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Company accounts – Redeemable Preference Shares

Company accounts – Redeemable Preference Shares. INTRODUCTION.

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Company accounts – Redeemable Preference Shares

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  1. Company accounts – Redeemable Preference Shares

  2. INTRODUCTION Under Section 100 of the Companies Act, a company is not allowed to return to its shareholders the share money without the permission of the court. But permission of the court is not necessary, if the refund is to be made to the preference share holder. When the capital is raised by issuing redeemable preference shares , it is to be paid back by the company to such shareholders after the expiry of the of a stipulated period whether the company is to be wound up or not. Ordinarily, the amount of such shares will be paid back during the life time of company either out of the profits or proceeds of the issues of fresh shares

  3. Important Provisions regarding the redemption of preference shares under section 80 of companies act • Such shares cannot be redeemed unless they are fully paid up . this provision is made in order to protect the interest of the creditors . • Such shares can be redeemed either out of profits which would be available for dividend or out of the proceeds of a fresh issue of shares made with the object of redemption .these shares cannot be redeemed out of the proceeds of fresh issue of debentures or out of the sale proceeds of any property of the company as it will lead to erosion of available security to the creditors .this clause is inserted to protect the interest of creditors.

  4. Capital profits such as shares forfeited account, development rebate account, capital redemption reserve account, securities premium account, profit prior to incorporation, capital reserve are not available for dividend. • When shares are redeemed out of profits available for distribution as dividend, a sum equal to the nominal amount of the shares so redeemed must be transferred out of profits to a reserve account to be called “Capital Redemption Reserve Account". This provision is made in order to immobilize profits from being used for any other purpose. • Such reserve can be used for issuing fully paid bonus shares to the shareholders. This account cannot be reduced except in accordance with the sanction of the court relating to reduction of share capital. • Redemption of preference shares should not be regarded as a reduction of the authorized capital of the company and as such the reduced shares should remain part of the authorized capital and must be shown in the Balance Sheet.

  5. Purpose of legal restrictions • The purpose of all legal restrictions on redemption of preference shares is not to allow redemption of preference shares which may adversely affect the security available to the creditors of company. • The purpose is to keep the security intact which is available to the creditors even after the preference shares are redeemed. • Another purpose of legal restrictions on redemption of preference shares is that there should be no reduction of share capital.

  6. Other Provisions under Section 80 of the Companies Act. • Preference shares can be redeemed either out of the proceeds of the fresh issues of shares or out of profits available for dividend purposes. If preference shares are redeemed out of the proceeds of fresh issues of shares, capital provided by fresh issue of shares will be substituted by the capital which will be reduced by redemption of preference shares. • If preference shares are redeemed out of revenue profits available for dividend purposes, nominal value of shares so redeemed must be transferred to Capital Redemption Reserve Account. Capital Redemption Reserve Account is just like capital because it can only be used for issue of fully paid-up bonus shares. Hence, redemption of preference shares will not amount to reduction of capital.

  7. Journal Entries for redemption of preference shares • If shares are partly paid up, then first of all we have to convert partly paid up shares into fully paid up shares to make them eligible for redemption – • Preference share final call a/c dr To Preference share capital a/c • Bank a/c dr To Preference share final call a/c

  8. Amount due to preference shareholders including the face value and premium to be paid on redemption – Redeemable preference share capital a/c dr Premium on redemption a/c dr To Preference shareholders a/c • Issue of equity shares either with or without premium – Bank a/c dr Discount on issue of shares a/c dr To Equity share capital a/c To Securities premium a/c

  9. Provide premium to be paid on redemption of preference shares out of the securities premium account – Securities premium/ Surplus /General reserve a/c dr To Premium on redemption a/c • Appropriate amount from profit and loss or general reserve or any other reserve- Surplus or general reserve a/c dr To Capital redemption reserve a/c

  10. If liquid assets are not available ,current assets may be sold by the company or bank loan may be arranged for making payment to preference shareholders – • Bank a/c dr Surplus a/c (loss on sale) dr To Current assets a/c • Bank a/c dr To Bank loan a/c • Payment to be made to preference shareholders- Preference share capital a/c dr To Bank a/c

  11. If redemption is made by conversion of some other shares – Preference share capital a/c dr To New share capital a/c • Sometimes Capital Redemption Reserve is utilised for issuing fully paid bonus shares. • When decision is taken to issue bonus shares- Capital redemption reserve Or Securities premium Or Any other reserve a/c dr To Bonus to equity shareholders a/c • When issue of bonus shares is made – Bonus to equity share holders a/c dr To Equity share capital a/c

  12. ILLUSTRATION: A company in a series of operations • Issues at par 20,000 redeemable preference shares of Rs. 1o each redeemable at premium of 50 paisa per share. • Redeems 10,000 of the redeemable preference shares out of profits of the company. • Issues at par for cash 20,000 equity shares of Rs. 10 each and out of the proceeds redeems the balance of the redeemable preference shares. Journalise these transactions including those relating to cash. SOLUTION: Journal Entries

  13. ILLUSTRTION: Exchange ltd. has an issued share capital of 650 7% redeemable preference shares of Rs. 100 each and 4500 equity shares of Rs. 50 each. The preference shares are redeemable at a premium of 7.5% on April 1,2011. The company’s balance sheet as on 31st march,201 2was as follows:

  14. In order to facilitate the redemption of the preference shares, the company decided – (a) to sell all the investments for RS. 16,000; (b) to finance part of the redemption from company’s funds, subject to leaving a balance of Rs.12000 in the profit and loss account, and (c) to issue sufficient equity shares f Rs.50 each at a premium of Rs.13 per share to raise the balance of funds required. You are required to prepare – (1) the necessary journal entries to record the above transactions (including cash ) and (2) the balance sheet as on completion.

  15. BALANCE SHEET OF EXCHANGE LTD. as on 1st April, 2012

  16. Working notes: (1) Calculation of numbers of equity shares to be issued Rs. Rs. Balance in Surplus account 48,000 Less: Loss on sale of investment 2,500 Amount to be retained as balance 12,000 14,500 Amount available for transfer to CRR a/c 33,500 Nominal value of equity shares to be issued (Rs. 65,000-Rs.33,500) 31,500 No. of equity shares=31,500/Rs.50=630 shares

  17. (2) Calculation of balance at bankBANKACCOUNT

  18. Use of Algebraic Equation for finding out the Face Value of Shares to be issued to be issued for Redemption of Preference Shares The use of algebraic equation may be useful for finding out the minimum face value of shares to be reissued.

  19. 1) When fresh issue is to be made at a premium- Redeemable Preference [Balance in Security Share Capital = Premium A/c in B/S] + +Premium on Redemption [Revenueprofits available for redemption] +[N] +[N (% rate of premium on fresh issue)] Here N= face value of fresh issue of shares for redemption of preference shares.

  20. When no. of shares to be calculated with the help of equation ( in case of premium): • ILLUSTRATION: Determine the amount of fresh issue of shares from the following information: 1. Redeemable preference shares Rs.2,00,000 2. Premium on redemption 10% 3. Divisible profits available Rs.60,000 4. Balance in general reserve Rs.40,000 5. Securities Premium Account Rs.15,000 Fresh issue is to be made at a premium of 5%.

  21. SOLUTION: Redeemable Preference [Balance in Security Share Capital = Premium A/c in B/S] + +Premium on Redemption [Revenue profits available for redemption] +[N] +[N (% rate of premium on fresh issue)] 2,00,000 + 20,000 = 15,000 + 60,000 + 40,000 + N + 0.05 N 1.05 N = 2,20,000 – 1,15,000 N = 1,05,000 1.05 N = Rs.1,00,000.

  22. 2) When fresh issue of shares is to be made at a discount – Redeemable preference [balance in the securities share capital = premium a/c in b/s+ +premium on redemption [revenue profits available for redemption] + [N] + [N (% rate of premium on fresh issue)]

  23. When no. of shares are to be calculated with the help of equation (in case of discount): • ILLUSTRATION: Determine the amount of fresh issue of shares from the following information: 1. Redeemable preference shares Rs.2,00,000 2. Premium on redemption 10% 3. Divisible profits available Rs.60,000 4. Balance in general reserve Rs.40,000 5. Securities Premium Account Rs.15,000 Fresh issue is to be made at a discount of 10%.

  24. SOLUTION: Redeemable preference [balance in the securities share capital = premium a/c in b/s] + +premium on redemption [revenue profits available for redemption] + [N] + [N (% rate of premium on fresh issue)] 2,00,000 + 20,000 = 15,000 + 60,000 + 40,000 + N – 0.1 N 0.9 N = 2,20,000 – 1,15,000 N = 1,05,000 0.9 N = Rs.1,16,667.

  25. ILLUSTRATION: (Use of equation). Ledger balances are as follows:

  26. The Redeemable Preference Shares are to be redeemed at a premium of 10%. The directors wish that only the minimum number of fresh equity shares of Rs.10 each at a premium of 5% be issued to provide for redemption of such preference shares as could not otherwise be redeemed. You are required to give the journal entries and also prepare the Balance Sheet after redemption. SOLUTION: JOURNAL ENTRIES

  27. BALANCE SHEET OF …….. as at …….

  28. Working Note: (1) Calculation of Minimum Number of Fresh Shares to be issued by Equation Redeemable Preference Share Capital + Premium on Redemption = Balance in Share Divisible or N + N * % Rate of Premium A/c Free Profit Premium on Fresh Issue

  29. or Rs.5,00,000 + Rs.50,000 = Rs. 15,000 + Rs.74,995 + N + 0.05 N or 1.05 N = Rs. 5,50,000 – 89,995 N = Rs.4,60,005 1.05 N = Rs. 4,38,100 or No. of Shares = Rs.4,38,100 Rs.10 = 43,810 shares.

  30. THANKS

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