10 min readConcept sheetOften a 5- or 10-mark journal question

Debentures and the redemption of preference shares and debentures

A debenture is a long-term loan to a company with fixed interest. Redemption means repaying debenture holders or redeemable preference shareholders, from cash, profits or a fresh issue.

DebentureWritten acknowledgement of a long-term loan

Debenture interestA finance cost, paid even in a loss year

Debenture holders areCreditors, not owners

Funding a redemptionFresh issue of shares and/or retained profits

Shares vs debentures

SharesOwners' capital. Dividends are paid only if profits allow and the board declares them. Ordinary shareholders vote. Repaid last on winding up.

DebenturesA loan. Interest is a finance cost that must be paid even in a loss year. Holders are creditors with no vote. Often secured on assets and repaid before shareholders.

Worked example 1: issue of debentures and accrued interest

Problem

On 1 July 2025 Lakdiva Foods PLC issued 50,000 12% debentures of Rs. 1,000 each at par, for cash. Interest is paid yearly on 30 June. The financial year ends on 31 March 2026.

Working

Cash raised: 50,000 × 1,000 = 50,000,000. Dr Bank 50,000,000; Cr 12% Debentures 50,000,000.
Yearly interest: 12% × 50,000,000 = 6,000,000.
Interest for 1 July 2025 to 31 March 2026, 9 months: 6,000,000 × 9/12 = 4,500,000.
Adjusting entry: Dr Debenture interest 4,500,000; Cr Accrued debenture interest 4,500,000.

Answer

Debentures Rs. 50,000,000 (non-current liability); interest expense Rs. 4,500,000, all accrued (current liability) at 31 March 2026.

Worked example 2: redemption of debentures

Problem

(a) Lakdiva Foods redeems 10,000 debentures of Rs. 1,000 at a premium of 5%, i.e. Rs. 1,050 each. (b) Later it buys 5,000 of its own debentures on the stock market at Rs. 960 each and cancels them.

Working

(a) Payment: 10,000 × 1,050 = 10,500,000. Face value: 10,000 × 1,000 = 10,000,000. Premium: 10,500,000 − 10,000,000 = 500,000.
(a) Dr Debentures 10,000,000; Dr Premium on redemption 500,000; Cr Bank 10,500,000.
(b) Payment: 5,000 × 960 = 4,800,000. Face value: 5,000 × 1,000 = 5,000,000.
(b) Dr Debentures 5,000,000; Cr Bank 4,800,000; Cr Gain on redemption 200,000 (5,000,000 − 4,800,000).

Answer

(a) The premium of Rs. 500,000 is a cost to the company. (b) Buying below face value gives a gain of Rs. 200,000.

Worked example 3: redemption of preference shares

Problem

Lakdiva Foods has 100,000 redeemable preference shares issued at Rs. 100 each (Rs. 10,000,000), to be redeemed at the issue price. To fund this it issues 200,000 ordinary shares at Rs. 30 each and uses retained profits for the rest.

Working

Fresh issue: 200,000 × 30 = 6,000,000. Dr Bank 6,000,000; Cr Stated capital 6,000,000.
Amount due: 100,000 × 100 = 10,000,000. Dr Redeemable preference shares 10,000,000; Cr Preference shareholders (redemption) 10,000,000.
Payment: Dr Preference shareholders 10,000,000; Cr Bank 10,000,000.
Part funded from profits: 10,000,000 − 6,000,000 = 4,000,000.
No capital redemption reserve is needed under the Companies Act No. 7 of 2007: shares have no par value, and the solvency test protects creditors instead. Older par value textbooks (old law) add Dr Retained earnings 4,000,000; Cr Capital redemption reserve 4,000,000; use that step only if a question asks for it.

Answer

Rs. 10,000,000 is repaid: Rs. 6,000,000 from the fresh issue and Rs. 4,000,000 from cash generated by retained profits.

Why redemption needs care

Redeeming shares or debentures sends cash out of the company, which can weaken the position of its creditors. Textbooks therefore fund redemptions from profits or the proceeds of a fresh issue. Under the Companies Act No. 7 of 2007, a redemption at the company's option counts as a distribution, so the board must be satisfied that the company passes the solvency test. A sinking fund, built up by setting cash aside each year, is one way to prepare for a large redemption. Under the Sri Lanka Accounting Standards, preference shares that the company must redeem are usually shown as liabilities, not equity, because they carry an obligation to pay. Under the full standards a premium payable on redemption is normally spread over the life of the debentures as part of the finance cost; introductory questions often charge it when paid, as above.

In Sri Lankan business

Sri Lankan banks and finance companies regularly raise money through listed debentures on the Colombo Stock Exchange, paying fixed interest and repaying holders at maturity. Investors who want steady income often buy them instead of shares.

Exam angle

Short answer: “Distinguish a debenture from a share.” A debenture is a loan with fixed interest and its holder is a creditor; a share is ownership capital whose dividend depends on profits, and its holder is an owner.

Structured question: “Journalise the issue of debentures and the accrual of debenture interest at the year end.” Cash received and debentures credited; yearly interest = rate × face value; time-apportion to the year end; Dr Debenture interest, Cr Accrued interest.

Essay: “Explain the methods of redeeming debentures and preference shares and show the journal entries.” Redemption at par, at a premium and by open-market purchase; funding by fresh issue or profits; entries with figures; why creditors need protection.

Remember it

Debenture = loan; interest = expense. Share = ownership; dividend = distribution of profit. Buying debentures below face value gives a gain; paying above face value is a cost.