Purchase of Own Debentures: Journal Entries | Capital | Accounting

The purchase of own debentures in the market may be for different reasons: 1. Where Debentures are Purchased for Cancellation 2. When Debentures are Purchased for Investment.

1. Where Debentures are Purchased for Cancellation:

When Company’s own debentures are purchased by the Company, “Own Debenture Account” (or Investment in Own Debenture Account) will be debited as against cash paid for it. Purchases of own debentures are to be treated in accounts in the same way as ordinary investments.

The entry will be:

Own Debentures Account ‘ Dr.

(Investment in Own Debenture A/c)

To bank Account

As and when the Company cancels the investments in Own Debenture Account, the paid up value of the debentures purchases should be debited. When the Company cancels its own debentures immediately after purchase, outstanding debentures are reduced by the amount cancelled. After the redemption, the Company need not pay any interest on such debentures. The profit or loss on redemption of debenture should be credited or debited to Profit and Loss on redemption of Debenture Account. The amount paid as interest is debited to Interest Account.

Illustration 1: 

On 1st January 2004, a Company issued Rs 20, 00,000 7% Debentures at 5% discount repayable in five years at par. The Company reserved the right to redeem to the extent of Rs. 2, 00,000 in any year by purchase in the open market. The interest was payable half-yearly on 30th June and 31st December and the same was duly paid.

On 31st December 2004, the Company purchased Rs 2, 00,000 debentures at a cost of Rs 1, 91,000. Pass necessary journal entries in the books of the Company up to 31st December 2004 including closing entries on that date if the above redemption was: Out of Profit.

Solution:

 

2. When Debentures are Purchased for Investment:

When Company’s own Debentures are purchased by the Company in the open market, it may like to hold its own debentures as an investment for any period as the Company may think fit. Own Debentures Account is carried forward from year to year as an asset in the Balance Sheet.

When a Company purchases its own debentures, as an investment, then total debentures including purchased debentures are outstanding. When the Company purchases own debentures for cancellation, the usual practice is to ignore interest on such debentures and the interest payable to outsiders are accountable. In the absence of cancellation of debentures, interest becomes payable on the whole debenture amount that is, debentures held by the Company as well as outsiders.

Cum-Interest and Ex-Interest:

When a Company purchases its own debentures in the market soon after the interest on such debentures has been paid, the question of interest can be ignored. When the debentures are purchased on the date when the interest is due, the interest will be paid to seller i.e. the old Debenture holder.

Sometimes, a Company may purchase its own debentures before the date on which the interest on debentures falls due for payment. In such case seller is entitled to get the interest for the period for which he held the debentures. Now the question arises, when debentures are purchased within the interest period, whether the price includes the interest or not.

If the price is cum-interest it means that the price is inclusive of interest i.e. the purchasing company is entitled to the interest that has been accrued, and interest will not be paid to the seller. At the same time, if the price is ex-interest, it means that the price is exclusive of interest i.e. the purchasing company is not entitled to the interest that has been accrued, and the seller is entitled to receive it.

Again, under ex-interest price, the purchasing company has to pay the purchase price plus interest accrued to the seller. It is important to note that at the time of purchasing own debentures, Own Debentures Account is debited with capital portion and Interest Account is debited with revenue portion.

Points:

1. In respect of Government securities and debentures, the price quoted is ex-interest unless otherwise stated.

2. In respect of non-Government securities and debentures, it is cum-interest unless otherwise stated.

Example:

On 1st April 2007, Mr. A purchased 20, 12% debentures of Rs. 100 each @ Rs. 98 (cum-interest). Debentures interest is payable half yearly, on 30th June and 31st December. Date of closing the book of account is 31st December every year.

Cost and interest accrued is to be calculated as follows:

1. Calculation of period (in months): From 1.1.2007 to 31.3.2007 = 3 months

2. Accrued Interest:

Rs. 2,000 x 3/12 x 12% = Rs. 60

3. Cost:

Rs. 98 x 20 = Rs. 1,960 – Rs. 60 = Rs. 1,900

4. Journal Entry:

Illustration 2:

A Company issued 3,000 6% Debentures of Rs 100 each in 1997. On 30th April 2004, the Company purchased 1,000 debentures at Rs 96. Interest is payable on 30th June and 31st December each year.

You are required to calculate the value of debentures if the price is (i) cum-interest and (ii) ex-interest.

Pass entries in the books of the Company at the time of:

(i) Purchase of debentures and

(ii) Cancellation of debentures.

Solution: