accounts - redemption of preference share

Presentation Of AccountsPresentation Of Accounts

Redemption of Preference Redemption of Preference SharesShares

ContentsContents

1. Introduction1. Introduction2. Objectives2. Objectives3. Types of Preference shares3. Types of Preference shares4. Conditions for redemption of preference 4. Conditions for redemption of preference sharesshares5. Capital Redemption Reserve (CRR) 5. Capital Redemption Reserve (CRR) AccountAccount6. Journal for accounting entries6. Journal for accounting entries7. Worked out Examples 7. Worked out Examples

IntroductionIntroductionThe fund provided by the owners in to a business is known as capital. You The fund provided by the owners in to a business is known as capital. You

know that capital of the business depends upon the form of business know that capital of the business depends upon the form of business organization. From ownership point of view, there are number of business organization. From ownership point of view, there are number of business

organizations like, sole proprietorship business, partnership business, organizations like, sole proprietorship business, partnership business, cooperative societies, joint stock companies etc. Total capital of the cooperative societies, joint stock companies etc. Total capital of the

company is divided into a number of small units of fixed amount and each company is divided into a number of small units of fixed amount and each such unit is called a share. The fixed value of a share register with the such unit is called a share. The fixed value of a share register with the

registrar of Companies is called face/ nominal value. However, a company registrar of Companies is called face/ nominal value. However, a company can issue shares at a price different from its nominal value or face value. As can issue shares at a price different from its nominal value or face value. As

the total capital of the company is divided into shares, the capital of the the total capital of the company is divided into shares, the capital of the company is known as share capital. A company can issue two types shares company is known as share capital. A company can issue two types shares equity shares and preference shares. The issue of preference shares is one equity shares and preference shares. The issue of preference shares is one

of the important sources of capital of a company. Redemption is the process of the important sources of capital of a company. Redemption is the process of repaying an obligation at predetermined amounts and timings. The of repaying an obligation at predetermined amounts and timings. The

redeemable preference shares are issued on the terms that share holders will redeemable preference shares are issued on the terms that share holders will at a future date be repaid amount which they invested in the company. at a future date be repaid amount which they invested in the company.

According to the Companies Act, 1956, a company can issue only According to the Companies Act, 1956, a company can issue only redeemable shares i.e. at present a company cannot issue irredeemable redeemable shares i.e. at present a company cannot issue irredeemable

preference shares. preference shares. Now, we are going to discuss about the redemption of preference shares. Now, we are going to discuss about the redemption of preference shares.

Learning ObjectivesLearning Objectives

Identify the different types of preference shares; Identify the different types of preference shares; Describe how companies redeem its preference Describe how companies redeem its preference

shares; shares; Prepare account for the scheme of redemption; and Prepare account for the scheme of redemption; and Utilize the capital redemption reserve account. Utilize the capital redemption reserve account.

Types of Preference Shares Types of Preference Shares Equity shares get dividend at a rate fixed at the Annual General Meeting Equity shares get dividend at a rate fixed at the Annual General Meeting

(AGM) depending on the profit available for a particular year. The rate of (AGM) depending on the profit available for a particular year. The rate of dividend also varies from year to year. The preference shareholders dividend also varies from year to year. The preference shareholders contribute capital to the company. According to section 85 of the Companies contribute capital to the company. According to section 85 of the Companies Act, 1956, persons holding preference shares, called preference shareholders. Act, 1956, persons holding preference shares, called preference shareholders. They are assured of a preferential dividend at a fixed rate during the life of They are assured of a preferential dividend at a fixed rate during the life of the company. This type share holders carry preferential right over other the company. This type share holders carry preferential right over other shareholders to be paid first in case of liquidation of the company. shareholders to be paid first in case of liquidation of the company. Companies use this mode of financing as it is cheaper than raising debt. The Companies use this mode of financing as it is cheaper than raising debt. The preference shares can be of various types. These are: preference shares can be of various types. These are:

i) i) Redeemable Preference Shares:Redeemable Preference Shares: A company may issue this type of A company may issue this type of shares on the condition that the company will repay the amount of shares on the condition that the company will repay the amount of share capital to the holders of this category of shares after the fixed share capital to the holders of this category of shares after the fixed period or even earlier at the discretion of the company. Section 80 of period or even earlier at the discretion of the company. Section 80 of the Companies Act, 1956 deals with the redemption of preference the Companies Act, 1956 deals with the redemption of preference shares. shares.

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ii) ii) Irredeemable Preference Shares:Irredeemable Preference Shares: The preference shares, The preference shares, which do not carry the agreement of redemption are known as which do not carry the agreement of redemption are known as irredeemable preference shares. irredeemable preference shares.

iii) iii) Convertible Preference Shares:Convertible Preference Shares: This type of shares enjoy This type of shares enjoy the right to the holder to get them converted into equity shares the right to the holder to get them converted into equity shares according to the terms and conditions of the issue. according to the terms and conditions of the issue.

iv) iv) Non-convertible Preference Shares:Non-convertible Preference Shares: The holders of these The holders of these shares do not enjoy the right to get the shares converted into shares do not enjoy the right to get the shares converted into equity shares. Unless otherwise stated, Preference shares are equity shares. Unless otherwise stated, Preference shares are non-convertiblenon-convertible

v) v) Participating Preference Shares:Participating Preference Shares: The holder of this type The holder of this type of preference shares enjoy the right to participate in the of preference shares enjoy the right to participate in the surplus profits, if any, after the equity shareholders have been surplus profits, if any, after the equity shareholders have been paid dividend at a rate fixed in the AGM. So the shareholders paid dividend at a rate fixed in the AGM. So the shareholders get additional dividend with their normal dividend. get additional dividend with their normal dividend.

vi) vi) Non-participating Preference Shares:Non-participating Preference Shares: These shares carry only These shares carry only a fixed rate of dividend without any right to get additional dividend. a fixed rate of dividend without any right to get additional dividend. Unless otherwise stated, The preference shares are non-participating. Unless otherwise stated, The preference shares are non-participating.

vii) vii) Cumulative Preference Shares:Cumulative Preference Shares: The cumulative preference The cumulative preference shares carry the right to a fixed amount of dividend. The holders of shares carry the right to a fixed amount of dividend. The holders of these shares are entitled to get dividend out of future profit if current these shares are entitled to get dividend out of future profit if current year’s profit is insufficient for the same. So, the dividend on these year’s profit is insufficient for the same. So, the dividend on these shares accumulates till the final payment. shares accumulates till the final payment.

viii) viii) Non-cumulative Preference Share:Non-cumulative Preference Share: In this case the dividend In this case the dividend for the shareholders does not accumulate. If there is no sufficient for the shareholders does not accumulate. If there is no sufficient profit, this type of preference shareholders will not get any dividend. profit, this type of preference shareholders will not get any dividend. In this case, the dividend will be lapsed and there will be no arrear In this case, the dividend will be lapsed and there will be no arrear dividend. dividend.

Conditions for redemption of Conditions for redemption of preference shares preference shares

Before going to redeem the preference shares as per section 80 Before going to redeem the preference shares as per section 80 of the Companies Act, 1956, a company should have to follow of the Companies Act, 1956, a company should have to follow the conditions: the conditions:

i) There must be a provision in the Articles of Association i) There must be a provision in the Articles of Association regarding the redemption of preference shares. regarding the redemption of preference shares.

ii) The redeemable preference shares must be fully paid up. If ii) The redeemable preference shares must be fully paid up. If there is any partly paid share, it should be converted in to fully there is any partly paid share, it should be converted in to fully paid shares before redemption.paid shares before redemption.

iii) The redeemable preference shareholders should be paid iii) The redeemable preference shareholders should be paid out of undistributed profit/ distributable profit or out of fresh out of undistributed profit/ distributable profit or out of fresh issue of shares for the purpose of redemption.issue of shares for the purpose of redemption.

iv) If the shares are redeemed at a premium, it should iv) If the shares are redeemed at a premium, it should be should be provided out of securities premium or be should be provided out of securities premium or profit and loss account or general reserve account.profit and loss account or general reserve account.

v) The proceeds from fresh issue of debentures v) The proceeds from fresh issue of debentures cannot be utilized for redemption.cannot be utilized for redemption.

vi) The amount of capital reserve cannot be used for vi) The amount of capital reserve cannot be used for redemption of preference shares. redemption of preference shares.

vii) If the shares are redeemed out of undistributed vii) If the shares are redeemed out of undistributed profit , the nominal value of share capital, so profit , the nominal value of share capital, so redeemed should be transferred to Capital redeemed should be transferred to Capital Redemption Reserve Account. This is also known as Redemption Reserve Account. This is also known as capitalization profit. capitalization profit.

Capital Redemption Reserve (CRR) Capital Redemption Reserve (CRR) Account Account

If you go through the conditions as discussed in the previous section, it will be If you go through the conditions as discussed in the previous section, it will be clear that, if the preference shares are redeemed out of accumulated profit, it clear that, if the preference shares are redeemed out of accumulated profit, it will be necessary to transfer an amount equal to the amount repaid on the will be necessary to transfer an amount equal to the amount repaid on the redemption to Capital Redemption Reserve Account. If the company issues redemption to Capital Redemption Reserve Account. If the company issues any fresh shares for redemption purpose, the transferred amount will be the any fresh shares for redemption purpose, the transferred amount will be the difference between nominal value of shares redeemed and the nominal value of difference between nominal value of shares redeemed and the nominal value of shares issued (shares issued (i.e. i.e. amount transferred to CRR = Nominal value of shares amount transferred to CRR = Nominal value of shares redeemed – Nominal value of shares issuedredeemed – Nominal value of shares issued). The capital redemption reserve ). The capital redemption reserve account can be used for issuing fully paid bonus shares.account can be used for issuing fully paid bonus shares.

The importance of creation of capital redemption reserve account are to a) The importance of creation of capital redemption reserve account are to a) protect the interest of creditors and b) maintain working capital. Redemption of protect the interest of creditors and b) maintain working capital. Redemption of preference shares involves repayment of capital before paying creditors of the preference shares involves repayment of capital before paying creditors of the company. It may affect the interest of creditors. In addition to that the working company. It may affect the interest of creditors. In addition to that the working capital of the company will be depleted as a result of outflow of cash due to capital of the company will be depleted as a result of outflow of cash due to redemption. The amount is capitalized by creating the capital redemption redemption. The amount is capitalized by creating the capital redemption reserve account. As a result this amount will not be available for distribution of reserve account. As a result this amount will not be available for distribution of dividend. It help protect the interest of creditors and on the other hand it dividend. It help protect the interest of creditors and on the other hand it replenishes working capital. replenishes working capital.

Journal for accounting entries Journal for accounting entries

The redeemable preference shares can be The redeemable preference shares can be redeemed by redeemed by

a) the proceeds of a fresh issue of equity shares/ a) the proceeds of a fresh issue of equity shares/ preference shares, preference shares,

b) the capitalization of undistributed profit i.e. b) the capitalization of undistributed profit i.e. creating capital redemption reserve account, or creating capital redemption reserve account, or

c) a combination of both (a) and (b). let us see c) a combination of both (a) and (b). let us see the accounting entries required for redemption the accounting entries required for redemption of preference shares. of preference shares.

i) i) When new shares are issued at par:When new shares are issued at par: Bank A/c …………………Dr. Bank A/c …………………Dr. To Share Capital A/c. To Share Capital A/c. ii) ii) When new shares are issued at premium:When new shares are issued at premium: Bank A/c ……………………..Dr. Bank A/c ……………………..Dr. To Share Capital A/c To Share Capital A/c To Share Premium A/c To Share Premium A/c iii) iii) When new shares are issued at a discount:When new shares are issued at a discount: Bank A/c ………………Dr. Bank A/c ………………Dr. Discount on Issue of Share Capital………..Dr. Discount on Issue of Share Capital………..Dr. To Share Capital A/c. To Share Capital A/c. iv) iv) Conversion of partly paid shares into fully paid shares:Conversion of partly paid shares into fully paid shares: a) Share Call A/c ………..Dr. a) Share Call A/c ………..Dr. To Share Capital A/c To Share Capital A/c b) Bank A/c ……………..Dr. b) Bank A/c ……………..Dr. To Share Call A/c. To Share Call A/c.

v) v) When preference shares are redeemed at par:When preference shares are redeemed at par: Redeemable Preference Share Capital A/c ……Dr. Redeemable Preference Share Capital A/c ……Dr. To Preference shareholders A/c.To Preference shareholders A/c. vi) vi) When preference shares are redeemed at a premium:When preference shares are redeemed at a premium: Redeemable Preference Share Capital A/c …………Dr Redeemable Preference Share Capital A/c …………Dr Premium of Redemption Preference Share Capital A/c….Dr. Premium of Redemption Preference Share Capital A/c….Dr. To Preference shareholders A/c. To Preference shareholders A/c. vii) vii) Adjustment of premium on redemption:Adjustment of premium on redemption: Profit and Loss A/c………………..Dr. Profit and Loss A/c………………..Dr. Share Premium A/c ……………….Dr. Share Premium A/c ……………….Dr. To Premium of Redemption Preference Share Capital A/cTo Premium of Redemption Preference Share Capital A/c viii) viii) Transferring the amount to Capital Redemption Reserve Transferring the amount to Capital Redemption Reserve

Account:Account: General Reserve A/c …………….Dr. General Reserve A/c …………….Dr. Profit and Loss A/c …………….Dr. Profit and Loss A/c …………….Dr. To Capital Redemption Reserve A/c To Capital Redemption Reserve A/c

ix) ix) Expenses on issue of shares:Expenses on issue of shares: Expenses on Issue of shares A/c…………….Dr. Expenses on Issue of shares A/c…………….Dr. To Bank A/c. To Bank A/c. x) x) When payment is made to preference shareholders:When payment is made to preference shareholders: Preference Shareholders A/c ……………Dr. Preference Shareholders A/c ……………Dr. To Bank A/c. To Bank A/c. xi) xi) When the fully paid bonus shares are issued:When the fully paid bonus shares are issued: Capital Redemption Reserve A/c …………….Dr. Capital Redemption Reserve A/c …………….Dr. General Reserve A/c …………………………..Dr. General Reserve A/c …………………………..Dr. Share Premium A/c ……………………………Dr. Share Premium A/c ……………………………Dr. Profit & Loss A/c …………………………….. Dr. Profit & Loss A/c …………………………….. Dr. To Bonus to Shareholders A/c To Bonus to Shareholders A/c xii) xii) Capitalization of profit:Capitalization of profit: Bonus to Shareholders A/c ………………Dr. Bonus to Shareholders A/c ………………Dr. To Equity share capital A/c To Equity share capital A/c

Worked out Examples Worked out Examples Example 1. XY Co. Ltd. had part of its share capital in 2000 preference shares of Rs.10 each fully paid up and these have become due for redemption. The preference share capital was to be redeemed out of a fresh issue of equity shares at par made particularly for this purpose and the general reserve of the company stood at Rs.25,000. Show the journal entries for the above transactions.

Solution:

Journal Entries in the Books of XY Ltd.

Date Date Particulars Particulars LLFF

Dr. Dr. (Rs.) (Rs.)

Cr. Cr. (Rs.) (Rs.)

2008 2008 April 1 April 1

Preference share capital A/c …………….Dr.Preference share capital A/c …………….Dr. To Preference shareholders A/c To Preference shareholders A/c(Being amount payable on redemption of 2000 (Being amount payable on redemption of 2000 preference shares) preference shares)

20,00020,00020,000 20,000


Dr.Dr.(Rs.) (Rs.)

Cr.Cr.(Rs.) (Rs.)


Bank A/c ……………………………………...Dr.Bank A/c ……………………………………...Dr. To Equity Share Capital A/c To Equity Share Capital A/c (Being the amount received on issue of 2000 equity shares (Being the amount received on issue of 2000 equity shares of Rs.10 each made for the purpose of redemption of of Rs.10 each made for the purpose of redemption of preference shares as per Board’s Resolution preference shares as per Board’s Resolution dated…………).dated…………).

20,00020,00020,000 20,000


Preference shareholders A/c …………………Dr.Preference shareholders A/c …………………Dr. To Bank A/c To Bank A/c(Being the amount due to preference shareholders paid)(Being the amount due to preference shareholders paid)

20,00020,00020,000 20,000

Example 2.Kitkat Co. Ltd. Issued 50,000 Equity shares of Rs.10 each and 3000, 10% Preference shares of Rs.100 each, all shares being fully paid. On 31.3.08, Profit and Loss Account showed an undistributed profit of rs.50,000 and General Reserve Account stood at Rs.1,20,000. On 2.4.08, the directors decided to issue 1500, 6% Preference shares of Rs.100 each for cash and to redeem the existing preference shares at Rs.105 utilizing as much as would be required for the purpose. Show the journal entries to record the transactions.

Solution:

Journal Entries in the Books of Kitkat Ltd.


Dr. (Rs.) Dr. (Rs.) Cr. (Rs.) Cr. (Rs.)


10% Preference share capital A/c …………….Dr. 10% Preference share capital A/c …………….Dr. Premium on Redemption of Preference shares capital Premium on Redemption of Preference shares capital A/c………………..Dr. A/c………………..Dr. To Preference shareholders A/c To Preference shareholders A/c (Being amount payable on redemption of 3000 preference (Being amount payable on redemption of 3000 preference shares, with premium of 5%).shares, with premium of 5%).

3,00,0003,00,000

15,000 15,000 3,15,000 3,15,000


Dr.Dr.(Rs.) (Rs.)

Cr.Cr.(Rs.) (Rs.)

" " Bank A/c ……………………………………...Dr.Bank A/c ……………………………………...Dr. To 6% Preference Share Capital A/c To 6% Preference Share Capital A/c (Being the amount received on issue of 1500, 6% Preference (Being the amount received on issue of 1500, 6% Preference shares of Rs.100 each made for the purpose of redemption of shares of Rs.100 each made for the purpose of redemption of preference shares as per Board’s Resolution dated…………).preference shares as per Board’s Resolution dated…………).

150,000150,000

150,000 150,000

" " General Reserve A/c …………………………..Dr.General Reserve A/c …………………………..Dr. To Premium on Redemption of Preference shares capital A/c To Premium on Redemption of Preference shares capital A/c(Being the amount written off against general reserve)(Being the amount written off against general reserve)

15,00015,000

15,000 15,000

" " General Reserve A/c …………………………Dr.General Reserve A/c …………………………Dr.Profit & Loss A/c …………………………….Dr.Profit & Loss A/c …………………………….Dr. To Capital Redemption Reserve A/c To Capital Redemption Reserve A/c( Being amount transferred equal to the difference between the ( Being amount transferred equal to the difference between the nominal value of shares redeemed and proceeds of new issue).nominal value of shares redeemed and proceeds of new issue).

105,000105,000

45,000 45,000 150,000 150,000

" " Preference shareholders A/c …………………Dr.Preference shareholders A/c …………………Dr. To Bank A/c To Bank A/c(Being the amount due to preference shareholders paid).(Being the amount due to preference shareholders paid).

315,000315,000

315,000 315,000

Example 3.The preference shares were redeemed on April 1, 2008 at a premium of Rs.5.00 per share, the whereabouts of the holders of 1500 such shares not being known. At the same time, a bonus issue of equity share was made at par, one share being issued for every four equity shares held. Show the journal entries to record the above transactions and the Balance sheet as it would appear after the redemption. The following is the balance sheet of Black Diamond Co. Ltd. As at 31 st March,2008.

Liabilities Liabilities AmountAmount(Rs.) (Rs.)

Assets Assets AmountAmount(Rs.) (Rs.)

Issued & Subscribed Capital:Issued & Subscribed Capital: 40,000 Equity shares of Rs.10 each fully paid40,000 Equity shares of Rs.10 each fully paid18,000, 8% Preference shares of Rs.10 each 18,000, 8% Preference shares of Rs.10 each fully paid fully paid Reserves & Surplus:Reserves & Surplus: Profit & Loss AccountProfit & Loss AccountCurrent Liabilities:Current Liabilities: Sundry CreditorsSundry Creditors

4,00,000 4,00,000

1,80,000 1,80,000

4,80,000 4,80,000

40,000 40,000

Fixed AssetsFixed Assets

Current Current Assets Assets

7,00,0007,00,000

4,00,000 4,00,000

11,00,000 11,00,000 11,00,000 11,00,000

Solution:Journal Entries in the Books of Black Diamond Ltd.


Dr.Dr.(Rs.) (Rs.)

Cr.Cr.(Rs.) (Rs.)

2008 2008 April April 1 1

8% Preference share capital A/c …………….Dr.8% Preference share capital A/c …………….Dr.Premium on Redemption of Preference shares capital Premium on Redemption of Preference shares capital A/c………….Dr.A/c………….Dr. To Preference shareholders A/c To Preference shareholders A/c(Being amount payable on redemption of 18000 preference (Being amount payable on redemption of 18000 preference shares, with premium of Rs.5 each).shares, with premium of Rs.5 each).

1,80,0001,80,000

90,000 90,000 270,000 270,000

" " Profit And Loss A/c …………………………Dr.Profit And Loss A/c …………………………Dr. To Premium on Redemption of Preference shares capital To Premium on Redemption of Preference shares capital A/cA/c(Being the amount written off against Profit And Loss A/c) (Being the amount written off against Profit And Loss A/c)

90,00090,000

90,000 90,000

" " Profit & Loss A/c …………………………….Dr.Profit & Loss A/c …………………………….Dr. To Capital Redemption Reserve A/c To Capital Redemption Reserve A/c( Being amount transferred equal to the nominal value of ( Being amount transferred equal to the nominal value of shares redeemed and proceeds of new issue). shares redeemed and proceeds of new issue).

1,80,0001,80,0001,80,000 1,80,000

Date Date Particulars Particulars LLF F

Dr.Dr.(Rs.) (Rs.)

Cr.Cr.(Rs.) (Rs.)

"" Capital Redemption Reserve A/c…………..Dr.Capital Redemption Reserve A/c…………..Dr. To Bonus to Shareholders A/c To Bonus to Shareholders A/c(Being issue of 1 bonus share to every 4 equity shares held (Being issue of 1 bonus share to every 4 equity shares held as per shareholders Resolution No. Dated…) as per shareholders Resolution No. Dated…) 40,000x1/4xRs.10 40,000x1/4xRs.10

1,00,000 1,00,000 1,00,000 1,00,000

" " Bonus to Shareholders A/c ………………….Dr.Bonus to Shareholders A/c ………………….Dr. To Equity Share capital A/c To Equity Share capital A/c(Being the amount capitalised by issue of bonus shares) (Being the amount capitalised by issue of bonus shares)

1,00,000 1,00,000 1,00,000 1,00,000

" " Preference shareholders A/c …………………Dr.Preference shareholders A/c …………………Dr. To Bank To Bank(Being the amount due to preference shareholders paid (Being the amount due to preference shareholders paid except 1500 share holders). except 1500 share holders).

2,47,000 2,47,000 2,47,000 2,47,000

Balance sheet of Black Diamond Co. Ltd. as at 1st April, 2008.

Liabilities Liabilities AmountAmount(Rs.) (Rs.)

Assets Assets AmountAmount(Rs.) (Rs.)

Issued & Subscribed Capital:Issued & Subscribed Capital: 50,000 Equity shares of Rs.10 each fully paid50,000 Equity shares of Rs.10 each fully paid(of the above shares, 10,000 shares have been allotted (of the above shares, 10,000 shares have been allotted as fully paid bonus shars) as fully paid bonus shars) Reserves & Surplus:Reserves & Surplus: Capital Redemption Reserve Account (Rs.180000-Capital Redemption Reserve Account (Rs.180000-100000)100000)

Profit & Loss Account (Rs.480000-90000-180000)Profit & Loss Account (Rs.480000-90000-180000)Current Liabilities:Current Liabilities: Sundry CreditorsSundry CreditorsOutstanding claim (Pref. Shareholders)Outstanding claim (Pref. Shareholders)

5,00,000 5,00,000

80,000 80,000

2,10,000 2,10,000

40,000 40,000 22,500 22,500

Fixed AssetsFixed Assets

Current Current Assets Assets (Rs.400000-(Rs.400000-247500) 247500)

7,00,0007,00,000

4,00,000 4,00,000

8,52,500 8,52,500 8,52,5000 8,52,5000

Presentation Made By :Presentation Made By :

Arunima JainArunima Jain

accounts - redemption of preference share

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