Redemption of Preference Shares: Notes Notes | Study Accounting for CA Intermediate - CA Foundation

CA Foundation: Redemption of Preference Shares: Notes Notes | Study Accounting for CA Intermediate - CA Foundation

The document Redemption of Preference Shares: Notes Notes | Study Accounting for CA Intermediate - CA Foundation is a part of the CA Foundation Course Accounting for CA Intermediate.
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 Page 1


LEARNING OUTCOMES 
*    
 
 
REDEMPTION OF 
PREFERENCE SHARES 
 
 
 
After studying this chapter, 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. 
CHAPTER 
7 
Page 2


LEARNING OUTCOMES 
*    
 
 
REDEMPTION OF 
PREFERENCE SHARES 
 
 
 
After studying this chapter, 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. 
CHAPTER 
7 
 
 
 
7.2 
 
ACCOUNTING 
  
 
  
 1. INTRODUCTION 
Redemption is the process of repaying an obligation, at prearranged amounts and 
timings. It is a contract giving the right 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 
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)
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.
 
Page 3


LEARNING OUTCOMES 
*    
 
 
REDEMPTION OF 
PREFERENCE SHARES 
 
 
 
After studying this chapter, 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. 
CHAPTER 
7 
 
 
 
7.2 
 
ACCOUNTING 
  
 
  
 1. INTRODUCTION 
Redemption is the process of repaying an obligation, at prearranged amounts and 
timings. It is a contract giving the right 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 
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)
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.
 
 
 
7.3 
 
 REDEMPTION OF PREPERENCE SHARES 
 
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. 
 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, 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 India, the issue and redemption of preference shares is governed by Section 55 
of the Companies Act, 2013. 
 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; 
Page 4


LEARNING OUTCOMES 
*    
 
 
REDEMPTION OF 
PREFERENCE SHARES 
 
 
 
After studying this chapter, 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. 
CHAPTER 
7 
 
 
 
7.2 
 
ACCOUNTING 
  
 
  
 1. INTRODUCTION 
Redemption is the process of repaying an obligation, at prearranged amounts and 
timings. It is a contract giving the right 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 
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)
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.
 
 
 
7.3 
 
 REDEMPTION OF PREPERENCE SHARES 
 
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. 
 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, 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 India, the issue and redemption of preference shares is governed by Section 55 
of the Companies Act, 2013. 
 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; 
 
 
 
7.4 
 
ACCOUNTING 
(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: 
  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 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. 
Page 5


LEARNING OUTCOMES 
*    
 
 
REDEMPTION OF 
PREFERENCE SHARES 
 
 
 
After studying this chapter, 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. 
CHAPTER 
7 
 
 
 
7.2 
 
ACCOUNTING 
  
 
  
 1. INTRODUCTION 
Redemption is the process of repaying an obligation, at prearranged amounts and 
timings. It is a contract giving the right 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 
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)
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.
 
 
 
7.3 
 
 REDEMPTION OF PREPERENCE SHARES 
 
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. 
 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, 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 India, the issue and redemption of preference shares is governed by Section 55 
of the Companies Act, 2013. 
 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; 
 
 
 
7.4 
 
ACCOUNTING 
(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: 
  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 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. 
 
 
7.5 
 
 REDEMPTION OF PREPERENCE SHARES 
 
 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 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. But, 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 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; or 
(c) a combination of (a) and (b) above. 
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