Redemption of preference shares

Redemption of redeemable preference shares

This is the repayment made by the company to the shareholders to repossess the preference shares which were issued as redeemable at a particular stated future date. Share redemption involves an outflow of cash from a company in getting back its own shares so that it may then cancel them. Legally, 'redeeming' means the buying back of shares which were originally issued as 'redeemable shares'. The actual terms of redemption are declared when the shares are issued. 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. The redemption price will be stated in the terms of issue.

The following conditions must be fulfilled for the shares to be redeemed:

1. There must be authority in the articles of association to redeem such shares;
2. Shares redeemed must be fully paid up;
3. The redemption can be financed by proceeds of new issue of equity shares or from profit available for dividends (internal funds) or both

Accounting for redemption of redeemable preference shares

Accounting for redemption of redeemable preference shares is governed by S.61 of the Companies' Act 2002. The accounting treatments for redemption of preference shares is done in two (2) different ways.

That is, accounting treatments when the redemption is financed through proceeds of new issue of equity shares, and accounting treatment when redemption is financed through distributable profits/internal profits. These accounting treatments are described in detail in the next subsections. Accounting entries for redemption of preference shares if redemption is financed by issuing new equity shares are provided as follows:

Journal entry - Redemption of redeemable preference shares

Details	Dr. (Debit)	Cr. (Credit)
Cancelling Redeemable Preference Share Capital Being Redeemed	xx
Redeemable Preference Share Capital Account		xx
If Shares Are Redeemed at Premium (Premium on Redemption)	xx
Premium on Redemption		xx
Settlement of Liability Due to Shareholders	xx
Shareholders Account		xx
Settlement of Liability via Bank Account	xx
Bank Account		xx
Premium on Redemption Written off from Profits Available for Dividends	xx
Profit or Loss Account		xx
Premium on Redemption Account		xx

Example

The statement of financial position of MOPA Ltd. as at 30th June, 2021 is given below:

Balance Sheet

Details	TZS
Noncurrent assets
Property, plant and equipment	375,000,000
Current assets
Cash at bank	40,000,000
Total assets	415,000,000
Shareholders' equity and liabilities
Equity share capital of TZS 10,000	325,000,000
8% redeemable preference shares of TZS 10,000	30,000,000
Share premium	35,000,000
Profit or loss (Retained earnings)	20,000,000
Current liabilities
Trade payables	5,000,000
Total Shareholders' equity and liabilities	415,000,000

8% redeemable preference shares were redeemed on 1st July, 2021 at a premium of 5%. To finance the redemption, 25,000 Equity shares of TZS 1,000 were issued at TZS 1,300 each. Shareholders of 8% Redeemable preference shares were paid on 21st July, 2021.

You are required to prepare:

1. Ledger accounts to effect the redemption; and
2. Statement of financial position after redemption

8% Redeemable Preference Share Capital Account

Date	Details	Amount (TZS '000)	Date	Details	Amount (TZS '000)
1st July, 2021	Preference Shareholders	30,000	1st July, 2021	Balance b/d	30,000

Preference Shareholders Account

Date	Details	Amount (TZS '000)	Date	Details	Amount (TZS '000)
21st July, 2021	Bank	31,500	1st July, 2021	8% Redeemable Preference Share Capital	30,000
1st July, 2021	Premium on Redemption	1,500

Property, Plant, and Equipment Account

Date	Details	Amount (TZS '000)	Date	Details	Amount (TZS '000)
1st July, 2021	Balance b/d	375,000	1st Aug., 2021	Balance b/d	375,000

Bank Account

Date	Details	Amount (TZS '000)	Date	Details	Amount (TZS '000)
1st July, 2021	Balance b/d	40,000	1st July, 2021	Equity Share Capital	25,000
1st July, 2021	Share Premium	7,500	1st Aug., 2021	Balance b/d	72,500
21st July, 2021	Shareholders	31,500	31st July, 2021	Balance c/d	41,000

Equity Share Capital Account

Date	Details	Amount (TZS '000)	Date	Details	Amount (TZS '000)
31st July, 2021	Balance c/d	350,000	1st July, 2021	Balance b/d	325,000
1st Aug., 2021	Bank	25,000

Share Premium Account

Date	Details	Amount (TZS '000)	Date	Details	Amount (TZS '000)
31st July, 2021	Balance c/d	42,500	1st July, 2021	Balance b/d	35,000
1st Aug., 2021	Bank	7,500

Profit or Loss Account

Date	Details	Amount (TZS '000)	Date	Details	Amount (TZS '000)
31st July, 2021	Premium on Redemption	1,500	31st July, 2021	Balance c/d	18,500
1st July, 2021	Balance b/d	20,000

Premium on Redemption Account

Date	Details	Amount (TZS '000)	Date	Details	Amount (TZS '000)
1st July, 2021	Preference Shareholders	1,500	31st July, 2021	Profit and Loss	1,500

Trade Payables Account

Date	Details	Amount (TZS '000)	Date	Details	Amount (TZS '000)
31st July, 2021	Balance c/d	5,000	1st July, 2021	Balance b/d	5,000
1st Aug., 2021	Balance b/d	5,000

MOPA Ltd. Statement of Financial Position as at 31st July, 2021

Details	Amount (TZS)
Noncurrent assets	375,000,000
Current assets	Cash at Bank
Total assets	416,000,000
Shareholders' Equity and Liabilities
Equity Share Capital	350,000,000
Share Premium	42,500,000
Profit or Loss Account	18,500,000
Current Liabilities	Creditors
Total Shareholders' Equity and Liabilities	416,000,000