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Difficulty: HardIssue and Redemption of Debentures

Zenith Engineering Ltd issued 5,0005,000, 10%10\% debentures of ₦100\text{₦}100 each at a discount of 4%4\%. The terms of issue specify that the debentures are redeemable after five years at a premium of 5%5\%. What is the total loss on issue of debentures to be written off over the tenure of the debentures?

  1. \text{₦}45,000Answer
  2. B
    \text{₦}20,000
  3. C
    \text{₦}25,000
  4. D
    \text{₦}5,000

Answer

\text{₦}45,000
The correct answer is \text{₦}45,000. When debentures are issued at a discount and redeemable at a premium, the total capital loss incurred by the issuing company equals the sum of the discount granted upon issue (\text{₦}20,000) and the premium promised upon redemption (\text{₦}25,000). Both components represent a cost of borrowing that must be recognized and written off over the tenure of the debentures.

Step-by-Step Solution

1
Calculate the total nominal value of the debentures issued.
\text{Nominal Value} = 5,000 \times \text{₦}100 = \text{₦}500,000
The nominal value forms the base for calculating both the issue discount and the redemption premium.
2
Calculate the discount allowed on the issue of debentures.
\text{Discount on Issue} = 4\% \times \text{₦}500,000 = \text{₦}20,000
Issuing debentures below face value represents an immediate capital loss.
3
Calculate the premium payable on the redemption of debentures.
\text{Premium on Redemption} = 5\% \times \text{₦}500,000 = \text{₦}25,000
Agreeing to redeem debentures above face value creates an additional capital liability/loss at the date of issue.
4
Sum the discount on issue and premium on redemption to find the total loss on issue.
\text{Total Loss on Issue} = \text{₦}20,000 + \text{₦}25,000 = \text{₦}45,000
Both items are capital losses arising from the issue contract and must be amortized over the debentures' life.

Key Concept

Accounting for Issue of Debentures Redeemable at a Premium
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Topics

Issue and Redemption of Debentures

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