Page 112 - DCOM201_ACCOUNTING_FOR_COMPANIES_I

Unit 5: Redemption of Preference Shares

Choose the answer: Notes
5. The redemption of preference shares can be from:
(a) Capital reserve
(b) Proceeds of issue of debentures

(c) Development rebate reserve
(d) General reserve

5.2 Sources of Redemption

Redeemable Preference shares are those shares, the capital of which is refunded by the company
after a specified duration. The redemption of such shares is made in accordance with the provisions
of section 80 of the Companies Act.
In case preference shares can be redeemed when they are fully paid up. In case a company has
partly paid preference shares, it must see that they are made fully paid up before they are
redeemed.
Sources of Redemption of Preference Shares
1. Fresh Issue
2. Capital Redemption Reserve

5.2.1 Explanation of Proceeds of Fresh Issue

There is a lot of controversy and confusion over the term proceeds of a fresh issue of shares. It is
therefore, compulsory to understand this term properly. A closer examination of the provisions
and intentions of Company Law implies the meaning of the word ‘proceeds’ as the amount
received excluding the premium on the fresh issue and net amount received in the case of
discount or at par. In other words, if the fresh shares are issued at par, ‘proceeds’ means the actual
amount realised. If the fresh shares are issued at discount, proceeds means the net amount
realised from the issue of fresh shares i.e., nominal value of shares minus discount allowed. This
is done because nominal value of shares does not represent the wholly tangible assets capable of
providing the real protection to the creditors (third party). This can be understood properly
with the help of the following example. If a company has to redeem preference shares of
2,00,000 and decides to issue the equity shares at a discount of 10%, it will get only 1,80,000
(2,00,000 – 20,000) in cash from the cash issue. But the company will needs 2,00,000 in cash for
the redemption of preference shares. On the liability side of the balance sheet, the nominal value
of fresh shares will replace properly the redeemable preference shares by an equivalent sum i.e.,
2,00,000. But on the assets side, there will appear two items (i) cash of 1,80,000 (ii) discount on
issue of shares (loss) 20,000. Further, suppose this company goes into liquidation immediately
after the redemption of preference shares and due to a bad financial position it is unable to
satisfy the claims of the third party in full. Here, it would mean the repayment of capital in
priority over creditors to the extent of 20,000, which is discount. This is a clear violation of
Section 80.

Notes If the fresh shares are issued at premium for the redemption of redeemable
preference shares, meaning of ‘proceeds’ will be the amount realised from the issue of
fresh shares excluding the amount of premium.

LOVELY PROFESSIONAL UNIVERSITY 105