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Redemption of Pref Shares

Redemption of Pref Shares

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Published by Umesh Kumar

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Published by: Umesh Kumar on Oct 26, 2010
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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.

‡ Out of the fresh issue of shares made for the purpose of the redemption. .Sources of Redemption ‡ Out of profits of the company which would otherwise be available for dividend. ‡ 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.

. 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. ‡ Where the redemption is other then out of the proceeds of fresh issue.Conditions ‡ No such shares shall be redeemed unless they are fully paid.

The capitalization of undistributed profits. The proceeds of a fresh issue of shares.Methods of Redemption ‡ The gap created in the company¶s capital by the redemption of redeemable preference shares must be filled-in by: a. Combination of µa¶ and µb¶ . b. or c.

(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. .

‡ Section 78(2) clause µd¶ 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.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. . ‡ 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 µproceeds¶ for the purpose of redemption of preference shares. .

when the shares are issued at a discount. ‡ Thus. that is the face value less the discount. .Fresh Issue at Discount ‡ Proceeds in this case would only mean the net amount received. 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.

. 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.Grounds for Issue of New Equity Shares ‡ When company realizes that permanent capital is needed. ‡ 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. .

A/c Dr Premium on Redemption A/c Dr To Preference Shareholder A/c .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.

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 .

. ‡ Thus Act says that any premium collected from the new issue cannot be utilised for the purpose of paying premium on redemption. 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. if any.Premium on Redemption of Preference shares ‡ Companies Act states that the premium.

every company makes provision for premium on redemption well in advance . ‡ In practice. So we cannot treat premium of new issues as premium before 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.

. an amount equal to the face value of shares redeemed is transferred to Capital Redemption Reserve Account by taking part of the distributable profit.(b) The capitalization of undistributed profits ‡ According to the provision of section 80 (1) (d) When shares are redeemed by utilizing 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 .

The willingness of the company to redeem its preference share would suggest the company¶s period of recovery was over. .CRR ‡ Why create CRR?  To maintain capital intact. But the shortage of capital may reappear. Company was geared with a scale of capital just before redemption.

‡ This has been achieved by giving only two statutory methods for redemption. ‡ Section 80 of the companies Act ensures. the maintenance of that capital which helped the company to overcome the financial crisis by issuing preference shares.CRR ‡ So the government would not like to take any chance. either out of proceeds of fresh issue of shares or creating the required CRR out of profits. first. .

CRR ‡ The utilization of CRR is restricted to issue of fully PAID-UP BONUS SHARES ONLY TO COMPLETE THE PICTURE OF CAPITALIZATION. since the directors of the company may distribute divisible profits by way of dividend. . ‡ The another reason for the creation of CRR is for the protection of the company¶s creditors.

Example Balance Sheet of ABC Ltd as on 31 December. 2006 Liabilities 25000 equity shares 5000 Redeemable preference shares Profit & Loss Account Creditors Rs 250000 50000 Assets Fixed Assets Stock in trade Rs 210000 100000 150000 160000 610000 Debtors Cash 100000 200000 610000 TOTAL TOTAL .

the effects of the transfer to a capital redemption reserve can be as follows: . Now.Example ‡ As per the terms and condition of the issue. 2007. preference shares were redeemed on 1 January.

Amount available to creditors 31 December 2006 1 Jan 2007 Without transfer to CRR 1 Jan 2007 After transfer to CRR Total Assets 610000 Less: Retained 150000 profits available Net amount for 460000 creditors (security) 560000 (cash reduced) 150000 410000 560000 100000(trf to CRR) 460000 .

(c) A combination of both methods ‡ Amount to be transferred to CRR Face value of shares redeemed Less: Proceeds from new shares ------------------------------‡ µProceeds¶ to be collected from new issue Face value of shares redeemed ---------Less: Profits available for distribution ------------------- .

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