REDEMPTION OF PREFERENCE SHARES
Redemption of Preference Shares means returning the capital to the preference shareholders either at a fixed date or after a certain time period during the lifetime of the company provided company must complied certain conditions.
ACCORDING TO THE COMPANIES ACT 2013
“A company is not allowed to return to its shareholders the share money without the permission of the court.”
A refund of money requires court permission. But Section 80 of the Companies Act allows the company, if authorized by its articles to issue preference shares which can be redeemed, if all the conditions of the Section are satisfied.
PROVISIONS/ CONDITIONS FOR REDEMPTION OF PREFERENCE SHARES
AUTHORIZATION BY ARTICLES OF ASSOCIATION
The company must be authorized by its articles of association. An article of Association is a document that governs the internal affairs of the company.
REDEMPTION OF FULLY PAID UP SHARES ONLY
No such shares shall be redeemed unless they are fully paid up. It means the partly paid up shares cannot be redeemed. If they are partly paid up, in that case a final call be made to convert the partly paid up shares into fully paid up shares. Then the company can proceed for redemption of shares.
SOURCES OF FUNDS FOR REDEMPTION
The Preference Shares can be redeemed out of the following arrangements:
- Out of profits available for distribution as dividend.
- Out of proceed of fresh issue of shares.
CREATION OF CAPITAL REDEMPTION RESERVE
If the shares are to be redeemed out of the profits available for the distribution for dividend, a sum equal to the nominal amount of shares to be redeemed, must be transferred to CAPITAL REDEMPTION RESERVE.
UTILIZATION OF CAPITAL REDEMPTION RESERVE
The CRR account can be utilized for the issue of fully paid up bonus shares to the shareholders.
REDEMPTION OF SHARES AT PREMIUM
If the preference shares are redeemed at premium, then such premium must be provided either out of profits of company or out of company’s security premium account.
METHODS OF REDEMPTION OF PREFERENCE SHARES
There are three widely accepted method for redemption of preference shares which are as follows:
PROCEEDS OF FRESH ISSUE OF SHARES
The word ‘Proceeds’ means the amount received excluding the amount of Share premium. It means it stands for the actual amount received if shares are issued at par. The company redeems the Preference shares by issuing fresh shares particularly, when
- The balance of profit is not sufficient to declare the dividends.
- The liquidity position of the company is not sound
- The company requires permanent capital, either for the purpose of acquiring fixed assets, by issuing equity shares as it bears a fixed rate of dividend.
The amount redeemed out of proceeds of fresh issue are:
IF FRESH ISSUE IS MADE AT PAR: Only the nominal value of shares issued will constitute the profits.
IF FRESH ISSUE IS MADE AT PREMIUM: Only the net amount received on issue of shares (excluding the amount of premium).
JOURNAL ENTERIES IN THE BOOKS OF ACCOUNTS
FOR THE AMOUNT PAYABLE ON REDEMPTION
1. If Redeemable at Par
| Redeemable Preference Shares A/c Dr. To Redeemable Preference shareholders A/c |
2. If redeemable at premium
| Redeemable Preference Shares A/c Dr. Premium on redemption of Preference shares A/c Dr. To Preference shareholders A/c |
WHEN SHARES ARE REDEEMED OUT OF PROCEEDS OF FRESH ISSUE OF EQUITY / PREFERENCE SHARES AT PAR
1.Shares redeemed out of fresh issue proceeds
| Bank A/c Dr. To Equity Share Capital A/c To Preference Share Capital A/c |
2.When shares issued at premium
| Bank A/c Dr. To Share Capital A/c To Securities Premium A/c |
FOR ADJUSTING PREMIUM ON REDEMPTION OF SHARES (if any)
1.Adjustment of Premium
| Securities Premium A/c Dr. Profit and Loss A/c Dr. To Premium on redemption of preference shares A/c |
2.For payment to shareholders
| Preference Shareholders A/c Dr. To Bank A/c |
CAPITALISATION OF UNDISTRIBUTED PROFITS/ RESERVES
The Preference shares can be redeemed out of profits available for dividends by creating Capital Redemption Reserve.
In other words, it is another aspect of redemption other than issue of fresh shares which is also permitted by Companies Act. It is provided that when preference shares are redeemed out of profits, a sum equal to face/ nominal value of redeemable preference shares must be transferred to CRR.
The most significant aspect for creating CRR out of profit is to maintain the capital intact i.e. in order to safeguard the interests of shareholders, this principle has been suggested. It is known that as soon as redemption takes place the company experience a liquidity crisis to maintain its budgeted level of operation can be overcome by raising funds from issuing preference shares.
JOURNAL ENTERIES IN THE BOOKS OF ACCOUNTS
FOR AMOUNT PAYABLE ON REDEMPTION
1.If redeemable at par
| Redeemable Preference Shares A/c Dr. To Redeemable Preference Shareholders A/c |
2. If redeemable at premium
| Redeemable Preference Shares A/c Dr. Premium on redemption of Preference shares A/c Dr. To Preference shareholders A/c |
FOR TRANSFERRING TO CAPITAL REDEMPTION RESERVE
| General Reserve/ Reserve Fund A/c Dr. Profit and Loss A/c Dr. Dividend Equalization A/c Dr. Workmen’s Compensation Fund A/c Dr. To CRR A/c |
IF CRR IS APPLIED FOR ISSUING FULLY PAID BONUS SHARES
| CRR A/c Dr. To Bonus to shareholders A/c |
FOR TRANSFERRING BONUS TO SHAREHOLDERS
| Bonus to Shareholders A/c Dr. To Equity Share Capital A/c |
FOR ADJUSTING PREMIUM ON REDEMPTION
| Securities Premium A/c Dr. Profit and Loss A/c Dr. To premium on Redemption of preference shares A/c |
FOR PAYMENT OF AMOUNT TO PREFERENCE SHAREHOLDERS
| Preference Shareholders A/c Dr. To Bank A/c |
APPLICATION OF BOTH
Under the circumstances a company can redeem its preference shares:
- Fresh issue of shares
- Out of profits creating by CRR
Sale of Investment/ Fixed Assets: As per Section 80 A, the proceeds of selling investments or selling fixed assets must not affect the amount which is required for creating CRR.
These can be used as a liquid source of funds for redeeming preference shares. But any profit or loss on sale should be transferred to profit and Loss Account as they are capital profits.
Because if any fixed asset is sold, profit on sale of such asset must be transferred to capital Reserve as a Capital profit.
Proceeds of Issuing Debentures or Long Term Loans: The treatment will be same as “Sale of Investments/ Fixed Assets.”
Untraceable Preference Shares: Sometimes it may so happen that some preference shares are found untraceable. As such, they are not paid. The amount of those shares will remain in preference shareholders account which will appear in the liabilities side of Balance Sheet as a current liability with the nominal value plus premium, if any. There will be no separate entry for the purpose. Only the amount will be deducted from this amount paid to preference shareholders.
ASCERTAINMENT OF MINIMUM FRESH ISSUE OF EQUITY SHARES
METHOD 1:
- At first, calculate the amount paid to the preference shareholders (without premium) i.e. principal amount.
- Deduct the amount taken from General Reserve/ Profit and Loss Account for CRR.
- Balance left should be required funds to be met from the fresh issue at par.
METHOD 2:
If the minimum balance is to be maintained by the fresh issue of equity shares, in that case what will be the deficit/ shortfall in the debit side as the amount of fresh issue of shares. Now, if the fresh issue of equity shares is made at a premium, in that case the required deficit should be divided by the face value plus premium per share in order to get number of shares.
Thereafter, the required amount to be apportioned between the amount of securities premium in the ratio of face value of shares and premium per share.