WRITING OFF THE DISCOUNT ON ISSUE OF DEBENTURES :
Discount on issue of debentures is a capital loss of the company and it is required to be shown on the assets side of the Balance Sheet under the heading Other Current or other Non Current Asset until written off. Although, there is no legal obligation on the part of the company to write off such a loss, sound business policy demands that it should be written off as quickly as possible.
Discount on issue of debentures can be treated in any of the following two ways:
1. Discount on issue of debentures being a capital loss, can be written off against capital profits.
2. Discount on issue of debentures can be treated as deferred revenue expenditure and written off against revenue over the period of life of the debentures.
In case there is no capital profit and it is decided to treat discount on issue of debentures as deferred revenue expenditure, it is desirable to write it off against revenue over the period of life of the debentures on an equitable basis.The following are the two methods which are generally adopted for this purpose.
1. Fixed Instalment Method: Under this method, the total amount of discount allowed on issue of debentures is spread over the life of the debentures equally and every year a fixed amount is written off against revenue. For example, if the total discount allowed on issue of debentures is ` 10,000 and the debentures are issued for 10 years, the amount of discount to be written off every year will be 1/10th of the total discount, i.e., every year an amount equal to (1/10 x 10,000) = 1,000 will be written off over a period of 10 years. At the end of the 10th year Discount on Issue of Debentures Account would be completely written off. This method is simple and can be applied only if the debentures are redeemed at the expiry of the period. This method has the advantage of spreading the burden of discount equally over the period of the debentures.
2. Fluctuating Instalment Method: Where debentures are redeemed by annual drawings, the first method is not suitable for the simple reason that the burden of discount is equally spread over the period of life of the debentures. Under this method, the amount of discount to be written off every year should bear a proportion to the debentures outstanding at the beginning of each year. Thus, the amount of discount to be written off every year under this method cannot be fixed and will go on diminishing every year, i.e., the burden of discount will be in proportion to the benefits derived out of the debentures. The initial year should bear a greater burden of discount than the subsequent years as each subsequent year has the use of a lesser amount of debentures. Let us take an example as follows:
Nu Look Ltd. issued 1,000, 12% Debentures of ` 100 each at a discount of 10%. The terms of issue provided the repayment of the debentures at par by annual drawing of ` 20,000 over a period of 5 years. How should the amount of discount to be written off be determined?
The total discount on issue of debentures is ` 10,000. This total discount of ` 10,000 has to be written off in proportion to the debentures outstanding at the beginning of each year. Thus, outstanding balance ratio will be as follows:
1st year … … = Rs.1,00,000
2nd Year Rs.(1,00,000 – 20,000) = Rs. 80,000
3rd Year Rs. (80,000 – 20,000) = Rs.60,000
4th Year Rs.(60,000 – 20,000) = Rs.40,000
5th Year Rs. (40,000 – 20,000) = Rs.20,000
Outstanding balance ratio = 1,00,000 : 80,000 : 60,000 : 40,000 : 20,000
= 5 : 4 : 3 : 2 : 1
Therefore, amount of discount to be written off every year will be as follows:
1st Year = Rs.10,000 x 5/15 = Rs.3,333
2nd Year = Rs.10,000 x 4/15 = Rs.2,667
3rd Year = Rs.10,000 x 3/15 = Rs. 2,000
4th Year = Rs.10,000 x 2/15 = Rs.1,333
5th Year = Rs.10,000 x 1/15 = Rs.667
Total Rs.10,000
Accounting Entries: Every year, when the discount on issue of debentures is written off against revenue, the
following entry is required to be shown in the books of the company:
Profit and Loss A/c Dr. with the amount written off
To Discount on Issue of Debentures A/c
Illustration 8
Indra Ltd. issued 10,000 debentures of Rs.100 each at a discount of 6%. The expenses on issue amounted to Rs.35,000. The debentures have to be redeemed at the rate of Rs.1,00,000 each year commencing with end of fifth
year. How much discount and expenses should be written off each year?
Solution:
Total amount of discount and expenses is Rs.95,000.
It should be written off each year according to the ratios of the amounts outstanding.
Years Ratio
1 10
2 10
3 10
4 10
5 10
6 9
7 8
8 7
9 6
10 5
11 4
12 3
13 2
14 1
Total of ratios = 95
In each of the first five years, discount to be written off will be
|
Rs.95,000X10____ 95 |
=Rs. 10,000 |
In 6th year =
| Rs.95,000X 9___
95 |
=Rs. 9,000 |
In 7th year =
| Rs.95,000X 8___
95 |
=Rs. 8,000 |
In 8th year =
| Rs.95,000X 7__
95 |
=Rs. 7,000 |
In 9th year =
| Rs.95,000X 6__
95 |
=Rs. 6,000 |
In 10th year =
| Rs.95,000X 5__
95 |
=Rs. 5,000 |
In 11th year =
| Rs.95,000X 4__
95 |
=Rs. 4,000 |
In 12th year =
| Rs.95,000X 3__
95 |
=Rs. 3,000 |
In 13th year =
| Rs.95,000X 2__
95 |
=Rs. 2,000 |
In 14th year =
| Rs.95,000X 1_
95 |
=Rs.1,000 |