Debentures

Debentures are long term loan made to the company by the public. Only
limited liability companies can issue debentures. The debenture is authorized
by the company by affixing the company’s seal on the certificate. This
evidences validity.
According to section 166 of CAMD 1990, a Company may borrow money for
the purpose of its business or objects and may mortgage or charge its
undertaking, property and uncalled capital, or any part thereof, and issue
debentures, debenture stock and other securities whether outright or as
security for any debt, liability or obligation of the company or of any party.

The limited company issues certificate to serve as an evidence of
borrowing. This is called debenture certificate. The debenture certificate
contains the following:
(a)      Acknowledgement that the
company owes the person stated in the certificate a stated of money;
(b)      Promises that a state rate
of interest will be paid periodically to the person named.
(c)       That the amount borrowed
will be repaid by the company on or before a certain date.
(d)      The precise detail of the
security which is giving to the person named in the certificate.
*Security is the act of charging an asset for the debenture.
Debenture deed
This is the agreement or terms of the contact. In practice the debenture
trust deed contains an undertaking (stated in clear and unequivocal term) which
gives the owner the right to seize the asset, sell them and then recover his
amount of claim in the event of company failing to satisfy the obligations it
has undertaken under the term of the issue of the debenture. This undertaking
the company enters into is called “charging the asset or making a charge on the
asset”, the asset so charged are referred to as “SECURITY”.
Charges on the assets of
the company
There are two types of charges:
1.         Fixed charges: – It is a Mortgage on a specified asset. That is,
the owner of the asset in consideration of loan makes a transfer of ownership
of the asset to another person when the debenture is entered into. Although the
security is made, we do not have a physical transfer until the event of the
original owner failing to carry out his or any of the condition agreed to when
the loan was made to him.
2.         Floating charge: – This is a charge against a class of assets. It
is not restricted to a particular class of asset.
Types of debentures
According to section 171 of CAMD 1990, a company may issue perpetual
debentures, and a condition contained in any debentures, shall not be invalid
by reason only that the debentures are made irredeemable or redeemable only on
the happening of contingency, however remote, or on the expiration of a period,
however long, any rule of equity to the contrary notwithstanding.
According to section 172 of CAMD 1990, debentures may be issued upon the
terms that in lieu of redemption or repayment, they may, at the option of the
holder or the company, be converted into shares in the company upon such terms
as may be state in the debentures.
Debentures may either be secured by a charge over the company’s property
or may be unsecured by any charge referred to as a Naked Debentures. (Section
173 (1).
Debentures may be secured by a fixed charge on certain of the company’s
property or a floating charge over the whole or a specified part of the company’s
undertaking and assets, or by both a fixed charge on certain property and a
floating charge (Section 173 (2).
A charge security debenture shall become enforceable on the occurrence
of the events specified in the debentures or the deed security the same
(Section (3).
Methods of redemption
Most issues of debentures are redeemable, that is, the borrower must pay
back this money to the lender. The following are some methods used in redeeming
debentures:
1.         Sinking fund- This is the setting aside of a part of the profit of
limited companies by transferring such part to a special account called sinking
fund and at same time;
2.         Buy for each, suitable
investment (government stock etc.) the cost of which is usually equal to the
amount set aside as in (1) above.
The two usual purposes of sinking fund are:
(a)      To replace debenture
(b)      To replace assets
Sinking fund is built up over a period of time in other to meet some
future demand on the finances of company. The company saves so as to be able to
pay for something in few years time.
Redemption of debentures at
maturity
Many debentures when they are first stated to be repayable on or before
a certain day. The actual year is usually stated. This type of debenture lends
itself very readily to the sinking fund method because the company knows the
amount of time it has available to make up the amount of money for repayment.
The sinking fund investment is especially earmarked for the purpose of
repaying debenture holders on the appointed date, and will not be available for
business should it find itself short of money for its normal trading purposes.
Alternative From of
Investment.
Alternative to the purchase of stock or shares is for the company to
take up an endowment assurance policy. Two important virtues of this method
are:
(a)      It produces the required
sum of money on the date it will be required
(b)      Since the policy is only
kept alive by payment of yearly premium, there is less temptation to let slide
should times be difficult financially.
Basis Bookkeeping Entries.
When yearly an amount is set aside from profit for redemption of
debenture through sinking fund.
Debit Profit and Loss
Appropriation Account
Credit: Cash/Bank
Redemption of Debentures At
a Premium
When debentures are offered to the public, the terms of redemption are
often stated: –
Frequently one of the items of redemption is that they will be repaid at
a higher value than their nominal value, this will then attract investors.
Example
Suppose some 6% N100 debentures
were offered as being redeemable at N105
10 years after the date of issue.
Solution
This simply means that for every N100
SUBSCRIBED NOW, N105 will be paid to
the holder at the time of redemption. The yearly interest is 6% of N100 = N6.
There should be a total sum of (10×6 +N5)
= N65 (that is, within 10 years, the
interest is N60 +N5.
Premium Payable On
Redemption
By premium, we mean an additional charge on the funds. Using our example
above, the following are two basis ledger entries to reglect 6% debenture
account and premium on redemption account.
6% Debenture Account
            
             N
                                 N
Balance C/d
105
Balance b/d
Premium or Redemption A/C
100
   
5  

   105

        105
Premium On Redemption
Account
                                 N
                                N
6% Debenture A/C
5
Balance C/D
5
5
5
The premium which is payable on redemption will now be written off by
transferring to the debit side of the sinking fund account. Thus if there were
a balance of sinking fund account before redemption took place, we would
transfer N5 from the credit of premium
on redemption account to the debit side of the sinking fund account, thereby
reducing the balance on the account to N95.
This balance will then be transferred to general reserve account.
Redemption of Debentures on
Discount
In the event of the redemption of debentures at discount, the borrowing
company gains. A discount in this case means the amount is to be repaid at a
lower par value. The basis book keeping entries to record redemption of
debentures at a discount are:
                                                                        Dr.
                                                                    Cr
Cash (net Sum received)                          xx
Discount on Debenture a/c                  
xx
Debenture a/c                                             (Full nominal value of debenture)   xx
Sinking fund for redemption
of debentures
Unlike an equity source of financing (that is whereby) you contribute
money), a debenture like any other liability has to be repaid. A debenture or
any other long term loan usually involve some large sum and need proper
planning to ensure that there is sufficient cash at the repayment is due be
made.
The creation of sinking fund is designed to meet this need at the
maturity of the date, as already mentioned, the amount set aside in the sinking
fund can also be invested to earn some revenue. Note that this money set aside
is normally kept in the insurance money and must be banked.
What is done again is to set an equal amount which with compound
interest will amount to the sum required to pay- off the debentures at the
predetermined date, the sinking fund is RE-INVESTED.
Situation where  RE-INVESTMENT will occur are:
1.         If you have purchased
shares in the open market and thus its returns continues to fall.
2.         When you want to recoup
money invested in other to redeem debenture.
EXAMPLE
            Assume that XYZ company
Ltd made an issue of N100,000 5%
debenture at par on Jan. 1, 1994. The terms of the debenture provides that XYZ
Ltd provides for a sinking fund for redemption on December 31st 1996 (3yrs)
that is, at the end of 1996 we should pay off the debenture and re-invest.
Required-                 Show all the journal entries and ledger account for
the period ignoring tax and expenses. 

Solution
            The first thing to go
to your sinking fund annuity table and read thus:
%tage

Period            2.5%                            3%                   4%                               5%…..100%

Yr.
1.
2
3   …………………………………………………………….*.3172
4
5
Thus the amount to be set aside every until the debenture is redeem is
                        3172 x
100,000 = N31,720.
Journal Entries
1.         Director 31, 1994
                                                                                    Dr.                               Cr.
                                                                                  N                                      N
P & L Appropriation A/C                                   31, 720                  
      Sinking Fund                                                                                          31,720
being amount set aside out of profit to redeem debenture
2.         Sinking Fund Investment
A/C                  31,720      
                 Bank/cash                                                                               31,720
            To record sinking fund
investment at 5% for year 1
3.         Cash                                                                  1,586                          
                  Sinking Fund                                                                                1,586
To record the interest received on fund
invested.
At this Stage, the total
amount will be N31, 720 + N1, 586 = N33, 306.
DEC. 31, 1995                                              Dr.                               Cr.
                                                                                    N                                  N
1.         P & L Appropriate
Account                  31, 720
                  Sinking Fund                                                                                31,720
            To record amount set
aside
to redeem debenture at Yr.
2
2.         Sinking Fund Investment
A/C      
                      31, 720
                 Bank / Cash                                                                                  31,720
To record sinking fund invested at 5%m on
2nd  year.
3.         Cash                                                                          3,251.3
                 Sinking Fund                                                                                   3,251.3
            To record the interest
received on (N31, 720 + N33, 306) Fund invested,
NOTE:
            On the 3rd year, XYZ
CO. LTD                            Dr.                               Cr.
            will de-invest and
recoup to repay the debenture.
            Cash  :                                                                       100,000                     
                 Sinking Fund Investment A/C                                                            100,000
            To record the cash
realization on the
            sinking fund
investment.
            Debenture A/C                                                      100,000
                Cash                                                                                                          100,000
            To redeem the 5%
debenture A/C
            Sinking Fund A/C                                                   100,000
                  Reserves                                                                                                 100,000
            To close the sinking
Fund A/C
The sinking fund account and investment account will appear as follow:
Sinking Fund Account
N
N
31/12/96
reserves
100,000
31/12/94
P & L A/C
31, 720
31/12/94
Cash
1,586
31/12/95
P & L
31,720
31/12/95
Cash
3,254
31/12/96
P & L A/C
31,720
100,000
100,000
Sinking Fund Investment
Account
N
N
31/12/94
Cash
31,720
31/12/96
cash
100,000
31/12/ 94
Cash
1,586
31/12/95
Cash
31,720
31/12/95
Cash
3,254
31/12/96
Cash
31,720
100,000
100,000

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