CORPORATE ACCOUNTING

CHAPTER - 8 - REDEMPTION OF DEBENTURES

(Notes compiled by Dr. RUCHIKA KAURA)
SINKING FUND METHOD / DEBENTURE REDEMPTION FUND METHOD

A Sinking Fund, also known as Debenture Redemption Fund is a fund created by appropriating
some profits annually for the purpose of redemption of debentures at the time of their maturity
and then, investing the amount appropriated in some investments. There are basically two types
of sinking funds:

a) Cumulative Sinking Fund: This is popular type of sinking fund where the interest earned on
sinking fund investments is also reinvested again. That means, the amount of investment will be
equal to the annual appropriation from surplus plus the interest earned on earlier investments.

b) Non-cumulative Sinking Fund: In this type of sinking fund, the interest earned on sinking
fund investments will not be reinvested again. That means, the amount of investments will be
equal to the annual appropriation only and the interest received from sinking fund investments
will be treated as interest earned on general investments and is transferred to P & L account.

Accounting Treatment (For Cumulative Sinking Fund)

Read the following process from book J.R. Monga (Page no. 8.11) :
Three new ledger accounts will be opened:

1. Sinking Fund Account (The annual appropriation from surplus will be transferred to it. The
balance remaining in this account will appear under Reserves and Surplus head in the Balance
Sheet.)

2. Sinking Fund Investment Account (The investments made every year with the amount of
annual appropriation will be debited to this account. The balance of this account will appear as
Investments in Non-Current Assets in the Balance Sheet)

3. Interest on Sinking Fund Investment Account (Every year the interest received on Sinking
Fund Investments will be credited to this account and then, subsequently, this account will be
closed by transferring the interest received on sinking fund investments to Sinking Fund account)

Journal Entries
At the end of first year
For appropriation of profits Surplus A/C......Dr.
To Sinking Fund A/C
For Investment of the amount of Sinking Fund Investment A/C.......Dr.
appropriation To Bank A/C
At the end of second and other subsequent years
For receiving the interest on Sinking Fund Bank A/C.......Dr.
Investments To Interest on Sinking Fund Investment A/C
For transferring the interest to Sinking Fund Interest on Sinking Fund Investment A/C......Dr.
account To Sinking Fund A/C
For appropriation of profits Surplus A/C......Dr.
To Sinking Fund A/C
For Investment of the amount of Sinking Fund Investment A/C.......Dr.
appropriation plus the interest received on To Bank A/C
investments
At the end of last year
For receiving the interest on Sinking Fund Bank A/C.......Dr.
Investments To Interest on Sinking Fund Investment A/C
For transferring the interest to Sinking Fund Interest on Sinking Fund Investment A/C......Dr.
account To Sinking Fund A/C
For appropriation of profits Surplus A/C......Dr.
To Sinking Fund A/C
For sale of investments Bank A/C.......Dr.
To Sinking Fund Investments A/C (With the
amount received on the sale of investments)
Profit on sale of investments Sinking Fund Investments A/C.......Dr.
To Sinking Fund A/C (With the amount of
profit)
Loss on sale of investments Sinking Fund A/C....Dr.
 To Sinking Fund Investments A/C (With the
amount of loss)
For making redemption of debentures due to Debentures A/C......Dr.
the debentureholders Premium on Redemption of Debentures A/C.....Dr.
To Debentureholders A/C
For payment to debentureholders Debentureholders A/C......Dr.
To Bank A/C
For transferring the balance of Sinking Fund Sinking Fund A/C.......Dr.
account to General Reserve account To General Reserve A/C

Let us understand this accounting process with the help of an illustration. Given below is the
detailed explanation of Illustration number 5 from book J.R. Monga (Page number 8.16):

Solution

First of all, we will calculate the amount of annual appropriation from surplus:

10% Debentures of Rs, 10,00,000 are issued on 1st April, 2014 which are to be redeemed on 31st
March, 2017. That means we have to accumulate Rs. 10,00,000 in 3 years. Sinking Fund table
shows that if we invest Rs. 0.317208 annually in 5% investments, it will become Rs. 1 in 3 years.

Now, we want to make Rs. 10,00,000 in 3 years and we are also establishing a sinking fund in
such a way that sinking fund investments will earn 5% interest per annum. So, the amount that
we need to appropriate and invest annually will be:

Rs. 10,00,000 * 0.317208 = Rs. 3,17,208

Journal Entries in the books of Prakash Enterprises Ltd.

Date Explanation Particulars/Entries Debit Credit

2014 For the issue of debentures Bank A/C.....Dr. 10,00,000
April 1 To 10% Debentures A/C 10,00,000
2015 For payment of annual Debenture Interest A/C.....Dr. 1,00,000
March 31 interest on debentures @ To Bank A/C 1,00,000
10% per annum
For making annual Surplus A/C.....Dr. 3,17,208
appropriation from surplus To Sinking Fund A/C 3,17,208
For investment of the Sinking Fund Investment 3,17,200
amount of appropriation. A/C.....Dr.
Appropriation is made in To Bank A/C 3,17,200
the multiples of 100, so,
instead of Rs. 3,17,208, Rs.
3,17,200 is invested by
rounding it to the nearest
multiple of 100.
For transferring the amount Statement of P & L A/C.....Dr. 1,00,000
of debenture interest to P&L To Debenture Interest A/C 1,00,000
account.
2016 For payment of annual Debenture Interest A/C.....Dr. 1,00,000
March 31 interest on debentures @ To Bank A/C 1,00,000
10% per annum
For receiving the amount of Bank A/C......Dr. 15,860
interest (3,17,200 * 5%) on To Interest on Sinking Fund 15,860
sinking fund investments. Investment A/C
Since one year has
completed on making
investments worth Rs.
3,17,200, interest @ 5%
will be received on these.
For transferring the interest Interest on Sinking Fund 15,860
received above in sinking Investment A/C......Dr.
fund account. Whatever To Sinking Fund A/C 15,860
interest is received on
sinking fund investments, it
will all be transferred to
sinking fund account only
because it is not a general
income; this income is
related to sinking fund only.
Moreover, it is also a
cumulative sinking fund
where interest also needs to
be reinvested.
For making annual Surplus A/C.....Dr. 3,17,208
appropriation from surplus To Sinking Fund A/C 3,17,208
For investment of the Sinking Fund Investment 3,33,100
amount of appropriation A/C.....Dr.
plus the amount of interest To Bank A/C 3,33,100
received and transferred to
sinking fund. So,
 investments will be equal
to= 3,17,208 +15, 860
=3,33,068 = 3,33,100 (by
rounding off to the
multiples of 100)
For transferring the amount Statement of P & L A/C.....Dr. 1,00,000
of debenture interest to P&L To Debenture Interest A/C 1,00,000
account.
2017 For payment of annual Debenture Interest A/C.....Dr. 1,00,000
March 31 interest on debentures @ To Bank A/C 1,00,000
10% per annum
For receiving the amount of Bank A/C......Dr. 32,515
interest To Interest on Sinking Fund 32,515
((3,17,200+3,33,100) * 5%) Investment A/C
on sinking fund
investments. Since now
sinking fund investments
are worth Rs. 6,50,300;
interest @ 5% will be
received on these.
For transferring the interest Interest on Sinking Fund 32,515
received above in sinking Investment A/C......Dr.
fund account. Whatever To Sinking Fund A/C 32,515
interest is received on
sinking fund investments, it
will all be transferred to
sinking fund account only.
For making annual Surplus A/C.....Dr. 3,17,209
appropriation from surplus. To Sinking Fund A/C 3,17,209
You will notice that instead
of Rs.3,17,208, Rs. 3,17,209
is appropriated this time.
Last year's appropriation
may have to be adjusted a
little so as to make the
balance of sinking fund
account equal to Rs.
10,00,000.
For sale of sinking fund Bank A/C.....Dr. 6,56,000
investments. As this is the To Sinking Fund Investments 6,56,000
date when debentures are to A/C
be redeemed, no new
investments will be made.
Instead, the sinking fund
investments are sold off at
Rs. 6,56,000 (given).
These investments are sold Sinking Fund Investments 5,700
at Rs. 6,56,000, but, the A/C....Dr.
sinking fund investments To Sinking Fund A/C 5,700
account was totaling only
 Rs. 6,50,300, so, there will
be a profit of Rs. 5,700
which will also be
transferred to sinking fund
account.
For transferring the amount Statement of P & L A/C.....Dr. 1,00,000
of debenture interest to P&L To Debenture Interest A/C 1,00,000
account.
For making the debenture 10% Debentureholders A/C...Dr. 10,00,000
redemption due to To Debentureholders A/C 10,00,000
debentureholders.
For payment to Debentureholders A/C.....Dr. 10,00,000
debentureholders To Bank A/C 10,00,000
For transferring balance Sinking Fund A/C....Dr. 10,05,700
remaining in sinking fund To General Reserve A/C 10,05,700
account to general reserve
account. This amount will
be equal to the amount of
debentures redeemed (Rs.
10,00,000) plus the profit on
sale of sinking fund
investments (Rs. 5,700).

Suggestion for students: While doing these questions, it is important that you prepare the ledger
accounts also side by side for each year so that you are able to calculate the correct amounts
while passing the entries.

Reference Book:

Fundamentals of Corporate Accounting By J.R. Monga