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

2. 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

3. 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.

4. 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.

10. 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’.

12. 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 ,000
Payment made to redeem shares.

13. 5.1 (a) (cont’d) Balances Effect Balances
before Dr Cr after
Net assets (except bank) 20, ,000
Bank 13,000 (A1) 5,000 (D2) 5, ,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
Ordinary share applicants – (B1) 5,000 (A2) 5,000 –
Share premium 2, ,000
22, ,000
Profit and loss 11, ,000

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

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

20. (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 ,250
Payment on redemption.

21. Balances Effect Balances
before Dr Cr after
Net assets (except bank) 20, ,000
Bank ,000 (D2) 6, ,750
33, ,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
Capital redemption reserve – (C2) 5, ,000
Share premium , ,000
22, ,000
(C1) 5,000
Profit and loss 11,000 (B1) 1, ,750

23. (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 ,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
(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 ,000
Amount payable on redemption.

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

25. 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.