Redemption of Debentures

Meaning

Redemption of debentures is the process of discharging the liability on account of debentures in accordance with the terms of redemption stated in the debenture trust deed. Discharge of debenture liability is usually by paying cash to the debenture holders. But this can take other forms such as conversion or rollover. In the case of conversion debentures are converted into preference shares or equity shares. Rollover refers to the issue of new debentures, in exchange for the old ones. Both conversion and rollover are subject to detailed SEBI guidelines.

When a company issues debenture it must also plan the resources required for such redemption. This can be done by setting aside profits every year and investing them wisely in investments outside, so that there will be no liquidity problem at the time of redemption. Alternatively the company can take an insurance policy by paying regular premium, so that the policy matures coinciding with the time of redemption. With the amount received on the maturity of policy the company faces no problem in carrying out the redemption. These are the two ways in which a company can make provisioning for redemption of debentures. The question of provisioning was earlier left to the discretion of company and many companies did provisioning routinely, as a matter of financial prudence. Now under the SEBI guidelines, the matter is no more a matter of discretion or financial prudence. SEBI guidelines provide for compulsory provisioning and also restrictions on the payment of dividends till debentures are redeemed. We will first deal with SEBI guidelines before proceeding with the accounting aspects of creating sinking fund for redemption of debentures.

SEBI on Creation of Debenture Redemption Reserve (DRR)

1. A company has to create DRR in case of issue of debentures with maturity of more than 18 months.

2. The issuer must create DRR in accordance with the provisions given below.

a.       If debentures are issued for project finance DRR can be created upto the date of commercial production.

b.      The DRR in respect of debentures issued for project finance may be created either in equal installments or higher amounts if profits so permit.

c.       In the case of PCDs, DRR must be created for the non-convertible portion of debenture issues on the same lines as applicable for fully non-convertible debenture issue.

d.      In respect of convertible issues by new companies, the creation of DRR must commence from the year the company earns profits for the remaining life of debentures.

e.       DRR shall be treated as part of general reserve for consideration of bonus issue proposals and for price fixation related to post-tax return.

f.        Company must create DRR equivalent to 50% of the amount of debenture issue before debenture redemption commences. Only after the company has actually redeemed 10% of the debenture liability, drawl from DRR is permissible only after the company has actually redeemed 10% of the debenture liability. The requirement of creation of DRR is not applicable to issue of debt instruments by infrastructure companies.