MCom I Semester Corporate Accounting Redemption Preference Shares Study Material Notes

MCom I Semester Corporate Accounting Redemption Preference Shares Study Material Notes:  condition of Redemption fo Preference Shares Journal Entries  Augmenting Liquid Balance Sheet Long Answer Questions Short Answer Question Objectives Questions:

CTET Paper Level 2 Previous Year Science Model paper II in Hindi

Redemption of Preference Shares

Redemption of preference shares implies paying back by a company the amount of its preference shareholders. Section 80 of Indian Companies Act, 1956 provides that a company limited by shares may, so authorized by its Articles, issue redeemable preference shares. By virtue of sub-section (SA) of section 80 inserted by the Companies (Amendment) Act, 1996, which came into force on 1-3-97, no company can issue any preference share, which is irredeemable or is redeemable after the expiry of 20 years from the date of its issue.

Conditions for Redemption of Preference Shares

Preference shares can be redeemed either at the option of the company or after the expiry of an stipulated period of time without the permission of the Court as required under Section 100. But such redemption is subject to the following legal restrictions :

(1) No such shares can be redeemed unless they are fully paid. As such, redemption of redeemable partly paid preference shares is not allowed.

Explanatory Notes : (i) If only partly paid preference shares are given in the examination problem and it is required to redeem these shares, then it will be presumed that the company has made and received the final call on these shares before their redemption.

(ii) If both partly paid and fully paid preference shares are given in the examination problem then in the absence of any specific instruction, it will be presumed that only fully paid preference shares are required to be redeemed.

(2) Such shares can be redeemed either (a) out of the profits of the company, which would otherwise be available for dividend, or (b) out of the proceeds of a fresh issue of shares made for the purpose of redemption.

Explanatory Notes.

(i) Such shares can be redeemed out of the proceeds of a fresh issue of shares, whether preference or equity, but certainly not out of the proceeds of borrowings, loans or debentures or of any property of the company.

(ii) No where in the Act, the phrase “proceeds of fresh issue” has precisely been defined. As such, there is much scope for confusion as to what constitute the proceeds of fresh issue in various circumstances like issue of shares – (a) at par, (b) at premium or (C) at discount. If the fresh issue is at par then the nominal value of shares issued will constitute the proceeds of fresh issue. If the fresh issue is at premium then also the nominal value of shares issued (i.e., excluding the amount of securities premium) should be treated as the proceeds of fresh issue. The securities premium is excluded because firstly, Section 78 (2) of the Act has clearly specified the four purposes for which this amount can be utilised and the use of this amount for redemption purposes is outside the scope of the four purposes. So, if securities premium account is used for redemption purposes, it will amount to reduction of capital. Secondly, since securities premium can be utilised for the various purposes as stated under Section 78 (2), it can not be treated as substitute for paid-up capital and so the security available to creditors may be reduced later on by the amount of premium utilised for these purposes. If the fresh issue is at discount then net amount received on issue of shares (not the nominal value of shares) should constitute the proceeds since the amount of discount does not represent tangible assets capable of providing protection to the creditors.

(iii) Such shares may also be redeemed partly out of profits and partly out of the proceeds of a fresh issue of shares.

(iv)  In the examination problem, existence of profits may be assumed if preference shares are conceded without issue of fresh shares.

(v) The use of general reserve for redemption of preference shares would not be desirable as long as were is a balance in profit and loss account.

(3) Where any such shares are redeemed out of profits, a sum equal to the nominal amount of the lates so redeemed must be transferred out of the profits of the company, which would otherwise be available for dividend to a reserve account called “Capital Redemption Reserve Account”, otherwise such redemption would involve a reduction of share capital. Examples of profits available for dividend are general reserve, reserve fund, contingency reserve, dividend equalisation fund, insurance fund, workmen’s compensation fund, workmen’s accident fund, voluntary debenture sinking fund, profit and loss account etc. But capital profits such as share forfeiture account, securities premium account, development rebate reserve, capital reserve, investment allowance reserve, profit prior to incorporation etc. are not available for dividend.

(4) If such shares are redeemable at premium then such premium must be provided for out of the profits of the company or out of the company’s securities premium account, before the shares are redeemed.

Explanatory Note : Any balance on securities premium account, whether arising in connection with the fresh issue of shares made for the purpose of redemption of preference shares or any other previous issue, may be applied in providing the premium on the redemption of redeemable preference shares. Although there is no compulsion to utilise this account for this purpose but it would be wise to take advantage of the opportunity to do so, as the utilisation of this account is very much limited. As such, in the examination problem, balance of securities premium account should be applied for this purpose in priority to profits or any other reserve of the company.

(5) The Capital Redemption Reserve Account can be used for issuing fully paid bonus shares to the shareholders of the company. Otherwise, it must be maintained intact unless otherwise sanctioned by the Court. It is quite obvious that partly paid up shares can not be made fully paid up by the issue of bonus shares out of Capital Redemption Reserve Account.

(6) Redemption of preference shares shall not be taken as reduction of the amount of its authorised share capital. So, such reduced shares shall remain part of the authorised capital in the balance sheet. The company shall have the power to issue upto the nominal amount of the shares redeemed or to be redeemed as if those shares had never been issued.

(7) If new shares are issued for the purpose of redemption of preference shares, it will not be treated as increase of capital for the purpose of capital duty under Section 611. But where the new shares are issued before redemption, they are not exempted from capital duty unless the redeemable preference shares are redeemed within one month.

(8) If a company fails to comply with provisions of this section, the company and every officer of the company who is in default shall be punishable with fine, which may extend to one thousand rupees.

The Intention of Section 80: The intension of the provisions of Section 80 is to protect the interest of creditors of the company by keeping the share capital intact even after the redemption of redeemable preference shares. When the redemption is made by the fresh issue of shares, the same amount of share capital (though not necessarily the same class of share capital) is maintained intact. Similarly, when the redemption is made out of divisible profits, Capital Redemption Reserve Account takes the place of Redeemable Preference Share Capital Account after the redemption. There is no depletion of the company’s assets after the redemption since Capital Redemption Reserve Account is created by retaining! permanently the profits, which may be paid to shareholders by way of dividend at any time. The purpose of disallowing the redemption of partly paid redeemable preference shares is also to protect the interest of the creditors who calculate the security of their loans on the basis of the face value of the issued capital. If redemption of partly paid shares is allowed, it would mean replacement of only the paid-up value of such shares and uncalled amount of such shares, which the creditors may expect to receive upon the liquidation of the company, will never be available to them after the redemption.

5. If the company utilises the amount of Capital Redemption Reserve Account in issuing fully paid ares to its shareholders, the following journal entries are made :

(i) Capital Redemption Reserve Account                    Dr.

To Bonus to Shareholders Account

(ii) Bonus to Shareholders Account                             Dr.

To Share Capital Account

Some Important Notes:

(1) Untraceable Shareholders : It may be that after giving notice, some preference shareholders could not be traced and so their amount can not be paid to them. This amount will remain in the Balance Sheet under current liabilities in, say, Preference Shareholders Account.

(2) Calls-in-Arrears : It may be that some of the preference shareholders might not have paid some of the calls made on their shares, in such a case :

(i) Only that portion of the capital is to be replaced out of proceeds of fresh issue and free reserves, which are fully paid.

(ii) The partly paid preference shares would be redeemed only when their amount of unpaid calls is collected by the company. The unredeemed preference shares would continue to be shown under share capital of the company until the calls-in-arrears are received.

(iii) To protect the interest of creditors, the company should accumulate sufficient balance in divisible profits accounts for the unredeemed preference share capital so that when calls-in-arrears are collected on these preference shares, the company could capitalise the divisible profits by creating a Capital Redemption Reserve Account equal to the nominal value of unredeemed preference shares. However, it is advisable that full capital redemption reserve should be created in the beginning for all the preference shares, if forfeiture of defaulting shares is not intended and the redemption is out of profits.

(3) Forfeiture of Shares: If the company has forfeited the defaulting shares then the question of their redemption does not arise. It is unlikely that such forfeited shares will be reissued because of immediate redemption of rest of the preference shares. Hence, it is necessary to make arrangement for all the preference shares including the forfeited shares to protect the interest of the creditors. If, however, such forfeited shares have been reissued as fully paid up then these shares will be redeemed like other preference shares.

Redemption of Preference Shares at Par

Illustration 1, Pass necessary journal entries in each of the following cases : (A) Komalika Ltd. had issued 10,000, 8% Redeemable Preference Shares of Rs. 100 each which are redeemable at par on January 1, 2006. In order to meet this obligation, the company decides to issue 50,000 fresh equity shares of Rs. 10 each at Rs. 12 and 5,000 9% preference shares of Rs. 100 each at Rs. 110. The whole amount is received in cash and 8% preference shares are redeemed. Show the necessary Journal entries in the books of the company.

(B) Goodluck Ltd. issued on 1-1-1993 10,000, 8% Redeemable Preference Shares of Rs. 100 each, redeemable at par on January 1, 2006. The company has a credit balance of Rs. 8,00,000 in Profit and Loss Account and Rs. 5,00,000 General Reserve. Show necessary entries in the books of the company for the redemption of 8% preference shares.

Redemption of Preference Shares at Premium

Illustration 3. Pass the necessary journal entries in the books of the company in connection with redeemable preference shares in the following cases, assuming sufficient balance of profits:

(1) For payment of 200, 12% redeemable preference shares of Rs. 100 each at a premium of 10%, the company used its profits.

(2) For payment of 200, 12% redeemable preference shares of Rs. 100 each at a premium of 5%, the company issued 2,000 equity shares of Rs. 10 each at a premium of 10%.

(3) For payment of 2,000, 12% redeemable preference shares of Rs. 500 each at a premium of 15%, the company issued 1,15,000 equity shares of Rs. 10 each at par.

(4) The company issued 2,000 equity shares of Rs. 10 each at a premium of Rs. 2 per share for cash to redeem at par 3,000, 14% redeemable preference shares of Rs. 10 each.

(5) For payment of 1,000, 12% redeemable preference shares of Rs. 100 each at a premium of 15%, the company issued 5,000 equity shares of Rs. 10 each at a discount of 10%.