ICAI Notes- Unit 5: Redemption of Preference Shares | Principles and Practice of Accounting - CA Foundation PDF Download

 Page 1


 
 
  
 11.151
COMPANY ACCOUNTS 
 
LEARNING OUTCOMES 
 
UNIT – 5: REDEMPTION OF PREFERENCE SHARES  
 
 
After studying this unit, you will be able to: 
? understand the meaning of redemption and the purpose of issuing 
redeemable preference shares; 
? learn various provisions of the Companies Act, 2013 regarding 
preference shares and their redemption; 
? familiarise yourself with various methods of redemption of fully 
paid-up preference shares by:  
(i)  Fresh issue of shares; Or  
(ii)  Capitalisation of divisible or undistributed profits; Or 
(iii) Combination of (i) and (ii) above; 
? understand the logic behind the creation of Capital Redemption 
Reserve; 
? learn the accounting treatment for redemption of: 
(i)  fully paid-up preference shares; 
(ii)  partly called-up preference shares; and  
(iii)  fully called-up but partly paid-up preference shares. 
  
© The Institute of Chartered Accountants of India
Page 2


 
 
  
 11.151
COMPANY ACCOUNTS 
 
LEARNING OUTCOMES 
 
UNIT – 5: REDEMPTION OF PREFERENCE SHARES  
 
 
After studying this unit, you will be able to: 
? understand the meaning of redemption and the purpose of issuing 
redeemable preference shares; 
? learn various provisions of the Companies Act, 2013 regarding 
preference shares and their redemption; 
? familiarise yourself with various methods of redemption of fully 
paid-up preference shares by:  
(i)  Fresh issue of shares; Or  
(ii)  Capitalisation of divisible or undistributed profits; Or 
(iii) Combination of (i) and (ii) above; 
? understand the logic behind the creation of Capital Redemption 
Reserve; 
? learn the accounting treatment for redemption of: 
(i)  fully paid-up preference shares; 
(ii)  partly called-up preference shares; and  
(iii)  fully called-up but partly paid-up preference shares. 
  
© The Institute of Chartered Accountants of India
  
 
ACCOUNTING a
  
11.152 
 
 
 5.1 INTRODUCTION 
Redemption is the process of repaying an obligation, at prearranged amounts and timings. It 
is a contract specifying the obligation to redeem preference shares within or at the end of a 
given time period at an agreed price. These shares are issued on the terms that shareholders 
will at a future date be repaid the amount which they invested in the company (apart from 
the frequent payments of a specified amount of dividend as return on investment during the 
tenure of the preference shares). The redemption date is the maturity date, which specifies 
when repayment is scheduled to take place and is usually printed on the preference share 
certificate. Through the process of redemption, a company can also adjust its financial 
structure, for example, by eliminating preference shares and replacing those with other 
securities if future growth of the company makes such change advantageous. 
Methods of redemption of Preference shares
(a) By fresh issue of shares
(b) By capitalisation of 
undistributed profits
(c)  By combination of  (a) 
and (b)
UNIT OVERVIEW 
Section 52 of the Companies Act, 
2013 provides that the securities 
premium account may be applied 
by the company:
[NOTE: Certain class of Companies 
whose financial statements comply 
with the Accounting Standards as 
prescribed under Section 133 of 
the Companies Act, 2013, can’t 
apply the securities premium 
account for the purposes (b) and 
(d)] 
(a)  Towards issue of un-issued shares of the 
company to be issued to members of the company 
as fully paid bonus securities
(b)  To write off preliminary expenses of the 
company
(c)  To write off the expenses of, or commission 
paid, or discount allowed on any of the securities or 
debentures of the company
(d)  To provide for premium on the redemption of 
redeemable preference shares or debentures of the 
company.
(e)  For the purchase of its own shares or other 
securities.
© The Institute of Chartered Accountants of India
Page 3


 
 
  
 11.151
COMPANY ACCOUNTS 
 
LEARNING OUTCOMES 
 
UNIT – 5: REDEMPTION OF PREFERENCE SHARES  
 
 
After studying this unit, you will be able to: 
? understand the meaning of redemption and the purpose of issuing 
redeemable preference shares; 
? learn various provisions of the Companies Act, 2013 regarding 
preference shares and their redemption; 
? familiarise yourself with various methods of redemption of fully 
paid-up preference shares by:  
(i)  Fresh issue of shares; Or  
(ii)  Capitalisation of divisible or undistributed profits; Or 
(iii) Combination of (i) and (ii) above; 
? understand the logic behind the creation of Capital Redemption 
Reserve; 
? learn the accounting treatment for redemption of: 
(i)  fully paid-up preference shares; 
(ii)  partly called-up preference shares; and  
(iii)  fully called-up but partly paid-up preference shares. 
  
© The Institute of Chartered Accountants of India
  
 
ACCOUNTING a
  
11.152 
 
 
 5.1 INTRODUCTION 
Redemption is the process of repaying an obligation, at prearranged amounts and timings. It 
is a contract specifying the obligation to redeem preference shares within or at the end of a 
given time period at an agreed price. These shares are issued on the terms that shareholders 
will at a future date be repaid the amount which they invested in the company (apart from 
the frequent payments of a specified amount of dividend as return on investment during the 
tenure of the preference shares). The redemption date is the maturity date, which specifies 
when repayment is scheduled to take place and is usually printed on the preference share 
certificate. Through the process of redemption, a company can also adjust its financial 
structure, for example, by eliminating preference shares and replacing those with other 
securities if future growth of the company makes such change advantageous. 
Methods of redemption of Preference shares
(a) By fresh issue of shares
(b) By capitalisation of 
undistributed profits
(c)  By combination of  (a) 
and (b)
UNIT OVERVIEW 
Section 52 of the Companies Act, 
2013 provides that the securities 
premium account may be applied 
by the company:
[NOTE: Certain class of Companies 
whose financial statements comply 
with the Accounting Standards as 
prescribed under Section 133 of 
the Companies Act, 2013, can’t 
apply the securities premium 
account for the purposes (b) and 
(d)] 
(a)  Towards issue of un-issued shares of the 
company to be issued to members of the company 
as fully paid bonus securities
(b)  To write off preliminary expenses of the 
company
(c)  To write off the expenses of, or commission 
paid, or discount allowed on any of the securities or 
debentures of the company
(d)  To provide for premium on the redemption of 
redeemable preference shares or debentures of the 
company.
(e)  For the purchase of its own shares or other 
securities.
© The Institute of Chartered Accountants of India
 
 
  
 11.153
COMPANY ACCOUNTS 
5.2  PURPOSE OF ISSUING REDEEMABLE PREFERENCE 
SHARES 
A company may issue redeemable preference shares because of the following: 
1. It is a proper way of raising finance in a dull primary market. 
2. A company may face difficulty in raising share capital, as its shares are not traded on 
the stock exchange. Potential investors who may, hesitate in putting money into shares 
that cannot easily be sold may be encouraged to invest if the shares are redeemable 
by the company. 
3. The preference shares may be redeemed when there is a surplus of capital and the 
surplus funds cannot be utilised in the business for profitable use. 
4.  No dividend is required to be paid, if there is loss or no profit, whereas interest is 
payable on debentures or loans even in case of loss. In other words, preference 
dividend declared / paid continues to be regarded as an appropriation of profits 
(similar treatment is given for equity shares), as against interest on debentures, which 
is a charge against profits. 
In India, the issue and redemption of preference shares is governed by Section 55 of the 
Companies Act, 2013. 
5.3 PROVISIONS OF THE COMPANIES ACT  
(SECTION 55) 
A company limited by shares if so authorised by its Articles, may issue preference shares which 
at the option of the company, are liable to be redeemed within a period, normally not 
exceeding 20 years from the date of their issue. It should be noted that: 
(a) no shares can be redeemed except out of divisible or distributable profit, (i.e. out of 
the profit of the company which would otherwise be available for dividend) or out of 
proceeds of fresh issue of shares made for the purpose of redemption; 
(b) no such shares can be redeemed unless they are fully paid; 
(c) (i)  in case of such class of companies, as may be prescribed and whose financial 
statement comply with the accounting standards prescribed for such class of 
companies under Section 133, the premium, if any, payable on redemption shall 
be provided for out of the profits of the company, before the shares are 
redeemed:
© The Institute of Chartered Accountants of India
Page 4


 
 
  
 11.151
COMPANY ACCOUNTS 
 
LEARNING OUTCOMES 
 
UNIT – 5: REDEMPTION OF PREFERENCE SHARES  
 
 
After studying this unit, you will be able to: 
? understand the meaning of redemption and the purpose of issuing 
redeemable preference shares; 
? learn various provisions of the Companies Act, 2013 regarding 
preference shares and their redemption; 
? familiarise yourself with various methods of redemption of fully 
paid-up preference shares by:  
(i)  Fresh issue of shares; Or  
(ii)  Capitalisation of divisible or undistributed profits; Or 
(iii) Combination of (i) and (ii) above; 
? understand the logic behind the creation of Capital Redemption 
Reserve; 
? learn the accounting treatment for redemption of: 
(i)  fully paid-up preference shares; 
(ii)  partly called-up preference shares; and  
(iii)  fully called-up but partly paid-up preference shares. 
  
© The Institute of Chartered Accountants of India
  
 
ACCOUNTING a
  
11.152 
 
 
 5.1 INTRODUCTION 
Redemption is the process of repaying an obligation, at prearranged amounts and timings. It 
is a contract specifying the obligation to redeem preference shares within or at the end of a 
given time period at an agreed price. These shares are issued on the terms that shareholders 
will at a future date be repaid the amount which they invested in the company (apart from 
the frequent payments of a specified amount of dividend as return on investment during the 
tenure of the preference shares). The redemption date is the maturity date, which specifies 
when repayment is scheduled to take place and is usually printed on the preference share 
certificate. Through the process of redemption, a company can also adjust its financial 
structure, for example, by eliminating preference shares and replacing those with other 
securities if future growth of the company makes such change advantageous. 
Methods of redemption of Preference shares
(a) By fresh issue of shares
(b) By capitalisation of 
undistributed profits
(c)  By combination of  (a) 
and (b)
UNIT OVERVIEW 
Section 52 of the Companies Act, 
2013 provides that the securities 
premium account may be applied 
by the company:
[NOTE: Certain class of Companies 
whose financial statements comply 
with the Accounting Standards as 
prescribed under Section 133 of 
the Companies Act, 2013, can’t 
apply the securities premium 
account for the purposes (b) and 
(d)] 
(a)  Towards issue of un-issued shares of the 
company to be issued to members of the company 
as fully paid bonus securities
(b)  To write off preliminary expenses of the 
company
(c)  To write off the expenses of, or commission 
paid, or discount allowed on any of the securities or 
debentures of the company
(d)  To provide for premium on the redemption of 
redeemable preference shares or debentures of the 
company.
(e)  For the purchase of its own shares or other 
securities.
© The Institute of Chartered Accountants of India
 
 
  
 11.153
COMPANY ACCOUNTS 
5.2  PURPOSE OF ISSUING REDEEMABLE PREFERENCE 
SHARES 
A company may issue redeemable preference shares because of the following: 
1. It is a proper way of raising finance in a dull primary market. 
2. A company may face difficulty in raising share capital, as its shares are not traded on 
the stock exchange. Potential investors who may, hesitate in putting money into shares 
that cannot easily be sold may be encouraged to invest if the shares are redeemable 
by the company. 
3. The preference shares may be redeemed when there is a surplus of capital and the 
surplus funds cannot be utilised in the business for profitable use. 
4.  No dividend is required to be paid, if there is loss or no profit, whereas interest is 
payable on debentures or loans even in case of loss. In other words, preference 
dividend declared / paid continues to be regarded as an appropriation of profits 
(similar treatment is given for equity shares), as against interest on debentures, which 
is a charge against profits. 
In India, the issue and redemption of preference shares is governed by Section 55 of the 
Companies Act, 2013. 
5.3 PROVISIONS OF THE COMPANIES ACT  
(SECTION 55) 
A company limited by shares if so authorised by its Articles, may issue preference shares which 
at the option of the company, are liable to be redeemed within a period, normally not 
exceeding 20 years from the date of their issue. It should be noted that: 
(a) no shares can be redeemed except out of divisible or distributable profit, (i.e. out of 
the profit of the company which would otherwise be available for dividend) or out of 
proceeds of fresh issue of shares made for the purpose of redemption; 
(b) no such shares can be redeemed unless they are fully paid; 
(c) (i)  in case of such class of companies, as may be prescribed and whose financial 
statement comply with the accounting standards prescribed for such class of 
companies under Section 133, the premium, if any, payable on redemption shall 
be provided for out of the profits of the company, before the shares are 
redeemed:
© The Institute of Chartered Accountants of India
ACCOUNTING a
 
11.154 
Provided also that premium, if any, payable on redemption of any preference 
shares issued on or before the commencement of this Act by any such company 
shall be provided for out of the profits of the company or out of the company’s 
securities premium account, before such shares are redeemed. 
(ii) in case of other companies (not falling under (i) above), the premium, if any
payable on redemption shall be provided for out of the profits of the company or
out of the company’s securities premium account, before such shares are
redeemed.
(Refer to the Note given in para 5.4.1 for the basis applied in the Illustrations in
this Chapter.)
(d) where any such shares are proposed to be redeemed out of the profits of the company,
there shall, out of the divisible profits, i.e. the profits which would otherwise have been
available for dividends, be transferred to a reserve account to be called Capital
Redemption Reserve Account, a sum equal to the nominal amount of the shares
redeemed; and the provisions of the Act relating to the reduction of the share capital of
a company shall, except as provided in the Section, apply as if the Capital Redemption
Reserve (CRR) Account were the paid-up share capital of the company. The utilisation of
CRR Account is further restricted to issuance of fully paid-up bonus shares only.
From the legal provision outlined above, it is apparent that on the redemption of redeemable 
preference shares out of accumulated divisible profits, it will be necessary to transfer to the 
Capital Redemption Reserve Account an amount equal to the amount repaid on the 
redemption of preference shares on account of face value less proceeds of a fresh issue of 
shares made for the purpose of redemption. The object is that with the repayment of 
redeemable preference shares, the security for creditors/ bankers, etc. should not be reduced. 
At times, a part of the preference share capital may be redeemed out of accumulated divisible 
profits and the balance out of a fresh issue. 
5.4 METHODS OF REDEMPTION OF FULLY PAID-UP 
SHARES 
Redemption of preference shares means repayment by the company of the obligation on 
account of shares issued. According to the Companies Act, 2013, preference shares issued by 
a company must be redeemed within the maximum period (normally 20 years) allowed under 
the Act. Thus, a company cannot issue irredeemable preference shares.  
Section 55 of the Companies Act, 2013, deals with provisions relating to redemption of 
preference shares. It ensures that there is no reduction in shareholders’ funds due to 
© The Institute of Chartered Accountants of India
Page 5


 
 
  
 11.151
COMPANY ACCOUNTS 
 
LEARNING OUTCOMES 
 
UNIT – 5: REDEMPTION OF PREFERENCE SHARES  
 
 
After studying this unit, you will be able to: 
? understand the meaning of redemption and the purpose of issuing 
redeemable preference shares; 
? learn various provisions of the Companies Act, 2013 regarding 
preference shares and their redemption; 
? familiarise yourself with various methods of redemption of fully 
paid-up preference shares by:  
(i)  Fresh issue of shares; Or  
(ii)  Capitalisation of divisible or undistributed profits; Or 
(iii) Combination of (i) and (ii) above; 
? understand the logic behind the creation of Capital Redemption 
Reserve; 
? learn the accounting treatment for redemption of: 
(i)  fully paid-up preference shares; 
(ii)  partly called-up preference shares; and  
(iii)  fully called-up but partly paid-up preference shares. 
  
© The Institute of Chartered Accountants of India
  
 
ACCOUNTING a
  
11.152 
 
 
 5.1 INTRODUCTION 
Redemption is the process of repaying an obligation, at prearranged amounts and timings. It 
is a contract specifying the obligation to redeem preference shares within or at the end of a 
given time period at an agreed price. These shares are issued on the terms that shareholders 
will at a future date be repaid the amount which they invested in the company (apart from 
the frequent payments of a specified amount of dividend as return on investment during the 
tenure of the preference shares). The redemption date is the maturity date, which specifies 
when repayment is scheduled to take place and is usually printed on the preference share 
certificate. Through the process of redemption, a company can also adjust its financial 
structure, for example, by eliminating preference shares and replacing those with other 
securities if future growth of the company makes such change advantageous. 
Methods of redemption of Preference shares
(a) By fresh issue of shares
(b) By capitalisation of 
undistributed profits
(c)  By combination of  (a) 
and (b)
UNIT OVERVIEW 
Section 52 of the Companies Act, 
2013 provides that the securities 
premium account may be applied 
by the company:
[NOTE: Certain class of Companies 
whose financial statements comply 
with the Accounting Standards as 
prescribed under Section 133 of 
the Companies Act, 2013, can’t 
apply the securities premium 
account for the purposes (b) and 
(d)] 
(a)  Towards issue of un-issued shares of the 
company to be issued to members of the company 
as fully paid bonus securities
(b)  To write off preliminary expenses of the 
company
(c)  To write off the expenses of, or commission 
paid, or discount allowed on any of the securities or 
debentures of the company
(d)  To provide for premium on the redemption of 
redeemable preference shares or debentures of the 
company.
(e)  For the purchase of its own shares or other 
securities.
© The Institute of Chartered Accountants of India
 
 
  
 11.153
COMPANY ACCOUNTS 
5.2  PURPOSE OF ISSUING REDEEMABLE PREFERENCE 
SHARES 
A company may issue redeemable preference shares because of the following: 
1. It is a proper way of raising finance in a dull primary market. 
2. A company may face difficulty in raising share capital, as its shares are not traded on 
the stock exchange. Potential investors who may, hesitate in putting money into shares 
that cannot easily be sold may be encouraged to invest if the shares are redeemable 
by the company. 
3. The preference shares may be redeemed when there is a surplus of capital and the 
surplus funds cannot be utilised in the business for profitable use. 
4.  No dividend is required to be paid, if there is loss or no profit, whereas interest is 
payable on debentures or loans even in case of loss. In other words, preference 
dividend declared / paid continues to be regarded as an appropriation of profits 
(similar treatment is given for equity shares), as against interest on debentures, which 
is a charge against profits. 
In India, the issue and redemption of preference shares is governed by Section 55 of the 
Companies Act, 2013. 
5.3 PROVISIONS OF THE COMPANIES ACT  
(SECTION 55) 
A company limited by shares if so authorised by its Articles, may issue preference shares which 
at the option of the company, are liable to be redeemed within a period, normally not 
exceeding 20 years from the date of their issue. It should be noted that: 
(a) no shares can be redeemed except out of divisible or distributable profit, (i.e. out of 
the profit of the company which would otherwise be available for dividend) or out of 
proceeds of fresh issue of shares made for the purpose of redemption; 
(b) no such shares can be redeemed unless they are fully paid; 
(c) (i)  in case of such class of companies, as may be prescribed and whose financial 
statement comply with the accounting standards prescribed for such class of 
companies under Section 133, the premium, if any, payable on redemption shall 
be provided for out of the profits of the company, before the shares are 
redeemed:
© The Institute of Chartered Accountants of India
ACCOUNTING a
 
11.154 
Provided also that premium, if any, payable on redemption of any preference 
shares issued on or before the commencement of this Act by any such company 
shall be provided for out of the profits of the company or out of the company’s 
securities premium account, before such shares are redeemed. 
(ii) in case of other companies (not falling under (i) above), the premium, if any
payable on redemption shall be provided for out of the profits of the company or
out of the company’s securities premium account, before such shares are
redeemed.
(Refer to the Note given in para 5.4.1 for the basis applied in the Illustrations in
this Chapter.)
(d) where any such shares are proposed to be redeemed out of the profits of the company,
there shall, out of the divisible profits, i.e. the profits which would otherwise have been
available for dividends, be transferred to a reserve account to be called Capital
Redemption Reserve Account, a sum equal to the nominal amount of the shares
redeemed; and the provisions of the Act relating to the reduction of the share capital of
a company shall, except as provided in the Section, apply as if the Capital Redemption
Reserve (CRR) Account were the paid-up share capital of the company. The utilisation of
CRR Account is further restricted to issuance of fully paid-up bonus shares only.
From the legal provision outlined above, it is apparent that on the redemption of redeemable 
preference shares out of accumulated divisible profits, it will be necessary to transfer to the 
Capital Redemption Reserve Account an amount equal to the amount repaid on the 
redemption of preference shares on account of face value less proceeds of a fresh issue of 
shares made for the purpose of redemption. The object is that with the repayment of 
redeemable preference shares, the security for creditors/ bankers, etc. should not be reduced. 
At times, a part of the preference share capital may be redeemed out of accumulated divisible 
profits and the balance out of a fresh issue. 
5.4 METHODS OF REDEMPTION OF FULLY PAID-UP 
SHARES 
Redemption of preference shares means repayment by the company of the obligation on 
account of shares issued. According to the Companies Act, 2013, preference shares issued by 
a company must be redeemed within the maximum period (normally 20 years) allowed under 
the Act. Thus, a company cannot issue irredeemable preference shares.  
Section 55 of the Companies Act, 2013, deals with provisions relating to redemption of 
preference shares. It ensures that there is no reduction in shareholders’ funds due to 
© The Institute of Chartered Accountants of India
 
 
  
 11.155
COMPANY ACCOUNTS 
redemption and, thus, the interest of outsiders is not affected. For this, it requires that either 
fresh issue of shares is made, or distributable profits are retained and transferred to ‘Capital 
Redemption Reserve Account’.  
The rationale behind these provisions is to protect the interest of outsiders to whom the 
amount is payable before redemption of preference share capital. The interest of outsiders is 
protected if the nominal value of capital redeemed is substituted, thus, ensuring the same 
amount of shareholders’ fund.  
? In case of redemption of preference shares out of proceeds of a fresh issue of shares, 
replacement of capital and tangible assets is obvious.  
? If redemption is done out of distributable profits, replacement of capital is ensured in 
an indirect manner by retention of profit by transfer to Capital Redemption Reserve. 
In this case, the amount which would have otherwise gone to shareholders in the form 
of dividend is retained in the business and is used for settling the claim of preference 
shareholders. Thus, there is no additional drain from the net assets of the Company. 
The transfer of divisible profits to Capital Redemption Reserve makes them non-
divisible profits. As Capital Redemption Reserve can be used only for issue of fully paid 
bonus shares, profits retained in the business ultimately get converted into share 
capital.  
Security cover available to outside stakeholders depends upon called-up capital as well as 
uncalled capital to be demanded by the company as per its requirements. To ensure that the 
interests of outsiders are not reduced, Section 55 provides for redemption of only fully paid-
up shares. 
From the above paras, it can be concluded that the ‘gap’ created in the company’s capital by 
the redemption of redeemable preference shares must be filled in by: 
(a) the proceeds of a fresh issue of shares; or  
(b) the capitalisation of undistributed profits (by creating Capital Redemption Reserve); or 
(c) a combination of (a) and (b) above. 
5.4.1  Redemption of Preference Shares by Fresh Issue of Shares 
One of the methods for redemption of preference shares is to use the proceeds of a fresh 
issue of shares. A company can issue new shares (equity shares or preference shares) and the 
proceeds from such new shares can be used for redemption of preference shares. 
  
© The Institute of Chartered Accountants of India