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Financial Accounts


  • 1.Buy- Back of Shares andRedemption of Preference shares Concepts, accounting treatment, Income tax applications. By Prof.Augustin Amaladas M.Com., AICWA.,PGDFM.,B.Ed. Prof. Shanthi Augustin M.Com., M.Phil., MBA., B.Ed.

2. An old lady, with shabby looks was picking up something from the sea shorebut the people, scared of her, did not allow their children to go near her. What was she picking? Why were the people scared of her? 3. Did she pick upShells or Stones? Think, before having a look at the next slide. 4. She picked up broken pieces of glass Why did she pick up these? 5. So that these piecesshould not harm the children. Judge not by the looks or colour!!!!! 6. Meaning of Redemption

  • Pay back the capital before winding up either by cash or conversion of preference shares into equity shares or pay cash to such share holders.

7. Buy- Back of shares-Meaning

  • Take back the equity shares from market or shareholders by paying cash and reduce equity shares available in the share market. It isalso known as astock repurchase .
  • , cash is exchanged for a reduction in the number of shares outstanding. The firm either retires the shares or keeps them as treasury stock, available for re issuance.

8. Methods of pr-purchase of shares in the USA

  • 1. Open market share purchase:
  • 95% of repurchase is done through this method
  • Daily re-purchase of shares from market is limited
  • The company may not openly announce that it will re-purchase shares from open market

9. 2. Fixed price tender offer

  • Single purchase price and number of shares sought are mentioned.
  • Person would like to sell to the company should come with offer of the price and number of shares that he offers to the company.
  • If offer from public exceeds than shares sought it may buy on pro rata basis.

10. Method-3.Dutch auction share repurchases

  • Range of prices that the company would like to re-purchase are mentioned in the offer. Shareholders can indicate their prices within the rage prescribed.
  • Lowest bidder to highest price bidder are chosen
  • The company has right to cancel the entire offer if a few take holders.

11. 4.Equal access buy-backs

  • All share holders have given equal opportunity to sell shares to the company.

12. 5.Selective buy-backs

  • In broad terms, a selective buy-back is one in which identical offers are not made to every shareholder, for example, if offers are made to only some of the shareholders in the company. The scheme must first be approved by all shareholders, or by a special resolution (requiring a 75% majority) of the members in which no vote is cast by selling shareholders or their associates. Selling shareholders may not vote in favour of a special resolution to approve a selective buy-back

13. Employees stock option re-purchase

  • A company may also buy back shares held by or for employees or salaried directors of the company or a related company. This type of buy-back, referred to as anemployee share scheme buy-back , requires an ordinary resolution

14. on-market buy-backs and minimum holding buy-back

  • A listed company may also buy back its shares in on-market trading on the stock exchange, following the passing of an ordinary resolution.The stock exchanges rules apply toon-market buy-backs .
  • A listed company may also buy unmarketable parcels of shares from shareholders (called aminimum holding buy-back ). This does not require a resolution but the purchased shares must still be cancelled.

15. Contradicting sections on Buy- back of shares in India

  • Section 77 of the Companies Act does not allow a company to buy its own shares until the winding up of companies.
  • but the subsequent Section 77A permits buyback subject to certain conditions. What is the rationale behind?

16. Section-77 of the Companies Act

  • Most of the sections in the Companies Act tries to protect the interest of the outsiders who had lent money in the form of debentures or loans or deposits by restricting company not to pay unless outsiders(loan vendors) are paid fully.
  • Share holders are paid last and has taken maximum risk in the company.

17. Other sections to protect the interest of outsiders

  • Section 80 of the Companies Act 1956:-
  • Redemption of preference shares:-
  • Preference shares can be redeemed out of fresh issue of shares or divisible profits which are normally available for the declaration of dividend or both(Partly by fresh issue of shares and divisible profits)
  • Preference shares can not be redeemed out of fresh issue of Debentures. Why?

18. Debentures can not be issued to redeem preference shares

  • Debentures are loan funds from outsiders which will reduce long term solvency of the existing debenture holders of the company.More debt will reduce credit worthiness further.
  • If further shares are issued for redemption of preference shares, one type of own funds go out and another type of own funds come to the company which do not affect credit worthiness of existing debenture holders. Law tries to protect the existing debenture holders.It is the reason Section 77 says own capital can not be returned before making payment to debenture holders.

19. Rules for redemption of preference shares

  • Section-80 of the Companies Act:
  • Rule 1:
  • Only fully paid preference shares can be redeemed- Why?
  • When preference shares are issued, it was assured that all money ie to the extent of nominal value of shares will be received by the company.It is a statutory liability of every shareholders to pay fully to the extent of nominal value of shares. The debenture holders are given security not only on the present assets but also future assets that will be realised from partly paid up preference shares.There is a legal obligation on the part of the company to receive the balance of amount from preference share holders before winding up.

20. Rule-2

  • No company can issue any preference shares, shall issue any preference shares which is irredeemable or redeemable beyond 20 years

21. Rule-3

  • Preference shares can be redeemed either by fresh issue of shares or out of divisible profits or both.-Why?
  • Divisible profits is profits which are freely available for the declaration of dividend to shareholders. Only such profits which are free from all clutches can be used for redemption. How is it done? What is the logic?

22. What is the mechanism of using revenue profit to CRR account?

  • Revenue profits which are free for dividend have to be converted into Capital profit.The converted capital profit is known as Capital Redemption Reserve fund.Capital redemption funds(CRR) are used to capitalise proft into fully paid up bonus shares. It means revenue profit becomes shares which will be with the firm for ever and gives effective protection to existing Debenture holders.
  • Journal entry:
  • Profit and loss Account Debit
  • Capital Redemption Account credit
  • It means reduce revenue profit and increase Capital profit.otherwise share holders will ask the company to declare dividend out of revenue profit.

23. If there is no revenue profits?

  • Go for fresh issue of shares. It can be equity or preference.It should not be debentures or loan funds.

24. If free reserves used For redemption CRR to Fully paid up Bonus shares Bonus shares toEquity shares Revenue profit toBe transferred toCRR account Steps from Left to right Redemption ofPreference shares 25. If fresh issue of shares Issued for redemption withCRR Cash received to the extend ofNominalvalueof shares Premium on issue to be accountedseparately + CRR = Nominal value of Redeemable preference shares Note 26. Divisible profits or Profits for redemption 1.Profit and loss Account 2.Reserves 3.Investment fluctuationReserve 4.Dividend equalisationreserve 1.Security premium 2.Capital RedemptionReserve Account 3.Development rebate reserve 4. Capital profits/reserve 6. Statutory reserve 7. Profits prior to Incorporation Not divisible/Capitalprofits Kept in the company for ever (Married) Can be used for any purpose (bachelor) 27. If loss occurred due to sale ofAny asset Set off such capital withCapital reserve If not enough Set off against revenue Profit. the balance isDIVISIBLE PROFITS 28. Premium on redemption To be set off against existingsecurity premium account and newSecurity premium on fresh issue of shares If not enough Reduce such deficit with revenue profitsThen calculate divisible profits. 29. Amalgamation cost of acquisition of the asset of old company deemed to be the cost of acquisition of the new company(continuing company conversion of bonds or debentures, debenture-stockthe cost of acquisition of the asset to the assessee shall be deemed to be that part of the cost of debenture, debenture- stock or deposit certificates in relation to which such asset is acquired by the assessee.If Section 2(1B) is fulfilled it does not attract capital gain as per Income tax Actto share holders. Section 2(1B) states that all assets and liabilities to be transferred to the new company and the new company should be an Indian company. At least 75% of share holders should be the shareholders of the new company(acquiring company) 30. Demerger

  • The cost of acquisition of the shares in the resulting company shall be the amount which bears to the cost of acquisition of shares, held by the assessee in the demerged company.
  • No capital gain to the share holder who exchange shares if all conditions are fulfilled.

31. Buy back of shares( Sec.77A)

  • Why buy back of shares introduced in India?
  • In late 1996-1999 Indian share market did not move. People hesitate to buy and people were not interested in sell shares as they felt that share market might go up. It is one of the mechanism to make the market to be vibrant in such situation.How?

32. How?

  • When shares were issued at premium, the company earned capital profits. If shares are quoted in the market less than nominal value or a little above nominal value the company has a chance tore-purchase such shares from market at low price and cancel such shares from the share capital. The remaining share holders value go up because net worth of the firm remain almost the same to the remaining number of shares.


  • to allow promoters to get a better hold on the company.
  • To wit, if the existing promoters in the saddle are having 20 per cent of the shares and the company announces a 20 per cent buyback in which obviously the promoters will not participate, the bottomline would be their stake now going up to 25 per cent (20 divided by 80).
  • There cannot be a simpler and less expensive way of beefing up one's control in a company. In fact the promoters gain at the expense of the company whose cash is used in bankrolling this exercise.

34. Buy back of shares

  • Sec.46A (Income tax act and share holders point of view)
  • Transfer in the year of buy back
  • Capital gain=consideration received minus cost of acquisition(Index if long term)

35. Buy back and Companies Act

  • Section-77A(since 1999)
  • Sources for buy back
  • Free reserves(divisible profit)
  • The security premium account
  • Fresh issue of shares(ESOP other securities)

36. Maximum Buy back

  • Upto 25% of total paid up share capital and free reserves.

37. Other conditions

  • 1. Debt equity ratio should not be more than 2:1 after buy back
  • (all secured and unsecured debts are included)
  • 2. All the shares other securities are fully paid up( It is same like redemption of preference shares)
  • 3. Such securities are to be listed on recognised stock exchange
  • 4. If free reserves used the amount used for such purpose to be transferred to Capital Redemption Reserve Account.

38. Buy-Back from whom?

  • 1. Existing security holders on a proportional basis
  • 2. From open market
  • 3. ESOP
  • 4.If listed securities smaller than such buy back, as prescribed by Stock exchange.

39. Thank you Help your father/mother in cooking Do your house hold work Without giving excuses.