Redemption of Preference Shares- Journal Entries and Rules
When students study company accounts, topics such as hdfc bank bonus shares and preference shares often appear in share capital discussions. Among these topics, redemption is important because it explains how a company returns preference share capital to its shareholders after the agreed period. The redemption of preference shares means that a company repays the capital received from preference shareholders according to the terms of issue. After repayment, the company removes those preference shares from its share capital.
What Is Redemption of Preference Shares?
Redemption of preference shares means the repayment of preference share capital by a company to its preference shareholders. A company normally issues redeemable preference shares with specific terms that state when and how the company will repay the shareholders. For example, a company may issue 10,000 preference shares with a face value of Rs. 100 each. If the shares become redeemable after five years, the company must arrange the required funds and repay the shareholders according to the issue terms.
The redemption of preference shares does not mean that shareholders sell their shares to another investor. Instead, the company itself makes the repayment and completes the redemption process.
Why Do Companies Redeem Preference Shares?
| Redemption Type | Meaning | Example |
|---|---|---|
| At par | Company pays face value | Rs. 100 share paid at Rs. 100 |
| At premium | Company pays more than face value | Rs. 100 share paid at Rs. 110 |
| Premium amount | Extra amount paid above face value | Rs. 10 in the example |
Main Conditions for Redemption
The redemption of preference shares must follow the applicable company law and the terms attached to the shares. For Indian company accounting, Section 55 of the Companies Act, 2013 provides important rules for redeemable preference shares. According to guidance published by the Institute of Chartered Accountants of India, preference shares can generally be redeemed out of profits that would otherwise be available for dividends or from the proceeds of a fresh issue of shares made for redemption. The shares must also be fully paid before redemption.
These conditions help protect the company’s capital. They also prevent a company from reducing its paid up capital without following the required legal process.
Sources Used for Redemption
| Source of Funds | Basic Treatment |
|---|---|
| Distributable profits | Amount may be transferred to Capital Redemption Reserve |
| Fresh share issue | Proceeds can finance the redemption |
| Combination | Company can use both available profits and fresh issue proceeds |
What Is Capital Redemption Reserve?
Capital Redemption Reserve, commonly called CRR, is an important part of the accounting treatment. When a company redeems preference shares out of profits rather than proceeds from a fresh share issue, it transfers an amount equal to the nominal value of the shares redeemed to CRR under the applicable rules. For example, assume a company redeems preference shares with a nominal value of Rs. 500,000 using distributable profits. The company generally transfers Rs. 500,000 to the Capital Redemption Reserve.
The purpose of CRR is to help maintain the company’s capital position after redemption. ICAI material explains that the reserve receives the nominal amount of shares redeemed when the company uses distributable profits for the redemption.
How Does the Redemption Process Work?
The redemption of preference shares normally begins with checking the terms of issue and the amount that the company must pay. The company then identifies an appropriate source of funds and completes any required legal and accounting procedures. If the company uses profits, it determines the amount that needs to move into CRR. If it issues new shares, it calculates how much money the new issue must raise to meet the redemption requirement.
The company then records the amount payable to preference shareholders. After making the payment, it removes the redeemed preference share capital from the relevant accounts.
Example of Redemption of Preference Shares
Consider a company that has 5,000 redeemable preference shares with a face value of Rs. 100 each. The shares will be redeemed at a premium of 10%.
First, calculate the nominal value:
5,000 × Rs. 100 = Rs. 500,000
The redemption premium equals:
10% of Rs. 500,000 = Rs. 50,000
Therefore, the company needs to pay:
Rs. 500,000 + Rs. 50,000 = Rs. 550,000
The following table makes the calculation easier to understand.
| Particular | Amount |
|---|---|
| Number of preference shares | 5,000 |
| Face value per share | Rs. 100 |
| Nominal value | Rs. 500,000 |
| Redemption premium | 10% |
| Premium amount | Rs. 50,000 |
| Total redemption amount | Rs. 550,000 |
Accounting Entries for Redemption
The redemption of preference shares also requires suitable journal entries in the company’s books. The entries depend on whether the company redeems the shares at par or at a premium. When shares are redeemed at par, the company transfers the amount payable to the preference shareholders. When shares are redeemed at a premium, the company records both the share capital and the premium payable.
ICAI study material provides journal entries for redemption at par, redemption at a premium, payment to preference shareholders, and adjustment of the redemption premium.
A simplified presentation is shown below.
| Transaction | Basic Journal Treatment |
|---|---|
| Redemption at par | Preference Share Capital Dr. to Preference Shareholders |
| Redemption at premium | Preference Share Capital Dr. and Premium on Redemption Dr. to Preference Shareholders |
| Payment made | Preference Shareholders Dr. to Bank |
| Premium adjustment | Appropriate profit or eligible reserve account Dr. to Premium on Redemption |
Redemption Through Fresh Issue of Shares
A company may raise new share capital to finance the redemption. This method can reduce the amount that the company needs to take from its existing profits. Suppose a company needs Rs. 600,000 to redeem preference shares. It may issue new equity shares and use the proceeds to meet the redemption amount, provided the issue complies with the applicable legal requirements.
ICAI’s study material also explains how students can calculate the minimum fresh issue required when the company uses a combination of new share proceeds and available profits.
What Happens If Preference Shares Are Not Fully Paid?
Only fully paid preference shares can normally be redeemed under the applicable Indian company law rules. Therefore, a company must address unpaid amounts before completing the redemption.
ICAI study material explains that when preference shares are partly paid, the necessary unpaid amount must be received so that the shares become fully paid before normal redemption can take place. This rule makes sure that the company does not redeem share capital before completing the required payment on those shares.
Importance of Redemption in Company Accounts
The redemption of preference shares affects several parts of a company’s financial records. It reduces the preference share capital and may also affect cash, reserves, securities premium, and other relevant accounts.
Students should therefore understand both the legal conditions and the accounting entries. A correct solution normally starts by identifying the nominal value, redemption price, available profits, fresh issue proceeds, and any premium involved.
Difference Between Redemption and Transfer of Shares
Redemption and transfer are different transactions. In a transfer, one shareholder usually transfers shares to another person, while the company continues to have the share capital represented by those shares. In redemption, the company repays the preference shareholder and removes the redeemed capital according to the applicable rules. This difference is important because the accounting treatment for the two transactions is not the same.
| Basis | Redemption | Transfer |
|---|---|---|
| Main action | Company repays shareholder | Shareholder transfers shares |
| Company capital | Redeemed capital is removed | Capital generally remains |
| Payment | Company makes the redemption payment | Buyer normally pays seller |
| Purpose | Repayment according to redemption terms | Change in ownership |
Conclusion
The redemption of preference shares is the process through which a company repays redeemable preference share capital according to the agreed terms and applicable company law. The most important points are the source of funds, fully paid status, redemption price, premium, and Capital Redemption Reserve. Students should also learn the journal entries because accounting questions often require both calculations and entries.
A simple way to remember the concept is that the company receives capital when it issues preference shares and returns the relevant capital when it redeems them. Understanding this basic flow makes the accounting treatment much easier to follow.
