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The fund provided by the owners in to a business is known as capital. You know that capital of the business depends upon the form of business organization. From ownership point of view, there are number of business organizations like, sole proprietorship business, partnership business, cooperative societies, joint stock companies etc. Total capital of the company is divided into a number of small units of fixed amount and each such unit is called a share. The fixed value of a share register with the registrar of Companies is called face/ nominal value. However, a company can issue shares at a price different from its nominal value or face value. As the total capital of the company is divided into shares, the capital of the company is known as share capital. A company can issue two types shares equity shares and preference shares. The issue of preference shares is one of the important sources of capital of a company. Redemption is the process of repaying an obligation at predetermined amounts and timings. The redeemable preference shares are issued on the terms that share holders will at a future date be repaid amount which they invested in the company. According to the Companies Act, 1956, a company can issue only redeemable shares i.e. at present a company cannot issue irredeemable preference shares. Now, in this unit we are going to discuss about the redemption of preference shares.
Learning Objectives
After reading this chapter, you are expected to be able to:
Identify the different types of preference shares; Describe how companies redeem its preference shares; Prepare account for the scheme of redemption; and Utilize the capital redemption reserve account.
particular year. The rate of dividend also varies from year to year. The preference shareholders contribute capital to the company. According to section 85 of the Companies Act, 1956, persons holding preference shares, called preference shareholders. They are assured of a preferential dividend at a fixed rate during the life of the company. This type share holders carry preferential right over other shareholders to be paid first in case of liquidation of the company. Companies use this mode of financing as it is cheaper than raising debt. The preference shares can be of various types. These are: i) Redeemable Preference Shares: A company may issue this type of shares on the condition that the company will repay the amount of share capital to the holders of this category of shares after the fixed period or even earlier at the discretion of the company. Section 80 of the Companies Act, 1956 deals with the redemption of preference shares. ii) Irredeemable Preference Shares: The preference shares, which do not carry the agreement of redemption are known as irredeemable preference shares. iii) Convertible Preference Shares: This type of shares enjoy the right to the holder to get them converted into equity shares according to the terms and conditions of the issue. iv) Non-convertible Preference Shares: The holders of these shares do not enjoy the right to get the shares converted into equity shares. Unless otherwise stated, Preference shares are nonconvertible. v) Participating Preference Shares: The holder of this type of preference shares enjoy the right to participate in the surplus profits, if any, after the equity shareholders have been paid dividend at a rate fixed in the AGM. So the shareholders get additional dividend with their normal dividend. vi) Non-participating Preference Shares: These shares carry only a fixed rate of dividend without any right to get additional dividend. Unless otherwise stated, The preference shares are non-participating. vii) Cumulative Preference Shares: The cumulative preference shares carry the right to a fixed amount of dividend. The holders of these shares are entitled to get dividend out of future profit if current years profit is insufficient for the same. So, the dividend on these shares accumulates till the final payment. viii) Non-cumulative Preference Share: In this case the dividend for the shareholders does not accumulate. If there is no sufficient profit, this type of preference shareholders will not get any dividend. In this case, the dividend will be lapsed and there will be no arrear dividend.
4. Mark True (T) or False (F) for the following statements. (i) Redeemable preference shares can be redeemed either at par or at premium. (ii) Preference share holders enjoy voting rights.
(iii) Non-cumulative preference shareholders can get arrear dividend. (iv) Participating preference shareholders have no right to get an additional dividend.
3. Mark True (T) or False (F) for the following statements (i) Sale proceeds of investment can be utilized for redemption of preference shares. (ii) For the purpose of redemption, debenture can be issued. (iii) Capital Reserve cannot be used for the purpose of capital Redemption
(ii)Compare your answer with the model answer given in the Answer section 1. How the Capital Redemption Reserve Account is created?
Date
Particulars
LF
Dr.(Rs.)
Cr.(Rs.)
2008 April 1
Preference share capital A/c .Dr. To Preference shareholders A/c (Being amount payable on redemption of 2000 preference shares)
20,000 20,000
2008 April 1
Bank A/c ...Dr. To Equity Share Capital A/c (Being the amount received on issue of 2000 equity shares of Rs.10 each made for the
20,000 20,000
2008 April 1
Preference shareholders A/c Dr. To Bank (Being the amount due to preference shareholders paid)
20,000 20,000
Example 2. Kitkat Co. Ltd. Issued 50,000 Equity shares of Rs.10 each and 3000, 10% Preference shares of Rs.100 each, all shares being fully paid. On 31.3.08, Profit and Loss Account showed an undistributed profit of rs.50,000 and General Reserve Account stood at Rs.1,20,000. On 2.4.08, the directors decided to issue 1500, 6% Preference shares of Rs.100 each for cash and to redeem the existing preference shares at Rs.105 utilizing as much as would be required for the purpose. Show the journal entries to record the transactions.
Date
Particulars
LF
Dr.(Rs.)
Cr.(Rs.)
2008 April 2
10% Preference share capital A/c .Dr. Premium on Redemption of Preference shares capital A/c..Dr. To Preference shareholders A/c (Being amount payable on redemption of 3000 preference shares, with premium of 5%).
"
Bank A/c ...Dr. To 6% Preference Share Capital A/c (Being the amount received on issue of 1500, 6% Preference shares of Rs.100 each made for the purpose of redemption of preference shares as per Boards Resolution dated).
150,000 150,000
"
General Reserve A/c ..Dr. To Premium on Redemption of Preference shares capital A/c (Being the amount written off against general reserve)
15,000 15,000
"
General Reserve A/c Dr. Profit & Loss A/c .Dr. To Capital Redemption Reserve A/c ( Being amount transferred equal to the difference between the nominal value of shares redeemed and proceeds of new issue).
"
Preference shareholders A/c Dr. To Bank (Being the amount due to preference shareholders paid).
315,000 315,000
Example 3. The King Kong Ltd.s Balance sheet shows the following balance s on 31-3-08. 30,000 equity shares of Rs.10 each fully paid; 18,000 10% Redeemable Preference shares of Rs.10 each fully paid; 4000, 15% Redeemable Preference shares of Rs.10 each, Rs.8 paid up. General Reserve
Rs.12,000; Securities Premium Rs.15,000; Profit Loss Account Rs.80,000 and capital Reserve Rs.20,000. Preference shares are redeemed on 1-4.08 at a premium of Rs.2 per share. For redemption, 4000 equity shares of Rs.10 each are issued at 10% premium. A bonus issue of equity share was made at par, two shares being issued for every five held on that date. Show the journal entries to record the above transactions.
Solution: Note: Partly paid up preference shares cannot be redeemed. Journal Entries in the Books of King Kong Ltd.
Date
Particulars
LF
Dr.(Rs.)
Cr.(Rs.)
2008 April 1
10% Preference share capital A/c .Dr. Premium on Redemption of Preference shares capital A/c.Dr. To Preference shareholders A/c (Being amount payable on redemption of 18000 preference shares, with premium of 2%).
"
Bank A/c ...Dr. To Equity Share Capital A/c To Securities Premium A/c (Being the amount received on issue of 4000, Equity shares of Rs.10 each made with premium of 10% for the purpose of redemption of preference shares as per Boards Resolution dated).
"
Profit And Loss A/c Dr. To Premium on Redemption of Preference shares capital A/c (Being the amount written off against general reserve)
"
General Reserve A/c Dr. Profit & Loss A/c .Dr. To Capital Redemption Reserve A/c ( Being amount transferred equal to the difference between the nominal value of shares redeemed and proceeds of new issue).
"
"
Preference shareholders A/c Dr. To Bank (Being the amount due to preference shareholders paid).
"
216,000 216,000
"
Capital Redemption Reserve A/c..Dr. To Bonus to Shareholders A/c Being the amount utilised for issue of bonus shares in 5:2 ratio as per shareholders Resolution No. Dated) 30,000x2/5xRs.10
"
120,000 120,000
"
Bonus to Shareholders A/c .Dr. To Equity Share capital A/c (Being the amount capitalised by issue of bonus shares)
120,000 120,000
Example 4. The preference shares were redeemed on April 1, 2008 at a premium of Rs.5.00 per share, the whereabouts of the holders of 1500 such shares not being known. At the same time, a bonus issue of equity share was made at par, one share being issued for every four equity shares held. Show the journal entries to record the above transactions and the Balance sheet as it would appear after the redemption. The following is the balance sheet of Black Diamond Co. Ltd. As at 31 st March,2008. Liabilities Amount(Rs.) Assets Amount(Rs.)
Issued & Subscribed Capital: 4,00,000 40,000 Equity shares of Rs.10 each fully paid 18,000, 8% Preference shares of Rs.10 each fully paid Reserves & Surplus: Profit & Loss Account Current Liabilities: Sundry Creditors 1,80,000
Fixed Assets
7,00,000
4,80,000
40,000
11,00,000
11,00,000
Date
Particulars
LF
Dr.(Rs.)
Cr.(Rs.)
2008 April 1
8% Preference share capital A/c .Dr. Premium on Redemption of Preference shares capital A/c.Dr. To Preference shareholders A/c (Being amount payable on redemption of
"
Profit And Loss A/c Dr. To Premium on Redemption of Preference shares capital A/c (Being the amount written off against Profit And Loss A/c)
90,000 90,000
"
Profit & Loss A/c .Dr. To Capital Redemption Reserve A/c ( Being amount transferred equal to the nominal value of shares redeemed and proceeds of new issue).
"
1,80,000 1,80,000
'
Capital Redemption Reserve A/c..Dr. To Bonus to Shareholders A/c Being issue of 1 bonus share to every 4 equity shares held as per shareholders Resolution No. Dated) 40,000x1/4xRs.10
1,00,000 1,00,000
"
Bonus to Shareholders A/c .Dr. To Equity Share capital A/c (Being the amount capitalised by issue of bonus shares)
1,00,000 1,00,000
"
2,47,000 2,47,000
(Being the amount due to preference shareholders paid except 1500 share holders).
Liabilities
Amount(Rs.)
Assets
Amount(Rs.)
Issued & Subscribed Capital: 50,000 Equity shares of Rs.10 each fully paid (of the above shares, 10,000 shares have been allotted as fully paid bonus shars) Reserves & Surplus: Capital Redemption Reserve Account (Rs.180000-100000) Profit & Loss Account (Rs.480000-90000-180000) Current Liabilities: Sundry Creditors Outstanding claim (Pref. Shareholders)
7,00,000
4,00,000
80,000
2,10,000
40,000 22,500
8,52,500
8,52,5000
Let's Sum Up
Answers to SAQs
Self-Assessment Quesitons-1: 1. What do you mean by share and share capital? The amount provided by the owner is known as capital. The capital of a company is share capital. Total capital id divided into a number of small indivisible units of a fixed amount and each such unit is known as share. 2. What are the different types of share capital? Share capital are of two types, viz. equity share capital and preference share capital. A company can issue eight types preference share capital. These are i) Redeemable Preference Shares, ii) Irredeemable Preference Shares, iii) Convertible Preference Shares, iv) Non-convertible Preference Shares, v) Participating Preference Shares , vi) Non-participating Preference Shares, vii) Cumulative Preference Shares, viii) Non-cumulative Preference Share. 3. What is meant by redeemable preference shares? Redemption is the process of repaying an obligation at predetermined amount. The redeemable preference shares are issued on the terms that the shareholders will be repaid the amount which they invested at future date. 4. (i) T, (ii) F, (iii) F, (iv) F . Self-Assessment Questions-2: 1. Yes. A company can redeem its redeemable preference shares out of fresh issue of shares. For the purpose of redemption of preference shares, a company may issue either equity shares or preference shares. But remember, a company cannot issue debenture for redemption of preference shares. 2. A company can redeem its preference share out of either fresh of shares or from accumulated profit. When the company redeems its preference shares out of accumulated profit, it is necessary to create the capital redemption reserve account. The basic purpose of creation of this account is to protect the interest of sundry creditors and maintain the working capital.
3. (i) False, (ii) False, (iii) True . Self-Assessment Questions-3: 1. How the Capital Redemption Reserve Account is created? By transferring the amount of general reserve, profit and loss account, the Capital redemption reserve account is created.
General Reserve A/c .Dr. Profit and Loss A/c ...Dr. Investment Allowance Reserve..Dr. To Capital Redemption Reserve A/c
2. Why the CRR account is created? The main purpose of creating CRR is to protect the interest of sundry creditors and to maintain the working capital. Redemption of preference shares involves repayment of capital before paying creditors of the company. It may affect the interest of creditors. In addition to that the working capital of the company will be depleted as a result of outflow of cash due to redemption. That is why, the amount is capitalized by creating the capital redemption reserve account.