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WORKING PAPER ON REDEMPTION OF SHARE
By Muhammad Hanif Ghanchi
A per Companies Act 1985 (Amended 1989):

A company is not allowed to redeem its share capital (repurchase of
shares) unless the shares were originally issued as redeemable.

The Article of Association of the Company should permit the company to
issue redeemable shares.

The Company is required to first issue irredeemable (permanent) shares
before issuing the redeemable shares.

The company may redeem its Redeemable shares as follows:
1. Through issue of new shares to provide funds for the redemption.
2. Through internal funds by creating a “Capital Redemption Reserve”.
3. Combination of both – a partial issue of new shares and the balance
from internal funds.
Rules for creation of Capital Redemption Reserve:
(i) Creation of CRR, if no new shares are issued to financed the redemption:
A company redeeming its share capital from internal funds, that is without issue
of new shares to finance the redemption, is required by the Companies Act to
create a Capital Redemption Reserve equal to the nominal value of share capital
redeemed, out of distributable profits. It means the profits, which were available
for payment of cash dividends to the ordinary shareholders, are no more
available due to redemption of share capital and they have been blocked into
Capital Redemption Reserve account. The purpose of creating the Capital
Redemption Reserve is to protect the creditors.
(ii) Creation of CRR, if the redemption is financed partially:
In case, the company finances the redemption of share capital partially, then the
amount of Capital Redemption Reserve will be equal to the difference between
the nominal value of share capital redeemed and cash received from issue of
new shares, including share premium.
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Rules for treatment of Redemption premium:
The redeemable shares may be redeemed at par or at premium. The premium
paid on redemption of shares may be charged to share premium account, subject
to following rules:
1. The shares being redeemed at premium should have originally been
issued at premium and redemption premium should not exceed the
amount of premium received originally.
2. The shares being redeemed at premium are financed, fully or partially,
through issue of new shares.
3. There should be sufficient balance in the share premium account. The
share premium account should not end up with a debit balance.
REDEMPTION OF DEBENTURES:
There is no legal obligation to create a “Debenture Redemption Reserve” on
redemption of debentures, because the debentures are themselves creditors.
However, it is purely a matter of discretion to the company to create a Debenture
Redemption Reserve, to preserve the capital structure of the company.
Any premium paid on redemption of debentures may be charged to Share
Premium account, provided a balance exists in share premium account,
irrespective of whether the debentures were original issued at premium or not, or
the redemption is being financed by issue of new debentures or not.
DIFFERENT SITUATIONS OF CAPITAL REDEMPTION:
There are (5) five different situations of capital redemption in this paper with
their suggested answer:
Situation 1
A company redeemed its 200,000 6% Preference share capital of $1 each at
a premium of $0.10. Originally these shares were issued at a premium of
$0.05 per share. There was no issue of new shares to finance the
redemption.
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6% Preference Share Capital (200,000 x $1)
Profit and Loss A/c
(200,000 x $0.10)
Bank A/c
(200,000 x $1.10)
Profit and Loss A/c
Capital Redemption Reserve
Debit
200,000
20,000
Credit
220,000
200,000
200,000
Although the preference shares being redeemed were originally issued
at premium but the redemption is not being financed by issue of new
shares, therefore, the entire redemption premium will be charged to the
Profit and Loss Account.
Since the redemption is not financed by issue of new shares, therefore,
it is required to create a CRR equal to the nominal value of share capital
redeemed.
Situation 2
To finance the redemption, a company issued 150,000 ordinary shares of $1
each at a premium of $0.25 per share. There were 100,000 8% Preference
shares of $0.75 each, which were redeemed at a premium of $0.10 per share.
These shares were originally issued at par.
Bank A/c
(150,000x$1.25)
Ordinary Share Capital (150,000x$1.00)
Share Premium A/c
(150,000x$0.25)
Debit
187,500
Credit
150,000
37,500
8% Preference Share Capital
(100,000x$0.75)
75,000
Profit and Loss A/c
(100,000x$0.10)
10,000
Bank A/c
(100,000x$0.85)
85,000
Since the redemption is financed through issue of new shares and cash
received is more than the nominal value of share capital redeemed,
therefore, this situation does not involve creation of any CRR.
The Preference Shares being redeemed at premium were originally
issued at par, therefore, the redemption premium will be charged to
Profit and Loss Account.
Situation 3
A company redeemed its 180,000 8% Preference share capital of $1 each at
a premium of $0.15 per share by issuing equal number of 6% Preference
shares of $0.50 per share at par. The shares being redeemed were originally
issued at a premium of $0.25 and there exist sufficient balances in share
premium and Profit & Loss accounts.
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Bank A/c
(180,000x$0.50)
6% Preference Share Capital (180,000x$0.50)
8% Preference Share Capital
Share Premium A/c
Bank A/c
(180,000x$1.00)
(180,000x$0.15)
(180,000x$1.15)
Debit
90,000
Credit
90000
180,000
27,000
207,000
Profit and Loss A/c (180,000 -90,000)
90,000
Capital Redemption Reserve
90,000
The redemption is being financed partially, that is, the cash received from
issue of new shares is less then the nominal value of capital redeemed,
therefore, a CRR for the difference will be created.
Since the redemption premium of $27,000 (180,000 x $0.15) is less then
the amount of share premium received originally at the time of issue of
these share i.e. $45,000 (180,000 x $0.25), and there exist enough
balance in the share premium account, therefore, the entire redemption
premium will be charged to the Share Premium Account.
Situation 4
A company issued 100,000 6% Preference share of $1 at a premium of $0.15
per share to finance the redemption of 200,000 8% Preference shares of
$0.50 at a premium of $0.15 per share. Originally, these shares were issued
at a premium of $0.10 per share, which was utilized for issue bonus shares to
the ordinary shareholders and there is no balance in the share premium
account.
Debit
(100,000x$1.15) 115,000
Bank A/c
6% Preference Share Capital (100,000x$1.00)
Share Premium A/c
(100,000x$0.15)
8% Preference Share Capital
Share Premium A/c
Profit and Loss A/c
Bank A/c
(200,000x$0.50)
(200,000x$0.65)
Credit
100,000
15,000
100,000
15,000
15,000
130,000
Since the redemption is financed through issue of new shares and cash
received is more than the nominal value of share capital redeemed,
therefore, this situation does not involve creation of CRR.
Although the share capital, being redeemed, was issued at premium of
$20,000 (200,000 x $0.10) and now being redeemed at a premium of
$30,000 (200,000 x $0.15), therefore, $20,000 could be charged to
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share premium account subject to a balance in the share premium
account, but there is no balance available in the share premium account.
Therefore, the redemption premium to be charged to the share premium
account will be equal to the premium received from issue of new share
that is $15,000, so that the share premium account should not end up
with a debit balance. The balance of redemption premium will be
charged to Profit and Loss account
Situation 5
A company, which had issued 100,000 8% Preference share capital of $1 at
par, redeemed its share capital at premium of $.15 per share. To finance the
redemption, the company issued 100,000 6% Preference shares of $0.50
each at $1.15.
Debit
115,000
Bank A/c
6% Preference Share Capital
Share Premium A/c
Credit
50,000
65,000
8% Preference Share Capital
100,000
Profit and Loss A/c
15,000
Bank A/c
115,000
Since the redemption is financed through issue of new shares and cash
received is more than the nominal value of share capital redeemed,
therefore, this situation does not involve creation of CRR.
The Preference Shares being redeemed at premium were originally
issued at par, therefore, the redemption premium will be charged to
Profit and Loss Account.