## Debenture Redemption with Premium and Accrued Interest

When debentures are redeemed during the year, the Cash Flow Statement must handle three separate items:

1. Principal repaid — Financing outflow

2. Premium on redemption — Financing outflow (or added back to PBT in Operating if written off through P&L)

3. Interest paid — Financing outflow (calculated via Unpaid/Accrued Interest ledger)

### Key Rule: Interest on Debentures Redeemed During the Year

> Calculate interest on the full opening balance if redemption occurs at the end of the year, because interest accrues for the entire year before redemption.

Formula: `Interest Expense = Opening Debenture Balance × Rate`

### Premium on Redemption

If debited to P&L: Add back to PBT (non-cash if written off against Securities Premium / P&L Reserve, cash outflow in Financing when actually paid).
Premium paid = Financing outflow.

### T-account approach

Debentures A/c:

```

Redemption (CIB) ××× | Opening balance ×××

Closing balance ××× |

```

Accrued Interest Income (if any investments exist):

```

Accrued Interest Receivable

Opening balance ××× | CIB (interest received) ×××

P&L Interest Inc ××× | Closing balance ×××

```

Interest received = Opening + P&L credit − Closing

Unpaid Interest on Debentures:

```

Unpaid Interest (Liability)

CIB (interest paid) ××× | Opening balance ×××

Closing balance ××× | P&L Int Expense ×××

```

Interest paid = Opening + P&L charge − Closing

### Cash Flow Statement structure

```

A. Operating Activities

PBT ×××

Add: Premium on Debenture Redemption ××× (if in P&L)

Add: Interest Expense (on debentures) ×××

Less: Interest Income (on investments)(×××)

...

B. Investing Activities

Interest received on investments ××× (cash, from ledger)

C. Financing Activities

Redemption of Debentures (×××)

Premium paid on redemption (×××)

Interest paid on debentures (×××)

```

Worked example

### Example 1

Illustration — 10% Debentures redeemed at premium; 10% Investments

Given:

10% Debentures: Opening ₹1,10,000; Redemption during year ₹33,000 (at end of year); Closing ₹77,000
Premium on redemption = 5% → 33,000 × 5% = ₹1,650
10% Investments = ₹3,50,000 → Interest income = ₹35,000 p.a.
Unpaid interest on debentures: Opening ₹275; Closing ₹1,175
Accrued interest on investments: Opening ₹0; Closing ₹10,500

Interest on Debentures calculation:

> Redemption at end of year → interest on full ₹1,10,000 for full year

> Interest expense = 1,10,000 × 10% = ₹11,000

Unpaid Interest A/c:

```

CIB (cash paid) 10,100 | Opening balance 275

Closing balance 1,175 | P&L Int Expense 11,000

------ ------

11,275 11,275

```

Cash interest paid on debentures = ₹10,100

Accrued Interest Income A/c:

```

Opening balance 0 | CIB (cash received) 24,500

P&L Int Income 35,000 | Closing balance 10,500

-------- --------

35,000 35,000

```

Cash interest received on investments = ₹24,500

Cash Flow Statement (extracts):

```

A. Operating Activities

PBT ×××

Add: Premium on redemption (P&L) 1,650

Add: Interest expense on debentures 11,000

Less: Interest income on investments (35,000)

...

B. Investing Activities

Interest received on investments 24,500

C. Financing Activities

Redemption of 10% Debentures (33,000)

Premium paid on redemption (1,650)

Interest paid on debentures (10,100)

```

⚠️ Common exam mistakes

Calculating interest only on the post-redemption (closing) balance when redemption happens at year end — interest accrues on the full balance for the full year.
Showing accrued interest income as 'received' without adjusting for opening/closing accrued interest asset in the ledger.
Netting premium on redemption into the principal repayment instead of showing it separately.
Placing interest received and interest paid in Operating Activities instead of Investing and Financing Activities respectively (AS 3 requires separate disclosure).
Forgetting to add back premium on redemption to PBT when it has been debited to P&L as a charge.

Bare-Act text Paragraph 31 · AS 3 — Cash Flow Statements · click to expand

Interest paid and interest and dividends received are usually classified as operating cash flows for a financial enterprise. However, there is no consensus on the classification of these cash flows for other enterprises. Interest paid may be classified as an operating cash flow because it enters into the determination of net profit or loss. Alternatively, interest paid may be classified as a financing cash flow because it is a cost of obtaining financial resources.

Now that you've read this — what's next?

Move from understanding → mastery in 3 clicks. Each option below picks up from this lesson's topic.

🔥 Drill 5 Qs on this → ✍️ Adaptive practice →