from the following sources:

(1) Fresh Issue of Share Capital and Debentures: Redemption of debentures from proceeds of fresh issue of share capital and debentures is mere conversion of one liability into another. By raising fresh issue, the company can maintain its working capital intact or can adjust its working capital or debt-equity ratio. Fresh shares or debentures can be issued at par, at discount or at premium. In such a situation, there is no need to create Debenture Redemption Reserve, because the additional Share Capital or Debentures issued for redemption of debentures replaces the existing debentures only.

(2) Redemption out of Accumulated Profits and Sinking Fund: The company may face a financial difficulty case of redemption of debentures because a large amount is required for the redemption. To remove this differently, the company goes on retaining a part of its profits and accumulating it to meet the future requirements. In such a case, the company with holds the profits and :

(a) invest in the business for internal financing;

(b) invest the amount of divisible profits in marketable securities or subscribes in insurance policy.

(3) Redemption out of Surplus Funds: Surplus funds of the company may also be utilized for redemption of debentures i.e., for the purpose of redemption, a company purchases its own debentures out of its surplus funds.

(4) Redemption from Realizing the Assets: A company may redeem its debentures, by the funds realized from the sale proceeds of fixed assets. In practice, it is an unusual source of finance because this method adversely affects the reputation of the company.

METHODS OF REDEMPTION OF DEBENTURES

The debentures may be redeemed in one of the following five ways (methods):

(1) Lump-sum Payment Method: Under this method, the company redeems the debentures by paying the whole amount in one lump-sum to the debenture holders at the expiry of the agreed time or earlier at the option of the company after passing the necessary resolution at the meeting of debenture holders. In such a case, the time of repayment is known in advance and the company can plan its financial resources accordingly. Such redemption will be made profits only.

(2) Annual Instalments Payment Method: Under this method, redemption of debentures is made” in instalments at the end of each year during the life time of the debentures. The total amount of debenture liability is divided by the number of years it is to last. The amount of debentures to be redeemed each year are selected by lottery. Thus, it is also known as drawings by lottery or draw of lots. Due to this method, the amount of annual drawings tends to remain constant, however in some cases, there may be unequal too. Such redemption will be made out of profits only.

(3) Purchase in the Open Market Method: Under this method, the company discharges the debenture liability in full or in part by purchasing its own debentures in open market through Stock Exchange either for immediate cancellation or keeping them as investment and cancel at a later date. Generally, a company is interested to purchase its own debentures when the rate of interest on debentures is higher than the market interest rate.

(4) Conversion Method: Under this method, a company can redeem its debentures by converting them into new class of debentures or shares. If shareholders find that the offer is beneficial to them, they can exercise their right of converting their debentures into new class of debentures or shares. These new shares or debentures can be issued at par, at discount or at premium. This method is applicable only to convertible debentures, non-convertible debentures can be redeemed in this way.

(5) Payment after a fixed period: Sinking Fund Method: Sinking Fund Method is another method by which the debentures can be redeemed on maturity. Under this method, a fixed amount worked out with the help of Sinking Fund Table is transferred from Statement of Profit & Loss or Surplus in Profit & Loss and a sinking fund is created. This amount is then invested in certain government securities. The amount so set aside earns a certain amount of interest, which is reinvested together with fixed amount in the subsequent years. In the last year, the interest and the appropriated amount are not invested. On the other hand, all investments are sold and the amount so obtained is used for redeeming the debentures.