redemption of preference shares and bonus issue

Prof. M. C. Sharma 1

Redemption of Preference Shares and

Bonus Issue

M. C. SharmaAssociate Professor

Department of CommerceShaheed Bhagat Singh Evening College

(University of Delhi), Delhi, INDIA


Meaning of Preference Shares

Preference shares are those shares which have the two preferential rights:

(1)A right to receive dividend at a given rate before any dividend is paid on equity shares; subject to declaration by the company. Rate of dividend is mentioned on the face of the share certificate.

For example – 12% Preference Shares.

Here, 12% is rate of dividend.

(2)A right to repayment of capital before equity shareholders at the time of liquidation of the company.


Types of Preference Shares• Cumulative Preference Shares

– If dividend is not paid on such shares, the arears of dividend are carried forward and are paid in subsequent years.

– All preference shares are cumulative unless clearly stated to be non-cumulative.

• Non-cumulative Preference Shares– Dividend is paid out of the each year’s profits. – If dividend is not paid on such shares, the right to

dividend lapses.– It is not carried as arrears.


Types of Preference Shares (Contd.)

• Participative Preference Shares

– In addition to basic preferential rights, such shares

also carries (a) the right to participate in surplus

profits left after payment of preference and equity

dividend, and (b) in the event of winding up, the right

to participate in the surplus assets left after

repayment of preference and equity capital.



• Non-Participative Preference Shares

– Such preference shares have only basic preferential

rights and no additional rights to participate in surplus

profits and surplus assets.



• Convertible Preference Shares

A convertible preference share gets the right of

conversion into equity share.

• Non-convertible Preference Shares–A non-convertible preference share does not have the

right of conversion into equity share.

–All preference shares are non-convertible unless

clearly stated to be convertible.



• Redeemable Preference Shares

On such preference shares, the amount is refunded in

accordance with Sec. 55 of the Companies Act 2013.

• Irredeemable Preference Shares

Irredeemable preference shares can not be redeemed

during the life of the company.

A company limited by shares cannot issue irredeemable

preference shares in India.


Redemption of Preference Shares – Important Provisions

• Redemption of preference shares means repayment of

preference share capital to preference shareholders.

• The Companies Act 2013 allows the issue of redeemable

preference shares if articles of association of the company

so authorise or permit.

• No company limited by shares shall, after the

commencement of this Act, issue any preference shares

which are irredeemable.


Redemption of Preference Shares – Important Provisions

• The preference shares must be redeemed within a period 20

years from the date of issue of such shares. [Sec. 80(5A)]. To

finance infrastructure projects, a company can issue preference

shares for exceeding 20 years but not more than 30 years.

• According to rule 10 of the Companies (Shares and Debentures)

Rules 2014, the tenure of such preference shares cannot exceed

30 years and the company shall redeem every year at least 10%

of such preference shares.


Conditions of Redemption [Sec. 55]

1. Such shares must be fully paid.

• Partly paid preference shares must be made fully

paid before redemption by making final call due

and received.

• In case of calls in arrear, such shares can not be

redeemed till they are made fully paid.


Conditions of Redemption [Sec. 55]

2. Such shares can be redeemed out of distributable

profits or out of the proceeds of a fresh issue of shares

made for the purpose of redemption.

Distributable or divisible profits:

Profits which can be distributed as dividend.(Capital

Redemption Reserve can be created by transfer from

divisible profits only)


• Examples Distributable or divisible profits:

– Surplus in the Profit and Loss A/c

– General Reserve or Reserve Fund

– Dividend Equalisation Reserve.

– Insurance Fund or Reserve, Workmen Compensation

Fund, Contingency Reserve, Provision for doubtful

debts, Provision for Taxation (Only in excess of the

required provision or a liability against such Reserve or

Fund can be used to create CRR.)


• Non-distributable profits: Profits which can not be distributed as dividend. (Transfer to CRR is not allowed from these accounts)

• Examples:–Securities Premium A/c–Capital Reserve –Pre-incorporation Profits–Share Forfeited A/c–Revaluation Reserve–Profit on sale of Fixed Assets/Investments–Debenture Redemption Reserve (DRR)–Investment Allowance Reserve–Development Rebate Reserve (Dev. RR)(Investment Allowance Reserve and Dev. RR are available for CRR, only when specified in the question)


3. Any premium payable on redemption of such shares shall be

provided from out of the security premium account or out of the

profits.

4. When preference shares are redeemed out of the profits, an

amount equal to the face value of such shares redeemed shall

be transferred from the distributable profits to Capital

Redemption Reserve (CRR) Account.

5. The amount credited to CRR may be used by the company only

by way of issue of fully paid bonus shares.

Conditions of Redemption (Contd.)


Calculation of Capital Redemption Reserve (CRR) and Net Proceeds from Fresh Issue

• CRR required = Nominal Value of Preference Shares to be redeemed – Net Proceeds from Fresh Issue of Shares

• Net Proceeds from Fresh Issue of Shares = Nominal Value of Shares issued (Premium on such issue, if any, is to be ignored)If new shares issued are partly paid, then only the paid up nominal amount should be considered.

• Fresh Shares to be issued = Nominal Value of Preference Shares to be redeemed – Profits available for CRR.

Illustration 1:Calculate net proceeds from fresh issue:

1. Issued 1,50,000 shares of Rs. 10 each at par

2. Issued 1,50,000 shares of Rs. 10 each at a premium of

Rs. 2 per share

3. Issued 1,50,000 shares of Rs. 10 each at par, only Rs. 8

called and paid.

4. Issued 1,50,000 shares of Rs. 10 each at a premium of

Rs. 2 per share. Only Rs. 9 including premium is called

and paid.Prof. M. C. Sharma 16

Illustration 1:Calculate net proceeds from fresh issue:

Answer:

(1)15,00,000;

(2)15,00,000;

(3)12,00,000;

(4)10,50,000.


Illustration 2Calculate the amount of CRR required in the following cases:

Preference Shares to Be redeemed

Fresh issue of share capital

1. Rs. 12,00,000 at par Rs. 10,00,000 at par

2. Rs. 15,00,000 at a premium of 5% Rs. 10,00,000 at par

3. Rs. 12,00,000 at par Rs. 9,00,000 at premium of 10%

Answer:

1. Rs. 2,00,000

2. Rs. 5,00,000

3. Rs. 3,00,000


Journal Entries

1. If redeemable preference shares are not fully

paid, then to make them fully paid, a final call

should be made and received:


(a) Pref. Share Final Call A/c

To Pref. Share Capital A/c

Dr.

(b) Bank A/c

To Pref. Share Final Call A/c

Dr.

Journal Entries

2. If there is calls-in-arrear on some shares:

• EITHER such amount shall be received,

• OR such shares shall be forfeited and then re-issued

before redemption.

• Entries shall be passed accordingly.


Journal Entries (Contd.)


3. For sale of assets/investments to arrange cash for

redemption

Bank A/c

To Assets or Investment A/c

Dr.

* Any loss on sale of assets/investments shall be

debited to Surplus (Profit and Loss A/c).

* Any Profit on sale of assets/investments shall be

credited to Capital Reserve.



4. For issue of debentures, if any

Bank A/c

To Debentures Application A/c

Dr.

Debentures Application A/c

To Debentures A/c

Dr.



5. For issue of new shares, if anyBank A/c

To Share Application & Allotment A/cDr.

Share Application & Allotment A/cTo Share Capital A/cTo Securities Premium A/c (if any)

Dr.

6. For making due redemptionRedeemable Pref. Share Capital A/c*Premium on Redemption on of Pref. Shares A/c

To Preference Shareholders A/c* If preference shares are redeemed at premium.

Dr.Dr.



7. For writing off Premium on Redemption, if any

Securities Premium A/cCapital Reserve A/c*General Reserve A/cSurplus A/c

To Premium on Redemption of Pref. Shares A/c

Dr.Dr.Dr.Dr.

*

*

Above order or preference is not legally required. It is desirable that minimum use of free reserve or divisible profits is made for this purpose.Capital reserve (profit) can be used only if it was realised in cash.



8. For arrangement of bank loan or bank overdraft, if required

Bank A/c

To Bank Loan or Bank Overdraft A/c

Dr.

9. For payment to Preference Shareholders

Preference Shareholders A/c

To Bank A/c

Dr.

Redemption of Preference Shares by Conversion

• Preference shares may be redeemed by

conversion into equity shares. Such preference

shares are Convertible Preference Shares.

• When Preference shares are redeemed by

conversion, there is no need to create Capital

Redemption Reserve.


Journal Entries for Redemption by Conversion


1. For making due redemption

Pref. Share Capital A/c

*Prem. On Redemption of Pref. Shares A/c

To Preference Shareholders A/c

* If preference shares are redeemed at

premium.

Dr.

Journal Entries for Redemption by Conversion


2. For issue of equity shares at par


To Equity Share Capital A/c

Dr.

3. For issue of equity shares at premium



To Securities Premium A/c

Dr.

Issue of Bonus Shares• Capital Redemption Reserve (CRR) and

Securities Premium can be used for issue of fully

paid bonus shares.

• Free reserves and surplus can be used to pay

bonus to shareholders either to issue fully paid

bonus shares or to make existing partly paid

shares as fully paid up.


Journal Entries for Issue of Bonus Shares (Contd.)


3. When Bonus to shareholders is declared

Capital Redemption Reserve A/c

Securities Premium A/c

General Reserve A/c

Surplus OR Divisible Profits A/c

To Bonus to Shareholders A/c

Dr.

Dr.

Dr.

Dr.

2. For issue of fully paid bonus shares

Bonus to Shareholders A/c


Dr.

Journal Entries for Issue of Bonus Shares


3. When Bonus to shareholders is used to make existing partly

paid shares as fully paid up:

(a) For making final call due

Equity Share Final Call A/c


Dr.

(b) For adjusting bonus to shareholders against

final call due:

Bonus to Shareholders A/c

To Equity Share Final Call A/c

Dr.

redemption of preference shares and bonus issue

Business