CORPORATE ACCOUNTING

UNIT II
II B/COM GEN- A&B
DR.J.CHITHRALEGA
Debentures Meaning
Debentures refer to long-term debt instruments issued by a government or corporation to
meet its financial requirements. In return, investors are compensated with an interest income
for being a creditor to the issuer.
They are usually an unsecured form of borrowing from the public and have a lengthy tenure,
usually exceeding ten years.
According to Section 2 (30) of the Companies Act, 2013, “Debenture includes debenture
stock, bonds and any other instrument of a company evidencing a debt, whether constituting a
charge on the assets of the company or not”.
Types of Debentures
From the point of view of security:
1. Secured or Mortgage Debenture: Debentures are secured by a charge on the fixed
assets of the company. If the company fails on payment of the principal amount or
interest amount, assets under charge are sold to repay the amount due to debenture
holders.
2. Unsecured Debentures: These debentures are not secured by any charge on asset.
They do not have a security.
2. From the point of view of Tenure:
1. Redeemable Debentures: These are debentures which are to be repaid within a
stipulated period.
2. Irredeemable Debentures: These debentures do not have any fixed period of
redemption. These debentures are redeemable at the time of winding up.
3. From the Point of view of Convertibility:
1. Convertible Debentures: These are the debentures which can be converted into
equity shares or other securities after a specified period, at the option of the debenture
holders. This can be further categorize into two parts:
a. Partly Convertible Debentures: These are the debentures where only a part of the
debenture amount is convertible into equity shares.
b. Fully Convertible Debentures: These are the debentures where whole amount of
debenture is convertible into equity shares.
2. Non-Convertible Debentures: The holders of these debentures have no right to
convert them into equity shares
4. From the point of view of Registration:
1. Registered Debentures: These debentures have a record of name, address and
particulars of holdings of debenture holders in the register of the company. These
debentures are not freely transferable.
2. Bearer Debentures: These debentures are transferable by mere delivery. The
company keeps no records of such debenture holders. Payment will be made only to
the bearer of the debenture. Coupons are provided by the company with these
debentures for the payment of interest.
5. From the point of view of Coupon Rate:
1. Specific Rate (Coupon rate) Debentures: These debentures are issued with a
specific rate of interest, which is called the coupon rate. The specified rate may either
be fixed or floating. The floating interest rate is usually tagged with the bank rate.
2. Zero Coupon Debentures: These debentures do not carry a specific rate of
interest. Such debentures are issued at substantial discount and the difference between
the nominal value and the issue price is treated as the amount of interest related to the
duration of the debentures.
REDEMPTION OF DEBENTURES
MEANING
Redemption of Debentures means repayment of debentures to the debenture holders.
It implies of the principal amount as well as interest due on debentures to the
debenture holders. In other words, it refers to the discharge of liability on debentures
in accordance with the terms of issue.

Journal entries at the time of redemption of debentures:

Redemption of Debentures at Par
(a) Debentures A/C Dr
To Debentureholders’ A/C
(Being debentures due for redemption)
(b) Debentureholders’A/C Dr
To Bank A/C
(Being amount paid on redemption)
Redemption of Debentures at Premium
(a) Debentures A/C Dr
Premium on Redemption of Debentures A/C Dr
To Debentureholders’A/C
(Being debentures due for redemption at premium)
(b) Debentureholders’A/C Dr
To Bank A/C
(Being amount paid on redemption)
Debenture Redemption Reserve (DRR)
According to section 71(4) of the Companies Act 2013 and the Securities and
Exchange Board of India (SEBI) guidelines requiring creation of Debenture
Redemption Reserve equivalent to at least 25% of the amount of debentures issued
before redemption commences, it is not possible to redeem debentures purely out of
capital. Hence, a Company cannot redeem its debentures purely out of capital. At least
25% of debentures issued must be redeemed out of profits by creating a “Debentures
Redemption Reserve” and the balance of debentures issued may be redeemed out of
profits or out of capital.
METHODS OF REDEMPTION OF DEBENTURES
• Lump sum payment at the end of fixed period
• Redemption of Debentures in instalments (By draw of lots)
• By Purchase of own debentures in the open market
• By conversion into shares
LUMP SUM PAYMENT AT END OF FIXED PERIOD
Under this method, the total amount of debentures is paid to the debenture holders as
a single complete sum of money at the expiry of a specified period i.e at
maturity of the debentures.
REDEMPTION BY DRAW OF LOTS
Under this method, the company while issuing debentures mentions that its
debentures will be redeemed annually in a certain proportion, through the selection by
the draw of lots. The holders of the selected debentures are then repaid the amount at
par or at a premium according to the terms of issue.
BY PURCHASE OF OWN DEBENTURES IN THE OPEN MARKET
A company, if authorised by its Articles of Association, can redeem its own
debentures in full or in part by purchasing them from the stock market for
cancellation. Debentures can be purchased at par or at premium. Generally, a
company redeem its debentures by purchasing in the open market when the interest
rate of debentures is higher than the market interest rate.
BY CONVERSION INTO SHARES
Under this method, debenture holders are given the right to exercise the option to
convert their debentures into shares or new class of debentures. But this option is to
be exercised at a stipulated date within a specified period but before the actual date of
redemption.

Profit Prior to Incorporation

Profit prior to incorporation" is the profit earned or loss suffered during the period
before incorporation. It is a capital profit and is not legally available for distribution
as dividend because a company cannot earn a profit before it comes into existence.
Profit earned after incorporation is revenue profit, which is available for dividend.

Pre-Incorporation and Post Incorporation period

Pre-Incorporation and Post Incorporation period: The period before incorporation and
the period after incorporation is called as pre incorporation and post incorporation
period.
Example For Pre-incorporation And Post Incorporation Period
Eg1: X ltd was formed on 1.4.2012 to take over the
business of Y ltd from 1.1.2012. The year ended on
31/3/2012. Calculate the pre and post incorporation
period.
Business was taken over from 1.1.2012
• Incorporated on 1.4.2012
• Therefore pre incorporation period = Jan + Feb + March
• = 3 months (i,e. period between the business taken over and incorporated) • Post
incorporation period = April to Dec = 9 months.
 STEPS TO DETERMINE PREINCORPORATION PROFIT/LOSS
• Prepare a Trading a/c for the whole period.
• Calculate Time Ratio and Sales Ratio.
• Time Ratio can be calculated by taking preincorporation and post-incorporation time.
• From the eg1: pre-incorporation period is 3 months
• Post-incorporation period is 9
• months Therefore Time Ratio = 3:9 or 1:3
• Sales Ratio can be calculated on the sales taken place
• during pre and post incorporation period.
Example
M Company was incorporated on 1.6.2012 and acquired a business with effect from
1/4/2012. Total sales from 1/4/12 up to 31/3/13 were Rs.450000.Sales for April and
May were double the average sales. Sales from June to September= ¼ of the average
monthly sales, sales from November to February = the average monthly sales and the
sales in March is Double the average sales.
Sol: Average monthly sales = 450000/12 = 37500 (total sales/12months)
Now calculate sales from April to March
April – 37500 x 2 = 75000 • May – 37500 x 2 = 75000
June- 37500 x ¼ = 9375 • July- 37500 x ¼ = 9375 • Aug- 37500 x ¼ = 9375
Sep- 37500 x ¼ = 9375
Oct- 37500 = 37500 (because it is equal to average sales)
Nov- 37500 = 37500
Dec- 37500 =37500
Jan- 37500 = 37500
Feb- 37500= 37500
Mar- 37500 x 2 = 75000
Pre-incorporation sales: Post –incorporation sales • 150000: 300000 • 1 : 2
Therefore Sales Ratio = 1:2
And Last Step Is:-
• Prepare a net profit statement to analyze pre and post incorporation period
Points to be noted while preparing net profit statement
• Gross profit to be calculated on sales ratio.
• Divide all standing expenses or fixed expenses on time basis. E.g., Salaries, rent,
printing & stationery telephone charges, postage & telegram, general expenses
depreciation, administration expenses, audit fees etc
• Divide all variable expenses on sales ratio e.g., carriage outwards, advertisement,
salesman salaries, commission, brokerage, bad debts etc.,
• Salary of partners, interest on purchase
• consideration, interest on vendor capital are to be charged to pre-incorporation period
( i.e. expenses incurred up to the date of incorporation)
• Some expenses exclusively belong to post incorporation period and they have to be
charged for post incorporation e.g., managing director’s salary, director’s fees,
debenture interest, discount on issue of shares, discount on issue of debenture,
preliminary expenses written off, underwriting commission written off etc.,
• Audit fees can be divided for pre-incorporation period or post- incorporation period
based on time ratio. Audit fees can also be charged exclusively for post incorporation
period, assuming auditing is compulsory for the company)
• Bad debts recovered can be charged to both the period depending on where it relates
to.
• Interest received can be charged for both the period based on sales ratio.
UNDERWRITING OF SHARES AND DEBENTURES
Underwriting means guaranteeing to subscribe to an agreed. number of shares or
debentures for a certain consideration. The public companies enter into underwriting
arrangements. Underwriting means guaranteeing to subscribe to an agreed. number of
shares or debentures for a certain consideration.
Firm underwriting: Firm underwriting is an underwriting agreement where an
underwriter agrees to buy a definite number of shares or debentures in addition to the
shares or debentures he has already promised to subscribe under the underwriting
agreement. In firm underwriting, the underwriters are liable to take up the agreed
number of shares or debentures even if the issue is over subscribed.
Complete underwriting: when the whole issue of shares or debentures of a
company is underwritten, it is called complete underwriting. In such a case the whole
issue is underwritten either by an individual/institution agreeing to take the entire risk
or by a number of firms or institutions, each agreeing to take the risk to a limited
extent.
Partial underwriting. When only a part of the issue of shares or debentures of a
company is underwritten, it is known as partial underwriting. In such a case the part
of the issue is underwritten either by an individual/institution or by a number of firms
or institutions each agreeing to take the risk to a limited extent.
Syndicate Underwriting: When the issue is very big and it is impossible to be
underwritten by a single underwriter syndicate underwriting comes to rescue. In
syndicate underwriting, few underwriting firms form a syndicate and jointly
undertake to underwrite the issue. The amount to be underwritten and the ratio is
determined in advance among the firms. For example, For an issue of 10,000 6
underwriters may form a syndicate and underwrite in the ratio of 30:20:20:10:10:10.
Joint Underwriting: In Joint underwriting, when the issue is too large, the issuer
company itself appoint more than one underwriter to reduce the burden from a single
underwriter. Each Underwriter underwrites for a specified amount and in a specified
ratio. It is different from a syndicate underwriting in a way that in Syndicate
underwriting the underwriting firm themselves form a syndicate and represent
themselves as single underwriting firm but in Joint underwriting, the issuer company
itself appoint a number of firms to underwrite the issue.
Sub-underwriting: If an underwriter has promised to underwrite an issue and later
on it feels that it is beyond his individual capacity, then he may appoint a sub-
underwriter to safeguard himself. For example, if an underwriter A has underwritten
for an amount of 40 crores, and later on he finds it difficult to underwrite alone, he
may appoint a sub-underwriter to underwrite 10 crores. In this case, the sub-
underwriter is liable to underwriter only and he has no connection with the company.
the relationship between underwriter and sub-underwriter is same as an agent and sub-
agent.
Importance of Underwriting:
1. Underwriting acts as a sort of insurance or guarantee against the danger of not
receiving minimum subscription, in the absence of underwriting agreement, there
is always uncertainty regarding subscription of shares of debentures by the public.
The guarantee of the underwriters removes the uncertainty.
2. When shares or debentures are sold through underwriters, there arise more
confidence amongst the public. This is because underwriters undertake shares or
debentures of only those companies which are sound concerns and whose future is
bright.
3. Underwriting creates an impression regarding sound status of a company. It
increases the goodwill of the company.