Learning objectives After you have studied this chapter, you should be able to: Explain, in the context of shares and loan notes, the difference between.

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Chapter 6 Companies purchasing and redeeming their own shares and loan notes

Learning objectives After you have studied this chapter, you should be able to: Explain, in the context of shares and loan notes, the difference between the terms ‘purchasing’ and ‘redeeming’ Describe the alternative ways in which a company may purchase or redeem its own shares and loan notes Explain the difference between the purchase/redemption opportunities available to private companies, and those available to other companies Record the accounting entries relating to the purchase and the redemption of shares and loan notes

Rules for redemption or purchase In all cases, shares can only be redeemed or purchased when they are fully paid. In respect of the nominal value of shares redeemed or purchased, either (a) there must be a new issue of shares to provide the funds for redemption or purchase or (b) sufficient distributable profits must be available (i.e. a large enough credit balance on the appropriation account) which could be diverted from being used up as dividends to being treated as used up for the purpose of redeeming or purchasing the shares.

Purchasing and redeeming own shares ‘purchasing’ and ‘redeeming’ may appear to be identical and interchangeable They both involve an outflow of cash However, legally, ‘redeeming’ means the buying back of shares which were originally issued as ‘redeemable shares In contrast, when shares issued are not stated to be redeemable, if they are subsequently bought back by the company, the company is said to be ‘purchasing’ its own shares rather than ‘redeeming’ them.

Advantages to companies of being able to purchase and redeem their own shares For public companies, the main advantage is that those with surplus cash resources can return some of this surplus cash back to its shareholders by buying back some of their own shares, rather than being pressurised to use such cash in other, less economic ways. For private companies it relate to overcoming problems which occur when shareholders cannot sell their shares on the ‘open market’.

5.1 (a) Dr Cr (A1) Bank 5,000 (A2) Ordinary share applicants 5,000 Cash received from applicants. (B1) Ordinary share applicants 5,000 (B2) Ordinary share capital 5,000 Ordinary shares allotted. (C1) Preference share capital 5,000 (C2) Preference share redemption 5,000 Shares to be redeeemed. (D1) Preference share redemption 5,000 (D2) Bank 5,000 Payment made to redeem shares.

5.1 (a) (cont’d) Balances Effect Balances before Dr Cr after Net assets (except bank) 20,000 20,000 Bank 13,000 (A1) 5,000 (D2) 5,000 13,000 33,000 33,000 Preference share capital 5,000 (C1) 5,000 Preference share redemption – (D1) 5,000 (C2) 5,000 – Ordinary share capital 15,000 (B2) 5,000 20,000 Ordinary share applicants – (B1) 5,000 (A2) 5,000 – Share premium 2,000 2,000 22,000 22,000 Profit and loss 11,000 11,000

(A2) Ordinary share applicants 1,500 Cash received from applicants. (c) Dr Cr (A1) Bank 1,500 (A2) Ordinary share applicants 1,500 Cash received from applicants. (B1) Ordinary share applicants 1,500 (B2) Ordinary share capital 1,500 Ordinary shares allotted. (C1) Profit and loss appropriation 3,500 (C2) Capital redemption reserve 3,500 Part of redemption not covered by new issue, to comply with Companies Act. (D1) Preference share capital 5,000 (D2) Preference share redemption 5,000 Shares to be redeemed. (E1) Preference share redemption 5,000 (E2) Bank 5,000 Payment made for redemption.

Balances Effect Balances before Dr Cr after Net assets (except bank) 20,000 20,000 Bank 13,000 (A1) 1,500 (E2) 5,000 9,500 33,000 29,500 Preference share capital 5,000 (D1) 5,000 – Preference share redemption – (E1) 5,000 (D2) 5,000 – Ordinary share capital 15,000 (B2) 1,500 16,500 Ordinary share applicants – (B1) 1,500 (A2) 1,500 – Capital redemption reserve – (C2) 3,500 3,500 Share premium 2,000 2,000 22,000 22,000 Profit and loss 11,000 (C1) 3,500 7,500 33,000 29,500

(d) Dr Cr (A1) Preference share capital 5,000 (A2) Preference share redemption 5,000 Shares to be redeemed. (B1) Profit and loss appropriation 1,250 (B2) Preference share redemption 1,250 Premium on redemption of shares not previously issued at premium. (C1) Profit and loss appropriation 5,000 (C2) Capital redemption reserve 5,000 Transfer because shares redeemed out of distributable profits. (D1) Preference share redemption 6,250 (D2) Bank 6,250 Payment on redemption.

Balances Effect Balances before Dr Cr after Net assets (except bank) 20,000 20,000 Bank 13,000 (D2) 6,250 6,750 33,000 26,750 Preference share capital 5,000 (A1) 5,000 Preference share redemption – (D1) 6,250 (A2) 5,000 – (B2) 1,250 – Ordinary share capital 15,000 15,000 Capital redemption reserve – (C2) 5,000 5,000 Share premium 2,000 2,000 22,000 22,000 (C1) 5,000 Profit and loss 11,000 (B1) 1,250 4,750

(e) Dr Cr (A1) Bank 7,000 (A2) Ordinary share applicants 7,000 Cash received from applicants. (B1) Ordinary share applicants 7,000 (B2) Ordinary share capital 7,000 Ordinary shares allotted. (C1) Preference share capital 5,000 (C2) Preference share redemption 5,000 Shares being redeemed. (D1) Share premium account 1,500 (D2) Preference share redemption 1,500 Amount of share premium account used for redemption. (E1) Profit and loss appropriation 500 (E2) Preference share redemption 500 Excess of premium payable over amount of share premium account usable for the purpose. (F1) Preference share redemption 7,000 (F2) Bank 7,000 Amount payable on redemption.

Balances Effect Balances before Dr Cr after Net assets (except bank) 20,000 20,000 Bank 13,000 (A1) 7,000 (F2) 7,000 13,000 33,000 33,000 Preference share capital 5,000 (C1) 5,000 – Preference share redemption – (F1) 7,000 (C2) 5,000 (D2) 1,500 (E2) 500 – Ordinary share capital 1 5,000 (B2) 7,000 22,000 Ordinary share applicants – (B1) 7,000 (A2) 7,000 – Share premium account 2,000 (D1) 1,500 500 22,000 22,500 Profit and loss 11,000 (E1) 500 10,500 33,000 33,000

Redemption of loan notes Redemption may be done in one of three ways: (a) By annual transfers out of profits; (b) By purchase in the open market when the price is favourable; (c) In a lump sum to be provided by the accumulation of a sinking fund.