by When a company decides to redeem its preference shares or debentures, it must ensure that it has adequate cash balance to meet the redemption obligation. Redemption involves paying the holders of redeemable securities (like preference shareholders) either at par, premium, or as per the terms of the issue. As per the Companies Act, 2013, redemption of preference shares can only be made if the company has sufficient profits or has made a fresh issue of shares to raise the necessary funds. The main concern here is liquidity, i.e., the company must have enough cash on hand at the time of redemption.
Importance of Arranging Cash for Redemption:
The process of arranging a cash balance is critical because:
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Redemption payments are legally binding obligations.
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Failure to arrange funds can damage the company’s reputation.
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It ensures compliance with legal provisions regarding redemption.
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It prevents financial strain or disruption of regular operations.
Sources of Cash for Redemption:
A company may arrange the required cash balance for redemption through several means:
(a) Utilization of Existing Profits
The company may use its accumulated profits (like retained earnings, general reserve, or profit and loss account balance) to meet redemption payments. If preference shares are redeemed from profits, a Capital Redemption Reserve (CRR) must be created for an amount equal to the nominal value of shares redeemed.
(b) Fresh Issue of Shares
A company may issue new equity shares to raise funds specifically for redemption. The proceeds from the fresh issue can be directly used for payment. This option helps maintain working capital as profits are not depleted.
(c) Sale of Assets
If the company has surplus or non-essential assets, they can be sold to generate cash for redemption. However, this option must be carefully considered to avoid loss of income or operational capabilities.
(d) Borrowing
Short-term loans or debentures may be issued to meet redemption obligations. This provides quick liquidity but increases the company’s financial liabilities.
Legal Requirements Regarding Cash for Redemption:
According to Section 55 of the Companies Act, 2013:
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Preference shares must be fully paid before redemption.
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Redemption must be done either from distributable profits or proceeds from a fresh issue of shares.
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Premium on redemption must be provided out of Securities Premium Account or Profit and Loss Account.
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CRR must be created if redemption is made out of profits.
Accounting Treatment:
The accounting treatment depends on whether redemption is financed from profits or fresh issue proceeds.
Case 1: Redemption from Profits
When redemption is made from profits:
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Transfer an amount equal to the nominal value of shares redeemed from distributable profits to the CRR.
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Provide for the premium on redemption from Securities Premium Account or Profit and Loss Account.
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Pay the preference shareholders.
Case 2: Redemption from Fresh Issue Proceeds
When funds are raised from a fresh issue:
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Record the proceeds from the fresh issue.
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Apply the proceeds directly towards redemption.
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If the proceeds are less than the redemption amount, use profits to meet the shortfall and transfer the required CRR.
Journal Entries for Arranging Cash for Redemption:
| S.No. | Particulars | Debit (₹) | Credit (₹) |
|---|---|---|---|
| 1 |
Bank A/c Dr. (for proceeds from fresh issue) |
XXX | |
|
To Share Capital A/c |
XXX | ||
|
(Being fresh issue of shares made for the purpose of redemption) |
|||
| 2 |
Profit & Loss A/c Dr. |
XXX | |
|
To Capital Redemption Reserve A/c |
XXX | ||
|
(Being transfer to CRR on redemption out of profits) |
|||
| 3 |
Securities Premium A/c Dr. / Profit & Loss A/c Dr. |
XXX | |
|
To Premium on Redemption A/c |
XXX | ||
|
(Being provision made for premium on redemption) |
|||
| 4 |
Preference Share Capital A/c Dr. |
XXX | |
|
Premium on Redemption A/c Dr. |
XXX | ||
|
To Preference Shareholders A/c |
XXX | ||
|
(Being amount payable to preference shareholders on redemption) |
|||
| 5 |
Preference Shareholders A/c Dr. |
XXX | |
|
To Bank A/c |
XXX | ||
|
(Being payment made to preference shareholders) |
