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Accounting 3% exam weight

Debentures

Part of the ACCA/CA Pakistan study roadmap. Accounting topic accoun-009 of Accounting.

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Debentures

🟢 Lite — Quick Review (1h–1d)

Rapid summary for last-minute revision before your exam.

A debenture is a written acknowledgment of a long-term loan taken by a company, carrying a fixed coupon (interest) rate, a defined face/principal value, and a maturity date when the principal must be repaid. Holders are creditors, not owners, so debenture interest is a charge against profit (tax-deductible) while dividends are not.

Must-know formulas

  • Issue Price (par issued at discount) = Face Value × (100 − Discount %) / 100
  • Annual Cash Interest = Face Value × Coupon Rate
  • Redemption Amount = Face Value × (100 + Premium %) / 100
  • Loss on Issue at Par = (Face Value + Premium on Redemption) − Issue Proceeds

High-yield pointers

  1. Discount on issue and issue costs are a capital loss, written off against Securities Premium first, then retained earnings.
  2. A sinking fund accumulates cash (or investments) to redeem debentures on maturity.
  3. Bearer debentures are transferable by delivery; registered debentures transfer requires the company’s register entry.

🟡 Standard — Regular Study (2d–2mo)

Standard content for students with a few days to months.

Nature and Classification

A debenture is an instrument under IFRS 9 / IAS 32 evidencing a financial liability of the issuer. Classification matters because it dictates security, redemption treatment, and disclosure:

TypeSecurityKey Feature
Mortgage / Fixed ChargeSpecific assetPriority on default; registered with Registrar
Floating ChargeAll assets (changing)Crystallises on liquidation
Unsecured (Simple/Naked)NoneRank after secured creditors
Bearer vs RegisteredEitherBearer = transfer by delivery; Registered = transfer by company register
Irredeemable (Perpetual)EitherNo maturity; redeemable only by company decision
RedeemableEitherCarries a fixed maturity date

Issue — Par, Discount, or Premium

When a debenture is issued below face value, the difference (discount) is not an expense; it is a capital loss. Under CA Pakistan / IFRS practice, this loss, together with issue costs, is debited to a Discount on Issue of Debentures account and amortised over the debenture’s life, OR written off immediately against Securities Premium Account (Rule: if S.P. exists and the issue was part of the same scheme, the loss can be written off directly to S.P., per Companies (General Provisions) Regulations).

When issued at a premium, the excess is credited to Securities Premium, a component of equity.

Interest — Cash vs Effective

Two methods appear in exam questions:

  • Cash method (straight-line): Interest = Face Value × Coupon Rate; premium/discount amortised equally.
  • Effective Interest Rate (EIR) method (IFRS 9): Interest Expense = Opening Carrying Amount × Market Yield. The amortisation = Cash Interest − Effective Interest. This produces a constant effective rate on the balance-sheet liability.

Balance Sheet Presentation

Debentures are split into:

  • Non-current liability: principal due after 12 months.
  • Current liability: the portion repayable within the next 12 months (matched by accrued interest).

Typical ACCA/CA Pakistan Question Patterns

  • Compute Issue Price when issued in instalments with interest runs.
  • Prepare the liability table using EIR (APM/P2/BT/FA style).
  • Journal entries for: issue, interest payment, partial redemption by drawings, redemption by open-market purchase (gain/loss to P&L or S.P.), and conversion to shares (with share premium = shares issued at market − debenture carrying amount).

🔴 Extended — Deep Study (3mo+)

Comprehensive coverage for students on a longer study timeline.

Sinking Fund and Redemption Mechanics

A Sinking Fund is a non-distributable reserve backed by investments, built up by annual appropriations equal to the Future Value of an Annuity factor so that the fund matures at par on the debenture’s redemption date. Accounting steps each year:

  1. Dr. P&L (or Appropriation) Cr. Sinking Fund Reserve.
  2. Dr. Sinking Fund Investment Cr. Bank.
  3. At maturity: Sale of investments → Bank; Debentures redeemed → Bank; Sinking Fund transferred back to Retained Earnings via the Statement of Changes in Equity.

Partial redemption by drawings: Company selects numbers (often proportional), repays at face (plus premium), and any premium on redemption is a capital loss when paid out of profits, not from the Sinking Fund.

Open-market purchase: If buy-back price > carrying amount, the difference is a capital loss chargeable to S.P./RE. If buy-back price < carrying amount, the gain is credited to Capital Reserve.

Conversion of Debentures

On conversion, the carrying amount of debentures (face value plus any unamortised premium/discount and accrued interest) is extinguished, and share capital + share premium are credited at the market value of shares issued. Any balancing figure is the share premium — a structural question on FA Paper.

Common Mistakes

  • Treating debenture discount as an expense in the income statement (it is a capital loss / equity adjustment).
  • Crediting the issue of debentures at discount to a liability at face value while ignoring the discount cash receipt.
  • Using the coupon rate instead of the effective rate when applying IFRS 9 EIR amortisation.
  • Showing accrued debenture interest as non-current — it is always current.

Practice Prompts

  1. Scenario: A company issues 10,000 debentures of Rs 100 each at 8% coupon, redeemable at 110 in 5 years, when the market yield is 10%. Build the EIR amortisation table for 5 years and show the balance-sheet liability at year 3.
  2. Journalise: (a) issue at 90 cum-interest, (b) annual interest payment, (c) redemption of 3,000 debentures drawn at par using open-market purchases at 96, including the gain/loss treatment.

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Sources & verification