Question

Long Answer Question

Describe the steps for creating Sinking Fund for redemption of debentures.

Answer 1

The various steps involved in the creation of Sinking Fund for redemption of debentures can be better understood by the help of the example explained below.

A Company issued 10% Debentures of Rs 5,00,000 for 3 years. The investment is expected to earn 6% p.a. The Sinking Fund table shows that 0.31411 invested annually at 6% amount to Rs 1 in 3 years.

Step 1: Calculate the amount of instalment to be required every year for investment with the help of the Sinking Fund table. Like in the example Rs 1,57,055 (i.e. 0.31411 × 5,00,000) is required every year.

Step 2: The amount of instalment calculated in the above step is transferred to the Debenture Redemption Fund (Sinking Fund) by debiting from Profit and Loss Appropriation Account.

Step 3: In the first year, the above instalment is invested to yield amount required for redemption of debenture by debiting Debenture Redemption Fund Investment Account.

Step 4: The interest on investment is received on half yearly or annual basis. In the example, the interest of Rs 9,423 is received on annual basis. 

`(1,57,055 xx 6/100 = 9,423)`

Step 5: The total amount of investment, i.e. interest plus instalment is invested in the subsequent year. In the example, Rs 1,66,478 (i.e. Rs 1,57,055 + Rs 9,423) is invested in the next year.

Step 6: Repeat the Step 2, 3, 4 for each subsequent years up to the end of the life of the debenture. In the year of redemption, the instalment (i.e. the last instalment) will be debited to the Profit and Loss Appropriation Account but will not be invested.

Step 7: In the year of redemption, the investment is sold off.

Step 8: The profit (loss) on the sale of the investment is transferred by debiting (crediting) Debenture Redemption Fund Investment Account to the Debenture Redemption Fund Account.

Step 9: The payment to the debenture holder is made.

Step 10: The balance of Debenture Redemption Fund Account if any, is transferred to the General Reserve.