CA > Foundation > Paper 1 – Skim Notes

Unit 5:Redemption of Preference Shares

Overview

  • Understanding the concept of redemption and purpose of redeemable preference shares.
  • Provisions of the Companies Act, 2013 regarding preference shares.
  • Methods of redemption for fully paid-up preference shares.
  • Creation of Capital Redemption Reserve and its significance.
  • Accounting treatment for different types of preference shares redemption.

Key Topics

Meaning and Purpose of Redemption of Preference Shares

  • Redemption refers to repaying an obligation at predetermined amounts and times.
  • Redeemable preference shares are issued with a promise to repay the invested amount after a specified period.
  • The redemption date is an important date on the share certificate indicating repayment time.
  • Redemption allows companies to adjust their financial obligations or structure effectively.
  • Encourages investment in preference shares where capital is not easily raised in a dull market.

Deep Dive

  • Redemption enhances investor confidence as it assures return of capital after a set period.
  • Encourages companies to use surplus funds effectively, distributing them to shareholders post redemption.

Provisions of Companies Act, 2013

  • Section 55 allows issuing preference shares redeemable within maximum 20 years from issue.
  • Redemption should occur only from divisible profits or fresh issue proceeds.
  • Shares must be fully paid before redemption, ensuring no financial loss to stakeholders.
  • Redemption premiums must be provided from profits before shares are redeemed.
  • Capital Redemption Reserve Account is mandated to ensure company solvency post redemption.

Deep Dive

  • Legal consequences for non-compliance with Act, including potential penalties for company directors.
  • Assessment of solvency as a precondition for redemption guarantees protection for creditors.

Methods of Redemption of Fully Paid-Up Preference Shares

  • Redemption can be done through fresh issue of shares, capitalization of profits, or a combination of both.
  • Fresh issue involves using newly raised funds to redeem existing preference shares.
  • Capitalization involves using undistributed profits to transfer to the Capital Redemption Reserve before redemption.
  • Combination allows flexibility and preserves financial resources while ensuring compliance with regulations.
  • Accounting must reflect these transactions accurately in books.

Deep Dive

  • Consideration of market conditions for deciding between methods helps in strategic financial planning.
  • Potential for issuing shares at a premium, enhancing company valuation while facilitating redemption.

Capital Redemption Reserve (CRR)

  • CRR is established to protect creditors and ensure adequate funds remain within the company post redemptions.
  • An amount equal to the nominal value of shares redeemed must be set aside from profits to CRR.
  • Utilization of CRR is restricted to issuance of fully paid-up bonus shares only.
  • CRR is crucial for maintaining shareholder equity and preventing undercapitalization of the company.
  • Divisible profits only can create a CRR, excluding other reserves.

Deep Dive

  • CRR contributes to the stability of the financial structure of a company, safeguarding long-term solvency.
  • Companies need to strategize about CRR to optimize equity structure during redemption cycles.

Accounting Treatment for Redemption of Preference Shares

  • Different scenarios (fully paid-up, partly called-up shares) dictate the treatment processes according to the Act.
  • When fully paid-up shares are redeemed, entries reflect payment liability directly to shareholders.
  • Partly called-up shares must fulfill payments before any redemption occurs, requiring appropriate call management.
  • Records must differentiate the various stages of preference share redemption accurately, reflecting true company liabilities.
  • Premiums payable on redemption must also be accounted against profits before final payment.

Deep Dive

  • Sophisticated accounting systems could enhance monitoring of preference share status and corresponding cash management.
  • Implications of redemption on equity ratios and financial disclosures must be thoroughly analyzed.

Detailed Journal Entries for Redemption

  • Specific journal entries illustrate practical redemption accounting procedures for different scenarios.
  • Examples include issuing new shares to facilitate redemption or utilizing profits to create CRR.
  • Careful tracking of entry sequences and amounts is crucial during redemption to ensure compliance and accuracy.
  • Complexities arise when factoring in the premium on redemption; adjustments must correspond to Company Act provisions.
  • Illustrative examples showcase best practices for preserving shareholder capital integrity.

Deep Dive

  • Journal entries reflect a company’s financial health and transparent dealings with investors.
  • Strategic journal management can mitigate risks associated with misreporting or noncompliance.

Summary

The redemption of preference shares is a critical financial mechanism enabling companies to manage their capital structure, governed primarily by Section 55 of the Companies Act, 2013. The process involves repaying investors at stipulated times and amounts, ensuring that shares are fully paid before any redemption occurs. Companies can redeem preference shares through fresh issues of equity, capitalization of profits into a Capital Redemption Reserve, or a combination of both methods. The Capital Redemption Reserve is essential for maintaining the financial stability of the company, protecting the interests of creditors and shareholders. Proper accounting treatment and compliance with relevant regulatory provisions are crucial for accurate reflection of the company’s financial position and ensuring investor confidence.