Company accounts – Redeemable Preference Shares

INTRODUCTION Under Section 100 of the Companies Act, a company is not allowed to return to its shareholders the share money without the permission of the court. But permission of the court is not necessary, if the refund is to be made to the preference share holder. When the capital is raised by issuing redeemable preference shares , it is to be paid back by the company to such shareholders after the expiry of the of a stipulated period whether the company is to be wound up or not. Ordinarily, the amount of such shares will be paid back during the life time of company either out of the profits or proceeds of the issues of fresh shares

Important Provisions regarding the redemption of preference shares under section 80 of companies act Such shares cannot be redeemed unless they are fully paid up . this provision is made in order to protect the interest of the creditors . Such shares can be redeemed either out of profits which would be available for dividend or out of the proceeds of a fresh issue of shares made with the object of redemption .these shares cannot be redeemed out of the proceeds of fresh issue of debentures or out of the sale proceeds of any property of the company as it will lead to erosion of available security to the creditors .this clause is inserted to protect the interest of creditors.

Capital profits such as shares forfeited account, development rebate account, capital redemption reserve account, securities premium account, profit prior to incorporation, capital reserve are not available for dividend. When shares are redeemed out of profits available for distribution as dividend, a sum equal to the nominal amount of the shares so redeemed must be transferred out of profits to a reserve account to be called “Capital Redemption Reserve Account". This provision is made in order to immobilize profits from being used for any other purpose. Such reserve can be used for issuing fully paid bonus shares to the shareholders. This account cannot be reduced except in accordance with the sanction of the court relating to reduction of share capital. Redemption of preference shares should not be regarded as a reduction of the authorized capital of the company and as such the reduced shares should remain part of the authorized capital and must be shown in the Balance Sheet.

Purpose of legal restrictions The purpose of all legal restrictions on redemption of preference shares is not to allow redemption of preference shares which may adversely affect the security available to the creditors of company. The purpose is to keep the security intact which is available to the creditors even after the preference shares are redeemed. Another purpose of legal restrictions on redemption of preference shares is that there should be no reduction of share capital.

Other Provisions under Section 80 of the Companies Act. Preference shares can be redeemed either out of the proceeds of the fresh issues of shares or out of profits available for dividend purposes. If preference shares are redeemed out of the proceeds of fresh issues of shares, capital provided by fresh issue of shares will be substituted by the capital which will be reduced by redemption of preference shares. If preference shares are redeemed out of revenue profits available for dividend purposes, nominal value of shares so redeemed must be transferred to Capital Redemption Reserve Account. Capital Redemption Reserve Account is just like capital because it can only be used for issue of fully paid-up bonus shares. Hence, redemption of preference shares will not amount to reduction of capital.

Journal Entries for redemption of preference shares If shares are partly paid up, then first of all we have to convert partly paid up shares into fully paid up shares to make them eligible for redemption – Preference share final call a/c dr To Preference share capital a/c Bank a/c dr To Preference share final call a/c

Issue of equity shares either with or without premium – Amount due to preference shareholders including the face value and premium to be paid on redemption – Redeemable preference share capital a/c dr Premium on redemption a/c dr To Preference shareholders a/c Issue of equity shares either with or without premium – Bank a/c dr Discount on issue of shares a/c dr To Equity share capital a/c To Securities premium a/c

Provide premium to be paid on redemption of preference shares out of the securities premium account – Securities premium/ Surplus /General reserve a/c dr To Premium on redemption a/c Appropriate amount from profit and loss or general reserve or any other reserve- Surplus or general reserve a/c dr To Capital redemption reserve a/c

Payment to be made to preference shareholders- If liquid assets are not available ,current assets may be sold by the company or bank loan may be arranged for making payment to preference shareholders – Bank a/c dr Surplus a/c (loss on sale) dr To Current assets a/c Bank a/c dr To Bank loan a/c Payment to be made to preference shareholders- Preference share capital a/c dr To Bank a/c

If redemption is made by conversion of some other shares – Preference share capital a/c dr To New share capital a/c Sometimes Capital Redemption Reserve is utilised for issuing fully paid bonus shares. When decision is taken to issue bonus shares- Capital redemption reserve Or Securities premium Or Any other reserve a/c dr To Bonus to equity shareholders a/c When issue of bonus shares is made – Bonus to equity share holders a/c dr To Equity share capital a/c

SOLUTION: Journal Entries ILLUSTRATION: A company in a series of operations Issues at par 20,000 redeemable preference shares of Rs. 1o each redeemable at premium of 50 paisa per share. Redeems 10,000 of the redeemable preference shares out of profits of the company. Issues at par for cash 20,000 equity shares of Rs. 10 each and out of the proceeds redeems the balance of the redeemable preference shares. Journalise these transactions including those relating to cash. SOLUTION: Journal Entries i Bank a/c Dr. To Redeemable preference shares capital a/c (Amount received on issue of 20,000 redeemable preference shares) 2,00,000

ii Redeemable preference shares capital a/c Dr. Premium on redemption a/c Dr. To Redeemable preference shares holders a/c (Being transfer of amount due to redeemable preference shareholders) 1,00,000 5,000 1,05,000 Surplus a/c Dr. To Premium on redemption a/c To Capital redemption reserve a/c (Being premium provided out of profit & loss account and reserve created as required) Redeemable preference shareholders a/c Dr. To Bank a/c (Being the payment made to redeemable preference shareholders on redemption)

iii Redeemable preference shares capital a/c Dr. Premium on redemption a/c Dr. To Redeemable preference shareholders (Amount due on redemption transferred to redeemable preference shareholders account) 1,00,000 5,000 1,05,000 Bank a/c Dr. To Equity share capital a/c (Being the issue of equity shares for redemption of preference shares) 2,00,000 Surplus a/c Dr. To Premium on redemption a/c (Premium provided out of profit and loss account for redemption of preference shares) Redeemable preference shareholders a/c Dr. To Bank a/c (Amount paid on redemption of preference shares)

ILLUSTRTION: Exchange ltd. has an issued share capital of 650 7% redeemable preference shares of Rs. 100 each and 4500 equity shares of Rs. 50 each. The preference shares are redeemable at a premium of 7.5% on April 1,2011. The company’s balance sheet as on 31st march,201 2was as follows: Liabilities Rs. Assets Share capital Issued 650 7% Redeemable Preference Shares of Rs. 100 each fully paid up 4500 equity shares of Rs.50 each fully paid up Surplus Account Sundry Creditors 65,000 2,25,000 Fixed assets Investments Balance at bank 3,45,000 18,500 31,000 3,94,500 2,90,000 48,000 56,500

In order to facilitate the redemption of the preference shares, the company decided – (a) to sell all the investments for RS. 16,000; (b) to finance part of the redemption from company’s funds, subject to leaving a balance of Rs.12000 in the profit and loss account, and (c) to issue sufficient equity shares f Rs.50 each at a premium of Rs.13 per share to raise the balance of funds required. You are required to prepare – (1) the necessary journal entries to record the above transactions (including cash ) and (2) the balance sheet as on completion.

Bank a/c Dr. Profit and loss a/c Dr. To Investments a/c (Being the investments are sold at Rs. 16,000 and loss debited to profit and loss a/c) 16,000 2,500 18,500 7% Red. Preference share capital a/c Dr. Premium on redemption a/c Dr. To Preference shareholders a/c (Being the amount payable on redemption of 650 preference shares transferred to preference shareholders a/c) 65,000 4,875 69,875 Bank a/c Dr. To Equity Share Application and Allotment a/c (Being the application money received on 630 equity shares of Rs. 50 each at premium of Rs. 13 per share) 39,690

Equity Shares Application and Allotment a/c Dr. To Equity share capital a/c To Securities premium a/c (Being the allotment of 630 equity shares of 50 each at a premium of Rs.13 per share vide board resolution dated.) 39,690 31,500 8,190 Profit and loss a/c Dr. To CRR a/c (Being the amount transferred out of profits equal to nominal values of shares redeemed otherwise than out of proceeds of fresh issue) 33,500 Securities premium a/c Dr. To Premium on redemption a/c (Being the premium payable on red. of pref. shares charged to securities premium a/c) 4,875 Preference shareholders a/c Dr. To Bank a/c (Being the payment made on red. of pref. shares at a premium of 7.5%) 69,875

BALANCE SHEET OF EXCHANGE LTD. as on 1st April, 2012 (A) Equity and Liabilities (1) Shareholders’ Funds (a) Share Capital 5,310 Equity Shares of Rs.50 each fully paid (b) Reserve and Surplus: Rs. Capital Redemption Reserve 33,500 Security Premium A/c 3,315 Surplus A/c 12,000 Shareholders’ Funds (2) Non- current Liabilities (3) Current Liabilities: Trade Payables: Sundry Creditors Total Equity and Liabilities (1) + (2) + (3) 2,56,500 48,815 3,05,315 - 56,500 3,61,815

(B) Assets (1) Non – current Assets: Fixed Assets Total (2) Current Assets Cash and Cash Equivalents: Cash at Bank Total Assets (1) + (2) 3,45,000 16,815 3,61,815 Working notes: (1) Calculation of numbers of equity shares to be issued Rs. Rs. Balance in Surplus account 48,000 Less: Loss on sale of investment 2,500 Amount to be retained as balance 12,000 14,500 Amount available for transfer to CRR a/c 33,500 Nominal value of equity shares to be issued (Rs. 65,000-Rs.33,500) 31,500 No. of equity shares=31,500/Rs.50=630 shares

(2) Calculation of balance at bank BANK ACCOUNT To Balance b/d To Investment a/c To Share Application and Allotment a/c 31,000 16,000 39,690 86,690 By Preference Shareholders a/c By Balance c/d 69,875 16,815 86.690

Use of Algebraic Equation for finding out the Face Value of Shares to be issued to be issued for Redemption of Preference Shares The use of algebraic equation may be useful for finding out the minimum face value of shares to be reissued. Fresh issue can be made At Premium At Discount

1) When fresh issue is to be made at a premium- Redeemable Preference [Balance in Security Share Capital = Premium A/c in B/S] + +Premium on Redemption [Revenue profits available for redemption] +[N] +[N (% rate of premium on fresh issue)] Here N= face value of fresh issue of shares for redemption of preference shares.

When no. of shares to be calculated with the help of equation ( in case of premium): ILLUSTRATION: Determine the amount of fresh issue of shares from the following information: 1. Redeemable preference shares Rs.2,00,000 2. Premium on redemption 10% 3. Divisible profits available Rs.60,000 4. Balance in general reserve Rs.40,000 5. Securities Premium Account Rs.15,000 Fresh issue is to be made at a premium of 5%.

SOLUTION: Redeemable Preference [Balance in Security Share Capital = Premium A/c in B/S] + +Premium on Redemption [Revenue profits available for redemption] +[N] +[N (% rate of premium on fresh issue)] 2,00,000 + 20,000 = 15,000 + 60,000 + 40,000 + N + 0.05 N 1.05 N = 2,20,000 – 1,15,000 N = 1,05,000 1.05 N = Rs.1,00,000.

2) When fresh issue of shares is to be made at a discount – Redeemable preference [balance in the securities share capital = premium a/c in b/s+ +premium on redemption [revenue profits available for redemption] + [N] + [N (% rate of premium on fresh issue)]

When no. of shares are to be calculated with the help of equation (in case of discount): ILLUSTRATION: Determine the amount of fresh issue of shares from the following information: 1. Redeemable preference shares Rs.2,00,000 2. Premium on redemption 10% 3. Divisible profits available Rs.60,000 4. Balance in general reserve Rs.40,000 5. Securities Premium Account Rs.15,000 Fresh issue is to be made at a discount of 10%.

SOLUTION: Redeemable preference [balance in the securities share capital = premium a/c in b/s] + +premium on redemption [revenue profits available for redemption] + [N] + [N (% rate of premium on fresh issue)] 2,00,000 + 20,000 = 15,000 + 60,000 + 40,000 + N – 0.1 N 0.9 N = 2,20,000 – 1,15,000 N = 1,05,000 0.9 N = Rs.1,16,667.

ILLUSTRATION: (Use of equation). Ledger balances are as follows: Credit Balance Rs. Debit Balance Equity share Capital 80,000 shares of Rs.10 each fully paid up 2% Redeemable Preference Shares of Rs. 100 each, Rs. 80 per share called up and paid up Securities Premium Account Surplus Account Current Liabilities 8,00,000 4,00,000 15,000 74,995 1,15,235 14,05,230 Fixed Assets Investments Current Assets 9,75,000 50,000 3,80,230

The Redeemable Preference Shares are to be redeemed at a premium of 10%. The directors wish that only the minimum number of fresh equity shares of Rs.10 each at a premium of 5% be issued to provide for redemption of such preference shares as could not otherwise be redeemed. You are required to give the journal entries and also prepare the Balance Sheet after redemption. SOLUTION: JOURNAL ENTRIES 12% Redeemable Preference Share Final Call A/c Dr. To Redeemable Preference Share Capital A/c (Being final call of Rs. 20 each on 5,000 preference shares to make them fully paid up for making them eligible for redemption). Rs. 1,00,000

Bank A/c To 12% Redeemable Preference Share Final Call A/c (Being amount received against Preference. Share Final Call). 1,00,000 12% Redeemable Preference Share Capital A/c Dr. Premium on Redemption of Preference Shares A/c Dr. To Redeemable Preference Shareholders A/c (Being amount payable on redemption of 5,000 preference shares of Rs.100 each at 10% premium). 5,00,000 50,000 5,50,000 Bank Account Dr. To Equity Share Capital Account To Securities Premium Account (Being issue of 43,810 equity shares of Rs.10 each at a premium of 5%). 4,60,005 (1)4,38,100 21,905 Securities Premium Account Dr. Surplus Account To Premium on Redemption of Preference Shares A/c (Being premium payable on redemption of preference shares provided). 36,905 13,905

Surplus Account Dr. To Capital Redemption Reserve Account (Being provision created out of Profit and Loss Account for redemption of preference shares as required by Section 80 of the Companies Act,1956). 61,900 Redeemable Preference Shareholders Account Dr. To Bank Account (Being payment of amount due to preference shareholders on account of redemption). 5,50,000 BALANCE SHEET OF …….. as at ……. A. Equity and Liabilities (1) Shareholders’ Funds (a) Share Capital 1,23,810 Equity Shares of Rs.10 each fully paid (b) Reserve and Surplus: Capital Redemption Reserve A/c Total 12,38,100 61,900 13,00,000

(2) Non – current Liabilities Total Equity and Liabilities (1) + (2) + (3) Assets (1) Non – current Assets Fixed Assets Investments ( assumed to be non – current) Total (2) Current Assets (including Cash at Bank) Total Assets (1) + (2) Nil 1,15,235 14,15,235 9,75,000 50,000 10,25,000 3,90,235 Working Note: (1) Calculation of Minimum Number of Fresh Shares to be issued by Equation Redeemable Preference Share Capital + Premium on Redemption = Balance in Share Divisible or N + N * % Rate of Premium A/c Free Profit Premium on Fresh Issue

or Rs.5,00,000 + Rs.50,000 = Rs. 15,000 + Rs.74,995 + N + 0.05 N or 1.05 N = Rs. 5,50,000 – 89,995 N = Rs.4,60,005 1.05 N = Rs. 4,38,100 or No. of Shares = Rs.4,38,100 Rs.10 = 43,810 shares.

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