Company Accounts - Accounting for Buy-back of Equity Shares

 

ACCOUNTING FOR

Buy-back of equity shares

 

1.    Section 68(1) of the Companies Act, 2013 provides that a company can buy-back its own equity shares out of:

(i)    Free reserves,

(ii)    Securities premium account, and

(iii)   Proceeds from issue of preference shares, debentures and other specified securities.

 [Note: Equity shares cannot be issued for the purpose of buy-back of equity shares.]

 

2.      Free reserves include:

(a)   Securities Premium Account (For the purposes of buy-back of equity shares u/s 68 of the Companies Act, 2013 "free reserves" includes securities premium account),

(b)   Profit and loss account (credit balance),

(c)   General reserve / Revenue reserve,

(d)   Dividend equalisation reserve,

(e)   Investment allowance reserve, and

(f)    Sinking fund.

Important Note:

CRR, Revaluation Reserves and Capital Reserves (if received otherwise than in cash) are not free reserves or distributable profits.

 

3.      Deductions to be made from free reserves:

Following deductions should be made from free reserves to arrive at the net amount available for the purpose of buy-back of equity shares:

(a)   Unamortised miscellaneous expenditure;

(b)   Unamortised deferred revenue expenditure;

(c)   Goodwill;

(d)   Contingent liabilities likely to mature not provided for;

(e)   Any diminution in the value of long term investments

not provided for;

(f)    Any impairment in the value of tangible assets

not provided for;

(g)   Loss on sale of investments; and

(h)   Additional tax liability.

 

4.      Maximum amount that can be utilised for buy-back

(Resources test):

The buying back should not exceed 25% of the total paid-up share capital, securities premium account and other free reserves of the company.

 

5.      Maximum number of equity shares that can be bought back

(Number of shares outstanding test):

In respect of the buy-back of equity shares in any financial year, the buy-back should not exceed 25% of the total paid-up equity capital of the company in that financial year. In other words, the number of equity shares that can be bought back in any financial year should not exceed 25% of the total number of outstanding paid-up equity shares in that financial year.

 

6.      Post buy-back debt-equity ratio

(Debt-Equity Ratio test):

The post buy-back debt-equity ratio should not exceed 2:1.

[Debt-equity ratio = Debt: Equity

Where,  Debt   = Secured Debts + Unsecured debts (Both long term as well as short term debts)

            Equity  = Paid-up capital + Free reserves]

 

7.      All the shares intended to be bought back should be fully paid up.

 

8.      Creation of Capital Redemption Reserve (CRR) u/s 69 of the Companies Act, 2013:

Where shares have been bought back from free reserves, an amount equal to the face value (nominal value) of the shares bought back is transferred to a reserve called “Capital Redemption Reserve (CRR)” out of the free reserves and securities premium account of the company. Capital Redemption Reserve can be utilised, among others, for issue of fully paid bonus shares.

 

9.      Number of shares to be accepted from a shareholder:

In case the number of shares offered by the shareholders is more than the total number of shares to be bought back by the company, the acceptances per shareholder shall be calculated as follows:

Number of shares to be accepted from a shareholder =

Number of shares offered by the individual shareholder x (Total number of shares to be bought back by the company ÷ Total number of shares offered by all the shareholders)

10.   Journal entries:

	Particulars		Remarks
(i)	For the amount payable on buy back: Equity share capital A/c Securities premium A/c Profit and loss A/c General reserves A/c Other free reserves A/c       To Equity shareholders A/c	Dr Dr Dr Dr Dr	Nominal value Buy back premium Buy back premium Buy back premium Buy back premium
(ii)	For the actual payment of buy back amount: Equity shareholders A/c       To Bank A/c	Dr
(iii)	For transfer to Capital Redemption Res. A/c: Securities premium A/c Profit and loss A/c General reserves A/c Other free reserves A/c       To Capital Redemption Res. (CRR) A/c	Dr Dr Dr Dr	Nominal value

 

11.   Provisions of section 52 of the Companies Act, 2013:

(i)    Provisions of the Companies Act, 2013 relating to the reduction of the share capital of a company shall apply as if the Securities Premium Account were paid up share capital of the company.

(ii)    Securities premium account may be applied by the company –

(a)   Towards the issue of unissued shares of the company to the 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 off, or the commission paid or discount allowed on, any issue of shares or debentures of the company;

(d)   In providing for the premium payable on the redemption of any redeemable preference shares or of any debentures of the company;

(e)   For the purchase of its own shares or other securities under section 68.

 

Illustration: 1

Advent Limited has a paid up equity share capital of Rs 20,00,000 in 2,00,000 shares of Rs 10 each. It resolved to buy-back 50,000 equity shares at Rs 15 per share. For this purpose, it issued 20,000 12% preference shares of Rs 10 each, at par, payable along with application. The company has to its credit Rs 2, 50,000 in securities premium account and Rs 10, 00,000 in the general reserve account. The company utilized the general reserve. Pass the necessary journal entries

Solution: 1

In the Books of Advent Limited

Journal Entries

Date	Particulars		LF	Dr (Rs)	Cr (Rs)
	Bank A/c       To Pref. share app. and allot. A/c (Amount received on application and allotment of 20,000 12% preference shares of Rs 10 each)	Dr		2,00,000	2,00,000
	Pref. share app. and allot. A/c       To 12% Preference share capital A/c (Amount transferred to 12% preference share capital account)	Dr		2,00,000	2,00,000
	Equity share capital A/c Securities premium A/c       To Equity shareholders A/c (Amount due to equity shareholders consequent upon buy-back of 50,000 shares at Rs 15 each)	Dr Dr		5,00,000 2,50,000	7,50,000
	Equity shareholders A/c       To Bank A/c (Amount paid to equity shareholders on buy-back of 50,000 shares at Rs 15 each)	Dr		7,50,000	7,50,000
	General reserve A/c       To Capital redemption reserve A/c (Amount equivalent to nominal value of equity shares bought back out of free reserves transferred to capital redemption reserve account)	Dr		3,00,000	3,00,000

 

Illustration: 2

Parijat Limited has the following capital structure as at 31.03.2020:

                                                                                                                   (Rs in Crores)

	Particulars	Rs	Rs
1	Equity share capital (@ Rs 10 per share fully paid)		330
2	Reserves and surplus:
	General reserves account	240
	Securities premium account	90
	Profit and loss account	90
	Infrastructure development reserves account	180	600
3	Loan funds		1,800
	Total		2,730

The shareholders of Parijat Limited, on the recommendation of their Board of Directors, have approved on 12.09.2020 a proposal to buy-back the maximum permissible number of equity shares considering the large amount of surplus funds available at the disposal of the company.

The prevailing market price of the company’s shares is Rs 25 per share and in order to induce the existing shareholders to offer their shares for buy-back, it was decided to offer a buy-back price of 20% above the market price.

You are also informed that the infrastructure development reserve is created to satisfy Income Tax Act requirements.

You are required to compute the maximum number of equity shares that can be bought back in the light of the above information, and also under a situation where the loan funds of the company were either Rs 1,200 Crores or Rs 1,500 Crores.

Assuming that the entire buy-back is completed by 09.12.2020, show the accounting entries in the company’s books in each situation.

Solution: 2

Maximum number of shares that can be bought back

(in crores)

		Situation: 1	Situation: 2	Situation: 3
a.	Loan funds (Rs in crores)	1,800	1,200	1,500
b.	Resources test (WN: 1)	6.25	6.25	6.25
c.	Number of shares outstanding test (WN: 2)	8.25	8.25	8.25
d.	Debt-Equity Ratio test (WN: 3)	-	3.75	-
e.	Maximum number of shares that can be bought back [least of (b), (c) and (d)]	-	3.75	-

 

In the Books of Parijat Limited

Journal Entries for the buy-back of equity shares

(Applicable only when loan fund is Rs 1,200 crores)

                                                                                                                    (Rs in crores)

Date	Particulars		LF	Dr (Rs)	Cr (Rs)
	Equity share capital A/c Securities premium A/c       To Equity shareholders A/c (Amount due to equity shareholders consequent upon buy-back of 3.75 crores shares at Rs 30 each)	Dr Dr		37.50 75.00	112.50
	Equity shareholders A/c       To Bank A/c (Amount paid to equity shareholders on buy-back of 3.75 crores shares at Rs 30 each)	Dr		112.50	112.50
	General reserve A/c       To Capital redemption reserve A/c (Amount equivalent to nominal value of equity shares bought back out of free reserves transferred to capital redemption reserve account)	Dr		37.50	37.50

 

 Working notes:

1.    Resources test

	Particulars
a.	Paid up capital	Rs 330 crores
b.	Free reserves [General reserves 240 crores + Securities premium 90 crores + Profit and loss account 90 crores]	Rs 420 crores
c.	Shareholders’ funds (a + b)	Rs 750 crores
d.	25% of shareholders’ funds (750 crores × 25%)	Rs 187.50 crores
e.	Buy-back price per share	Rs 30
f.	Number of shares that can be bought back (d ÷ e)	6.25 crores

 

2.    Number of shares outstanding test

	Particulars
a.	Number of equity shares outstanding	33 crores
b.	25% of the shares outstanding (33 crores × 25%)	8.25 crores

 

3.    Debt-Equity Ratio test

		Situation: 1	Situation: 2	Situation: 3
a.	Loan funds (Rs in crores)	1,800	1,200	1,500
b.	Present equity (Rs in crores)	750	750	750
c.	Minimum equity required to be maintained for a post buy-back debt-equity ratio of maximum 2: 1 (Rs in crores)	900	600	750
d.	Maximum dilution in equity possible (b – c) (Rs in crores)	-	150	-
e.	Maximum number of shares that can be bought back at the buy-back price of Rs 30 per share [d ÷ (Nominal value per share + Transfer to CRR per share + Buy-back premium per share)] (in crores)	-	[150 ÷ (10 + 10 + 20)] = 3.75	-