Redemption of

Preference Shares
 Section 80
• In India the issue and redemption of
preference shares is governed by Section
80 of the Companies Act.
• Company limited by shares can issue
preference shares if authorised by its
articles.
• Company if does so, is liable to redeem
the preference shares.
 Sources of Redemption
• Out of profits of the company which would
otherwise be available for dividend.

• Out of the fresh issue of shares made for the

purpose of the redemption.

• The premium on redemption shall be provided

out of the profits or out of the company’s
Securities Premium Account before the shares
are redeemed.
 Conditions
• No such shares shall be redeemed unless they
are fully paid.

• Where the redemption is other then out of the

proceeds of fresh issue, amount equal to the
nominal amount of shares redeemed will be
transferred from the profit (which otherwise is
available for dividend) to Capital redemption
reserve account.
 Methods of Redemption
• The gap created in the company’s capital
by the redemption of redeemable
preference shares must be filled-in by:
a. The proceeds of a fresh issue of shares;
b. The capitalization of undistributed profits;
or
c. Combination of ‘a’ and ‘b’
 (a) Fresh Issue of shares
• One of the prescribed method
• Proceeds of new equity or preference
shares can be used for redemption
• The proceeds from issue of debentures
cannot be used for this purpose.
 Fresh Issue of shares at premium
• The word proceeds suggest that the proceeds of the issue
would also include the money received on account of
securities premium too.

• Section 78(2) clause ‘d’ of Securities premium provides

that: securities premium account can be used in providing
for the premium payable on the redemption of any
redeemable preference shares or of any debentures of the
company.

• Thus the above clause allows the premium on redemption

to be adjusted against securities premium account but the
entire redemption itself cannot be financed out of
premium.
 Conclusion

• Thus it can be concluded that securities

premium money out of fresh issue cannot
be treated as ‘proceeds’ for the purpose of
redemption of preference shares.
 Fresh Issue at Discount
• Proceeds in this case would only mean the net
amount received, that is the face value less the
discount.
• Thus, when the shares are issued at a discount,
then the number if shares to be issued at a
discount should be manipulated to ensure that at
least the face value of shares to be redeemed
has been procured out of the proceeds of fresh
issue at discount.
 Grounds for Issue of New
Equity Shares
• When company realizes that permanent
capital is needed; then it makes more
sense to issue Equity shares in place of
Redeemable Preference shares which
carry a fixed rate of dividend.
• When the balance of profit for payment of
dividend is insufficient.
• When the liquidity position of the company
is not good enough.
Advantages of fresh issue of equity
for redemption
• No cash outflow – Now or later

• New equity shares may be valued at

premium

• No capital gains tax for shareholders.

• Shareholders retain their equity interest.

 Disadvantages of fresh issue of
equity for redemption

• Possibility of dilution of future earnings

• Share holdings in the company are

changed.
 Accounting Entries
• When shares are redeemed at par:
Redeemable Pref share cap A/c Dr
To Preference Shareholder A/c
• When shares are redeemed at a premium
Redeemable Pref Sh.Cap. A/c Dr
Premium on Redemption A/c Dr
To Preference Shareholder A/c
 Accounting Entries
• When payment is made to preference
shareholders
Preference Shareholders A/c Dr
To Bank Account

• For adjustment of premium on redemption

Profit & Loss A/c Dr
Securities Premium A/c Dr
To Prem. on redemption A/c
 Premium on Redemption of
Preference shares
• Companies Act states that the premium, if any,
payable on redemption shall be provided out of
profits of the company or out of the company’s
securities premium account, before the shares
are redeemed.

• Thus Act says that any premium collected from

the new issue cannot be utilised for the purpose
of paying premium on redemption.
 Premium on Redemption of
Preference shares
• It should be considered here that resolution for
fresh issue of shares and for redemption of
preference shares are passed simultaneously.
So we cannot treat premium of new issues as
premium before redemption.

• In practice, every company makes provision for

premium on redemption well in advance
 (b) The capitalization of
undistributed profits

• According to the provision of section 80 (1)

(d) When shares are redeemed by utilizing
distributable profit, an amount equal to the
face value of shares redeemed is
transferred to Capital Redemption
Reserve Account by taking part of the
distributable profit.
 Advantages of Capitalization of
Undistributed profits

• No change in the percentage share

holdings of the company

• Future earnings are not diluted

Disadvantages of Capitalization of
Undistributed profits

There may be a reduction in

liquidity
 Accounting Entries
All the entries above in the first method and
– For transferring nominal amount of
shares redeemed to CRR account

General Reserve Account Dr

Profit and Loss Account Dr
To Capital Redemption Reserve Account
 Issue of Bonus Shares
• Sometimes, bonus shares are issued by utilizing
capital redemption reserve account and other
reserves.

• Capital Redemption Reserve A/c Dr

Other Reserve A/c Dr
To Bonus to shareholders A/c

• Bonus to shareholders A/c Dr

To Equity Share Capital A/c
 CRR
• Why create CRR?
 To maintain capital intact.
Company was geared with a scale of capital just
before redemption.

The willingness of the company to redeem its

preference share would suggest the company’s
period of recovery was over. But the shortage of
capital may reappear.
 CRR
• So the government would not like to take any
chance.
• Section 80 of the companies Act ensures, first,
the maintenance of that capital which helped
the company to overcome the financial crisis by
issuing preference shares.
• This has been achieved by giving only two
statutory methods for redemption, either out of
proceeds of fresh issue of shares or creating the
required CRR out of profits.
 CRR
• The utilization of CRR is restricted to issue of
fully PAID-UP BONUS SHARES ONLY TO
COMPLETE THE PICTURE OF
CAPITALIZATION.

• The another reason for the creation of CRR is

for the protection of the company’s creditors,
since the directors of the company may
distribute divisible profits by way of dividend.
 Example
Balance Sheet of ABC Ltd as on
31 December, 2006

Liabilities Rs Assets Rs
25000 equity 250000 Fixed Assets 210000
shares
5000 50000 Stock in trade 100000
Redeemable
preference
shares
Profit & Loss 150000 Debtors 100000
Account
Creditors 160000 Cash 200000

TOTAL 610000 TOTAL 610000

 Example

• As per the terms and condition of the

issue, preference shares were redeemed
on 1 January, 2007. Now, the effects of
the transfer to a capital redemption
reserve can be as follows:
 Amount available to creditors
31 1 Jan 2007 1 Jan 2007
December Without After
2006 transfer to transfer to
CRR CRR
Total Assets 610000 560000 560000
(cash
reduced)
Less: Retained 150000 150000 100000(trf
profits available to CRR)
Net amount for 460000 410000 460000
creditors
(security)
 (c) A combination of both methods
• Amount to be transferred to CRR
Face value of shares redeemed -----------
Less: Proceeds from new shares -----------
-----------
• ‘Proceeds’ to be collected from new issue
Face value of shares redeemed ----------
Less: Profits available for distribution ----------
----------