METHODS OF REDEMPTION OF DEBENTURES :
Following are the methods of redeeming the debentures:
(a) By annual drawings
Under this method, a certain portion of the total debentures is redeemed every year over the life-time of the debentures and thus at the end of the life time of the debentures, the debentures are fully redeemed. Which debenture should be paid in which year usually depends on the drawings. What is actually done is that slips bearing the number of debentures are mixed up and put into a drum and then as many slips as the debentures to be redeemed are taken out of the drum at random. This procedure is known as “Drawing by lot”. The amount of debentures to be redeemed every year is generally calculated by dividing the total amount of the debentures by the number of years for which they have been issued. In such a case, the amount of annual drawings will be equal. But the amount of annual drawings may also be unequal in some cases.
When debentures are redeemed by annual drawings, the amount of annual drawings should be transferred to General Reserve Account out of the profits of the company and the same need not be invested in any other way.
(b) By payment in one lump sum at the expiry of a specified period
Under this method the entire amount of the debenture debt is paid to the debentureholders in one lump sum at the expiry of a specified period, i.e., at maturity or at the option of the company at a date within such specified
period according to the terms of issue.
As the amount involved is large and the date of which debentures have to be redeemed is known to the company well in advance, it is possible for the company to make necessary arrangement to provide for the additional funds required for the debentures from the very beginning. In such a case, the best method is to set aside every year throughout the life of the debentures a part of the profits of the company which would otherwise be available for dividend and to invest the same in readily convertible securities together with compound interests at a fixed rate will amount to the sum required to pay off the debentures at the specified date.
The investments, thus made, are sold when the debentures become due for payment. This method ensures the availability of sufficient cash for the redemption of debentures when they become due and is known as “Sinking Fund method”.
(c) By purchase of debentures in the open market
Under this method, a company may purchase its own debentures in the open market if it seems to be convenient and profitable to the company. When the market price of the debentures goes down below par or debentures are quoted at a discount on the stock exchange, the company usually takes the opportunity to buy the debentures in the open market and to cancel them. Own debentures may, also, be purchased by the company for its own investment when it is desired to keep the debentures alive with a view to issuing them in future. The law does not prohibit a company from purchasing its own debentures unless the terms of issue specify otherwise.
In such a case, the purchase of debentures can be made out of the amount realised on sale of investments where sinking funds exists. Where there is no sinking fund, the debentures can be purchased out of the company’s cash balance.
(d) By conversion into shares
A company may issue convertible debentures giving option to the debentureholders to exchange their debentures for equity shares or preference shares in the company. The debentureholders are given the right on certain dates or before a specified date to exchange the debentures for the shares. A certain number of shares are offered for each debenture. When the debenture-holders exercise this option and the company issues the shares, it is referred as redemption by conversion.