Redemption
of Preference Shares Complete Notes
Corporate Accounting Notes
FOR BCOM Courses Under NEP syllabus
Meaning of Preference Shares:
Meaning of Preference Shares:
Sec. 43 (b) of the Companies Act, 2013 defines preference shares as those shares which carry preferential rights as the payment of dividend at a fixed rate and as to repayment of capital in case of winding up of the company. Thus, both the preferential rights viz.
(a) Preference in payment of
dividend and
(b) Preference in repayment
of capital in case of winding up of the company, must attach to preference
shares.
The rate of dividend on these shares is fixed and the dividend on these shares must be paid before any dividend is paid to ordinary shares. Directors, however, may decide not to pay any dividend to any class of shareholders even if there are sufficient profits. But, if any how, they decide to pay the dividend, preference shareholders will get the priority to pay the ordinary shareholders.
Following are the basic features of preference share:
a) Rate of dividend is
fixed.
b) Preference shareholders
get preference in payment of dividend over equity shareholders.
c) Preference shareholders
will get preference in redemption of capital in case of winding up of a
company.
d) No voting rights and
right to participate in management to the preference shareholders.
e) Preference shares can be
converted into equity shares.
Preference shares may be classified according to the
rights attached to them as follows:
(a) On the basis of dividend: Cumulative and Non-cumulative preference shares
Cumulative preference shares
are those which have the right to receive arrear of dividend before the
dividend is paid to the equity shareholders.
Non-cumulative preference
shares are those which do not have the right to receive arrear of dividends.
(b) On the basis of participation: Participating and non-Participating
preference shares
Participating preference
shares are those which have the rights to participate in remaining profits
after payment of dividends to the equity shareholders.
Non-Participating preference
shares are those which do not have the rights to participate in remaining
profits after payment of dividends to the equity shareholders.
(c) On the basis of conversion: Convertible and Non-Convertible
preference shares
Convertible preference shares
are those which have the right to be converted into equity shares.
Non-convertible preference
shares are those which do not have the right to be converted into equity
shares.
(d) On the basis of redemption: Redeemable and Irredeemable preference
shares
Redeemable preference shares
are those which are redeemable after the expiry of specific period of time.
Irredeemable preference
shares are those which are not redeemed by the company except in case of
winding up.
Advantages of Preference shares
a) Helpful in raising long term capital for a company.
b) There is no need to mortgage property on these shares.
c) Redeemable preference shares have the added advantages of repayment
of capital whenever there is surplus in the company.
d) Rate of return is guaranteed.
Disadvantages of Preference shares
a) Permanent burden on the company to pay a fixed rate of dividend
before paying anything on the other shares.
b) Not advantageous to investors from the point of view of control and
management as preferences shares do not carry voting rights.
c) Compared to other fixed interest bearing securities such as
debentures, usually the cost of raising the preference share capital is higher.
Conditions for redemption of Preference Shares:
When a company redeems its preference shares under Section 55 of the Companies Act, 2013, it must comply with these strict guidelines:
1. Fundamental Rules
a) No Irredeemable Shares: A company limited by
shares cannot issue irredeemable preference shares.
b) Maximum 20-Year Tenure: Preference shares must
be redeemed within a period not exceeding 20 years from their issue date
(except for approved infrastructure projects).
c) Articles of Association (AoA): The company must
be authorized by its Articles to issue redeemable preference shares, but
no separate authorization is needed to execute the redemption.
d) Fully Paid-Up Requirement: Only fully paid-up
preference shares can be redeemed. If shares are partly paid-up, a final call
must be made and collected before redemption.
2. Sourcing the Redemption
Funds
a) Preference shares can only be redeemed using two
legal sources:
* Out of the proceeds of a fresh issue of shares
(equity or preference) made specifically for the redemption.
(Note: Proceeds from a fresh issue of debentures
cannot be used).
* Out of divisible profits (profits otherwise
available for distribution as dividends).
3. Capital Redemption
Reserve (CRR) Rules
If preference shares are redeemed out of
undistributed profits, the nominal (face) value of the shares being redeemed
must be transferred to the Capital Redemption Reserve (CRR) Account. The law
specifies which reserves can and cannot be used for this transfer:
Reserves ALLOWED
for CRR Transfer (Divisible Profits):
a) Profit & Loss Account/Surplus
b) General Reserve
c) Reserve Fund
d) Dividend Equalization Fund
e) Insurance Fund
f) Workmen's Compensation / Accident Fund (Surplus
balance)
g) Voluntary Debenture Redemption Reserve / Sinking
Fund
Reserves NOT
ALLOWED for CRR Transfer (Non-Divisible Profits):
a) Securities Premium Account
b) Capital Reserve
c) Forfeited Shares Account
d) Profit Prior to Incorporation
e) Development Rebate Reserve
5. Utilization of CRR: The Capital Redemption Reserve account can only be
utilized for issuing fully paid bonus shares to the existing members of the
company.
6. Premium on Redemption: If preference shares are redeemed at a premium,
that premium must be provided for out of the company’s profits or out of the
Securities Premium Account before the shares are actually redeemed.
CORPORATE ACCOUNTING CHAPTER WISE NOTES
Unit-I: Shares & Debentures
1. ISSUE OF SHARES AND SHARE CAPITAL
2. RIGHTS SHARES AND BONUS SHARES
4. REDEMPTION OF PREFERENCE SHARES
5. ISSUE AND REDEMPTION OF DEBENTURES
Unit II: Preparation of financial statements of companies
1. FINAL ACCOUNTS OF COMPANIES
2. ACCOUNTS OF BANKING COMPANIES
Unit-III: Valuations of Goodwill and Shares & Cash Flow Statement
1. VALUATIONS OF GOODWILL AND SHARES
Unit-IV: Amalgamation, External Reconstruction and Internal Reconstruction
1. AMALGAMATION AND EXTERNAL RECONSTRUCTION
2. INTERNAL RECONSTRUCTION AND CAPITAL REDUCTIONS
Unit-V: Accounts of Holding Companies