Corporate Accounting and Auditing · Redemption of Preference Shares, Issue and Redemption of Debentures

Purchase of Own Debentures and Debenture Sinking Fund

Updated 10 October 2026 · Fact-checked

When a company buys its own debentures in the open market, record them at cost excluding accrued interest. On cancellation, a gain (nominal value minus cost) goes to Capital Reserve and a loss to the Profit and Loss statement. In the sinking fund method, you set aside yearly instalments and invest them, and the investments redeem the debentures.

Understand Redemption by Purchase in Open Market and Sinking Fund

A company can redeem debentures by buying them from the market, usually when the market price is below face value. It may keep them as investment for a time (own debentures) or cancel them at once. Either way, the debenture liability falls only when they are cancelled.

The key trap is interest. If the price is cum-interest, the price you pay includes interest accrued up to the date of purchase. You must split it: the interest part is an expense (or recovery of interest) and only the rest is the cost of the debentures. If the price is ex-interest, the price is for the debentures alone, and you pay the accrued interest separately on top.

On cancellation, compare the nominal value of the debentures with their cost (ex-interest). If cost is lower, the company has a profit on cancellation. It is a capital profit, so it is credited to Capital Reserve. If cost is higher, the difference is a loss, charged to the Profit and Loss statement. Own debentures still held at the year end are shown as a deduction from debentures or as investment, as the question directs. Interest on them is not a real outflow to outsiders.

In the debenture sinking fund method, the company transfers a fixed sum every year out of profits to a Sinking Fund account and invests an equal amount outside the business in securities. Interest earned on those investments is credited to the Sinking Fund account and is reinvested. By the redemption date, the investments (plus the last year's cash) equal the debenture amount. The investments are sold, debenture holders are paid, and the Sinking Fund balance, now a free profit, is transferred to General Reserve.

Section 71(4) of the Companies Act, 2013 requires a company issuing debentures to create a debenture redemption reserve out of profits available for payment of dividend, and the amount credited cannot be used except to redeem debentures. The quantum is fixed by the rules, so follow whatever figure the question gives. Section 52(2)(d) lets a company apply its securities premium account to provide for premium payable on redemption of debentures.

Key rules to remember

Accrued interest: Accrued interest = Nominal value × Rate of interest × Months since last interest date ÷ 12; Count from the last interest payment date to the date of purchase.
Cost of own debentures (cum-interest price): Cost = Price paid − Accrued interest; Price paid = Nominal value × quoted price ÷ 100. The accrued interest part is debited to Debenture Interest account.
Cost of own debentures (ex-interest price): Cost = Price paid; Cash paid = Price paid + Accrued interest; Accrued interest is paid separately and debited to Debenture Interest account.
Profit or loss on cancellation: Profit = Nominal value − Cost (ex-interest); Loss = Cost − Nominal value; Profit goes to Capital Reserve. Loss goes to Profit and Loss statement.
Sinking fund instalment: Annual instalment = Amount to be redeemed ÷ Annuity factor, where factor = [(1 + i)ⁿ − 1] ÷ i; Use the factor given in the question. Instalment is paid at the end of each year.
Interest on sinking fund investments: Interest for a year = Investments held at start of year × Rate of interest; No interest in year 1. Interest is credited to Sinking Fund account, not to Profit and Loss.
Sinking fund balance: Closing balance = Opening balance + Instalment + Interest; At the last year-end the balance should equal the debenture amount, apart from rounding.

How to solve Redemption by Purchase in Open Market and Sinking Fund questions

Use this order for any question on own debentures or the sinking fund method.

1Read the price words first: cum-interest or ex-interest, and the date of purchase against the interest dates.
2Compute accrued interest from the last interest date to the date of purchase.
3Find the cost: cum-interest, subtract accrued interest from the price paid. Ex-interest, the price is the cost and interest is paid extra.
4Pass the purchase entry: Own Debentures (cost) and Debenture Interest (accrued part) to Bank.
5On cancellation, debit Debentures at nominal value, credit Own Debentures at cost, and credit Capital Reserve with the profit (or debit Profit and Loss with the loss).
6For the sinking fund method, build a table: opening balance, interest on investments, instalment, closing balance, year by year.
7Pass the yearly entries: appropriation to Sinking Fund, purchase of investments, interest credit. In the last year, sell investments, pay debenture holders, and transfer the Sinking Fund balance to General Reserve.
8Check that the final sinking fund balance equals the amount to be redeemed.

Quickest way: Three-line check for cost and profit

When to use it: Use it for MCQs and for the first working note of any own-debenture sum.

Price paid = Nominal value × price ÷ 100. If cum-interest, cost = price paid − accrued interest. If ex-interest, cost = price paid.
Profit = Nominal value − cost. Positive means Capital Reserve, negative means loss.
Sinking fund: interest each year = 10% (or given rate) of investments held at the start, so the year-2 interest is on the year-1 instalment only. Last-year balance must equal the redemption amount.

Common mistakes in Redemption by Purchase in Open Market and Sinking Fund

Treating the whole cum-interest price as the cost of debentures.
The price is quoted as one figure, so students forget it contains interest.
Fix: Always compute accrued interest first and deduct it. Only the balance is the cost of own debentures.
Calculating profit on cancellation using the cash paid.
Students compare nominal value with total cash, which includes interest.
Fix: Profit = Nominal value − cost excluding interest. Interest is never part of the profit.
Crediting profit on cancellation to the Profit and Loss statement.
The gain looks like income.
Fix: It arises on a capital item, so credit Capital Reserve. Only a loss goes to Profit and Loss.
Adding interest on sinking fund investments in year 1.
Students apply the rate to the first instalment straight away.
Fix: The first instalment is invested at the end of year 1. Interest starts in year 2, on the opening investments.
Crediting interest on sinking fund investments to Profit and Loss.
It is investment income, so it feels like normal income.
Fix: Credit it to Sinking Fund account. It is the interest that builds the fund. Only the instalment is charged to Profit and Loss Appropriation.
Leaving the Sinking Fund balance in the books after redemption.
Students stop once the debenture holders are paid.
Fix: Transfer the balance to General Reserve, since the liability is gone and the amount is a free reserve.

Worked examples

Example 1

Moon Ltd has ₹10,00,000 12% debentures. Interest is paid on 30 June and 31 December. On 1 March 2027 it purchased ₹1,00,000 of its own debentures in the open market at ₹96 (a) cum-interest and (b) ex-interest, and cancelled them immediately. Pass the entries and find the profit.

Show the solution

Accrued interest: from 1 January to 1 March is 2 months. ₹1,00,000 × 12% × 2 ÷ 12 = ₹2,000.
Part (a), cum-interest: price paid = ₹1,00,000 × 96 ÷ 100 = ₹96,000. Cost = ₹96,000 − ₹2,000 = ₹94,000.
Entry (a): Own Debentures A/c Dr ₹94,000; Debenture Interest A/c Dr ₹2,000; to Bank ₹96,000.
Cancellation (a): 12% Debentures A/c Dr ₹1,00,000; to Own Debentures A/c ₹94,000; to Capital Reserve ₹6,000.
Part (b), ex-interest: cost = ₹96,000. Cash paid = ₹96,000 + ₹2,000 = ₹98,000.
Entry (b): Own Debentures A/c Dr ₹96,000; Debenture Interest A/c Dr ₹2,000; to Bank ₹98,000.
Cancellation (b): 12% Debentures A/c Dr ₹1,00,000; to Own Debentures A/c ₹96,000; to Capital Reserve ₹4,000.

Answer: (a) Cost ₹94,000, profit on cancellation ₹6,000 credited to Capital Reserve. (b) Cost ₹96,000, profit ₹4,000 credited to Capital Reserve.

Example 2

Sun Ltd has ₹3,31,000 debentures repayable at the end of 3 years. It creates a sinking fund by setting aside a fixed sum each year at year end and investing it in securities earning 10% a year. The annuity factor for 3 years at 10% is 3.31. Find the yearly instalment, prepare the Sinking Fund account and give the entries in year 3.

Show the solution

Instalment = ₹3,31,000 ÷ 3.31 = ₹1,00,000.
Year 1: opening ₹0; interest nil; instalment ₹1,00,000; closing ₹1,00,000. Investments bought ₹1,00,000.
Year 2: interest = 10% × ₹1,00,000 = ₹10,000. Credit to fund = ₹10,000 + ₹1,00,000 = ₹1,10,000. Closing = ₹2,10,000. Investments bought ₹1,10,000, so total investments ₹2,10,000.
Year 3: interest = 10% × ₹2,10,000 = ₹21,000. Credit to fund = ₹21,000 + ₹1,00,000 = ₹1,21,000. Closing = ₹3,31,000.
Entry: Bank A/c Dr ₹21,000; to Sinking Fund A/c ₹21,000 (interest received).
Entry: Profit and Loss Appropriation A/c Dr ₹1,00,000; to Sinking Fund A/c ₹1,00,000.
Entry: Bank A/c Dr ₹2,10,000; to Sinking Fund Investment A/c ₹2,10,000 (sale of investments at book value).
Entry: Debentures A/c Dr ₹3,31,000; to Debenture holders A/c ₹3,31,000; then Debenture holders A/c Dr; to Bank ₹3,31,000. Bank has ₹2,10,000 + ₹21,000 + ₹1,00,000 = ₹3,31,000 available from these items.
Entry: Sinking Fund A/c Dr ₹3,31,000; to General Reserve A/c ₹3,31,000.

Answer: Yearly instalment ₹1,00,000. Sinking fund closing balances: ₹1,00,000, ₹2,10,000, ₹3,31,000. The final balance of ₹3,31,000 is transferred to General Reserve after redemption.

Exam tips

Underline cum or ex before you start. The whole sum turns on that one word.
Show a working note for accrued interest and cost. Step marks are given even if the final entry has a slip.
In sinking fund sums, draw the table with columns for opening balance, interest, instalment and closing balance. Check the last balance against the debenture amount.
MCQs often ask only for the profit or the cost. Use the three-line check and ignore the rest.
If the question mentions premium on redemption or the debenture redemption reserve, follow the figure given and show the related transfer separately.

Practice questions from Redemption of Preference Shares, Issue and Redemption of Debentures

Redemption by Purchase in Open Market and Sinking Fund in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

CS ExecutiveRedemption by Sinking Fund and Purchase in Open Market

Redemption by Purchase in Open Market and Sinking Fund: frequently asked questions

What is the difference between cum-interest and ex-interest purchase of debentures?

In a cum-interest price, the amount you pay already includes interest accrued till the purchase date, so you deduct it to find the cost of the debentures. In an ex-interest price, the price is only for the debentures and you pay accrued interest separately on top.

How do I calculate profit on cancellation of own debentures?

Subtract the cost of the debentures, excluding accrued interest, from their nominal value. A positive result is a profit and is credited to Capital Reserve. A negative result is a loss and is charged to the Profit and Loss statement.

Why is there no interest on sinking fund investments in the first year?

The first instalment is set aside and invested only at the end of the first year. So there are no investments earning interest during that year. Interest begins in year 2, calculated on the investments held at the start of the year.

What happens to the Sinking Fund account after the debentures are redeemed?

After the investments are sold and the debenture holders are paid, the Sinking Fund account still shows a credit balance. Since no liability remains against it, the balance is transferred to General Reserve.