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Redemption by Fresh Issue of Shares

A company can issue new shares (equity or preference) and utilize its proceeds for redemption of preference shares. For this purpose, the new shares can be issued at par, premium or discount. It must be noted that the amount raised from the issue of debentures cannot be utilized for the redemption of preference shares.

 

Advantages

  • No cash outflow
  • New shares may be issued at a premium

Disadvantages

  • Dilution of Earnings Per Share (EPS). The more the number of shares issued, the lesser the EPS.
  • Change in the shareholding pattern leading to dilution of control of existing shareholders.

The journal entries to be passed are as follows:

 

 


 

Note: When shares are redeemed by issuing shares at a discount, the proceeds from the new issue must be sufficient to cover the face value of the shares redeemed.

 

Illustration 1

 

A Ltd. Had 1,000 10% redeemable preference shares of ₹ 100 each, fully paid-up. The company decided to redeem these preference shares at par by the issue of a sufficient number of equity shares of ₹ 10 each fully paid-up at par. Pass the necessary journal entries.
 

Solution:

 

Journal Entries in the Books of A Ltd.
 



Illustration 2

 

In the above illustration, assume that the redemption was at a premium of 10 per cent. The balance in the securities premium account as on the date of redemption was ₹ 50,000. Pass the necessary journal entries.
 

Solution:

 

Journal Entries in the Books of A Ltd.
 



Illustration 3

 

A Ltd. had 1,000, 10 per cent redeemable preference shares of ₹ 100 each, fully paid-up. The company decided to redeem these preference shares at par by the issue of a sufficient number of equity shares of ₹ 10 each fully paid-up, at a discount of 10 per cent. Pass the necessary journal entries.
 

Solution:

 

In the Books of A Ltd.
 



Working Note:

 

Calculation of Amount to be Raised Through Fresh Issue

 

Amount to be redeemed = ₹ 1,00,000

 

Rate of discount on new issue is 10 per cent

 

Amount to be raised = ₹ 1,00,000/90% = ₹ 1,11,110

 

Number of shares = ₹ 1,11,110/₹ 10 = 11,111 shares

Redemption by Capitalization of Undistributed Profits

A company can redeem its preference shares by capitalization of undistributed profits instead of the issue of fresh shares. With this method, an amount equal to the face value of the shares redeemed is transferred to Capital Redemption Reserve Account by debiting the undistributed profits which are distributable.
 

Advantages

  • No change in the shareholding pattern of the company
  • Future earnings per share of the company are not diluted

Disadvantages

  • The company may face liquidity problem

The journal entry in this method
 



Illustration 4

 

Given below is the extract from the balance sheet of A Ltd. as on 31st March 2012.

  • Share Capital: 20,000 equity shares of ₹ 10 each fully paid—₹ 2,00,000
  • 500, 10 per cent redeemable preference shares of ₹ 100 each fully paid—₹ 50,000
  • Reserves and Surplus: Capital reserve—₹ 25,000
  • Securities premium—₹ 25,000
  • General reserve—₹ 37,500
  • Profit and loss A/c—₹ 12,500
On 1st April 2012, the company decided to redeem the preference shares at par by utilization of the reserve. Pass the necessary journal entries in the books of A Ltd.
 

Note:

  • The amount transferred to CRR must be out of free reserves only.
  • The other entries on redemption remain the same as in the case of redemption by issue of new shares.

 

Solution:

 

Journal Entries in the Books of A Ltd.
 


Redemption by Combination of Fresh Issue and Capitalization of Undistributed Profits

A company can redeem the preference shares partly from the proceeds of a new issue and partly out of undistributed profits. The accounting treatment will be the same as mentioned in the two cases.
 

Illustration 5

 

A Ltd. Had 1,000, 10 per cent redeemable preference shares of ₹ 100 each, fully paid-up. The company had ₹ 50,000 in its general reserve. It decided to redeem these preference shares at par by the issue of a sufficient number of equity shares of ₹ 10 each, fully paid-up, after utilizing the existing balance in the General Reserve Account. Pass the necessary journal entries.
 

Solution:

 

Journal Entries in the Books of A Ltd.
 



Working Note: In the problem, it is mentioned that the amount available in free reserve is fully utilized for redemption of preference shares. The nominal value of shares redeemed being ₹ 1,00,000, the amount of fresh issue will be ₹ 1,00,000
- ₹ 50,000 = ₹ 50,000.

Redemption of Partly Called-up Preference Shares

Preference shares can be redeemed only if they are fully paid-up. If the problem states that the company decided to redeem the preference shares which are partly called-up, it should be assumed that the final call on those shares are made and received before the redemption. If a problem has both partly paid-up preference shares and fully paid-up preference shares, then only the fully paid-up preference shares will be redeemed. The accounting treatment will be the same as mentioned earlier, depending upon the method of redemption chosen by the company.

Redemption of Fully Called-up but Partly Paid-up Preference Shares

If there are calls-in-arrears, then such arrears should be either received by the company or such shares must be forfeited. If all calls-in-arrears are received, then they become fully paid-up, and hence the ­company can proceed with redemption. If the shares are forfeited, the usual entries for forfeiture are passed before the redemption. The forfeited shares are not reissued, as the reissued shares must be redeemed in the immediate future.




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