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TOPIC 4: REDEMPTION OF SHARES

TOPIC 4: REDEMPTION OF SHARES. Company are only allowed to redeem preference share only. Redeemable Preference share issued with an intention to buy back shares at par or premium within the specific time (Sec 67A) Entitled to receive dividend until the date of redemption

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TOPIC 4: REDEMPTION OF SHARES

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  1. TOPIC 4: REDEMPTION OF SHARES • Company are only allowed to redeem preference share only. • Redeemable Preference share issued with an intention to buy back shares at par or premium within the specific time (Sec 67A) • Entitled to receive dividend until the date of redemption • Accounting treatment for redeemable preference shares is under the Sec 61, Companies Act 1961 and FRS 132: Financial Instrument; Disclosure and Presentation.

  2. FRS 132: (Para 20) The issuer of financial instrument should classify the instrument based by: • Substance of the contractual arrangement • Initial recognition • Definition of financial liability and an equity instrument)

  3. FRS 132: (Para 35) • Interest, dividend, losses and gains relating to financial instrument, or classified as financial liability should be reported in the income statement (an expense). • Distribution to holders of a financial instrument classified as equity instrument should be debited by the issuer directly to equity.

  4. The redemption of preference shares may effect the cash flow, in order to maintain the cash outflow the company can: • Fresh issue new share • Sell asset • Transfer profits earned to the capital redemption reserve. • Partly issue new share and partly freeze past profits. ** the idea is to maintain the capital structure intact

  5. Statutory Requirement (Sec 61 Co Act 1965) Rules regarding redemption of preference share: • No reduction on authorized share capital • Can be redeem by: - out of profits - out of issue new share • If redeem other than issue new share, an amount equal to nominal amount of share

  6. redeemed must be transferred out of profits to a capital redemption reserve (treated as capital to the company) • The premium payable on redemption should be provided for out of profits or out of share premium account. • Shares must be fully paid before the redemption. • Give 14 days notice to CCM specify the shares redeem.

  7. Issue in Redeemable Preference Shares “A financial instrument should be classified as liability or as a equity in accordance with the substance of the contractual arrangement on initial recognition and definitions of financial liability.” (Legal form of equity but are liabilities in substance)

  8. A Redeemable Preference Share should be classified as financial liability as in the substance aspect: • contractual obligation (mandatory) to redeem the shares • fixed/determined future amount • fixed/determined future date - the holder given right to require the issuer to redeem the share. - the terms and conditions are such that the issuer may have no choice but to voluntarily redeem it at some point of time.

  9. In the 132: • RPS is the financial liability • Dividend is treated as an expense in the Income Statement • Gain/ Loss on issuance or redemption is taken to Income Statement • Premium or discount payable on maturity will be amortized in Income Statement over the term of issue.

  10. In the Co’s Act 1965: • RPS must be disclosed as part of share capital (9th Schedule) • Issuer must maintain the capital structure after redemption. • Dividend is not treated as appropriation of profit not expense (9th Schedule) • Premium from issue of RPS and Premium from redemption is taken from the share premium account)

  11. RPS at premium – redeem at par AirBag Bhd issued 10,000,000 of RM1 each at the price of RM1.10 on 1st Jan 2003. The shares carry tax – exempt dividend rate of 10% and are due for mandatory redemption at par on 31 Dec 2007.

  12. Value on issue: RM10,000,000 + RM1,000,000 Value of Redemption: At par value = RM10,000,000 Dividend: 10% x RM10,000,000 = RM1,000,000

  13. Journal Entries On Issue of RPS: Dt Cash 11,000,000 Kt RPS (liability) 11,000,000 On annual dividend payable: Dt Dividend Exp 800,000 RPS (liability) 200,000 Kt Cash 1,000,000

  14. Workings: Straight Line Method

  15. Journal Entries On redemptions: Dt RPS (liability) 10,000,000 Cr Cash 10,000,000 For maintaining capital structure: Dt Retained Earn. 10,000,000 Cr CRR 10,000,000 OR Dt Cash 10,000,000 Cr OSC 10,000,000

  16. RPS Issued at par –redeem at premium AirBag Bhd issued 10,000,000 of RM1 each at par on 1st Jan 2003. The shares carry tax – exempt dividend rate of 10% and are due for mandatory redemption at premium RM1.20 on 31 Dec 2007

  17. Value on issue: RM10,000,000 Value of Redemption: At premium = RM10,000,000 + RM2,000,000 Dividend: 10% x RM10,000,000 = RM1,000,000

  18. Journal Entries On Issue of RPS: Dt Cash 10,000,000 Cr RPS (liability) 10,000,000 On annual dividend payable: Dt Dividend Exp 1,400,000 CrRPS (liability) 400,000 Cr Cash 1,000,000

  19. Workings: Straight Line Method

  20. Journal Entries On redemptions: Dt RPS (liability) 12,000,000 Cr Cash 12,000,000 For maintaining capital structure: Dt Retained Earn. 10,000,000 Cr CRR 10,000,000 OR Dt Cash 10,000,000 Cr OSC 10,000,000

  21. Journal Entries For writing off premium on redemptions: Dt SP 2,000,000 Cr Retained Earn. 2,000,000

  22. RPS Issued at par –redeem at par AirBag Bhd issued 10,000,000 of RM1 each at par on 1st Jan 2003. The shares carry tax – exempt dividend rate of 10% and are due for mandatory redemption at par on 31 Dec 2007

  23. Value on issue: RM10,000,000 Value of Redemption: At premium = RM10,000,000 Dividend: 10% x RM10,000,000 = RM1,000,000

  24. Journal Entries On Issue of RPS: Dt Cash 10,000,000 Cr RPS (liability) 10,000,000 On annual dividend payable: Dt Dividend Exp 1,000,000 Cr Cash 1,000,000

  25. Workings: Straight Line Method

  26. Journal Entries On redemptions: Dt RPS (liability) 10,000,000 Cr Cash 10,000,000 For maintaining capital structure: Dt Retained Earn. 10,000,000 Cr CRR 10,000,000 OR Dt Cash 10,000,000 Cr OSC 10,000,000

  27. RPS Issued at premium –redeem at premium AirBag Bhd issued 10,000,000 of RM1 each at premium of RM1.30 on 1st Jan 2003. The shares carry tax – exempt dividend rate of 10% and are due for mandatory redemption at premium of RM1.60 on 31 Dec 2007

  28. Value on issue: RM10,000,000 + RM3,000,000 Value of Redemption: At premium = RM10,000,000 + RM6,000,000 Dividend: 10% x RM10,000,000 = RM1,000,000

  29. Journal Entries On Issue of RPS: Dt Cash 13,000,000 Cr RPS (liability) 13,000,000 On annual dividend payable: Dt Dividend Exp 1,600,000 Cr RPS (liability) 600,000 Cr Cash 1,000,000

  30. Workings: Straight Line Method

  31. Journal Entries On redemptions: Dt RPS (liability) 16,000,000 Cr Cash 16,000,000 For maintaining capital structure: Dt Retained Earn. 10,000,000 Cr CRR 10,000,000 OR Dt Cash 10,000,000 Cr OSC 10,000,000

  32. Journal Entries For writing off premium on redemption: Dr S/Premium 3,000,000 Cr Retained Earn. 3,000,000

  33. If the redeem at price of RM1.10 Value on issue: RM10,000,000 + RM3,000,000 Value of Redemption: At premium = RM10,000,000 + RM1,000,000 Dividend: 10% x RM10,000,000 = RM1,000,000

  34. Journal Entries On Issue of RPS: Dt Cash 13,000,000 Cr RPS (liability) 13,000,000 On annual dividend payable: Dt Dividend Exp 600,000 DtRPS (liability) 400,000 Cr Cash 1,000,000

  35. Workings: Straight Line Method

  36. Journal Entries On redemptions: Dt RPS (liability) 11,000,000 Cr Cash 11,000,000 For maintaining capital structure: Dt Retained Earn. 10,000,000 Cr CRR 10,000,000 OR Dt Cash 10,000,000 Cr OSC 10,000,000

  37. Redemption of Redeemable Preference Shares • Companies Act will not permit a reduction of the effective paid up capital. • To overcome this, upon redemption company must • make a fresh issue of shares, or • transfer profits earned to a capital redemption reserve account, or • partly make a fresh issue of shares and partly ‘freeze’ past profits.

  38. Redemption by a Fresh Issue of Shares • Balance Sheet before redemption • Issued and fully paid-up capital • 40,000,000 ordinary shares of RM1 each • 10,000,000 5% redeemable preference shares at RM1 each • Balance Sheet after redemption • Issued and fully paid-up capital • 50,000,000 ordinary shares of RM1 each

  39. Journal Entries: Dr Redeemable Pref Shares xx Premium on redemption xx Cr Pref. Share Redemption xx Dr Pref. Share redemption xx Cr Bank xx Dr Profit and Loss xx Cr Premium on redemption xx

  40. Dr Bank xx Cr Application xx Dr Application xx Cr Ordinary Share cap xx

  41. Redemption Out of Profits • After redemption • Issued and fully paid up capital • 60,000,000 ordinary shares of RM1 each • Capital reserve • Capital redemption reserve RM10,000,000 • Reserves • Profit and loss account RM 2,000,000 • Capital and reserves RM72,000,000

  42. Journal Entries: Dr Redeemable Pref. Share xx Premium on redemption xx Cr Pref. Share Redemption xx Dr Pref. Share Redemption xx Cr Bank xx Dr Profit and Loss xx Cr Capital Red. Reserve xx Premium on Redemption xx

  43. Redemption Partly by Fresh Issue of Shares and Partly Out of Profits • After redemption • Issued and fully paid up capital • 65,000,000 ordinary shares of RM1 each • Capital reserve • Capital redemption reserve RM 5,000,000 • Reserves • Profit and loss account RM 7,000,000 • Capital and reserves RM77,000,000

  44. Journal Entries: Dr Redeemable Pref Shares xx Premium on redemption xx Cr Pref. Share Redemption xx Dr Pref. Share redemption xx Cr Bank xx Dr Bank xx Cr Application xx

  45. Dr Application xx Cr Ordinary Share cap xx Share Premium xx Dr Profit and Loss xx Cr Capital Red. Reserve xx Dr Share Premium xx Profit and Loss xx Cr Premium on redemption xx

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