Buyback of Shares

IPCCPaper5:AdvancedAccountingChapter4

CA.Shruthi BN,Bangalore
Learning Objectives

Afterstudyingthisunit,youwillbeabletolearntheprovisions
1 oftheCompaniesAct,1956forbuybackofshares

Learntheprocessofbuybackofshares
2

Learntheconditionsprescribedforbuybackofshares
3

Learntosolvethequestionsunderdifferentscenarios
4

2
Buyback An Introduction
Buybackisanofferbyacompanytoitsshareholderstoacquirepre
agreednumberofitsownsecuritiesatapreagreedprice.

Inlaymanwords,Buybackofsharesisoneoftheformsofcancellation
ofshares/repaymentofcapital(bothEquityandPreferenceShare
Capital)

Buybackofsharescanbeundertakenbybothpublicandprivate
limitedcompanies

Provisionsofsection77,77A,77AAoftheCompaniesActwouldapply
forbuybackofshares

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Understanding
Buyback of Securities

Shareholders

Buybackofthe
shares/othersecurities

Company

4
BuybackofShares
Provisions of Companies Act,
1956

5
Section 77A(2) of the
Companies Act 1956
AspertheSection77A(2)oftheCompaniesAct1956,noCompany
shallpurchaseitsownshares/othersecuritiesunlessthefollowingtwo
conditionsaresatisfied:
TheArticlesofAssociationshouldauthorizetheCompanyto
buybackitsownshares.
Aspecialresolutionshouldbepassedinthegeneralmeetingof
theCompanyauthorizingthebuybacktheshares.
However,buybackofsharescanbemadewithoutaspecial
resolutionifthefollowingconditionsarefulfilled
Thebuybackis10%orless,ofthepaidupequitycapitalandfree
reservesoftheCompany;and
SuchbuybackhasbeenauthorizedbyaBoardresolution[ata
Boardmeeting];and
Thereisagapofatleast365daysbetweentwobuybackoffers
sanctionedbytheBoard. 6
Free Reserves for Buyback of
Securities
Freereservesforthelimitedpurposeofbuybackofsecurities
wouldmean:

SecuritiesPremium

GeneralReserve

Profitandlossaccount

7
Maximum amount available for
buy-back of Securities

Maximumamountavailableforbuybackofshares/other
securities:
Condition1.Thebuybackshouldnotexceed25percentofthe
Companyspaid upequitycapitalinasingle
financialyear
Thislimitisapplicableinthecontextofmaximum
numberofequitysharesthatcanbeboughtback
byaCompanyinafinancialyear

8
Example 1
ExtractofBalanceSheetofYLtdconsistsof:

EquityShareCapital Rs500,000ofRs10each

12%PreferenceShareCapital Rs100,000ofRs100each

14%DebentureCapital Rs200,000ofRs100each

Maximumequitysharecapitalthatcanbeboughtback
=Rs500,000*25%=Rs125,000

Maximumnumberofequitysharesthatcanbeboughtback
=Rs125,000/Rs10=12500equityshares

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Buy-Back of Securities
ConditionNo2. Thebuybackcannotexceed25percentofthepaid
upcapitalandfreereservesoftheCompany
Thislimitappliesinthecontextofthemaximum
amountthataCompanycanpayouttothe
shareholdersinabuybackoffer
Example2:ExtractofBalanceSheetofALtdconsistsof:
EquityShareCapital Rs1000
PreferenceShareCapital Rs500
Capitalreserve Rs300
GeneralReserve Rs200
Profitandlossaccount Rs100
Maximumbuybackprice=(1000+500+200+100)*25%=450
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Example 3

Extract of Balance Sheet of ABC Ltd consists of :

Equity Share Capital Rs 500,000 of Rs 10 each

12% Preference Share Capital Rs 100,000 of Rs 100 each

14% Debenture Capital Rs 200,000 of Rs 100 each

Revaluation reserve Rs 50,000

General reserve Rs 200,000

Profit and loss account Rs 200,000

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Answer

1.Maximumbuybackprice
=(500,000+100,000+200,000+200,000)*25%=250,000

2.Maximumnumberofpreferencesharesthatcanbeboughtback
=Nolimit.Therefore,entirepreferencesharecapitalcanbeboughtback

2a.Maximumbuybackpriceforbuyingbackpreferenceshares
=Rs.250,000/1000shares=Rs250pershare

3.Maximumnumberofequitysharesthatcanbeboughtback
=500,000/10*25%=12,500shares

3a.Maximumpricethatcanbepaidperequityshareboughtback
=Rs250,000/12,500shares=Rs.20perequityshare

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Resources for buy-back
Abuybackofsharesmaybemadeoutofthefollowing:
Freereserves.
Securitiespremiumaccount.
Proceedsofanysharesorspecifiedsecurities[however,no
buybackofsharescanbemadeoutoftheproceedsofan
earlierissueofthesamekindofshares].
Note: Wherethebuybackisfundedthroughfreereserves
Asumequaltothenominalvalueofthesharesboughtback
shouldbetransferredtotheCapitalRedemptionReserve
(CRR).

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Example 4

Liabilities Assets

EquitySharecapital 1000
Preferenceshare 200
capital

Revaluationreserve 100
Cash/Bank 150
Capitalreserve 100
Generalreserve 150
Profitandlossaccount 150

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Other Conditions
Postbuybackcondition
Theratioofdebt[allsecuredand
unsecureddebts]shouldnotbe Thesharestobeboughtbackshould
morethantwice thecapitaland befullypaidup
freereservesafterbuyback.

Afterbuybackofshares,the
Companycannotissuefurther
sharesofthesamekindasbought
backforaperiodofsixmonths
Exceptincaseofbonusshares,discharge
ofsubsistingobligationssuchas
conversionofwarrants,stockoptions,
conversionofpreferenceshares/
debentures
Buybackofsharesisnotpermitted,
interalia,wheretheCompanyhas
undertheCompaniesActnotfiled
itsannualreturnordefaultedin
distributionofdividendsor
repaymentoftermloan/interestto
anyfinancialinstitution/bank.

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Other Conditions

Buybackshouldbecompletedwithin12monthsfromthe
dateofpassingofthespecialresolutionintheGeneral
MeetingoftheshareholdersortheresolutionbytheBoardof
Directors,asthecasemaybe.

Afterbuyback,theCompanyisrequiredtoextinguishand
physicallydestroythesharesboughtbackwithin7daysoflast
datecompletionofbuyback

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How does actual Buy-Back
happen?

Thebuybackmaybefrom:
Theexistingsecurityholdersonaproportionatebasis
Theopenmarket
Oddlots
Purchasingthesecuritiesissuedtotheemployeesof
theCompanypursuanttoaschemeofstockoptionor
sweatequity

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Accounting entries
1.Saleofassets
Bankaccount.Dr
Lossonsaleofinvestments/assetsaccount..Dr
ToInvestments/assetsaccount(atbookvalue)

2.Transferringlossonsaleofinvestments/assetstoprofitandloss
account
ProfitandlossaccountDr
Tolossonsaleofinvestments/assetsaccount

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Accounting entries
3. Dueentryforbuybackofshares
Concernedsharecapitalaccount..Dr
Premiumonbuybackofsharesaccount..Dr
Toconcernedshareholdersaccount
Todiscountonbuybackofsharesaccount

4.Paymenttowardssharesboughtback
ConcernedshareholdersaccountDr
ToBankaccount

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Accounting entries
5.Issueoffreshsharesforthepurposeofbuyback
Bankaccount..Dr
ToConcernedsharecapitalaccount
6.Writingoffpremiumonbuybackagainstsecuritiespremiumbalance
Securitiespremiumaccount..Dr
ToPremiumonbuybackofsharesaccount
7.TransferringrequiredamounttoCRR
Securitiespremiumaccount..Dr
Generalreserveaccount..Dr
ProfitandlossaccountDr
ToCapitalredemptionreserveaccount

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Points to be noted

Itmustbenotedbythestudentsthatwhilesolvingthequestionsin
theexamination,followingthreecumulativeconditionsshouldbemet

Conditionofmaximumbuybackprice

Conditionofmaximumnumberofequityshares

Conditionofmaintainingpostbuybackdebtequityand
freereservesratio

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Illustration 1

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Problem Statement
PQRLimitedhasthefollowingcapitalstructureason31.03.2011

Particulars (Rsin
crores)
EquitySharecapital(Shares ofRs10eachfullypaid) 330
Generalreserve 240
Securities premiumaccount 90
Profitandlossaccount 90
Infrastructuredevelopmentreserve 180
Loanfunds 1800

TheshareholdersofPQRlimitedontherecommendationoftheirBOD
haveapprovedon12September2011aproposaltobuybackthe
maximumpermissiblenumberofequitysharesconsideringthelarge
surplusfundsavailableatthedisposaloftheCompany

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Problem Statement
TheprevailingmarketvalueoftheCompanyssharesisRs25per
shareandinordertoinducetheexistingshareholderstooffer
theirsharesforbuyback,itwasdecidedtooffer20%overthe
marketprice.
YouareinformedthattheInfrastructurereserveiscreatedto
satisfyIncomeTaxActrequirements
Youarerequiredtocomputethemaximumnumberofsharesthat
canbeboughtbackinthelightoftheaboveinformationandalso
underasituationwheretheloanfundsofthecompanywereRs
1200crores orRs1500crores
Assumingthattheentirebuybackiscompletedby9December
2011,showtheaccountingentriesinthecompanysbooksineach
situation

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 Answer (1/5)
Statementdeterminingmaximumnumberofsharestobeboughtback

Particulars Situation1 Situation2 Situation3

Sharesoutstandingtest 8.25 8.25 8.25

Resourcestest 6.25 6.25 6.25

Debtequityratiotest Nil 5.00 Nil

Maximum numberofshares Nil 5.00 Nil

thatcanbeboughtback
(leastoftheabove)

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 Answer (2/5)
Journalentriesforthebuyback(applicableonlyforSituation2)
Particulars Debit(Rs Credit(Rs
incrores) incrores)
1. EquitysharesbuybackaccountDr 150
ToBankaccount 150
(Beingequity sharesboughtbackvideBoardresolution
dated)
2. EquitysharecapitalaccountDr 50
Securitiespremiumaccount..Dr 90
GeneralreserveaccountDr 10
To Equitysharecapitalbuybackaccount 150
(BeingequitysharesbuybackduevideBoardresolution
dated)
3.GeneralreserveaccountDr 50
ToCapitalredemptionreserveaccount
(Being generalreserveusedforcreationofcapital 50
redemptionreserveonaccountofequitysharesbuyback)
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Answer (3/5)
WorkingnoteNo1:Sharesoutstandingtest

Particulars Sharesin
crores
1. Numberofsharesoutstanding 33

2. 25%ofthe sharesoutstanding 8.25

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Answer (4/5)
Workingnoteno2:Resourcestest

Particulars
1. Paidupcapital(Rs incrores) 330

2. Freereserves(Rsincrores) 420
2. Shareholdersfunds 750
2. 25%ofthesharehodlers funds 187.5
2. Buybackpricepershare Rs30
2. Number ofsharesthatcanbeboughtback 6.25
(sharesincrores)

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 Answer (5/5)
Workingnoteno3:Debtequityratiotest
Particulars Situation1 Situation2 Situation3
(incrores) (incrores) (incrores)
Loanfunds 1800 1200 1500
Minimumequitytobemaintained 900 600 750
afterbuybackintheratioof2:1

Presentequityshareholders funds 750 750 750

Maximumpermittedbuybackof Nil 150 Nil

equity
MaximumNumberofsharesthatcan Nil 5 Nil
beboughtbackatRs30pershare
(Sharesincrores)

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Illustration 2

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Problem Statement
FollowingistheBalancesheetofM/scompetentlimitedason
March31,2012

Liabilities Rs Assets Rs
Equity sharesofRs10each 1250000 Fixedassets 4650000
fullypaid
Revenue reserve 1500000 Current assets 30,00,000
Securitiespremium 2,50,000
Profitandlossaccount 1,25,000
12%debentures 18,75,000
Unsecuredloans 10,00,000
Currentliabilities 16,50,000
Total 76,50,000 Total 76,50,000

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Problem Statement
TheCompanywantstobuyback25,000equitysharesofRs10
each,on1st April2012atRs20pershares.
Buybackofsharesisdulyauthorizedbyitsarticlesofassociation
andnecessaryresolutionhasbeenpassedbytheCompany
towardsthis.
ThepaymentforbuybackofshareswillbemadebytheCompany
outofsufficientbankbalanceavailableaspartofcurrentassets
Commentwithyourcalculations,whetherbuybackofsharesby
theCompanyiswithintheprovisionsoftheCompaniesAct,1956.
Ifyes,passnecessaryjournalentriestowardsbuybackofshares
andpreparetheBalanceSheetafterbuybackofshares.

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Solution (1/6)
Determinationofbuybackofmaximumnumberofsharesasper
CompaniesAct1956
Sharesoutstanding test Shares
1. Numberofsharesoutstanding 125,000

2. 25%ofthe sharesoutstanding 31,250

Resourcestest
1. Paidupcapital(Rs ) 12,50,000

2. Freereserves(Rs15,00,000+2,50,000+1,25,000) 18,75,000
2. Shareholdersfunds 31,25,000
2. 25%oftheshareholdersfunds 781,250
2. Buybackpricepershare Rs20
2. Number ofsharesthatcanbeboughtback 39,063
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Solution (2/6)
Debtequityratiotest Situation1

Loanfunds(Rs18,75,000+10,00,000+16,50,000) 45,25,000
Minimumequitytobemaintainedafterbuyback 22,62,500
intheratioof2:1

Presentequityshareholders funds 31,25,000

Maximumpermittedbuybackofequity 8,62,500

MaximumNumberofsharesthatcanbebought 43,125
backatRs20pershare

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Solution (3/6)
Statementdeterminingmaximumnumberofsharestobebought
back
Particulars Shares
Sharesoutstandingtest 31,250

Resourcestest 39,063
Debtequityratiotest 43,125
Maximum numberofsharesthatcanbebought 31,250
back(leastoftheabove)

AstheCompanywantstobuybackonly25,000equitysharesatRs20,
provisionsoftheCompaniesAct,1956wouldbemet.

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Solution (4/6)
Journalentriesforthebuyback

Debit Credit
1. EquitysharesbuybackaccountDr 500,000
ToBankaccount 500,000

2. EquitysharecapitalaccountDr 250,000
Securitiespremiumaccount..Dr 250,000

To Equitysharecapitalbuybackaccount 500,000
3.RevenuereserveaccountDr 250,000
ToCapitalredemptionreserveaccount
250,000

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Solution Balance Sheet (5/6)
Sch No Rs
EquityandLiabilities
1.Shareholderfunds
Sharecapital(100,000Equity sharesof 10,00,000
Rs10each)
ReservesandSurplus 1 16,25,000
2. Noncurrentliabilities 2 28,75,000
3. Current liabilities 16,20,000
Total 71,50,000
Assets
1.Noncurrentassets
FixedAssets(Tangible assets) 46,50,000
2.Currentassets(30,00,0005,00,00) 25,00,000
Total
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Solution Schedules to B/S (6/6)
Schedule1 Rs
CRR 250,000
Revenuereserves 12,50,000
Profitandlossaccount 125,000
Total 1625,000

Schedule2 Rs
12%debentures 18,75,000
Unsecuredloans 10,00,000
Total 28,75,000

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Lesson Summary
Nocompanyshallpurchaseitsown
Buybackofsharescanbemadeout
sharesorotherspecifiedsecurities
of
unless:

Thebuybackisorlessthan25%ofthe
Itsfreereserves;or totalpaidupcapitalandfreereserves
oftheCompany

Thebuybackofequitysharesinany
financialyearshallnotexceed25%of
Securitiespremium;or itstotalpaidupequitycapitalinthat
financialyear
Theratioofthedebtowedbythe
Theproceedsofanyshares Companyisnotmorethantwicethe
orspecifiessecurities capitalanditsfreereservesaftersuch
buyback

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 Thank You

CA Shruthi BN
Bangalore