Page 106 - DCOM201_ACCOUNTING_FOR_COMPANIES_I

Unit 4: Buy Back of Securities by Private Limited and Unlisted Public Limited Companies

Access to Capital Notes
The company redemption/purchase of common stock also has dramatic effects on the
company’s creditors, who now have a lower stockholders’ equity account under their debt
position, and a debt-to-equity ratio of 3.3 to 1 ($1 million debt divided by $300,000
stockholders’ equity). In addition, the company’s future borrowing capacity is substantially
lower. Thus, if you are going to redeem any stock, be sure your overall cash position (today
and projected) is more than adequate to finance growth and contractual debt repayments.
What If You, the Owner, Are the Seller?
If you are the owner and your common stock is being purchased by the company,
read ”Owner Stock Repurchase Tax Traps”. Proceeds of your sale could be taxed to you at
ordinary income rates rather than capital gain rates unless you completely sever your
relationship with the company. Also, for liability reasons, make sure that the:

 Stock redemption price is at fair market value as established by an independent
appraiser.

 Shares are purchased by the company on an arm’s-length basis.
 Acquisition price and terms don’t discriminate against other stockholders.
 Tax impact of the sale/purchase on both you and the company has been reviewed by
your accountant.
4.5 Summary

 Buy back can be made From the existing shareholder holders on a proportionate basis
through private offers.

 By purchasing the securities issued to employees of the Company pursuant to a scheme of
stock option or sweat equity.
 Bonus can be distributed in the form of cash, portly paid up shares or fully paid up shares to
the shareholders. Bonus is generally not paid in cash. If it is paid in cash, the working capital
of the company will be adversely affected. Mostly companies use this amount to make up
the existing partly paid up shares as fully paid. This is called Bonus Issue or Bonus Shares

4.6 Keywords

Buy-Back: To buy that is previously sold.
Free Reserves: Difference between borrowed reserves and excess reserves.
Subsidiary Company: Company that is completely controlled by another company.

4.7 Review Questions

1. Write a note on funds for financing buy back.
2. Explain the circumstances where buy back is not allowed.
3. Write a note on manner of making buy back.

4. Mohan Limited has an authorised capital of 40,000 in equity shares of 10 each. The
issued capital of the company is 24,000 divided into shares of 10 each, with 8 per share
called and paid. A sum of 12,300 was capitalised out of reserve fund and out of amount so

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