(5) Buy-back is permitted only in respect of fully paid up shares.

Ans: (1) F (2) F (3) F (4) T (5) T

Questions

(1) What do you mean by ‘buy-back of shares’? State the conditions to be satisfied for buy
back of shares.
(2) What are the specific cases where a share buy-back is prohibited under the Act? Are there
any exceptions to it?
(3) What do you understand by an Escrow account in the case of a Share buy-back?
(4) Explain any three benefits a company achieves by a share buy-back plan.
(5) Detail SEBI guidelines in the case of a share buy-back.
(6) Briefly explain the accounting for share buy-back under various situations.

REDEEMABLE PREFERENCE SHARES

Introduction
Preference shares that can be redeemed by the company in accordance with the terms of issue
are called Redeemable Preference shares. However the Articles of the company must have the
provision in this regard.

The terms of issue generally stipulate the time of redemption and whether the redemption will
be at par or premium.

Irredeemable preference shares, on the other hand, are those preference shares which can not
be redeemed except the event of the company being wound up.

Prior to the amendment of the Companies Act, 1988, companies were permitted to issue both
redeemable and irredeemable preference shares. For all practical purposes there is not much
difference between the equity shares and irredeemable preference shares. But in terms of re-
turn, the equity shareholders enjoy a better return than the holders of irredeemable preference
shares do. This was considered as an anomaly and the Companies (Amendment) Act, 1988,
prohibited the issue of irredeemable preference shares in future and also provided for the
redemption of such shares, which were issued prior to the Act of 1988.

Conditions for Issue and Redemption of Redeemable Preference Shares

The conditions are provided in Sec. 80 of the Act and are summarized below:
1. A company limited by shares can issue redeemable preference shares subject to the pro-
visions of Sec. 80 of the Act. Such an issue must also be authorized by the Articles of the
company.

Financial Accounting 523

 JOINT STOCK COMPANIES

2. With effect from 1st March 1997 a company cannot issue irredeemable preference shares
or shares which can be redeemed beyond a period of 20 years (Amendment Act, 1996).
[See 80-5 (A)]
3. A company is permitted to carry out redemption from only two sources. They are:
(a) Profits of the company which would otherwise be available for dividend.
(b) Proceeds of fresh issue of shares made for the purpose of redemption.
The section rules out any other source such as issue of debentures, borrowing from banks and
other financial institutions for carrying out redemption.
4. Where shares are redeemed from out of profits otherwise available for dividend, a sum
equal to the nominal value of the shares redeemed must be transferred ‘Capital Redemp-
tion Reserve Account’.
5. Only fully paid preference shares are to be redeemed. If partly paid shares are to be re-
deemed, call must be made first and then redemption must be carried out.
6. Redemption may be at par or at premium according to the terms of issue. If redemption is
at premium, such premium must be met out of profits or the balance in ‘security premium
account’.
7. Capital Redemption Reserve Account is available only for the purpose of issue of bonus
shares. This reserve must be kept intact unless otherwise sanctioned by the court.
8. Redemption of redeemable preference shares does not result in the reduction of autho-
rized capital of the company. To the extent reduction has taken place, company can issue
further shares, as if those shares had never been issued.
9. If new shares are issued for the purpose of redemption, it will not amount to increase in
capital.
10. Subject to the provisions of this section, redemption must be carried out in accordance
with the terms provided in the Articles of the company.

Redemption of Irredeemable Preference Shares

While sub-section 5A of Sec. 80 bars the issue of irredeemable preference shares after the com-
mencement of the Amendment Act of 1996, Sec. 80 (A) provides for the redemption of irre-
deemable preference shares and redeemable preference shares which are redeemable beyond
ten years. The important points governing such redemption are:

1. Irredeemable preference shares issued, prior to the Amendment Act of 1988 are to be
redeemed, within a period of 5 years from the date of the commencement of amendment.
This in effect means, that all irredeemable preference shares, issued prior to the amend-
ment, must have been redeemed by 14th June 1993.
2. Redeemable preference shares providing redemption beyond ten years and issued before
the Amendment Act are required to be redeemed on the date on which they are due or
within a period not exceeding ten years whichever is earlier.

524 Financial Accounting

Illustration 1.

A Ltd. made the following issue of redeemable preference shares prior to the Amendment Act
of 1988. Determine the dates on which they are redeemable having regard to the provisions of
Sec. 80 (A) of the Amendment Act of 1988.

1. Issue of 10,000 redeemable preference shares on 1st April 1985 redeemable after 15 years.
2. Issue of 5,000 redeemable preference shares on 1st April 1986 redeemable after 11 years.

Solution.

1. Normal date of redemption as per terms of issue:

15 years from 1st Apri11985, that is 1st April 2000.
Ten years from the commencement of the Amendment Act.
Ten years from 14th June 1988. That is 14th June 1998.
As per Sec 80(A) redemption must take place on 14th June 1998.
2. Normal date of Redemption. 11 years from 1st April 1986 that is 1st April 1997.
10 years from the commencement of the Amendment Act, namely 14th June 1988 that is
14th June 1998.

As 1st April 1997 is earlier than 14th June 1998 is, the shares are to be redeemed on 1st
April 1997.

Where a company is not in a position to redeem the shares in the period mentioned in (2) and
to pay the dividend thereon, it may with the consent of the Company Law Board, on a petition
made by it, issue further redeemable preference shares (make a further issue) equal to the
amount due including the dividend thereon in respect of the unredeemed preference shares.
By the issue of such further shares the unredeemed preference shares are deemed to have been
redeemed.

Sec. 80 (A) was intended to cover the period of transition and will have no significance after
the companies fulfill the requirements stated therein.

CAPITAL REDEMPTION RESERVE

A> Transfer to capital redemption reserve account is allowed from these profits.
(i.e Profits otherwise available for dividend )
I. General reserve
2. Reserve fund
3. Dividend equalisation fund

Financial Accounting 525

 JOINT STOCK COMPANIES

4. Insurance fund
5. Workmen’s compensation fund
6. Workmen’s accident fund
7. Voluntary debenture redemption account
8. Voluntary debenture sinking fund
9. Profit and loss account.

B> Transfer to capital redemption reserve account is not allowed from these profits.
(i.e Profits otherwise not available for dividend )

1. Security premium account

2. Forfeited shares account
3. Profit prior to incorporation
4. Capital reserve
5. Development rebate reserve

Proceeds of fresh issue.

The word ‘proceeds’ used in the present context implies the amount received excluding the
amount of share premium, if shares are issued at premium; but the net amount received if shares
are issued either at par or at discount.

Though there remains the controversy over the meaning of the term but a closer examination
of the provisions and intentions of the company law reveals that, the word ‘proceeds of shares’
does not include the amount of premium if shares are issued at premium but stands for the
actual amount received if shares are issued at par or at discount. This may be clearer from the
following example:

A company is to redeem its preference shares of (say) Rs. 10,00,000. If the company decides to
redeem these shares by making an equivalent issue of fresh shares at (sayj10% discount, the
company, on the one hand, gets Rs. 9,00,000 in cash from the fresh issue and on the other hand
pays Rs. 10,00,000 for redeeming shares. Though the liability side of the balance sheet appar-
ently discloses that shares have been properly replaced because new shares of Rs. 10,00,000
will appear at face value, it does not amount to a replacement of assets utilized in the redemp-
tion of redeemable preference shares.

This is particularly significant, considering an extreme case, when by chance the company
goes into liquidation immediately after the redemption of preference shares, and when the
financial position of the company is as bad as not to be able to pay back its creditors in full. In
such a case it does mean the repayment of capital in priority over the creditors to the extent of
Rs. 1,00,000 which is the amount of discount. If ‘proceeds’ were interpreted as the amount

526 Financial Accounting

actually received, preference shares would have been redeemed only to the extent of Rs. 9,00,000
which is properly replaced by a fresh issue.

However, if shares are issued at premium the total amount received including the amount of
premium cannot be taken to purport ‘proceeds’ in the sense in which the Act has used this
word. The amount of premium is to be deducted from the total proceeds for arriving at the
‘proceeds of a fresh issue’ for the purpose of this section. This is based on the following pre-
mises:

(i) The proceeds of premium, although represented by tangible assets, do not provide any
protection to the third party as proceeds of premium may not be kept intact like proceeds
of the share capital until the repayment of all creditors because the premium has been
allowed to be used (not share capital) for the following four purposes under Sec. 78 (2) of
the Companies Act, 1956:

a) in paying up unissued shares of the company to be issued to members of the company

as fully paid bonus shares;
b) in writing off the preliminary expenses of the company;
c) in writing off the expenses of, or the commission paid or discount allowed on, any
issue of shares or debentures of the company, or
d) in providing for the premium payable on the redemption of any redeemable prefer-
ence shares or of any debentures of the company.

The utilization of the premium for the above purposes distinguishes it from the proceeds of
share capital which is made available only to creditors in the event of liquidation.
(ii) If proceeds of premium be allowed to be included in the total proceeds for the redemption
purpose, the capital redeemed will be replaced partly by share capital and partly by secu-
rity premium. If this interpretation of the proceeds is taken to be correct, the security
available to the creditors may be reduced after some time by the amount of premium as
the utilization of premium is open for specified purposes under the provisions of the Act
itself.
(iii) Sec. 78(1) further states that security premium if used for any other purpose except for
that stated in Sec. 78(2), will amount to reduction of share capital. This logically means
that security premium account is not treated as paid up capital of the company only when
it is used for the four purposes. The protection provided by the security premium thus, is only
incidental and uncertain.
(iv) Besides, the above negative approach, the Act clearly states that it premium account is
used for any purpose other than the four purposes stated in Sec. 78(2), it amounts to re-
duction of capital. Under such circumstances, if security premium is used for the redemp-
tion purpose which is outside the scope of the four purposes, it must amount to a reduc-
tion of capital.

Financial Accounting 527

 JOINT STOCK COMPANIES

Accounting Entries Necessary for Redemptions and issue of Bonus shares

Transaction Journal Entry

1.Due for redemption Red. Pref. Share Capital Alc Dr.

a> at a premium Premium on Redemption Alc Dr.
To Red. Pref. Shareholders Alc

b> at Par Red. Pref. Share Capital Alc Dr.

To Red. Pref. Shareholders Alc

2.Sale of Investment, if Bank Alc Dr.

any, for fund. P/L on To Investments Alc
Sale transferred to To Profit and Loss Alc
P/L A/c (Sale of investments & Profit transferred)

3.Fresh Issue for Fund, Bank Alc Dr.

If any, a> at par To Equity Share Capital A/c

b> at a premium Bank Alc Dr.

To Equity Share Capital A/c
To Securities Premium A/C

c> at a discount Bank Alc Dr.

Discount on issue of shares Dr.
To Equity Share Capital A/c

4.Transfer of Premium
on Securities Premium A/C , or Dr.
Redemption. Profit and Loss A/C Dr.
To Premium on Redemption Alc

5.Payment to
Shareholders Red. Pref. Shareholders Alc Dr.
To Bank Alc

6.Nominal value of
shares General Reserve Alc Dr.
Redeemed, not by Profit and Loss A/C Dr.
fresh issue of shares. To Capital Redemption Reserve Alc

528 Financial Accounting

 7.Issue of bonus shares Capital Redemption Reserve Alc Dr.
a> At a premium Securities Premium Alc Dr.
To Bonus to Shareholders Alc
b> At Par Capital Redemption Reserve Alc Dr.
To Bonus to Shareholders Alc

8.Conversion of bonus Bonus to Shareholders Alc Dr.

shares into equity shares To Equity Share Capital Alc

9. Conversion of Red.
Pref. Share into Red. Pref. Share Capital Alc Dr.
other shares To pref. / Equity share capital A/C

Illustration. Find out in each case what amount shall be transferred to capital redemption
reserve account:

Redeemable preference shares redeemed Fresh issue of share capital

a. Rs. 10,00,000 at par Rs. 10,00,000 at par

b. Rs, 10,00,000 at 5% premium Rs. 800,000 at par
c. Rs. 10,00,000 at par Rs. 800,000 at 10% premium
d. Rs. 10,00,000 at par Rs. 800,000 at 10% discount
e. Rs. 10,00,000 at 5% premium Rs. 800,000 at 10% premium

Solution.

For (a) Nil.

For (b), (c) and (e) Rs 2,00,000
For (d) Rs 2,80,000

Explantion:

Amount utilized from the existing sources towards the nominal value of the preference shares
redeemed, should be transferred to Capital Redemption Reserve Account. So, in the above
case, the difference of nominal value of shares redeemed and amount received from nominal
value of fresh issue is the transferable amount.
In case of (a) the total requirement is met up by fresh issue.
In cases of (b), (c) and (e): Rs 10,00,000 – 8,00,000 (from nominal value of fresh issue) i.e. Rs
2,00,000
In case of (d) Rs 10,00,000 – 7,20,000 (from nominal value of fresh issue) i.e. Rs 2,80,000.

Financial Accounting 529

 JOINT STOCK COMPANIES

Illustration. The balance sheet of Pixel Ltd. as on 31st March 2007 is given below:

Liabilities Rs./Lakh Assets Rs/Lakh

Share Capital:
10,00,000 Equity shares of
100 Fixed Assets 140
Rs. 10 each
1,00,000 Redeemable Pref. Investments 40
shares of Rs. 100 each 100 Stock 46
Less: Call-in-arrears on (4) Debtors 30
20,000 shares Bank 30
Security premium account 15
Reserve 30
Profit and Loss account 15
Creditors 30
286 286

On 1st April 2007, fixed assets costing Rs. 40 Lakh were sold for Rs.32 Lakh. On the same date
it was decided to reduce the preference shares at a premium of 20% by issuing sufficient num-
ber of equity shares at a discount of 10% subject to leaving a balance of Rs. 10 Lakh in the
reserve. All the payments were made except to a holder of 10000 shares who could not be
traced. The company also made bonus issue to the existing equity shareholders in the ratio of
1: 10. You are required to pass the necessary journal entries and show the resulting balance
sheet on 1st April 2007.

Solution

Workings

Requirement of Fund for Redemption

No. Rate Rs/Lakh

Pref Shares 1,00,000 100 100
Calls in Arrear 20,000 100 20
Bal. to be redeemed 80,000 80
Prem on redemption 20% 16
Total Fund requirement 96

Rs/Lakh

530 Financial Accounting

 Sources Nominal Premium Total
Value

Requirement 80 16 96
Securities Prem. A/C 15 15
P/L A/C 6 1 7
General Reserve 20 20
Balance fund requirement 54 54
(From fresh issue)
Discount (10%) 6
New Issue 60

Actual payment made = (80000-10000)*120 = Rs 84 Lakh

Transfer to Capital Redemption Reserve
Rs/Lakh Rs/Lakh
From P/L A/c
Balance 15
Less. Loss on Sale of Assets 8
Balance 7
Less, Uses for Premium on Redemption of
zpref.Shares 1 6
From General Reserve 20
Total 26

In the books of Pixel Ltd.

Journal entries
Dr Cr
Journal Entry Rs/lakh Rs/Lakh
Red. Pref. Share Capital Alc Dr. 80
Premium on Redemption Alc Dr. 16
To Red. Pref. Shareholders Alc 96
(Amount due on Redemption)
Bank Alc Dr. 32
Profit and Loss Alc Dr. 8
To Fixed Assets Alc 40
(Sale of Fixed Assets, Loss transferred)
Bank Alc Dr. 54
Discount on issue of Shares A/c Dr. 6
To Equity Share Capital A/c 60
( Issue of new shares)
Securities Premium A/C , Dr. 15

Financial Accounting 531

 JOINT STOCK COMPANIES

Securities Premium A/C , Dr. 15

Profit and Loss A/C Dr. 1
To Premium on Redemption Alc 16
( Transfer)
Red. Pref. Shareholders Alc Dr. 84
To Bank Alc 84
(Payment to Pref. Shareholders)
General Reserve Alc Dr. 20
Profit and Loss A/C Dr. 6
To Capital Redemption Reserve Alc 26
(Transfer)
Capital Redemption Reserve Alc Dr. 16
To Bonus to Shareholders Alc 16
(Bonus declared)
Bonus to Shareholders Alc Dr. 16
To Equity Share Capital Alc 16

Balance Sheet as on 1 st April 2007

Liabilities Rs./Lakh Assets Rs/Lakh

Share Capital:
10,00,000 Equity shares
of Rs 10 each 176 Fixed Assets 100
20,000 Redeemable Pref. Investments 40
shares of Rs. 100 each 20 Stock 46
Less: Call-in-arrears (4) Debtors 30
Reserve 10 Bank 32
Cap. Redemption Reserve 10 Discount on
Creditors 30 issue of shares 6
Red. Pref. Shareholders A/C 12
254 254

EXERCISE

1. State whether the following statements are true or false:

a. Capital Redemption Reserve Account is created to meet legal requirements.
b. Partly paid up preference shares can be redeemed.
c. Capital redemption reserve account cannot be utilised for issuing fuUy paid bonus
shares.

532 Financial Accounting

 d. Premium payable on redemption of preference shares must be debited to security
premium account only.
e. Capital redemption reserve account can be utilised in writing off preliminary
expenses.
f. Redemption of preference shares cannot be made out of the fresh issue of deben-
tures.
g. An amount equal to redemption of preference shares out of the profits must be
transferred to General reserve. ‘

Ans. (a) True; (b) False; (c) False; (d) False; (e) False; (f) True; (g) False;

2 Discuss the provisions of law with regard to redemption of Redeemable Preference Shares.
3. What do you mean by capital redemption reserve? How is it created? How is it utilised for
issuing fully paid bonus shares?

PROBLEMS

1. A company wishes to redeem its preference shares amounting to Rs. 100,00,000 at a pre-
mium of 5% and for this purpose issues 500,000 equity shares of Rs. 10 each at a premium
of 5%. The company has also a balance of Rs. 100,00,000 in General Reserve and Rs. 50.00,000
in profit and Loss Account. Give the journal entries to record the above transactions.
2. A company:
(1) Issues at par 40,000,000 Redeemable Preference Shares of Rs. 10 each, redeemable at
premium of 10 per cent.
(2) Redeems 15,00,000 of the Redeemable Preference Shares out of the profits of the
Company.
(3) Issues for cash 30,00,000 Equity Shares of Rs. 10 each at a premium of Re. 1 per share
and out of the proceeds, redeems the balance of the Redeemable Preference shares.
Journalise these transactions.
3. X and Company issued 50,00,000 Equity Shares of Rs. 10 each and 3,00,000 Redeemable
Preference Shares of Rs. 100 each, all shares being fully called and paid up. On 31st March
2006 Profit and Loss Account showed an undistributed profit of Rs. 50,00,000 and General
Reserve Account stood at Rs. 120,00,000. On 2nd April, 1996 the directors decided to issue
1,50,000 10% Preference Shares of Rs. 100 each for cash and to redeem the existing Prefer-
ence Shares at Rs. 105 utilising as much profits as would be required for the purpose.

Show the journal entries to record these transactions. Prepare also a summarised Balance Sheet
showing the position of the Company on completion of the redemption. On 31st March, 2006
the cash balance amounted to Rs. 185,00,000 and Sundry Creditors stood at Rs. 87,00,000.

Financial Accounting 533

 JOINT STOCK COMPANIES

Ans. [Bank Balance Rs. 20,00,000 ; Amount transferred from Profit and Loss Account to Capital
Redemption Reserve Account Rs. 45,00,000].

4. Pk Limited has issued Share Capital 60,000,000, 8% redeemable cumulative Preference

Shares of Rs. 20 each and 400,000,000 Equity Shares o.f Rs. 10 each. The Preference
Shares are redeemable at a premium of 5% on 1st April, 2007.

As at 31st March, 2007 the company’s Balance Sheet was:

Liabilities and Capital Rs’000. Assets Rs’000

Issued Share Capital: Plant and Machinery 25,00,000

60,000 10% Redeemable Furniture & Fixtures 9,00,000

Cumulative Preference Stock 15,00,000

Shares of Rs. 20 each, Debtors 14,00,000

fully paid 12,00,000 Investments 3,50,000

4,00,000 Equity Shares of Balance at Bank 3,50,000

Rs.10 each fully paid. 40,00,000

Profit and Loss A/c 7,00,000

Sundry Creditors 11,00,000

70,00,000 70,00,000

For redemption of Preference Shares it was decided:

(a) To sell the investments for Rs. 300,000,000.

(b) To finance part of the redemption from company funds subject to leaving a balance on
Profit and Loss Account of Rs. 200,000,000.
(c) To issue sufficient equity shares of Rs. 10 each at a premium of Rs.2 per share to raise the
balance of funds required.
The Preference Shares were redeemed on due date and Equity Shares were fully subscribed.
Prepare
(i) Journal entries to. record the above transactions.
(ii) A memorandum Balance Sheet as on completion of redemption.

Ans. [B/S Total (Rs’000) 65,90,000

534 Financial Accounting