1. FINANCIAL ACCOUNTING BBAF 308 ACCOUNTING FOR DEBENTURES
LECTURER:
MR. LEXIS TETTEH

2. Lecture 2: Issue of Debentures
Overview:
What is a debenture?
The various classes of debentures
Stages in the issue of shares of debentures
Accounting entries for the issue of debentures
Determination of effective interest rate
Redemption of debenture (Sinking Fund)

3. Debenture
Definition
Debenture is a written acknowledgement of indebtedness by the company setting out the terms and conditions of the loan.
A company may raise loan by issue a debenture or term loan.
A debenture holder is a special creditor who is entitled to fixed interest whether profit is made or not.

4. Debenture (cont.) Characteristics of Debentures:
Debenture holders are the creditors of the company carrying a fixed rate of interest.
Debenture is redeemed after a fixed period of time.
Debentures may be either secured or unsecured.
Interest payable on a debenture is a charge against profit and hence it is a tax deductible expenditure.
Debenture holders do not enjoy any voting right.
 Interest on debenture is payable even if there is a loss.

5. Debenture (cont.) Merits of Debentures (Company):
No dilution of control: Issue of debenture does not result in dilution of interest of equity shareholders as they do not have right either to vote or take part in the management of the company.
It is allowable expense : Interest on debenture is a tax deductible expenditure and thus it saves income tax.

6. Debenture (cont.) Demerits of Debentures (Company):
Payment of interest on debenture is obligatory and hence it becomes burden when the company makes loss.
Too much dependence on debentures increases the financial risk of the company.
Redemption of debenture involves a larger amount of cash outflow.

7. Debenture (cont.) Types of debenture
Redeemable (i.e. repayable at or by specified date) or
Perpetual debenture (i.e., redemption taking place only when the company is liquidated)
Convertible debenture (i.e., can be converted into equity shares).
Secured or naked debenture
debenture may be secured by a floating charge or a fixed charge or both.

8. Issue of Debenture
The mode of issue of debenture is similar to that of shares and the accounting entries are the same except the change in account names.
Debenture may be payable full on application or installment basis.
Debenture may be issued at par, discount or premium.

9. Debenture
The prices of debentures are stated in terms of the face value or the par value or principal of the debentures.
The price of the debenture is the interest rate: Face rate and market interest rate.
Face interest rate: This is the fixed rate of interest paid to bondholders on the face value (par value) of the bonds.
The rate and amount are fixed over the life of the bond.

10. Debenture
Market interest rate: This is the rate of interest paid in the market on debentures of similar risk.
It is also called the effective interest rate.
The market rate fluctuates daily.
The market interest rate often differs from the face interest rate on the issue date.

11. Issue of Debenture (cont.)
Issue of debenture at Par
It means that the debenture is issued at a price equal to the nominal value or the face value.
Accounting entry:
Dr. bank
Cr. Debenture (specific) with the amount received
Example: GHS20,000 20% debenture was issued at par to the public payable on application.
Dr bank 20,000
Cr. 20% Debenture 20,000

12. Issue of Debenture (cont.)
Issue at Discount
here the issue price is lower than the nominal value, hence there is a loss to the issuer.
Accounting entry
Dr. Bank with amount received
Dr. Discounts on debenture with discount
Cr. Debenture (specific)
Example: GHs20,000 20% debenture was issued at 98 to the public.
Dr. Bank GHs 19,600
Dr. Discount 400
Cr. 20% debenture 20,000

13. Issue of Debenture (cont.)
Issue at Premium
debenture is issued at a price above nominal value, resulting in capital gain.
Account entry
Dr. Bank with all amounts
Cr. Premium with the gain
Cr. 20% debenture with value of debenture
Example: GHs20,000 20% debenture issue at 102.
Dr bank 20,400
Cr. Premium 400
Cr 20% debenture 20,000

14. Issue of Debenture (cont.)
Practise Question 3:
Kofi Nti Co Limited issues debenture at par, redeemable in 3-year at the rate of 12%. The debenture was issued at nominal value of Ghc100,000. The debenture was issued on January 1, 2014.
You are required to show the entries in the statement of comprehensive income and the statement of financial position as at:
January 1, 2014
December 31, 2014
December 31, 2015
December 31, 2016

15. Issue of Debenture (cont.)
Practise Question 4:
Kofi Nti Co Limited issues debenture at discount, redeemable at 3-year at an interest rate of 12%. The debenture was issued at discount of Ghc97,600. The debenture was issued on January 1, 2014.
You are required to show the entries in the statement of comprehensive income and the statement of financial position as at:
January 1, 2014
December 31, 2014
December 31, 2015
December 31, 2016

16. Issue of Debenture (cont.)
Practise Question 5:
Kofi Nti Co Limited issues debenture at premium, redeemable at 3-year at an interest rate of 12%. The debenture was issued at premium of Ghc102,100. The debenture was issued on January 1, 2014.
You are required to show the entries in the statement of comprehensive income and the statement of financial position as at:
January 1, 2014
December 31, 2014
December 31, 2015
December 31, 2016

17. Issue of Debenture (cont.)
Determination of Effective Interest Rate Assume Kelewele Co. Ltd issue 5-year debenture at discount value of Ghc92,790 at the interest rate of 10% on January 1, Interest is payable on January 1 each year. Determine the effective rate.

18. Issue of Debenture (cont.)
Solution
Using interest rate of 11%
Year 1 2 3 4 5
Total
Cash inflow
92790
Interest
(10,000)
Principal
(100,000)
Cash in/outflow
92,790
Interest at 11%
0.9009
0.8116
0.7312
0.6587
0.5935
NPV
(9009)
(8116)
(7312)
(6587)
(65285)
(3,519)

19. Issue of Debenture (cont.)
Using interest rate of 13%
Year 1 2 3 4 5
Total
Cash inflow
92790
Interest
(10,000)
Principal
(100,000)
Cash in/outflow
92,790
0.8850
0.7831
0.6931
0.6133
0.5428
(8850)
(7831)
(6931)
(6133)
(59,708)
3,337

20. Issue of Debenture (cont.)

21. Redemption of Debenture
The Debenture Redemption Reserve/Surplus operates under one of the following:
An amount equal to the nominal value of the Debenture to be redeemed is debited to the Income Surplus account and credited to Debenture Redemption Reserve/Surplus .
After the redemption of the Debentures, any balance on the Debenture Redemption Reserve/Surplus is transferred to the general Capital Surplus.  
Where one-off or one lump sum redemption is to be effected, then the annual appropriations to the fund is managed on a sinking fund basis.

22. Redemption of Debenture
Installment Basis
Here, the debenture redemption is credited annually with the amount due for redemption from the income surplus.
The debenture due is transferred to the debenture redemption account and paid off.

23. Redemption of Debenture
Accounting entry for installment redemption
Under this debenture redemption reserve is created.
Transaction
Account to debit
Account to credit
Annual installment due
Income surplus
D. Redemption reserve
Redemption approved
Debenture
D. Redemption
Premium resulted from redemption
Premium / P&L
Discount resulted from redemption
Discount/P&L
Payment effected for the redemption
Bank
Balance on redemption reserve
Capital surplus

24. Redemption of Debenture
Sinking fund is maintained where one-off redemption is required.
Here annual appropriation is made from the income surplus to a sinking fund which is later invested in an interest bearing instrument.
Upon reaching the specified date of redemption the investment is realized and used to redeem the debenture on a one-off basis.

25. Redemption of Debenture – Sinking fund
Example;
A company issues 10% GHS10,000 redeemable debenture some years ago.
A debenture redemption fund backed by marketable securities was established for the redemption.
On 31 December 2010 the following balance were available; 10% Redeemable debenture stock GHs10,000, Debenture redemption fund GHs 4,900 and Debenture redemption fund investment GHS 4,100.