Redemption of Preference Shares: CRR, Premium and Which Reserves May Be Used
Vasant Ltd has authorised, issued and paid-up capital of ₹20,00,000 in 2,00,000 equity shares of ₹10 each and ₹8,00,000 in 80,000 9% redeemable preference shares of ₹10 each. The other balances on 31 March 20X5 are: securities premium ₹1,50,000; general reserve ₹6,00,000; capital reserve ₹1,00,000 (arising from revaluation of land in 20X3); surplus in statement of profit and loss ₹4,20,000. The articles authorise redemption.
The board decides to redeem the entire preference share capital on 1 August 20X5 at a premium of 5%. To fund this, the company will issue 40,000 equity shares of ₹10 each at ₹12.50, and apply reserves for the balance.
The finance director proposes to charge the redemption premium to the capital reserve, arguing that the securities premium is 'earmarked for a bonus issue next year', and asks whether the fresh equity could instead be issued at ₹9 to widen participation.
1. Determine the amount to be transferred to the capital redemption reserve and identify which reserves may lawfully be applied, with reasons.
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Legal framework. Section 55 permits redemption only if the preference shares are fully paid, the articles authorise it, and - where redemption is out of profits - a capital redemption reserve is created. Section 52(2)(c) expressly permits the securities premium account to be applied to the premium payable on redemption.
Fresh issue. 40,000 × ₹12.50 = ₹5,00,000, made up of ₹4,00,000 nominal capital and ₹1,00,000 securities premium. The nominal ₹4,00,000 is applied towards the ₹8,00,000 being redeemed.
CRR. ₹8,00,000 − ₹4,00,000 = ₹4,00,000, transferred from general reserve. The reserve is measured on the nominal value redeemed, and only the portion not covered by a fresh issue made for the purpose of redemption requires it. The securities premium of ₹1,00,000 on the fresh issue cannot be used to reduce the CRR - it is not nominal capital.
Premium on redemption. 5% of ₹8,00,000 = ₹40,000, charged to the securities premium account as permitted, leaving ₹2,10,000 there.
Which reserves. General reserve ₹6,00,000 and the ₹4,20,000 surplus are free reserves and may be applied. The ₹1,00,000 capital reserve is a revaluation surplus - an unrealised gain - and is not profit available for distribution or for redemption; using it would convert unrealised appreciation into a realised distribution.
2. Pass the necessary journal entries and show the reserves and surplus position immediately after redemption.
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Journal
| Dr ₹ | Cr ₹ | |
|---|---|---|
| Bank A/c Dr; To Equity share capital; To Securities premium | 5,00,000 | 4,00,000; 1,00,000 |
| 9% Redeemable preference share capital Dr; Securities premium Dr; To Preference shareholders (Bank) | 8,40,000 | 8,00,000; 40,000 |
| General reserve Dr; To Capital redemption reserve | 4,00,000 | 4,00,000 |
Position after redemption
| ₹ | |
|---|---|
| Equity share capital (2,40,000 shares of ₹10) | 24,00,000 |
| Securities premium (1,50,000 + 1,00,000 − 40,000) | 2,10,000 |
| General reserve (6,00,000 − 4,00,000) | 2,00,000 |
| Capital redemption reserve | 4,00,000 |
| Capital reserve (revaluation) | 1,00,000 |
| Surplus in statement of profit and loss | 4,20,000 |
| Total | 37,30,000 |
Check. Pre-redemption total ₹40,70,000 less net cash outflow ₹3,40,000 (₹5,00,000 received less ₹8,40,000 paid) = ₹37,30,000. The preference capital of ₹8,00,000 has gone, equity capital has risen by ₹4,00,000, and reserves have risen by ₹60,000, being the fresh premium of ₹1,00,000 less the ₹40,000 applied to the redemption premium.
Compliance. File Form SH-7 with the Registrar within 30 days of redemption, and ensure no default in deposits, interest or dividend subsists on the redemption date.
3. Advise on the finance director's two proposals: charging the premium to the capital reserve, and issuing the fresh equity at ₹9.
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Charging the premium to capital reserve - not permitted. A revaluation surplus is unrealised; AS 10 (and its Ind AS counterpart) requires it to be held in a revaluation reserve and it is not a free reserve. Section 55 requires redemption to be out of profits or a fresh issue, and a revaluation reserve is neither profits available for dividend nor proceeds of a fresh issue. Section 52 also lists exhaustively what the securities premium account may be applied to, and premium on redemption of preference shares is on that list - so the correct route is available and should be used.
The 'earmarking' argument is an internal intention of the board, not a legal restriction. The company can vary its own plan; an earmarking cannot displace the statute, and the accounts cannot be built around a future intention.
Issue at ₹9 - prohibited. Section 53 bars the issue of shares at a discount (sweat equity apart); any allotment at ₹9 would be void and the allottees would remain liable for the ₹1 discount. If wider participation is the aim, the price can be brought down to par ₹10 with a smaller issue, or the company can fund the redemption from the ₹4,20,000 surplus plus general reserve and skip the fresh issue - though that would consume distributable reserves and reduce dividend capacity.
Further considerations. The premium charged to securities premium reduces the balance available for a bonus issue but does not reduce the CRR; and a company cannot redeem preference shares unless they are fully paid, so the ₹10 paid-up status of all 80,000 shares must be confirmed before 1 August.