Buyback of Securities and Equity with Differential Rights; CA Intermediate Advance Accounting Notes

Buyback of shares

  • Purchase by company of its own shares,
  • It results decrease in paid up share capital,
  • It cannot purchase its own shares for the purpose of investment.

Advantages of Buyback of shares

  • It increases earning per share,
  • The proportion of promotor’s contribution will increase,
  • To pay surplus cash to shareholders, when company does not need for business.

Source of Buyback

The company can buyback its own shares out of

  1. Free Reserves,
  2. Securities Premium,
  3. Out of proceeds of fresh issue of shares or other securities made for the purpose of buyback.

Note:

Issue of shares or securities should not be the same kind of earlier issue.

Ex. Issue preference share for buyback of Equity shares.

Condition for Buyback

  • Buyback is authorized by the Articles of Association.
  • A special resolution has been passed at general meeting of the company for authorizing buyback. Special resolution not required buyback is up to 10% of paid up capital + free reserves.
  • The company has to file declaration of solvency with ROC and SEBI (in case f listed company).
  • Buyback formalities should be completed within 12 months from the date of passing special resolution.

Tests to be satisfied 

Share Outstanding Test:

  • No of shares bought back in FY cannot exceeds 25% of paid up share capital and free reserves.

Buyback Shares ≤ 25%(Paid up capital + free reserves)

Resource Test:

  • The amount of shares bought back cannot exceed 25% of paid up share capital and free reserves.

Amount of share bought ≤ 25%(Paid up capital + free reserves)

Debt-Equity Ratio Test:

  • Ratio of Debt-Equity after buyback cannot exceed 2 times

Debt/Equity after buyback =2

  • Equity after buyback = Paid up capital + free reserves

Important Points

The company shall exhibit and destroy the shares certificate within 7 days from the date of buyback.

Buyback of shares may be at

i) At Par

-

ii) At Discount

It’s a capital profit and should be credited to Capital Reserve A/c

iii) At Premium

It’s a loss, it should be met out of Securities premium

 

When shares are bought back out of profits of the company, amount equal to nominal value of shares bought back is transferred to Capital Redemption Reserve A/c. CRR shown under the head “Reserves & Surplus”. It can be used for issue of bonus shares.

Accounting Entries for Buyback of shares

S.No

Transactions

Journal Entries

1.

Equity amount due to shareholders.

 

 

i) Buyback at par

Equity share capital A/c Dr

To Equity share buyback A/c

 

ii) at Premium

Equity share capital A/c Dr

Premium on buyback A/c Dr

To Equity share buyback A/c

 

iii) at Discount

Equity share capital A/c Dr

To Discount on Buyback A/c

To Equity share buyback A/c

2.

Payment to shareholders

Share buyback A/c Dr

To Bank A/c

3.

For transfer of premium on buyback

Securities Premium A/c Dr

To Premium on buyback A/c

4.

For transfer of discount on buyback

Discount on buyback A/c Dr

To Capital Reserve A/c

5.

For Buyback Expenses

Buyback Expenses A/c Dr

To Bank A/c

6.

For transfer of Buyback Expenses

P&L A/c Dr

To Buyback Expenses A/c

7.

For Transfer to Capital Redemption Reserve

General Reserve A/c Dr

Profit and loss A/c Dr

To CRR A/c

8.

For declaration of Bonus Issue (Capitalization of profit)

CRR A/c Dr

To Bonus shareholders A/c

9.

For allotment of Bonus shares

Bonus shareholders A/c Dr

To Equity share capital A/c

To Securities Premium A/c

10.

For Fresh Issue of shares/Debentures

Bank A/c Dr

To Preference share capital A/c

To Debentures A/c

To Securities Premium A/c

11.

For Sale of Investments

Bank A/c Dr

To Investment A/c

To P & L A/c (Profit on sale)


Steps for solving problems

Step 1:

Check whether the company satisfies all 3 tests.

Step 2:

Pass Journal Entries

Steps 3:

Prepare the following ledger a/c

  • Equity share capital A/c
  • P & L A/c
  • Securities Premium A/c
  • Bank A/c
  • Capital Redemption Reserve A/c

Step 4:

Draw balance sheet of the company after buyback.

Issue of Equity Shares with Differential Rights

As per the Companies Act 2013, companies can issue equity shares with differential rights subject to the fulfilment of certain conditions. Companies (Share Capital and Debentures) Rules, deals with equity shares with differential rights.

Differentiation can be done by giving a superior dividend / Superior voting right / diluted voting right to a class of equity shareholders.

Share capital is of two types - equity and preference. Preference share capital with reference to any company limited by shares, means that part of the issued share capital of the company which carries or would carry a preferential right with respect to

  • Payment of dividend, either as a fixed amount or an amount calculated at a fixed rate, which may either be free of or subject to income-tax; and
  • Repayment, in the case of a winding up or repayment of capital, of the amount of the share capital paid-up or deemed to have been paid-up, whether or not, there is a preferential right to the payment of any fixed premium or premium on any fixed scale, specified in the memorandum or articles of the company.


The Companies Act, 2013 defines equity share capital to include two types viz.,

(i) With voting rights; or

(ii) With differential rights as to dividend, voting or otherwise in accordance with such rules as may be prescribed


Voting rights

  • Companies Act defines "voting right," as the right of a member of a company to vote in any meeting of the company or by means of postal ballot.
  • Equity shares have a general voting right, whereas preference shares have restrictive voting rights.

According to the provisions of the Companies Act:

  • Every member of a company limited by shares and holding equity share capital therein, shall have a right to vote on every resolution placed before the company; and
  • His voting right on a poll shall be in proportion to his share in the paid-up equity share capital of the company.

Normally preference shareholders have superior financial rights but less management control rights. Every member of a company limited by shares and holding any preference share capital therein shall, in respect of such capital, have a restrictive right to vote only on resolutions placed before the company:

  • Which directly affect the rights attached to his preference shares or
  • Any resolution for the winding up of the company or
  • For repayment or
  • Reduction of its equity or preference share capital.

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