Company Accounts - Redemption of Preference Shares

 

COMPANY ACCOUNTS

Accounting for

Redemption of Preference Shares

 

Part A: Discussion of various rules and provisions of the Indian Companies Act, 2013 in regard to accounting for redemption of preference shares of a joint stock company along with the relevant journal entries.

Part B: 3 Illustrations and their solutions

Part A

Meaning of ‘redemption’ and ‘redemption of preference shares’

Redemption is the process of regaining possession of something in exchange for payment, or clearing a debt usually at a prearranged date. Redemption of preference shares implies the process of regaining the preference shares from the preference shareholders by repaying them the amounts of their investments. The preference shares are issued on the terms that holders will at some future date be repaid the amounts which they invested in the company. The redemption date is the date of maturity of the preference shares which specifies when the repayment will take place. The redemption date is printed on the preference share certificate along with the redemption amount which will be paid back to the preference shareholders on redemption of the preference shares held by them at the time of redemption. No company limited by shares shall, u/s 55(1) of the Companies Act, 2013, issue any preference shares which are irredeemable.

 

Methods of redemption

From accounting point of view there are three methods of redemption of preference shares (as per the provisions of section 55 of the Companies Act, 2013):

1. Redemption out of the proceeds of fresh issue of shares;

2. Redemption out of the distributable profits of the company; and

3. Redemption partly out of proceeds of fresh issue of shares and partly out of distributable profits of the company.

 

Redemption out of proceeds of fresh issue of shares

A company can issue new shares (both equity and preference) and the proceeds from such new shares can be used for redemption of preference shares. Proceeds do not include the amount of securities premium if the shares are issued at premium. But Proceeds means actual amount received if the shares are issued at par.

 

How premium payable on redemption shall be provided for:

1.   In case of such class of companies, as may be prescribed and whose financial statement comply with the accounting standards prescribed for such class of companies under section 133, the premium, if any, payable on redemption shall be provided for out of the profits of the company, before the shares are redeemed:

Provided that premium, if any, payable on redemption of any preference shares issued on or before the commencement of this Act by any such company shall be provided for out of the profits of the company or out of the company's securities premium account, before such shares are redeemed.

 

2. In all other cases, the premium, if any, payable on redemption shall be provided for out of the profits of the company or out of the company's securities premium account, before such shares are redeemed.

 

In any case, the premium payable on redemption cannot be provided out of any securities premium collected from new issue of shares for the purpose of the redemption. In other words, securities premium received from fresh issue of shares cannot be utilised for the purpose of paying premium on redemption.

 

Journal entries

Dt.	Particulars	LF	Dr. (Rs)	Cr. (Rs)
1	Bank A/c                                        Dr
	To Share capital A/c
	(New shares issued at par)
2	Bank A/c                                        Dr
	To Share capital A/c
	To Securities premium A/c
	(New shares issued at premium)
3	Redeemable Pref. Sh. Capital      Dr
	To Preference shareholders A/c
	(Preference shares redeemed at par)
4	Redeemable Pref. Sh. Capital      Dr
	Prem. on Redemption of Pref. Sh. Dr
	To Preference shareholders A/c
	(Preference shares redeemed at premium)
5	Preference shareholders A/c         Dr
	To Bank A/c
	(Payment made to preference shareholders)
6	Profit and loss A/c                       Dr
	Securities premium A/c               Dr
	To Prem. on Redemption of Pref. Sh.
	(Premium on redemption of preference shares adjusted against Profit and Loss Account and/or Securities Premium Account)

 

Redemption out of distributable profits of the company

When shares are redeemed by utilising distributable profits, an amount equal to the face value of the shares redeemed is transferred to a reserve called “Capital Redemption Reserve (CRR)” out of the distributable profits of the company. Examples of distributable profits or free reserves are: Profit and Loss Account, General Reserve, Reserve Fund, Investment Allowance Reserve, Dividend Equalisation Fund, Workmen’s Compensation Fund, Insurance Fund, etc.

 

Important Note:

Securities Premium Account, Development Rebate Reserve, Forfeited Shares Account, Profit Prior to Incorporation, Revaluation Reserves and Capital Reserves (if received otherwise than in cash) are not distributable profits or free reserves.

 

Journal entries

Dt.	Particulars	LF	Dr. (Rs)	Cr. (Rs)
1	Redeemable Pref. Sh. Cap.   Dr
	To Preference shareholders A/c
	(Preference shares redeemed at par)
2	Redeemable Pref. Sh. Cap.   Dr
	Prem. on Redemption of Pref. Sh. Dr
	To Preference shareholders A/c
	(Preference shares redeemed at premium)
3	Preference shareholders A/c   Dr
	To Bank A/c
	(Payment made to preference shareholders)
4	Profit and loss A/c                  Dr
	Securities premium A/c          Dr
	To Prem. on redemption of Pref. Sh.
	(Premium on redemption of preference shares adjusted against Profit and Loss Account and/or Securities Premium Account)
5	General reserve A/c            Dr
	Profit and loss A/c              Dr
	To Capital redemption reserve A/c
	(Nominal (face) value of shares redeemed transferred to Capital Redemption Reserve (CRR) Account)

Redemption partly out of proceeds of fresh issue of shares and

Partly out of distributable profits of the company

When redemption of preference shares is to be made partly out of proceeds of fresh issue of shares and partly out of distributable profits of the company, the important workings required to be made are as follows:

 

1. Amount to be transferred to capital redemption reserve

	Particulars	Rs
	Face value of shares to be redeemed	×××
Less	Proceeds from fresh issue of shares	×××
	Amount to be transferred to CRR	×××

 

2. “Proceeds” to be collected from fresh issue of shares

	Particulars	Rs
	Face value of shares to be redeemed	×××
Less	Distributable Profits available for redemption	×××
	Proceeds to be collected from fresh issue of shares	×××

 

Issue of bonus shares by utilising capital redemption reserve (CRR)

Sometimes, bonus shares are issued by utilising capital redemption reserve, balance in securities premium account and other reserves. Necessary journal entries for this purpose will be as follows:

 

Journal entries

Dt.	Particulars	LF	Dr. (Rs)	Cr. (Rs)
1	Capital redemption reserve A/c     Dr
	Securities premium A/c                 Dr
	Capital reserve (if recd. in cash)   Dr
	General reserves A/c                     Dr
	Profit and loss A/c                         Dr
	To Bonus to shareholders A/c
	(Amount apportioned for issue of bonus shares)
2	Bonus to shareholders A/c             Dr
	To Equity share capital A/c
	(Bonus dividend utilised for issue of equity shares)

 

Other relevant important points

1.   Partly paid up preference shares cannot be redeemed.

2.  Under section 52 of the Companies Act, 2013, Securities Premium Account   may be applied by the company for the following purposes:

     For paying up unissued shares of the company to be issued to the members of the company as fully paid bonus shares;

      For writing off the preliminary expenses of the company;

     For writing off the expenses of, or the commission paid or discount allowed on, any issue of    shares or debentures of the company; or

    For providing for the premium payable on the redemption of any redeemable preference            shares or any debentures of the company.

    3. No limited company can, u/s 55 of the Companies Act, 2013, issue any preference shares which are irredeemable or are redeemable after the expiry of a period of twenty years from the date of their issue. In other words, irredeemable preference shares cannot be issued at all, whereas maturity period of redeemable preference shares cannot exceed twenty years from the date of issue of the shares. A company may, however, issue preference shares for a period exceeding twenty years for infrastructure projects, subject to the redemption of such percentage of shares as may be prescribed on an annual  basis at the option of such preferential shareholders.

 Part B

Illustration: 1

The Balance Sheet of Primrose Ltd. as on 31.12.2014:

(Rs in Lakh)

Liabilities	Rs	Assets	Rs
Equity Shares of Rs 10 each	100	Fixed Assets	140
Redeemable Pref. Sh. of Rs 100 each	100	Investments	40
Less: Calls-in-arrear on 20,000 Pref. Sh.	(4)	Stock	46
Securities Prem. A/c	15	Debtors	30
General Reserves	30	Bank	30
Profit and Loss A/c	15
Creditors	30
	286		286

 

On 1.1.2015, fixed assets costing Rs 40 Lakh were sold for Rs 32 Lakh. On 1.2.2015, the company decided to redeem the preference shares at a premium of 20% and accordingly, issued sufficient number of equity shares at par so as to finance the redemption and to leave a balance of Rs 10 Lakh in General Reserves. All the payments were made except to a holder of 10,000 shares who could not be traced. The company also made bonus issue to the existing equity shareholders in the ratio of 1: 10 as on 31.12.2014.

 

You are required to pass the necessary journal entries.

 

Solution: 1

In the books of Primrose Limited

Journal entries

(Rs in Lakh)

Dt.	Particulars	LF	Dr. (Rs)	Cr. (Rs)
1	Bank A/c                  Dr		32
	Profit and Loss A/c        Dr		8
	To Fixed Assets A/c			40
	(Fixed assets sold and loss on sale transferred to Profit and Loss Account)
2	Bank A/c                    Dr		54
	To Equity Share capital A/c			54
	(5,40,000 Eq. Sh. of Rs 10 each issued at par)
3	Redeemable Pref. Sh. Cap. Dr		80
	Prem. on Redemption of Pref. Sh. Dr		16
	To Pref. shareholders A/c			96
	(80,000 Pref. shares redeemed at a premium of 20%)
4	Pref. shareholders A/c  Dr		84
	To Bank A/c			84
	(Payment made to 70,000 pref. shareholders) [(96 ÷ 80,000) × 70,000]
5	Securities premium A/c    Dr		15
	Profit and loss A/c            Dr		1
	To Prem. on redemption of Pref. Sh.			16
	(Premium on redemption of preference shares adjusted against Securities Premium Account and Profit and Loss Account)
6	General Reserves A/c      Dr		20
	Profit and Loss A/c          Dr		6
	To Cap. Redemption Reserve A/c			26
	[Face value of shares redeemed out of distributable profits transferred to Capital Redemption Reserve (CRR) Account]
7	Capital Redemption Reserve  Dr		10
	To Bonus to Shareholders A/c			10
	(Bonus declared)
8	Bonus to Shareholders A/c      Dr		10
	To Equity Share Capital A/c			10
	(Bonus shares converted to Equity Shares)

 

Working notes:

1.   Distributable profits available for redemption

Particulars	Rs	Rs
General Reserves	30 L
Less: Balance to be maintained	(10 L)	20 L
Profit and Loss Account	15 L
Less: Loss on sale of Fixed Assets	(8 L)
Less: Adjustment against Premium on Redemption	(1 L)	6 L
Amount to be transferred to Capital Redemption Reserve (CRR)		26 L

 

2.   Proceeds to be collected from fresh issue of equity shares

Particulars	Rs	Rs
Face value of preference shares to be redeemed		80 L
Less: Distributable profits available for redemption		(26 L)
Proceeds to be collected from fresh issue of equity shares		54 L

 

Illustration: 2

The balance sheet of Goldrush Limited as on 31.12.2018:

Liabilities	Rs
Equity share of Rs 10 each	2,00,000
Less: Calls-in-arrear @ Rs 2 per share	(10,000)
14% Preference shares of Rs 100 each	1,00,000
Securities premium	10,000
Investment Allowance Reserve	40,000
Development Rebate Reserve	20,000
Workmen’s Compensation Fund	10,000
Dividend Equalisation Reserve	12,000
Profit and Loss Account	38,000
Unsecured Loans	80,000
	5,00,000
Assets	Rs
Non-current Assets	4,00,000
Current Assets (including bank balance Rs 10,000)	1,00,000
	5,00,000

 

The board of directors decided to redeem the preference shares on 1.1.2019 on the following conditions:

1.   Issue 4,000 equity shares and rupees 50,000 10% debentures.

2.   Redeem preference shares at a premium of 10%.

3.   Raise necessary bank loan to provide funds for redemption and to have rupees 15,000 as balance.

4.   Admit claim of Rs 4,000 for workmen compensation.

5.   Utilise Rs 10,000 out of Investment Allowance Reserve for this purpose.

 

Pass the necessary journal entries assuming that holders of 100 reference shares could not be traced by the company.

 

Solution: 2

In the books of Goldrush Limited

Journal entries

Dt.	Particulars	LF	Dr. (Rs)	Cr. (Rs)
1	Bank A/c         Dr		90,000
	To Equity Share Capital A/c			40,000
	To 10% Debenture A/c			50,000
	(4,000 equity shares of Rs 10 each and 500 10% debentures of Rs 100 each issued at par)
2	14% Pref. Sh. Capital A/c      Dr		1,00,000
	Prem. on Redemption.     Dr		10,000
	To Pref. shareholders A/c			1,10,000
	(1,000 14% Pref. sh. redeemed at a prem. of 10%)
3	Pref. shareholders A/c       Dr		99,000
	To Bank A/c			99,000
	(Payment made to 900 pref. shareholders) [(1,10,000 ÷ 1,000) × 900]
4	Securities premium A/c     Dr		10,000
	To Prem. on Redemption			10,000
	(Premium on redemption of pref. sh. adjusted against Securities Premium Account)
5	Workmen Comp. Fund Dr		4,000
	To Claim for workmen comp.			4,000
6	Inv. Allowance Reserve Dr		10,000
	Workmen Comp. Fund Dr		6,000
	Div. Equalisation Reserve Dr		12,000
	Profit and Loss A/c            Dr		32,000
	To Capital Redemption Reserve			60,000
	[Face value of shares redeemed out of distributable profits transferred to Capital Redemption Reserve (CRR) Account]
7	Bank A/c                   Dr		25,000
	To Bank Loan A/c			25,000
	(Bank loan raised to provide funds for redemption of preference shares)

 

Working notes:

1.   Bank loan required to be raised

Particulars	Rs
Amount payable to Preference Shareholders	1,10,000
Add: Bank balance required to be maintained	15,000
	1,25,000
Less: Cash at bank available before redemption	(10,000)
Less: Proceeds from issue of Eq. Share and debentures	(90,000)
Bank loan required to be raised	25,000

 

2.   Amount to be transferred to capital redemption reserve

Particulars	Rs
Face value of shares to be redeemed	1,00,000
Less: Proceeds from fresh issue of equity shares	(40,000)
Amount to be transferred to CRR	60,000

 

Illustration: 3

Books of Money-monger Limited show the following balances on 31.12.2018:

Particulars	Rs
15,000 Equity Shares of Rs 10 each fully paid	1,50,000
2,500 10% preference shares of Rs 100 each fully paid	2,50,000
General Reserve	75,000
Profit and Loss Account	1,60,000
Securities Premium Account	15,000
Investments	1,20,000
Cash at Bank	39,600

 

On 1.1.2019 the board of directors decided to redeem the preference shares at a premium of 8%. In order to pay off preference shareholders the company also decided to sell the Investments and use companies fund, and to raise the balance by issue of sufficient number of equity shares of Rs 10 each at a premium of Rs 1 per share subject to leaving a minimum bank balance of Rs 9,600 after such Redemption. Investments were sold at Rs 1, 08,000.

 

Show the necessary journal entries to record the above transactions.

 

Solution: 3

In the books of Money-monger Limited

Journal entries

Dt.	Particulars	LF	Dr. (Rs)	Cr. (Rs)
1	Bank A/c                            Dr		1,08,000
	Profit and Loss A/c            Dr		12,000
	To Investments A/c			1,20,000
	(Investments sold and loss on sale transferred to Profit and Loss Account)
2	10% Pref. Sh. Capital A/c   Dr		2,50,000
	Prem. on Redemption         Dr		20,000
	To Pref. shareholders A/c			2,70,000
	(Preference shares redeemed at a premium of 8%)
3	Bank A/c  (12,000 × 11)     Dr		1,32,000
	To Eq. Sh. Cap. (12,000 × 10)			1,20,000
	To Sec. Prem. (12,000 × 1)			12,000
	(12,000 equity shares of Rs 10 each issued at a premium of Rs 1 per share)    [W.N. 1 and 2]
4	Pref. shareholders A/c      Dr		2,70,000
	To Bank A/c			2,70,000
	(Payment made to preference shareholders)
5	Sec. Premium A/c          Dr		15,000
	Profit and loss A/c           Dr		5,000
	To Prem. on redemption			20,000
	(Premium on redemption of preference shares adjusted against Securities Premium Account and Profit and Loss Account)
6	General Reserves A/c                Dr		75,000
	Profit and Loss A/c                    Dr		55,000
	To Capital Redemption Reserve			1,30,000
	[Face value of shares redeemed out of distributable profits transferred to Capital Redemption Reserve (CRR) Account]    [W.N. 3]

 

Working notes:

1.   Amount of cash to be raised by issue of equity shares

Particulars	Rs	Rs
Amount payable to preference shareholders		2,70,000
Add: Minimum bank balance to be maintained after the  redemption		9,600
		2,79,600
Less: Proceeds from sale of investments	(1,08,000)
Less: Available cash at bank before the redemption	(39,600)	(1,47,600)
Cash to be raised by issue of equity shares		1,32,000

 

2.   Number of equity shares to be issued

= Rs 1, 32,000 ÷ (Rs 10 + Rs 1) = 12,000

 

3.   Amount to be transferred to capital redemption reserve (CRR)

Particulars	Rs
Face value of shares to be redeemed	2,50,000
Proceeds from fresh issue of shares     (12,000 × Rs 10)	(1,20,000)
Amount to be transferred to CRR	1,30,000