Preference Shares
By Asok Nadhani
27.1 Preference Shares
As per the Sec 85(1) of the companies Act, 1956, the
following conditions are to be fulfilled in respect of dividend & repayment
of preference share capital.
a.
Dividend: Dividend must be paid to Preference shareholders
before any dividend is paid to Equity shareholders.
b.
Repayment: In case of winding up of the company, the preference
shareholders will get repayment of capital before the payment of equity
shareholders.
27.1.1 Types of Preference
Shares
Preference shares may be classified as follows:
a.
As per Dividend
Payment:
i.
Cumulative Preference Shares: These
shares carry a fixed dividend and the dividend goes on accumulating till it is
fully paid off. The arrears dividend are carried forward and charged on
subsequent year’s profit. Preference shares are presumed cumulative preference
share unless stated otherwise.
ii.
Non-cumulative Preference Shares: These
shares carry a fixed percentage of dividends but the dividend does not go
accumulating. If there is no profit or inadequate profit in any year, the
shareholders get no dividend. They can not make claim on unpaid dividend in any
subsequent year.
b.
As per Profit
participation:
i.
Participating Preference Shares: These
shares are not only entitled to a fixed rate of dividend but also a share in
the surplus profits which remain after the claims of the equity shareholders
have been met.
ii.
Non- participating Preference Shares: These
shares are only entitled to a fixed rate of dividend. They do not get any share
in the surplus profits after paying dividends to equities shareholders.
c.
As per Convertibility into Equity Shares:
i.
Convertible Preference Shares: These shares have right to convert into
equity shares within a certain period.
ii.
Non- convertible Preference Shares: These shares have no right to convert into
equity shares.
d.
As per Repayment of Capital:
i.
Redeemable Preference Shares:
(a)
These
shares are repaid on expiry of certain period or at option of the Company, as
provided in the Articles.
(b)
Maximum
redemption period of preference share is 20 years from the date or its issue.
Issue or redeemable preference shares must be authorized by Articles of
Association.
ii.
Irredeemable Preference Shares: Earlier
companies could issue irredeemable preference shares also. After the amendment
of the Companies Act, 1988, no company can issue irredeemable preference shares
or redeemable preference shares which are redeemable after 20 years of its
issue. Such preference shares cannot be redeemed unless the company is
liquidated. A company cannot issue irredeemable preference shares.
27.2
Redemption of Preference Share
Redemption means repayment of share capital to the
shareholders. The Companies Act, 1956 empowers the company to redeem its
preference shares subject to fulfillment of some conditions.
27.3
Legal Provisions for Redemption
A company limited by shares can redeem preference
share within 20 years from the date of the issue of shares subject to the
following conditions:
1.
The
Article of Association must provide for the issue of such share.
2.
These
shares may be redeemed only out of:
a.
Profits
of the company available for dividends.
b.
Proceeds
of issue of shares made for such purpose.
3.
Shares
must be fully paid before its redemption.
4.
If
shares are redeemed at a premium, the premium must be paid either out of
profits or share premium account.
5.
When
shares are redeemed out of profits of the company available for dividends, an
amount equal to nominal value of shares, to be redeemed, will be transferred to
the Capital Redemption Reserve Account. This reserve can be used only for the
issue of fully paid Bonus share to the company’s members.
6.
In
case of new issue of shares for the purpose of redemption of preference shares,
it will be treated as replacement of capital instead of increase of capital.
7.
Sale
27.4
Utilisation of Reserve for Redemption of Preference Share
As per Sec.80, Co.s Act, 1956, the following funds are
available for redemption of preference shares. These reserves are treated as
Free Reserve and should be transferred to Capital redemption Reserve.
-
Profit
& Loss Account
-
General
Reserve
-
Reserve
Fund
-
Dividend
Equalization Reserves
-
Insurance
Fund
-
Workmen’s
Compensation Fund or Accident Fund
The following funds are not treated as Free Reserve or
the purpose of redemption of Preference Shares.
-
Capital
Reserve
-
Security
Premium Account
-
Profit
prior to incorporation
-
Revaluation
Reserve
-
Share
Forfeiture Account
-
Investment
Allowance Reserve
-
Development
Rebate Reserve
27.5 Premium on Redemption
of Preference Share
As per Sec.80 (1) (c), if shares are redeemed at a
premium, the premium must be paid either out of profits or company’s Share
Premium Account. Any premium collected from new or fresh issue can not be
utilized for redemption purpose (because it can not be taken as premium before
the redemption of shares). Entries for the redemption, and also issue of new
shares, are to be passed simultaneously.
27.6 Capital Redemption Reserve
(CRR)
If the company has issued fresh shares to facilitate the redemption,
then the amount to be transferred shall be reduced proportionately, by the
amount of:
i) Shares issued at par: The difference between the
nominal value of shares redeemed and nominal value of shares issued.
ii)
Shares issued at
premium: The difference between the nominal value of shares redeemed and nominal
value of shares issued. Securities premium shall not be considered.
iii)
Shares issued at
discount: The difference between the nominal value of shares redeemed and nominal
value of shares issued less discount.
27.7
Accounting Entries for Redemption of Preference Share
The following of
preference share can be made in the following ways-
i)
Redemption at Par:
ii)
Redemption at a Premium:
iii)
If Bonus is declared:
27.7.1 Redemption at
Par:
|
1. When new shares are
issued at par for redemption
|
|
|
Bank A/c
|
Dr.
|
|
To
Share Capital A/c
|
|
|
2. When new shares are
issued at a discount for redemption
|
|
|
Bank
A/c
|
Dr.
|
|
Discount
on Issue of share A/c
|
Dr.
|
|
To
Share Capital A/c
|
|
|
3. When new shares are
issued at a premium for redemption
|
|
|
Bank A/c
|
Dr.
|
|
To
Share Capital A/c
|
|
|
To
Securities Premium A/c
|
|
|
4. Creation of Capital
Redemption Fund on redemption made out of profits
|
|
|
Profit & Loss A/c
|
Dr.
|
|
General Reserve A/c
|
Dr.
|
|
To
Capital Redemption Reserve A/c
|
|
|
5. When payment is made
to Preference Shareholders
|
|
|
(i) Transfer of
Preference Share capital to Preference Shareholders:
|
|
|
Preference Share capital A/c
|
Dr.
|
|
To
Preference Shareholders A/c
|
|
|
(ii) Payment made
to Preference Shareholders:
|
|
|
Preference Shareholders A/c
|
Dr.
|
|
To
Bank A/c
|
|
27.7.2 Redemption at a
Premium:
If the
preference shares are redeemed at a premium, the following additional entries
are to be passed. Premium on redemption will be provided out of Company’s Security
Premium Account or out of profits. Any premium collected from new issue can not be utilized for redemption
purpose.
|
1. When premium on redemption made out of Security
Premium Account or out of profits
|
|
|
Profit & Loss
A/c
|
Dr.
|
|
Security Premium A/c
|
Dr.
|
|
To Capital Redemption Reserve A/c
|
|
|
2. When payment is made to Preference
Shareholders at a premium
|
|
|
(i) Adjustment of Premium on redemption is
|
|
|
Preference Share capital A/c
|
Dr.
|
|
Premium on Redemption A/c
|
Dr.
|
|
To Preference Shareholders A/c
|
|
|
(ii) Payment made to Preference
Shareholders
|
|
|
Preference Shareholders A/c
|
Dr.
|
|
To Bank A/c
|
|
27.7.3 If Bonus is
declared:
Capital Redemption
Reserve can be utilized only in issue of fully paid Bonus Shares.
|
1. When Bonus shares are paid to Equity Shareholders
|
|
|
Capital Redemption Reserve A/c
|
Dr.
|
|
To Bonus to Shareholders A/c
|
|
|
Bonus to Shareholders A/c
|
Dr.
|
|
To Share Capital A/c
|
|
Illustration:1
Balance
Sheet of N Ltd. as on 31st
March, 2009
|
Liabilities
|
Rs.
|
Assets
|
Rs.
|
||
|
SHARE CAPITAL
|
|
Sundry fixed assets
|
1,35,000
|
||
|
Issued & subscribed Capital:
|
|
Current Assets:
|
|
||
|
15,000 equity shares of
Rs.10 each
|
1,50,000
|
Stock
|
1,00,000
|
|
|
|
1,500, 12% Preference
Shares of Rs.100 each
|
1,50,000
|
Debtors
|
1,50,000
|
|
|
|
Reserve & Surplus:
|
|
|
Cash at bank
|
1,50,000
|
|
|
Profit & Loss Account
|
55,000
|
|
|
|
4,00,000
|
|
General Reserve
|
70,000
|
1,25,000
|
|
|
|
|
Current liabilities & Provisions:
|
|
|
|
|
|
|
Current liabilities
|
|
80,000
|
|
|
|
|
Provision for Tax
|
|
30,000
|
|
|
|
|
|
|
5,35,000
|
|
5,35,000
|
|
It was decided to issue further 5,000 equity shares at a premium of Rs.5
per share and to redeem the preference shares at par.
Show the necessary journal entries and prepare the Balance Sheet after
the redemption of preference shares as on 1st April, 2009 .
Solution:
Working Note:
|
Required amount
for redemption
|
1,50,000
|
|
Less: cash
received from fresh issue (excluding premium)
|
50,000
|
|
Amount required
to be transferred to CRR
|
1,00,000
|
|
Journal Entries in the
Books of N Ltd.
|
||||
|
|
|
|
Dr.
|
Cr.
|
|
Date
|
Particulars
|
|
Rs.
|
Rs.
|
|
2009
|
Bank A/c
|
Dr.
|
75,000
|
|
|
Mar.31
|
To Share
Capital A/c (5,000 x 10)
|
|
|
50,000
|
|
|
To Securities
Premium A/c (5,000 x 5)
|
|
|
25,000
|
|
|
(The issue of 5,000 equity
shares of Rs.10 each at a premium of Rs.5 per share for redemption of
preference shares as per Board’s Resolution No….dated….)
|
|
|
|
|
|
Profit & Loss A/c
|
Dr.
|
55,000
|
|
|
|
General Reserve A/c
|
Dr.
|
45,000
|
|
|
|
To Capital
Redemption Reserve A/c
|
|
|
1,00,000
|
|
|
(Creation of
Capital Redemption Reserve to the extent of the amount of redemption is not
covered by the issue of new shares.)*
|
|
|
|
|
|
12% Preference Share capital A/c
|
Dr.
|
1,50,000
|
|
|
|
To Preference
Shareholders A/c
|
|
|
1,50,000
|
|
|
(The transfer
of Preference Share capital to Preference Shareholders)
|
|
|
|
|
|
Preference Shareholders A/c
|
Dr.
|
1,50,000
|
|
|
|
To Bank A/c
|
|
|
1,50,000
|
|
|
(Payment made to
Preference Shareholders)
|
|
|
|
* The balance of profit & Loss account of Rs.55,000 is first
utilized, the balance(Rs.45,000) is utilized from General Reserve .
Balance
Sheet of N Ltd. as on April
1, 2009
|
Liabilities
|
Rs.
|
Assets
|
Rs.
|
||
|
SHARE CAPITAL
|
|
Sundry fixed assets
|
1,35,000
|
||
|
Issued & subscribed Capital:
|
|
Current Assets:
|
|
||
|
20,000 equity shares of
Rs.10 each
|
2,00,000
|
Stock
|
1,00,000
|
|
|
|
Reserve & Surplus:
|
|
Debtors
|
1,50,000
|
|
|
|
General Reserve (70,000 –
45.000)
|
|
25,000
|
Cash at bank
|
75,000
|
|
|
Capital Redemption Reserve
|
|
1,00,000
|
(1,50,000+75,000-1,50,000)
|
|
3,25,000
|
|
Securities Premium
|
|
25,000
|
|
|
|
|
Current liabilities & Provisions:
|
|
|
|
|
|
|
Current liabilities
|
|
80,000
|
|
|
|
|
Provision for Tax
|
|
30,000
|
|
|
|
|
|
|
4,60,000
|
|
4,60,000
|
|
Note: Premium collected
from new issue can not be utilized for redemption.
Illustration: (redemption
at a premium and bonus issue) The following is the Balance sheet of M Ltd.
Balance Sheet of M Ltd. as on June 30, 2009
|
Liabilities
|
Rs.
|
Assets
|
Rs.
|
||
|
SHARE CAPITAL
|
|
Fixed Assets
|
95,000
|
||
|
3,000, 6% Redeemable Pref.
Sh.Rs.10 each fully paid
|
30,000
|
Investments
|
21,000
|
||
|
6,000 Equity Shares of
Rs.10 each fully paid
|
60,000
|
Current Assets:
|
|
||
|
Reserve & Surplus:
|
|
Stock
|
40,000
|
||
|
General Reserve
|
|
30,000
|
Debtors
|
18,000
|
|
|
Profit & Loss account
|
|
25,000
|
Cash at bank
|
|
22,000
|
|
Securities Premium
|
|
30,000
|
|
|
|
|
Current liabilities & Provisions:
|
|
|
|
|
|
|
Creditors
|
|
21,000
|
|
|
|
|
|
|
1,96,000
|
|
1,96,000
|
|
The company wants
to redeem the Preference Share on July 1, 2009 at a premium of 5%. To assist in financing the
redemption, all the investment were sold, realizing Rs.19,000. On September 1, 2009 , the
company made a bonus issue of 1 equity share fully paid for every 6 equity
shares held on that date. The resolutions were passed and the transactions were
duly completed. You are required to show journal entries to record the transactions
in the books of the company and the Balance Sheet as it would appear after the
completion of transactions.
[C.A (Inter) - Adapted]
Solution:
1. Calculation of Profit or Loss on sale of Investment
|
|
Rs.
|
|
Book value of Investment
|
21,000
|
|
Less:
|
19,000
|
|
Loss on sale =
|
2,000
|
The amount of loss of
Rs.2,000 will be debited to Profit & Loss account. Therefore, the balance
of Profit & Loss account will be= Rs.(25,000 – 2,000) = Rs.23,000.
2. Amount to be transferred to Capital Redemption
Reserve (CRR)
|
|
Rs.
|
|
Required amount for
redemption (30,000 + 5% premium on 30,000)
|
31,500
|
|
Amount to be transferred
CRR:
|
|
|
From General Reserve
|
30,000
|
As per Sec.80 (1) (c), The company must pay premium
on redemption amount of Rs.1,500 out of the Security Premium Account. Premium
on redemption amount is not transferred to CRR.
3. Calculation of Bonus Issue
For every 1 equity share = 6 equity shares
For 6,000 equity share = 6,000 x 1/6 = 1,000 equity
shares
Bonus Share = 1,000 x Rs.10 = Rs.10,000
CRR fund will be utilized for Bonus issue.
CRR fund balance will be (30,000 – 10,000) = Rs.20,000.
|
Journal Entries in the
Books of M Ltd.
|
|||||
|
|
|
|
Dr.
|
Cr.
|
|
|
Date
|
Particulars
|
|
Rs.
|
Rs.
|
|
|
2009
|
Bank A/c
|
Dr.
|
19,000
|
|
|
|
July 1
|
Profit &
Loss A/c
|
Dr.
|
2,000
|
|
|
|
|
To Investment A/c
[Wn.1]
|
|
|
21,000
|
|
|
|
(Sale of Investment of
Rs19,000 and loss debited to Profit & Loss account.)
|
|
|
||
|
|
General Reserve A/c
|
Dr.
|
30,000
|
|
|
|
|
To Capital
Redemption Reserve A/c [Wn.2]
|
|
|
30,000
|
|
|
|
(Creation of
Capital Redemption Reserve fund to redeem preference shares.)
|
|
|
||
|
|
Securities
Premium A/c
|
Dr.
|
1,500
|
|
|
|
|
To Premium on
Redemption of Preference Shares A/c [Wn.2]
|
|
|
1,500
|
|
|
|
(Premium
payable on redemption adjusted against Securities Premium Account.)
|
|
|
|
|
|
|
6% Redeemable Preference Share capital A/c
|
Dr.
|
30,000
|
|
|
|
|
Premium on Redemption of Preference Shares A/c
|
Dr.
|
1,500
|
|
|
|
|
To Preference
Shareholders A/c
|
|
|
31,500
|
|
|
|
(The transfer
of Preference Share capital to Preference Shareholders)
|
|
|
||
|
|
Preference Shareholders A/c
|
Dr.
|
31,500
|
|
|
|
|
To Bank A/c
|
|
|
31,500
|
|
|
|
(Payment made to
Preference Shareholders)
|
|
|
||
|
Sept.1
|
Capital
Redemption Reserve A/c Dr.
|
10,000
|
|
||
|
|
To Bonus to Equity
Shareholders A/c [Wn.3]
|
|
10,000
|
||
|
|
(The amount
appropriated for issue of 1,000 bonus share of Rs.10 each.)
|
|
|
||
|
|
Bonus to Shareholders A/c
|
10,000
|
|
||
|
|
To Equity Share
Capital A/c
|
|
10,000
|
||
|
|
(The
utilization of bonus shares for issuing equity shares.)
|
|
|
||
Balance Sheet of M Ltd. as
on September 1, 2009
|
Liabilities
|
Rs.
|
Assets
|
Rs.
|
||
|
SHARE CAPITAL
|
|
Fixed Assets
|
95,000
|
||
|
7,000 Equity Shares of
Rs.10 each fully paid
|
70,000
|
Investments
|
Nil
|
||
|
(out of it 1,000 sh. have
been issued as Bonus share)
|
|
Current Assets:
|
|
||
|
Reserve & Surplus:
|
|
Stock
|
40,000
|
||
|
Capital Redemption Reserve
[Wn.3]
|
20,000
|
Debtors
|
18,000
|
||
|
Profit & Loss
account[Wn.1]
|
|
23,000
|
Cash at bank (22,000 +
19,000 – 31,500)
|
9,500
|
|
|
Securities Premium (30,000
– 1,500)
|
28,500
|
|
|
|
|
|
Current liabilities & Provisions:
|
|
|
|
|
|
|
Creditors
|
|
21,000
|
|
|
|
|
|
|
1,62,500
|
|
1,62,500
|
|
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