Redemption by Purchase in Open Market

Debentures are the type of investment or marketable security issued by an entity to raise money for long-term activities. The reimbursement of debentures is called the redemption of debentures, considered the entity’s liability. Debentures may be redeemed at par or premium or discount following the terms of the issue. Debentures are a charge on assets, and hence their repayment is necessary per the terms of issue, which are clearly stated in the debenture certificate. According to the Companies Act, if authorized by its article of association, a company can redeem its debentures by purchasing in the open market. The open market refers to purchasing own debentures from the stock market. The company shall adopt this procedure only when the debentures of its own company are at a discount on the stock market.

SEBI (Securities and Exchange Board of India) Guidelines for Redemption of Debentures

There are two basic guidelines according to SEBI for the redemption of debentures. These are as follows:

• The obligation for creating DRR (Debenture Redemption Reserve) is only for the non-convertible debentures and the non-convertible part of partly convertible debentures.
• The unlisted company will create a DRR, at least 10% equivalent to the nominal value of those outstanding debentures. 

Options after Purchasing their Own Debentures from the Open Market

After purchasing the debentures from the stock market, the company might follow these two options:

• In the first option, the company purchases the debentures for cancellation. This cancellation is only possible when the Board of Directors passes its resolution.
• Secondly, instead of cancelling the debentures, the company keeps them alive for issuing them in the future. The company keeps these debentures as the ‘investment in the own debentures’. 

A case when the Company Willingly Purchases own Debentures for Cancellation only

If the purchase price of these debentures is more than the nominal or face value, then there must be a loss on the redemption of such debentures. Moreover, the debited loss is in the form of ‘loss on Redemption of Debentures A/c’.

When the Company Purchases own Debentures for Immediate Cancellation and such Debentures are Redeemable at a Premium

When the Company Purchases its own Debentures for Immediate Cancellation and such Debentures are Redeemable at a premium, then the premium payable on the redemption will not be paid. Therefore, these debentures will become a capital profit for that company.

Note: When you pass the journal entry for cancellation of your own debentures bought from the open market, you must debit the premium on Redemption from Debentures A/c.

When own Debentures are kept as Investment for the Future

The company does not always cancel their debentures, but sometimes they keep it as an investment. It is usually when the company has surplus funds. Therefore, they do not wish to invest these funds in other companies but in their own. It may be due to the following three reasons:

• When the company’s own debentures are in the market at a lesser value than the nominal (face) value.
• They want to save the interest that otherwise would have been payable on such debentures.
• To keep alive and resell these debentures in the future.

Note: When a company buys its own debentures, not for cancellation, the debit is from the account “Investment in own Debentures” instead of “Own Debentures Account”. 

The Three Main Sources of finance for the redemption of debentures

The company can pay the amount for the redemption of debenture from the following three sources:

• Redemption of debentures out of capital: When their un-left profits to redeem debentures, it is known as the redemption of debenture out of capital. Thus, no transfer of profits to Debenture Redemption Reserve happens in such conditions. 
• Redemption of debentures out of profit: Redemption out of profit indicates that an amount equal to debentures outstanding (i.e. 100% of the nominal value) of outstanding debentures will be transferred from the divisible profits to the Debenture Redemption Reserve Account i.e. the newly opened account.
• Redemption of debentures out of capital and profits: Redemption of debentures out of capital and profits is partly out of capital and partly out of profits. For example, A company creates a Debenture Redemption Reserve of 30% of outstanding debentures, then this 30% will be the debentures out of profit. The other 70% shall be the redemption out of the capital of that company. 

Conclusion 

Redemption by purchase in an open market is a special condition for a company. The company has the authority to purchase its own debentures in the open market by the Article of Association. The company follows this procedure, especially when the debentures of its own company are at a discount on the stock market and they wants are willing to buy it. They might also want to buy it to save the interest that otherwise would have been payable on such debentures. After purchasing the debentures from the stock market, the company might either cancel the purchased debentures or keep them alive for issuing them in the future. The company keeps these debentures as the ‘investment in the own debentures’. The cancellation is only possible when the Board of Directors passes its resolution.