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You have already learnt various aspects of accountancy and corporate accounting in the previous

units. The fund provided by the owners in to a business is known as capital. You know thatcapital 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. Thefixed 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 asshare 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 redeemablepreference 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, 1956, a company can

issue only redeemable shares i.e. at present a company cannot issue irredeemable preference

shares.

Now, in this unit we are going to discuss about the redemption of preference shares.

Learning Objectives

After reading this chapter, you are expected to be able to:

Identify the different types of preference shares; Describe how companies redeem its preference shares; Prepare account for the scheme of redemption; and Utilize the capital redemption reserve account.

1.2 Types of Preference Shares

In previous sections we have discussed different sources of capital. Equity shares get dividend ata rate fixed at the Annual General Meeting (AGM) depending on the profit available for a
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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, 1956, personsholding 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 ofvarious types. These are:

i) Redeemable Preference Shares: 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 theCompanies Act, 1956 deals with the redemption of preference shares.

ii) Irredeemable Preference Shares: The preference shares, which do not carry the agreement

of redemption are known as irredeemable preference shares.

iii) Convertible Preference Shares: This type of shares enjoy the right to the holder to get themconverted into equity shares according to the terms and conditions of the issue.

iv) Non-convertible Preference Shares: The holders of these shares do not enjoy the right toget the shares converted into equity shares. Unless otherwise stated, Preference shares are non-

convertible.

v) Participating Preference Shares: 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.

vi) Non-participating Preference Shares: These shares carry only a fixed rate of dividendwithout any right to get additional dividend. Unless otherwise stated, The preference shares are

non-participating.

vii) Cumulative Preference Shares: 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 years profit is insufficient for the same. So, the dividend on these shares accumulates tillthe final payment.

viii) Non-cumulative Preference Share: 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 anydividend. In this case, the dividend will be lapsed and there will be no arrear dividend.


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Self-Assessment Questions (SAQs) -1

Notes:

(i) Write your answer in about 50 words in the space given.

(ii)Compare your answer with the model answer given in the Answer section.

1. What do you mean by share and share capital?

2. What are the different types of share capital?

3. What is meant by redeemable preference shares?

4. Mark True (T) or False (F) for the following statements.

(i) Redeemable preference shares can be redeemed either at par or at premium.

(ii) Preference share holders enjoy voting rights.
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(iii) Non-cumulative preference shareholders can get arrear dividend.

(iv) Participating preference shareholders have no right to get an additional dividend.

1.3 Conditions for redemption of preference shares

Before going to redeem the preference shares as per section 80 of the Companies Act, 1956, a

company should have to follow the conditions: i) There must be a provision in the Articles of

Association regarding the redemption of preference shares. ii) The redeemable preference shares

must be fully paid up. If there is any partly paid share, it should be converted in to fully paidshares before redemption. 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. 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) The proceeds from

fresh issue of debentures cannot be utilized for redemption. vi) The amount of capital reservecannot be used for redemption of preference shares. vii) If the shares are redeemed out of

undistributed profit , the nominal value of share capital, so redeemed should be transferred toCapital Redemption Reserve Account. This is also known as capitalization profit.

So, you may understand that a company must follow the above conditions for the purpose ofredemption of its redeemable preference shares. In the next section we shall discuss about the

Capital Redemption Reserve account.


Notes:


(ii)Compare your answer with the model answer given in the Answer section

1. Can a company redeems its preference shares out of fresh issue of shares?
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2. When the Capital Redemption Reserve account is created?

3. Mark True (T) or False (F) for the following statements(i) Sale proceeds of investment can be utilized for redemption of preference shares.

(ii) For the purpose of redemption, debenture can be issued.

(iii) Capital Reserve cannot be used for the purpose of capital Redemption

1.4 Capital Redemption Reserve (CRR) Account

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

(i.e. amount transferred to CRR = Nominal value of shares redeemed Nominal value of shares

issued). The capital redemption reserve account can be used for issuing fully paid bonus shares.

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 repaymentof 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.


Notes:

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(ii)Compare your answer with the model answer given in the Answer section

1. How the Capital Redemption Reserve Account is created?

2. Why the CRR account is created?

1.5 Journal for accounting entries

The redeemable preference shares can be redeemed by a) the proceeds of a fresh issue of equity

shares/ preference shares, b) the capitalization of undistributed profit i.e. creating capital

redemption reserve account, or c) a combination of both (a) and (b). let us see the accountingentries required for redemption of preference shares.

i) When new shares are issued at par:

Bank A/c Dr.

To Share Capital A/c.

ii) When new shares are issued at premium:

Bank A/c ..Dr.

To Share Capital A/c

To Share Premium A/c
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iii) When new shares are issued at a discount:

Bank A/c Dr.

Discount on Issue of Share Capital..Dr.

To Share Capital A/c.

iv) Conversion of partly paid shares into fully paid shares:

a) Share Call A/c ..Dr.

To Share Capital A/c

b) Bank A/c ..Dr.

To Share Call A/c.

v) When preference shares are redeemed at par:

Redeemable Preference Share Capital A/c Dr.

To Preference shareholders A/c.

vi) When preference shares are redeemed at a premium:

Redeemable Preference Share Capital A/c Dr

Premium of Redemption Preference Share Capital A/c.Dr.

To Preference shareholders A/c.

vii) Adjustment of premium on redemption:

Profit and Loss A/c..Dr.

Share Premium A/c .Dr.

To Premium of Redemption Preference Share Capital A/c

viii) Transferring the amount to Capital Redemption Reserve Account:

General Reserve A/c .Dr.

Profit and Loss A/c .Dr.

To Capital Redemption Reserve A/c

ix) Expenses on issue of shares:

Expenses on Issue of shares A/c.Dr.

To Bank A/c.

x) When payment is made to preference shareholders:

Preference Shareholders A/c Dr.

To Bank A/c.

xi) When the fully paid bonus shares are issued:

Capital Redemption Reserve A/c .Dr.

General Reserve A/c ..Dr.

Share Premium A/c Dr.


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Profit & Loss A/c .. Dr.

To Bonus to Shareholders A/c

xii) Capitalization of profit:

Bonus to Shareholders A/c Dr.

To Equity share capital A/c

1.6 Worked out Examples

Example 1.XY Co. Ltd. had part of its share capital in 2000 preference shares of Rs.10 each fully paid up

and these have become due for redemption. The preference share capital was to be redeemed outof a fresh issue of equity shares at par made particularly for this purpose and the general reserve

of the company stood at Rs.25,000. Show the journal entries for the above transactions.

Solution:

Journal Entries in the Books of XY Ltd.

Date Particulars LF Dr.(Rs.) Cr.(Rs.)

2008April

1

Preference share capital A/c

.Dr.

To Preference shareholders A/c

(Being amount payable on redemption of

2000 preference shares)

20,000

20,000

2008

April

1

Bank A/c

...Dr.

To Equity Share Capital A/c

(Being the amount received on issue of 2000

equity shares of Rs.10 each made for the

20,000

20,000
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purpose of redemption of preference sharesas per Boards Resolution dated).

2008April1

Preference shareholders A/cDr.

To Bank

(Being the amount due to preferenceshareholders paid)

20,000

20,000

Example 2.Kitkat Co. Ltd. Issued 50,000 Equity shares of Rs.10 each and 3000, 10% Preference shares ofRs.100 each, all shares being fully paid. On 31.3.08, Profit and Loss Account showed an

undistributed profit of rs.50,000 and General Reserve Account stood at Rs.1,20,000. On 2.4.08,

the directors decided to issue 1500, 6% Preference shares of Rs.100 each for cash and to redeemthe existing preference shares at Rs.105 utilizing as much as would be required for the purpose.

Show the journal entries to record the transactions.

Solution:

Journal Entries in the Books of Kitkat Ltd.


2008

April

2

10% Preference share capital A/c

.Dr.

Premium on Redemption of Preferenceshares capital A/c..Dr.To Preference shareholders A/c

(Being amount payable on redemption of3000 preference shares, with premium of

5%).

3,00,000

15,000 3,15,000


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" Bank A/c...Dr.

To 6% Preference Share Capital A/c

(Being the amount received on issue of1500, 6% Preference shares of Rs.100 each

made for the purpose of redemption of

preference shares as per Boards Resolution

dated).

150,000

150,000

" General Reserve A/c

..Dr.

To Premium on Redemption of Preference

shares capital A/c(Being the amount written off against

general reserve)

15,000

15,000


Dr.

Profit & Loss A/c

.Dr.


( Being amount transferred equal to thedifference between the nominal value of

shares redeemed and proceeds of new

issue).

105,000

45,000 150,000

" Preference shareholders A/c

Dr.

To Bank

(Being the amount due to preferenceshareholders paid).

315,000

315,000

Example 3.The King Kong Ltd.s Balance sheet shows the following balance s on 31-3-08. 30,000 equity

shares of Rs.10 each fully paid; 18,000 10% Redeemable Preference shares of Rs.10 each fully

paid; 4000, 15% Redeemable Preference shares of Rs.10 each, Rs.8 paid up. General Reserve


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Rs.12,000; Securities Premium Rs.15,000; Profit Loss Account Rs.80,000 and capital Reserve

Rs.20,000.Preference shares are redeemed on 1-4.08 at a premium of Rs.2 per share. For redemption, 4000

equity shares of Rs.10 each are issued at 10% premium. A bonus issue of equity share was made

at par, two shares being issued for every five held on that date. Show the journal entries to record

the above transactions.

Solution:

Note: Partly paid up preference shares cannot be redeemed.

Journal Entries in the Books of King Kong Ltd.


2008April

1

10% Preference share capital A/c

.Dr.

Premium on Redemption of Preference

shares capital A/c.Dr.


(Being amount payable on redemption of18000 preference shares, with premium of

2%).

180,000

36,000 216,000

" Bank A/c

...Dr.

To Equity Share Capital A/c

To Securities Premium A/c

(Being the amount received on issue of

4000, Equity shares of Rs.10 each madewith premium of 10% for the purpose of

redemption of preference shares as per

Boards Resolution dated).

44,00040,000

4,000

" Securities Premium A/c

..Dr.

19,000

17,000 36,000


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Profit And Loss A/c

Dr.


shares capital A/c(Being the amount written off against

general reserve)


Dr.

Profit & Loss A/c

.Dr.


( Being amount transferred equal to thedifference between the nominal value of

shares redeemed and proceeds of new issue).

" 120,000

20,000 140,000


Dr.

To Bank(Being the amount due to preference

shareholders paid).

" 216,000

216,000

" Capital Redemption Reserve

A/c..Dr.

To Bonus to Shareholders A/cBeing the amount utilised for issue of bonusshares in 5:2 ratio as per shareholders

Resolution No. Dated) 30,000x2/5xRs.10

" 120,000

120,000

" Bonus to Shareholders A/c

.Dr.

To Equity Share capital A/c

(Being the amount capitalised by issue of

bonus shares)

120,000120,000


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Example 4.

The preference shares were redeemed on April 1, 2008 at a premium of Rs.5.00 per share, the

whereabouts of the holders of 1500 such shares not being known. At the same time, a bonus

issue of equity share was made at par, one share being issued for every four equity shares held.

Show the journal entries to record the above transactions and the Balance sheet as it wouldappear after the redemption. The following is the balance sheet of Black Diamond Co. Ltd. As

at 31 st March,2008.

Liabilities Amount(Rs.) Assets Amount(Rs.)

Issued & Subscribed Capital:

40,000 Equity shares of Rs.10 eachfully paid

18,000, 8% Preference shares ofRs.10 each fully paid

Reserves & Surplus:Profit & Loss Account

Current Liabilities:Sundry Creditors

4,00,000

1,80,000

4,80,000

40,000

Fixed

Assets

CurrentAssets

7,00,000

4,00,000

11,00,000 11,00,000

Solution:

Journal Entries in the Books of Black Diamond Ltd.


2008April

1

8% Preference share capital A/c.Dr.

Premium on Redemption of Preferenceshares capital A/c.Dr.


(Being amount payable on redemption of

1,80,000

90,000 270,000


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18000 preference shares, with premium ofRs.5 each).

" Profit And Loss A/cDr.


shares capital A/c(Being the amount written off against Profit

And Loss A/c)

90,000

90,000

" Profit & Loss A/c

.Dr.

To Capital Redemption Reserve A/c( Being amount transferred equal to the

nominal value of shares redeemed and

proceeds of new issue).

" 1,80,000

1,80,000

' Capital Redemption Reserve

A/c..Dr.

To Bonus to Shareholders A/cBeing issue of 1 bonus share to every 4equity shares held as per shareholders

Resolution No. Dated) 40,000x1/4xRs.10

1,00,000

1,00,000

" Bonus to Shareholders A/c

.Dr.

To Equity Share capital A/c

(Being the amount capitalised by issue of

bonus shares)

1,00,000

1,00,000


Dr.

To Bank

2,47,000

2,47,000


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(Being the amount due to preferenceshareholders paid except 1500 share

holders).

Balance sheet of Black Diamond Co. Ltd. as at 1st April, 2008.

Liabilities Amount(Rs.) Assets Amount(Rs.)

Issued & Subscribed

Capital:

50,000 Equity shares of Rs.10each fully paid(of the above shares, 10,000

shares have been allotted as

fully paid bonus shars)

Reserves & Surplus:Capital Redemption Reserve

Account (Rs.180000-100000)

Profit & Loss Account

(Rs.480000-90000-180000)

Current Liabilities:Sundry Creditors

Outstanding claim (Pref.

Shareholders)

5,00,000

80,000

2,10,000

40,000

22,500

Fixed Assets

Current Assets(Rs.400000-247500)

7,00,000

4,00,000

8,52,500 8,52,5000


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Let's Sum Up

Answers to SAQs

Self-Assessment Quesitons-1:

1. What do you mean by share and share capital?The amount provided by the owner is known as capital. The capital of a company is share

capital. Total capital id divided into a number of small indivisible units of a fixed amount and

each such unit is known as share.

2. What are the different types of share capital?

Share capital are of two types, viz. equity share capital and preference share capital. A companycan issue eight types preference share capital. These are i) Redeemable Preference Shares, ii)

Irredeemable Preference Shares, iii) Convertible Preference Shares, iv) Non-convertible

Preference Shares, v) Participating Preference Shares , vi) Non-participating Preference Shares,

vii) Cumulative Preference Shares, viii) Non-cumulative Preference Share.

3. What is meant by redeemable preference shares?

Redemption is the process of repaying an obligation at predetermined amount. The redeemablepreference shares are issued on the terms that the shareholders will be repaid the amount which

they invested at future date.

4. (i) T, (ii) F, (iii) F, (iv) F .

Self-Assessment Questions-2:

1. Yes. A company can redeem its redeemable preference shares out of fresh issue of shares. For

the purpose of redemption of preference shares, a company may issue either equity shares or

preference shares. But remember, a company cannot issue debenture for redemption ofpreference shares.

2. A company can redeem its preference share out of either fresh of shares or from accumulated

profit. When the company redeems its preference shares out of accumulated profit, it is necessary

to create the capital redemption reserve account. The basic purpose of creation of this account isto protect the interest of sundry creditors and maintain the working capital.
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3. (i) False, (ii) False, (iii) True .

Self-Assessment Questions-3:

1. How the Capital Redemption Reserve Account is created?

By transferring the amount of general reserve, profit and loss account, the Capital redemptionreserve account is created.

General Reserve A/c .Dr.

Profit and Loss A/c ...Dr.

Investment Allowance Reserve..Dr.


2. Why the CRR account is created?

The main purpose of creating CRR is to protect the interest of sundry creditors and to maintain

the working capital. Redemption of preference shares involves repayment of capital beforepaying 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.That is why, the amount is capitalized by creating the capital redemption reserve account.

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