Redeemable at Fixed Time or by Drawing Lots

In corporate finance and advanced corporate accounting, preference shares and certain types of debentures may be redeemable, meaning the issuing company is obligated to return the invested capital to the holders after a certain period. Redemption can be carried out at a fixed time or by drawing lots, and both approaches involve specific procedures and accounting implications.

Redemption at Fixed Time:

When securities (especially preference shares or redeemable debentures) are redeemable at a fixed time, the company agrees to repay the principal on a pre-decided date as stated in the issue terms. This ensures predictability for investors and allows the company to plan for cash outflows in advance.

Features:

• Fixed maturity date (e.g., 5 or 10 years from the date of issue).

• Redemption amount is usually at par (sometimes at premium).

• Company sets aside funds through a Redemption Reserve or Sinking Fund.

• Mandatory compliance with Companies Act, 2013 in India and relevant accounting standards (AS-14 / Ind AS 109).

Journal Entries (Example: Redemption of Preference Shares at Par from Profits):

If redeemed at premium, Premium on Redemption of Preference Shares A/c is debited, and the Securities Premium A/c or Profit & Loss A/c is credited.

Redemption by Drawing Lots:

When redemption is done by drawing lots, it means not all securities are redeemed at once. Instead, a random selection process (lottery) is used to determine which security holders will be paid back in each redemption cycle.

Features:

• Used when redeemable securities are issued in large quantities.

• Redemption occurs gradually, often in equal instalments or annual batches.

• Selection of holders is random, providing equal opportunity.

• Helps in managing cash flow more efficiently.

• Often accompanied by a notice or draw date announcement to security holders.

Journal Entries (Example: Partial Redemption of Debentures by Drawing Lots):

If the redemption is at a premium:
Debit Premium on Redemption of Debentures A/c and credit Securities Premium A/c or Profit & Loss A/c.

Key Accounting Implications:

• Capital Redemption Reserve (CRR) is created when shares are redeemed out of profits, ensuring capital is preserved.

• Sinking Fund may be maintained to ensure availability of funds at redemption.

• Interest or dividend is paid on securities until the date of redemption.

• If the redemption is staggered (by drawing lots), only a part of the liability is extinguished at each step, affecting balance sheet and cash flow accordingly.

Legal Compliance (India):

Under the Companies Act, 2013:

• Section 55: Governs redemption of preference shares.

• Section 71: Governs redemption of debentures.

• Securities must be fully paid-up before redemption.

• Redemption can be made from:

  • Profits available for dividend.

  • Fresh issue of shares or debentures.

CRR must be created equal to the nominal value of shares redeemed out of profits.

illustrative Example:

Scenario: ABC Ltd. has issued ₹5,00,000 worth of 12% Redeemable Preference Shares, redeemable either at the end of 5 years or through annual redemption by drawing lots over 5 years.

Redemption Plan (by drawing lots):

• Year 1: ₹1,00,000

• Year 2: ₹1,00,000

• Year 3: ₹1,00,000

• Year 4: ₹1,00,000

• Year 5: ₹1,00,000

In each year, the company randomly selects shareholders to redeem ₹1,00,000 worth of shares.

Year 1 Entry:

This continues for each of the five years, gradually reducing the liability and preserving the capital structure.