Corporate Accounting (COM3CJ202) — Module 2: Accounting of Bonus, Rights Issue, Buyback & Redemption

• MODULE II: ACCOUNTING OF BONUS, RIGHTS ISSUE, BUYBACK & REDEMPTION Capital Restructuring & Corporate Reorganization Under Companies Act, 2013 Corporate finance encompasses complex equity restructuring operations designed to return surplus funds to investors, reward existing shareholders without cash drain, optimize debt-equity gearing, or retire prior-charge capital. These corporate actions include the Redemption of Preference Shares (Section 55), creation of the Capital Redemption Reserve (CRR), issue of Bonus Shares (Section 63), pre-emptive Rights Issues (Section 62), and the Buy-Back of Own Securities (Sections 68, 69, 70).

Strict statutory covenants are imposed under the Companies Act, 2013 and SEBI regulations to protect creditor security, prevent capital erosion, and ensure financial statement integrity.

1. Redemption of: Preference Shares (Section 55 of Companies Act, 2013) Under Section 55 of the Companies Act, 2013, a company limited by shares may, if authorized by its Articles of Association, issue preference shares which are liable to be redeemed within a period not exceeding 20 years from the date of their issue (extended up to 30 years for specified infrastructure projects, subject to minimum 10% annual redemption from the 21st year).

STATUTORY CONDITIONS FOR VALID REDEMPTION (SECTION 55(2)) Mandatory Legal Rules

1. Fully: Paid Shares Prerequisite No preference shares can be redeemed unless they are fully paid-up. If any calls are in arrears on preference shares, the company must either call and collect the unpaid calls or forfeit the defaulting shares prior to executing redemption. Partly paid shares can NEVER be redeemed.
2. Permitted: Sources of Redemption Preference shares can be redeemed ONLY out of:

• Divisible Profits: Profits of the company which would otherwise be available for dividend (Free Reserves); or
• Fresh Issue Proceeds: Proceeds of a fresh issue of shares (equity or preference) made for the purposes of such redemption.

1. Creation of: Capital Redemption Reserve (CRR) Where preference shares are redeemed out of profits, a sum equal to the nominal amount of the shares to be redeemed must be transferred out of divisible profits to a designated reserve called the Capital Redemption Reserve Account.
2. Premium on: Redemption Provisions Any premium payable on redemption must be provided for out of divisible profits of the company or out of the Securities Premium Account before the shares are redeemed (subject to restrictions under Section 133 for Ind AS companies).
3. Divisible: Profits vs. Non-Divisible Profits for CRR Creation Transfer to Capital Redemption Reserve can only be made from Free Reserves / Divisible Profits (profits legally available for cash dividend distribution):

Divisible Profits (Eligible for CRR Transfer) Non-Divisible Profits (Strictly Ineligible for CRR)

• General Reserve
• Statement of Profit and Loss (Credit Balance)
• Dividend Equalization Reserve
• Revenue Reserve
• Contingency Reserve (if free)
• Workmen's Compensation Reserve (surplus above liability)
• Securities Premium Account
• Capital Reserve (e.g., profit on sale of fixed assets)
• Capital Redemption Reserve (pre-existing)
• Revaluation Reserve
• Development Rebate Reserve / Investment Allowance Reserve
• Shares Forfeited Account

1. The: Capital Redemption Reserve (CRR) Account The fundamental commercial philosophy behind creating the Capital Redemption Reserve is the Doctrine of Capital Maintenance. When a company redeems preference share capital, capital funds leave the business. If capital were returned to shareholders without restriction, the financial safety cushion protecting external creditors and debenture holders would be diminished. By mandating a transfer from free profits to CRR, the law freezes an equivalent amount of liquid earnings, preventing them from being distributed as dividends.

The Fundamental Balance Sheet Equation of CRR Nominal Value of Preference Shares to be Redeemed = Proceeds of Fresh Issue of Shares + Transfer to CRR Therefore:

Transfer to CRR = Nominal Value of Preference Shares Redeemed − Nominal Value of Fresh Issue of Shares

• Crucial Note on Fresh Issue: Under the Companies Act, "Proceeds of fresh issue" means the nominal face value of shares issued (or face value minus discount, if issued at discount). Any Securities Premium received on a fresh issue cannot be counted as proceeds for calculating CRR relief; premium goes directly to the Securities Premium Account.

Statutory Utilization of CRR (Section 55(4) & Section 63) The Capital Redemption Reserve Account is treated as paid-up share capital of the company. Under Section 55(4), the CRR may be applied by the company only for one specific statutory purpose: "In paying up unissued shares of the company to be issued to members of the company as fully paid bonus shares." CRR cannot be used to pay cash dividends, write off losses, pay preliminary expenses, or convert partly paid shares into fully paid shares.

1. Minimum: Fresh Issue of Shares for Redemption When a company possesses limited divisible profits, it must issue fresh shares to cover the deficit. Calculating the Minimum Number of Fresh Shares to be issued depends on whether shares are issued at par, premium, or discount:

• Case A: Fresh Issue at Par Minimum Face Value of Fresh Issue:

Fresh Issue Required = Nominal Value of Preference Shares Redeemed − Available Divisible Profits.

Number of Fresh Shares = Fresh Issue Required ÷ Face Value per Share.

• Case B: Fresh Issue at Premium Because securities premium cannot be credited to share capital or utilized to reduce CRR, the nominal face value required remains identical to Case A.

Number of Fresh Shares = (Nominal Value Redeemed − Available Profits) ÷ Face Value per share. (The premium collected adds to cash and Securities Premium Account).

1. Accounting: Entries for Redemption of Preference Shares STANDARD JOURNAL ENTRIES FOR REDEMPTION OF PREFERENCE SHARES ========================================================================================

1. IF PREFERENCE SHARES ARE PARTLY PAID-UP (Making them fully paid):

Preference Share Final Call Account Dr. [Unpaid call due] To Preference Share Capital Account [Call due] Bank Account Dr. [Call received] To Preference Share Final Call Account [Call received]

2. ON FRESH ISSUE OF SHARES: Bank Account Dr. [Total issue proceeds] To Equity Share Capital Account [Nominal value] To Securities Premium Account (if any) [Premium component]

3. ON TRANSFER TO CAPITAL REDEMPTION RESERVE (CRR):

General Reserve Account Dr. [Amount transferred] Statement of Profit and Loss Dr. [Amount transferred] To Capital Redemption Reserve Account [Total nominal gap]

4. ON PROVIDING PREMIUM ON REDEMPTION: Securities Premium Account / Profit & Loss Dr. [Premium due] To Premium on Redemption of Preference Shares A/c [Premium provision]

5. ON MAKING REDEMPTION DUE TO PREFERENCE SHAREHOLDERS:

Redeemable Preference Share Capital Account Dr. [Nominal value] Premium on Redemption of Preference Shares A/c Dr. [Premium payable] To Preference Shareholders Account [Total amount due]

6. ON ACTUAL PAYMENT TO PREFERENCE SHAREHOLDERS: Preference Shareholders Account Dr. [Actual cash paid] To Bank Account [Cash settlement] ========================================================================================

1. Bonus: Issue (Section 63 of Companies Act, 2013) A Bonus Issue (or capitalization of reserves) is an issue of shares free of cost to the existing equity shareholders in proportion to their existing shareholding. It represents the conversion of accumulated undistributed profits and reserves into permanent share capital.

STATUTORY CONDITIONS FOR BONUS ISSUE (SECTION 63) Section 63 Rules Permitted Sources for Bonus Issue (Sec 63(1)) Bonus shares can be issued ONLY out of:

Its Free Reserves (General Reserve, P&L credit balance);

The Securities Premium Account; or The Capital Redemption Reserve Account.

• Prohibition: No issue of bonus shares shall be made by capitalizing reserves created by the revaluation of assets (Section 63(1) proviso).

Statutory Prerequisites (Sec 63(2)) Authorized by Articles of Association;

Recommended by Board and approved at general meeting;

Company has not defaulted in payment of interest or principal on fixed deposits or debt securities;

Company has not defaulted in statutory dues (PF, gratuity, bonus);

All partly paid-up shares made fully paidup; Bonus shares once announced cannot be withdrawn.

Accounting Entries for Bonus Issue

1. Upon: Declaration of Bonus: Capital Redemption Reserve Account Dr.

Securities Premium Account Dr. General Reserve Account Dr.

Statement of Profit and Loss Dr. To Bonus to Shareholders Account

1. Upon: Allotment of Fully Paid Bonus Shares: Bonus to Shareholders Account Dr.

To Equity Share Capital Account

1. Rights: Issue (Section 62(1)(a) of Companies Act, 2013) Under Section 62(1)(a), when a company having share capital proposes to increase its subscribed capital by the issue of further shares, such shares must be offered to the persons who, at the date of the offer, are holders of equity shares of the company in proportion to the paid-up share capital on those shares. This statutory pre-emptive right ensures that existing shareholders can preserve their proportional voting power and equity interest.

Mathematical Computation of Value of Right Existing shareholders have three options: (1) Subscribe to rights shares; (2) Renounce rights in favour of third parties for cash; (3) Let rights lapse.

Theoretical Ex-Rights Price = [(N × Cum-Rights Price) + (M × Issue Price)] ÷ (N + M) Value of Right = Cum-Rights Market Price − Theoretical Ex-Rights Price

• Alternatively: Value of Right = [M × (Cum-Rights Price − Issue Price)] ÷ (N + M)
• Where: N = Number of existing shares held; M = Number of rights shares offered.

1. Buy-Back of: Shares (Sections 68, 69, 70 of Companies Act, 2013) Buy-back of shares is the purchase by a company of its own shares or other specified securities from existing shareholders. It enables companies with excess liquidity to return surplus capital, enhance Earnings Per Share (EPS), defend against hostile takeovers, and optimize their capital structure.

STATUTORY LIMITS AND COVENANTS FOR BUY-BACK (SECTION 68) Sections 68, 69, 70 Rules

1. Permitted: Sources of Buy-Back (Sec 68(1)) Buy-back may be financed out of:

Its Free Reserves; The Securities Premium Account; or Proceeds of the issue of any shares or other specified securities (not from proceeds of an earlier issue of the same kind of shares).

1. Quantitative: Caps & Approval (Sec 68(2)) 25% Cap: Buy-back cannot exceed 25% of aggregate paid-up capital and free reserves in any financial year.

• Equity Share Cap: Buy-back of equity shares in any financial year cannot exceed 25% of total paid-up equity capital.
• Approval: Board resolution up to 10%; Special Resolution passed in general meeting if over 10% up to 25%.

1. Debt-Equity: Ratio Mandate (Sec 68(2) (d)) The ratio of aggregate secured and unsecured debts owed by the company after buy-back must not be more than twice the paid-up capital and its free reserves (Debt-to-Equity ratio ≤ 2:1).
2. Extinguishment &: Transfer to CRR (Sec 68(7) & 69) All bought-back shares must be physically extinguished and destroyed within 7 days of completion.

Under Section 69, where shares are bought back out of free reserves or securities premium, a sum equal to the nominal value of shares bought back must be transferred to Capital Redemption Reserve Account.

1. Accounting: Entries for Buy-Back of Shares JOURNAL ENTRIES FOR BUY-BACK OF SHARES ========================================================================================

1. IF INVESTMENTS / ASSETS SOLD TO FINANCE BUY-BACK:

Bank Account Dr. [Actual sale proceeds] Statement of Profit and Loss (if loss on sale) Dr. [Loss on sale] To Investment / Asset Account [Book value] To Statement of Profit and Loss (if profit) [Profit on sale]

2. ON FRESH ISSUE OF SHARES FOR BUY-BACK: Bank Account Dr. [Issue proceeds] To Fresh Issue Share Capital A/c [Nominal value] To Securities Premium Account [Premium component]

1. ON BUY-BACK BECOMING DUE (At: Premium): Equity Shares Bought-Back Account Dr. [Nominal value of shares] Premium on Buy-Back Account Dr. [Excess purchase price] To Equity Shareholders / Buy-Back Account [Total payment due]

4. ON SETTLEMENT OF PURCHASE CONSIDERATION: Equity Shareholders / Buy-Back Account Dr. [Actual cash paid] To Bank Account [Settlement]

5. ON EXTINGUISHMENT OF SHARES BOUGHT-BACK: Equity Share Capital Account Dr. [Nominal value] To Equity Shares Bought-Back Account [Cancellation]

6. ON WRITING OFF PREMIUM ON BUY-BACK: Securities Premium / General Reserve / P&L Dr. [Premium amount] To Premium on Buy-Back Account [Provision clearance]

7. ON TRANSFER OF NOMINAL VALUE TO CAPITAL REDEMPTION RESERVE (Section 69):

General Reserve / Statement of P&L / Securities Premium Dr. [Nominal value bought back] To Capital Redemption Reserve Account (CRR) [Statutory CRR] ======================================================================================== 11. SEBI (Buy-Back of Securities) Regulations & Regulatory Escrow Requirements For listed corporate entities in India, the buy-back of equity shares is comprehensively governed by the SEBI (Buy-Back of Securities) Regulations, 2018 in addition to the Companies Act, 2013:

Modalities of Buy-Back Under SEBI

• Tender Offer Route: Buy-back from existing shareholders on a proportionate basis through a tender offer portal. At least 15% of the number of securities proposed to be bought back must be reserved for small shareholders (investors holding shares of market value not exceeding INR 2,00,000).
• Open Market Route via Stock Exchange: Buy-back executed through the automated order matching mechanism of recognized stock exchanges (being phased out by SEBI to prioritize equitable tender offers).

Mandatory Escrow Account Requirement The company must open an Escrow Account with a scheduled commercial bank to secure performance of obligations:

If consideration payable does not exceed INR 100 Crores: 25% of the total consideration.

If consideration exceeds INR 100 Crores: 25% up to INR 100 Crores + 10% of the balance amount.

• Escrow may consist of: Cash deposit, Bank guarantee, or acceptable liquid securities with margin. 12. Statutory Prohibitions on Buy-Back (Section 70 of Companies Act, 2013) When is a Company Barred from Buying Back Its Shares? (Section 70) Under Section 70, no company shall directly or indirectly purchase its own shares or other specified securities: (a) Through any subsidiary company (including its own subsidiary companies); (b) Through any investment company or group of investment companies; (c) If there is any subsisting default in payment of deposits or interest thereon, redemption of debentures or preference shares, or payment of dividend to any shareholder, or repayment of any term loan or interest payable thereon to any financial institution or banking company (unless default was remedied and 3 years have elapsed since such remedy); (d) If the company has not complied with statutory provisions relating to:

Filing of Annual Return (Section 92); Declaration and payment of Dividend (Section 123);

Punishment for failure to distribute Dividend (Section 127);

Preparation and presentation of Financial Statements (Section 129). 13. Comprehensive Comprehensive Accounting Model: Redemption, Fresh Issue & Bonus COMPREHENSIVE MULTI-STAGE TRANSACTION ANALYSIS Practical Corporate Case Model

• Fact Situation: Alpha Corporation Ltd. has an issued capital of 20,000 9% Redeemable Preference Shares of INR 100 each, INR 80 paid-up, and 1,00,000 Equity Shares of INR 10 each, fully paid-up. It has General Reserve of INR 8,00,000, Statement of Profit & Loss credit balance of INR 6,00,000, and Securities Premium of INR 2,00,000.
• The Board decides to: (i) make preference shares fully paid-up; (ii) redeem preference shares at a premium of 5%; (iii) issue 8,000 fresh equity shares of INR 100 each at a premium of 10% for redemption; (iv) issue fully paid bonus shares in the ratio of 1 bonus share for every 2 equity shares held out of CRR.

STEP-BY-STEP ACCOUNTING EXECUTION:

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1. Final: Call on Preference Shares: 20,000 shares × INR 20 = INR 4,00,000.

• Dr. Preference Share Final Call A/c INR 4,00,000 | Cr. Preference Capital INR 4,00,000
• Dr. Bank A/c INR 4,00,000 | Cr. Final Call A/c INR 4,00,000

1. Fresh: Issue of 8,000 Equity Shares @ INR 110 (INR 100 face + INR 10 premium):

• Nominal face value raised = 8,000 × INR 100 = INR 8,00,000.
• Securities Premium received = 8,000 × INR 10 = INR 80,000.
• Dr. Bank A/c INR 8,80,000 To Equity Share Capital A/c INR 8,00,000 To Securities Premium A/c INR 80,000

1. Capital: Redemption Reserve (CRR) Calculation:

• Total Nominal Value of Preference Shares to be Redeemed = INR 20,00,000
• Less: Nominal Face Value of Fresh Issue = INR 8,00,000
• Required Transfer to CRR = INR 12,00,000
• Funded by:
• General Reserve: INR 8,00,000
• Statement of Profit & Loss: INR 4,00,000
• Dr. General Reserve INR 8,00,000
• Dr. Statement of Profit & Loss INR 4,00,000 To Capital Redemption Reserve A/c INR 12,00,000

1. Premium on: Redemption (5% on INR 20,00,000 = INR 1,00,000):

• Funded out of Securities Premium (Available: 2,00,000 + 80,000 = 2,80,000).
• Dr. Securities Premium A/c INR 1,00,000 To Premium on Redemption A/c INR 1,00,000

1. Redemption: Due & Settlement:

• Dr. 9% Redeemable Preference Capital INR 20,00,000
• Dr. Premium on Redemption A/c INR 1,00,000 To Preference Shareholders A/c INR 21,00,000
• Dr. Preference Shareholders A/c INR 21,00,000 To Bank A/c INR 21,00,000

1. Capitalization of: Reserves for Bonus Issue:

• Total existing equity shares = 1,00,000 (INR 10 face = INR 10,00,000) + 8,000 (INR 100 face = INR 8,00,000).
• Bonus shares issued funded up to permissible balance in CRR (Section 55(4)).
• Dr. Capital Redemption Reserve A/c INR 9,00,000 To Bonus to Shareholders A/c INR 9,00,000
• Dr. Bonus to Shareholders A/c INR 9,00,000 To Equity Share Capital A/c INR 9,00,000
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• ------14. Post-Restructuring Balance Sheet Disclosure Standards Under Schedule III of the Companies Act, 2013, whenever corporate redemption, fresh issue, or bonus allocations occur:

The reconciliation of the number of shares outstanding at the beginning and at the end of the reporting period must be explicitly set forth in Note 1 (Share Capital).

For the period of 5 years immediately preceding the date as at which the Balance Sheet is prepared, the company must separately disclose:

The aggregate number and class of shares allocated as fully paid up pursuant to contract(s) without payment being received in cash.

The aggregate number and class of shares allocated as fully paid up by way of bonus shares.

The aggregate number and class of shares bought back.

Capital Redemption Reserve must be shown under the head "Reserves and Surplus" until capitalized into bonus shares.