Corporate Accounting and Financial Management · Accounting for Debentures

Debenture Redemption by Sinking Fund and Open Market Purchase

Updated 11 October 2026 · Fact-checked

In the sinking fund method, you set aside yearly profits, invest them outside the business, and use the investments to repay debentures. In open market purchase, the company buys its own debentures, then cancels them or holds them as investment. Price is cum-interest (includes accrued interest) or ex-interest (excludes it).

Understand Redemption by Sinking Fund and Purchase in Open Market

A company can repay debentures from a lump sum at maturity. That sum must be ready. The sinking fund method builds it over the life of the debentures. Each year the company transfers a fixed amount from profits to a Debenture Sinking Fund Account and invests an equal amount in outside securities. The investments earn interest. That interest is also added to the fund and reinvested. At maturity the investments are sold, the cash repays debenture holders, and the fund balance is moved to General Reserve.

The fund is a reserve created out of profits. It is not a cash pile. The matching asset is the Debenture Sinking Fund Investment Account. Note that section 71(4) also requires a debenture redemption reserve out of profits available for payment of dividend. That reserve cannot be used except to redeem debentures. Follow the quantum and investment conditions given in the question or in the Rules. Do not assume them.

In open market purchase, the company buys its own debentures from the stock market, often when the price is below face value. Two things decide the entry: the price and the treatment. If bought at a discount, the difference between the nominal value and the cost is a profit on cancellation. It is a capital profit and goes to Capital Reserve. If bought at a premium, the difference is a loss, charged to Profit and Loss.

The purchased debentures can be cancelled at once. Then the liability disappears. Or they can be held as investment. Then they stay in the books at cost, interest on them is income, and they are cancelled later or sold. Cancellation happens on the date the question states.

Price quotes matter. Cum-interest means the price includes interest accrued up to the date of purchase. You split it into the cost of the debenture and the interest for the broken period. Ex-interest means accrued interest is paid separately, on top of the price. In both cases, the interest part is not part of the cost of the debenture. It goes to Debenture Interest Account. Also note that a company which has made default in repaying debentures, interest or dividend has restrictions on buy-back of its own securities under section 70. That section deals with buy-back of shares and other specified securities. Check the facts if a question mentions defaults.

Key rules to remember

Annual sinking fund instalment: Annual instalment = Debentures to be redeemed ÷ Future value annuity factor; Use the factor given in the question (a sinking fund table). Do not compute your own unless given the rate.
Cum-interest cost of debentures: Cost of debentures = Total price paid − Accrued interest; Accrued interest = Nominal value × rate × months from last interest date ÷ 12.
Ex-interest total cash paid: Total cash paid = Price of debentures + Accrued interest; Only the price part is the cost of the debentures.
Profit or loss on cancellation: Profit = Nominal value − Cost (excluding interest); Positive means profit, transferred to Capital Reserve. Negative means loss, charged to Profit and Loss.
Sinking fund balance at end of a year: Opening fund + Annual instalment + Interest on investments; The investments are made equal to the instalment plus interest received.
Capital redemption reserve: CRR transfer = Nominal value of shares purchased; Under section 69(1), where shares are purchased out of free reserves or securities premium. It is for shares, not debentures.

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

Follow this order for any sinking fund or open market question.

1Read the method and note the rate of interest, amount, and years. Identify whether it is a sinking fund, an open market purchase, or both.
2For sinking fund, find the annual instalment from the factor given. Prepare the Sinking Fund Account and the Investment Account for each year.
3Each year, pass entries: Profit and Loss Appropriation Account to Sinking Fund Account for the instalment, and Sinking Fund Investment Account to Bank for the investment.
4Record interest received on investments: Bank to Interest on Sinking Fund Investment, then Interest to Sinking Fund Account. Reinvest it.
5For open market purchase, split the amount paid into cost and interest. Cum-interest: subtract accrued interest. Ex-interest: price is the cost, interest is extra.
6Work out profit or loss on cancellation. Pass entries: Own Debentures to Bank, Interest to Bank, then cancellation entry with Capital Reserve or Profit and Loss.
7At maturity, sell the investments, pay debenture holders, and transfer the Sinking Fund balance to General Reserve. Adjust any profit or loss on sale of investments through the Sinking Fund Account.
8Show the final entries and ledger accounts neatly with working notes.

Quickest way: Three-line check for open market purchase

When to use it: Use when the question gives a purchase price, a purchase date and a last interest date, and asks only for journal entries.

Compute accrued interest first: Nominal value × rate × months ÷ 12.
Cost = Price − accrued interest (cum-interest) or Price (ex-interest). Never put interest inside the cost.
Profit or loss = Nominal value − Cost. Positive means Capital Reserve, negative means Profit and Loss. Then write the three entries in order: purchase, interest, cancellation.

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

Including accrued interest in the cost of own debentures.
Students take the full cash paid as cost.
Fix: Always separate interest first. Debit Debenture Interest Account for the broken-period interest.
Treating ex-interest price as if it included interest.
The words cum and ex look alike.
Fix: Ex-interest means interest is extra. Total cash is price plus interest.
Crediting profit on cancellation to Profit and Loss Account.
Students treat every profit as revenue.
Fix: Profit on cancellation of own debentures is a capital profit. Credit Capital Reserve.
Forgetting to invest the interest earned on sinking fund investments.
Students invest only the yearly instalment.
Fix: Invest instalment plus interest received. Compute each year's investment from the table.
Leaving the Sinking Fund balance in the books after redemption.
Students stop after paying debenture holders.
Fix: Transfer the balance to General Reserve. The fund has served its purpose.
Confusing the investment account with the fund account.
Both carry the same name and similar amounts.
Fix: The fund is a liability-side reserve. The investment is an asset. Close both at maturity.

Worked examples

Example 1

On 1 January 2026 Sagar Ltd had ₹10,00,000 of 9% debentures. Interest is paid on 30 June and 31 December. On 1 April 2026 the company bought ₹1,00,000 of its own debentures at ₹98 cum-interest and cancelled them immediately. Pass the journal entries.

Show the solution

Accrued interest from 1 January to 1 April is 3 months. Interest = 1,00,000 × 9% × 3 ÷ 12 = ₹2,250.
Total price paid = 1,00,000 × 98 ÷ 100 = ₹98,000.
Cost of debentures = 98,000 − 2,250 = ₹95,750.
Profit on cancellation = 1,00,000 − 95,750 = ₹4,250.
Entry 1: Own Debentures A/c Dr ₹95,750; Debenture Interest A/c Dr ₹2,250; to Bank A/c ₹98,000.
Entry 2: 9% Debentures A/c Dr ₹1,00,000; to Own Debentures A/c ₹95,750; to Capital Reserve A/c ₹4,250.

Answer: Cost is ₹95,750. Profit on cancellation of ₹4,250 goes to Capital Reserve. Interest of ₹2,250 is debited to Debenture Interest Account.

Example 2

A company bought ₹2,00,000 of its 12% debentures at ₹102 ex-interest on 1 May. Interest was last paid on 31 March. Find the total cash paid and the loss or profit on cancellation. Pass the entries.

Show the solution

Price of debentures = 2,00,000 × 102 ÷ 100 = ₹2,04,000. This is the cost.
Accrued interest for 1 month (1 April to 1 May) = 2,00,000 × 12% × 1 ÷ 12 = ₹2,000.
Total cash paid = 2,04,000 + 2,000 = ₹2,06,000.
Loss on cancellation = 2,04,000 − 2,00,000 = ₹4,000.
Entry 1: Own Debentures A/c Dr ₹2,04,000; Debenture Interest A/c Dr ₹2,000; to Bank A/c ₹2,06,000.
Entry 2: 12% Debentures A/c Dr ₹2,00,000; Profit and Loss A/c Dr ₹4,000; to Own Debentures A/c ₹2,04,000.

Answer: Total cash paid is ₹2,06,000. Loss on cancellation is ₹4,000, charged to Profit and Loss Account.

Exam tips

Write the interest split as a working note. Examiners give marks for it even if a later entry goes wrong.
Check the date of last interest and date of purchase. The number of months drives the accrued interest.
If the question gives the price as a percentage, apply it to nominal value, not to the total debentures outstanding.
For sinking fund problems, make a small table with year, opening balance, interest, instalment and closing balance. It prevents arithmetic slips.
State clearly whether debentures are cancelled or held as investment. The entry differs.

Practice questions from Accounting for Debentures

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

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

CMA IntermediateRedemption by Purchase in Open Market and Sinking Fund

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

What is the difference between cum-interest and ex-interest?

Cum-interest means the quoted price already includes accrued interest. You subtract it to find the cost. Ex-interest means the price excludes interest, so you add accrued interest to the cash payment.

Where does profit on cancellation of own debentures go?

It goes to Capital Reserve, because it is a capital profit. A loss on cancellation is charged to Profit and Loss Account.

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

The investments are sold and debenture holders are paid. Any remaining balance in the Sinking Fund Account is transferred to General Reserve.

Does section 71 require a reserve for debenture redemption?

Yes. Under section 71(4), where debentures are issued, the company creates a debenture redemption reserve out of profits available for payment of dividend. It cannot be used except for redeeming debentures. The quantum is as prescribed.