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Redemption of Preference
Shares
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Introduction
2 Objectives
3 Types of Preference shares
4 Conditions for redemption of preference
shares
5 Capital Redemption Reserve (CRR)
Account
6 Journal for accounting entries
7 Worked out Examples
 O  
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,

56, a company can issue only
redeemable shares i e at present a company cannot issue irredeemable
preference shares
Now, we are going to discuss about the redemption of preference shares
 


  



V Identify the different types of preference shares;

V Describe how companies redeem its preference
shares;
V Prepare account for the scheme of redemption;
and
V Utilize the capital redemption reserve account
 


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V Equity shares get dividend at a rate fixed at the Annual General Meeting
(AGM) depending on the profit available for a 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,

56, 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:

V i) 2



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 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,

56 deals with the redemption of preference
shares
V ii) O



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 The preference shares,
which do not carry the agreement of redemption are known as
irredeemable preference shares
V iii) —

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 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
V iv) Ê
Ê

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 The holders of these
shares do not enjoy the right to get the shares converted into
equity shares Unless otherwise stated, Preference shares are
non--convertible
non
V v) | 
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 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
V vi) Ê
Ê
 
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 These shares carry only
a fixed rate of dividend without any right to get additional dividend
Unless otherwise stated, The preference shares are non-
non-participating
V vii) —  
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 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
year¶s profit is insufficient for the same So, the dividend on these
shares accumulates till the final payment
V viii) Ê
Ê  
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 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
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V Defore going to redeem the preference shares as per section 80
of the Companies Act,

56, a company should have to follow
the conditions:
V i) There must be a provision in the Articles of Association
regarding the redemption of preference shares
V ii) The redeemable preference shares must be fully paid up If
there is any partly paid share, it should be converted in to fully
paid shares before redemption
V iii) The redeemable preference shareholders should be paid
out of undistributed profit/ distributable profit or out of fresh
issue of shares for the purpose of redemption
V iv) If the shares are redeemed at a premium, it should
be should be provided out of securities premium or
profit and loss account or general reserve account
V v) The proceeds from fresh issue of debentures
cannot be utilized for redemption
V vi) The amount of capital reserve cannot be used for
redemption of preference shares
V vii) If the shares are redeemed out of undistributed
profit , the nominal value of share capital, so
redeemed should be transferred to Capital
Redemption Reserve Account This is also known as
capitalization profit
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2


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—22 
 
V If you go through the conditions as discussed in the previous section, it
will be clear that, if the preference shares are redeemed out of accumulated
profit, it will be necessary to transfer an amount equal to the amount
repaid on the redemption to Capital Redemption Reserve Account If the
company issues any fresh shares for redemption purpose, the transferred
amount will be the difference between nominal value of shares redeemed
and the nominal value of shares issued (

(
„
„
„ 

 

„„ 
„ 

 „„ 
„ 
)

 
„„ 
„ 
)
The capital redemption reserve account can be used for issuing fully paid
bonus shares
V The importance of creation of capital redemption reserve account are to a)
protect the interest of creditors and b) maintain 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 The amount is capitalized by
creating the capital redemption reserve account As a result this amount
will not be available for distribution of dividend It help protect the interest
of creditors and on the other hand it replenishes working capital
 h 
  
 

V The redeemable preference shares can be
redeemed by
V a) the proceeds of a fresh issue of equity
shares/ preference shares,
V b) the capitalization of undistributed profit i e
creating capital redemption reserve account, or
V c) a combination of both (a) and (b) let us see
the accounting entries required for redemption
of preference shares
V i) K





 
Dank A/c «««««««Dr
To Share Capital A/c
V ii) K






 
Dank A/c «««««««« Dr
To Share Capital A/c
To Share Premium A/c
V iii) K




 
Dank A/c ««««««Dr
Discount on Issue of Share Capital««« Dr
To Share Capital A/c
V iv) —


  


 


a) Share Call A/c ««« Dr
To Share Capital A/c
b) Dank A/c ««««« Dr
To Share Call A/c
V v) K













 
Redeemable Preference Share Capital A/c ««Dr
To Preference shareholders A/c
V vi) K














 
Redeemable Preference Share Capital A/c ««««Dr
Premium of Redemption Preference Share Capital A/c« Dr
To Preference shareholders A/c
V vii)  



 



Profit and Loss A/c«««««« Dr
Share Premium A/c «««««« Dr
To Premium of Redemption Preference Share Capital A/c
V viii)  


 —
2


2



 
General Reserve A/c ««««« Dr
Profit and Loss A/c ««««« Dr
To Capital Redemption Reserve A/c
V ix) v






Expenses on Issue of shares A/c««««« Dr
To Dank A/c
V x) K

 










Preference Shareholders A/c «««««Dr
To Dank A/c
V xi) K


 
 



Capital Redemption Reserve A/c ««««« Dr
General Reserve A/c «««««««««« Dr
Share Premium A/c «««««««««««Dr
Profit & Loss A/c ««««««««««« Dr
To Donus to Shareholders A/c
V xii) —




Donus to Shareholders A/c ««««««Dr
To Equity share capital A/c
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 2  2 

2008 Preference share capital A/c ««««« Dr 20,000

April
To Preference shareholders A/c 20,000
(Deing amount payable on redemption of 2000
preference shares)
Ñ
 |     Ñ —
 2  2 

2008 Dank A/c «««««««««««««« Dr 20,000

April
To Equity Share Capital A/c 20,000
(Deing the amount received on issue of 2000 equity shares
of Rs
0 each made for the purpose of redemption of
preference shares as per Doard¶s Resolution
dated««««)

2008 Preference shareholders A/c «««««««Dr 20,000

April
To Dank A/c 20,000
(Deing the amount due to preference shareholders paid)
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2008
0% Preference share capital A/c ««««« Dr 3,00,000
April 2 Premium on Redemption of Preference shares capital
A/c«««««« Dr
5,000
To Preference shareholders A/c 3,
5,000
(Deing amount payable on redemption of 3000 preference
shares, with premium of 5%)
 
Ñ —
Ñ
 |    
2  2 

† Dank A/c «««««««««««««« Dr

50,000
To 6% Preference Share Capital A/c
(Deing the amount received on issue of
500, 6% Preference
50,000
shares of Rs
00 each made for the purpose of redemption of
preference shares as per Doard¶s Resolution dated««««)

† General Reserve A/c «««««««««« Dr

5,000
To Premium on Redemption of Preference shares capital A/c
(Deing the amount written off against general reserve)
5,000

† General Reserve A/c ««««««««««Dr

05,000
Profit & Loss A/c ««««««««««« Dr
To Capital Redemption Reserve A/c 45,000
50,000
( Deing amount transferred equal to the difference between the
nominal value of shares redeemed and proceeds of new issue)

† Preference shareholders A/c «««««««Dr 3

5,000
To Dank A/c
(Deing the amount due to preference shareholders paid) 3
5,000
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2  2 
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—
 Fixed Assets 7,00,000
40,000 Equity shares of Rs
0 each fully paid 4,00,000

8,000, 8% Preference shares of Rs

0 each
fully paid
,80,000
2


 
  Current
Profit & Loss Account Assets 4,00,000
—

 4,80,000
Sundry Creditors
40,000

,00,000

,00,000
R
 
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Ñ
 |     Ñ —
 2  2 

2008 8% Preference share capital A/c ««««« Dr

,80,000
April Premium on Redemption of Preference shares capital

A/c«««« Dr
0,000
To Preference shareholders A/c 270,000
(Deing amount payable on redemption of
8000 preference
shares, with premium of Rs 5 each)

† Profit And Loss A/c ««««««««««Dr
0,000

To Premium on Redemption of Preference shares capital
A/c
0,000
(Deing the amount written off against Profit And Loss A/c)
† Profit & Loss A/c ««««««««««« Dr
,80,000
To Capital Redemption Reserve A/c
,80,000
( Deing amount transferred equal to the nominal value of
shares redeemed and proceeds of new issue)
Ñ
 |     Ñ —
 2  2 

† Capital Redemption Reserve A/c«««« Dr

,00,000
To Donus to Shareholders A/c
,00,000
(Deing issue of
bonus share to every 4 equity shares held
as per shareholders Resolution No Dated«)
40,000x
/4xRs
0

† Donus to Shareholders A/c ««««««« Dr

,00,000
To Equity Share capital A/c
,00,000
(Deing the amount capitalised by issue of bonus shares)

† Preference shareholders A/c «««««««Dr 2,47,000

To Dank 2,47,000
(Deing the amount due to preference shareholders paid
except
500 share holders)



  


     

  


   
  
2  2 
O
   
—
 Fixed Assets 7,00,000
50,000 Equity shares of Rs
0 each fully paid 5,00,000
(of the above shares,
0,000 shares have been allotted
as fully paid bonus shars) Current
2


 
  Assets 4,00,000
Capital Redemption Reserve Account (Rs
80000-

80000- (Rs 400000-
400000-

00000) 80,000 247500)

Profit & Loss Account (Rs 480000

480000--
0000

0000--
80000) 2,
0,000
—


Sundry Creditors
Outstanding claim (Pref Shareholders) 40,000
22,500

8,52,500 8,52,5000
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Arunima Jain