Journal Entries for Redemption of Preference Shares

Step-by-step accounting for Bombay Ltd’s redemption transactions

corporate building with financial documents

Key Highlights

Redemption Entry: Record preference share capital and premium on redemption against the redemption liability.
Equity Share Issue Entry: Issue equity shares to fund the redemption liability.
Reserve Transfers: Move amounts from Profit & Loss and Capital Reserve to Capital Redemption Reserve as required by accounting standards.

Understanding the Scenario

Bombay Ltd has redeemed 4,000 fully paid 8% redeemable preference shares, each of ₹100, at a premium of ₹5 per share on 1st July 2020. The balances as of 30th June 2020 include:

Preference Share Capital: ₹4,00,000
Profit & Loss Account: ₹1,00,000
Capital Reserve: ₹20,000

To finance the redemption, Bombay Ltd issued fully subscribed equity shares of ₹10 each. The redemption amount, including the premium, totals ₹4,20,000. Consequently, the company should issue adequate equity shares to cover this amount.

Journal Entries for the Redemption Transactions

Step 1: Recording the Redemption of Preference Shares

The first entry reflects the removal of the preference shares from the books along with the premium on redemption. The redemption liability is recorded in a separate account.

Journal Entry – Redemption of Preference Shares


Dr. Preference Share Capital A/c..........................₹4,00,000
Dr. Premium on Redemption of Preference Shares A/c.......₹20,000
    To 8% Preference Share Redemption A/c.....................₹4,20,000

Explanation: The company debits the preference share capital and the premium ledger accounts to remove the balance of redeemed shares. The credit entry establishes a redemption liability of ₹4,20,000.

Step 2: Issuance of Equity Shares

To discharge the redemption liability, Bombay Ltd issues equity shares worth ₹10 each. The number of shares required is calculated by dividing the redemption proceeds by the face value of an equity share.

Calculation of Equity Shares Issued

Number of Equity Shares = Redemption Amount / Face Value = ₹4,20,000 / ₹10 = 42,000 shares.

Journal Entry – Issuance of Equity Shares


Dr. 8% Preference Share Redemption A/c...............₹4,20,000
    To Equity Share Capital A/c......................₹4,20,000

Explanation: In this entry, the liability created for redemption is extinguished by transferring it to the equity share capital account, reflecting the issuance of 42,000 equity shares.

Step 3: Transfer to Capital Redemption Reserve

To satisfy legal requirements on redemption, companies often transfer specified amounts from the Profit & Loss Account and the Capital Reserve to the Capital Redemption Reserve (CRR). For Bombay Ltd, the transfers include:

Journal Entry – Transfer from Profit & Loss Account


Dr. Profit & Loss A/c...............................₹1,00,000
    To Capital Redemption Reserve A/c.................₹1,00,000

Explanation: The entire balance of the Profit & Loss Account is transferred to the Capital Redemption Reserve to meet statutory requirements.

Journal Entry – Transfer from Capital Reserve


Dr. Capital Reserve A/c..............................₹20,000
    To Capital Redemption Reserve A/c.................₹20,000

Explanation: The available balance in the Capital Reserve is also transferred to the CRR to further support the redemption process.

Summary Table: Journal Entries for Redemption

Date	Account Title	Debit (₹)	Credit (₹)	Explanation
1st July 2020	Preference Share Capital A/c	4,00,000	4,20,000	To record redemption of 4,000 preference shares at a premium of ₹5 per share
	Premium on Redemption of Preference Shares A/c	20,000
	8% Preference Share Redemption A/c
1st July 2020	8% Preference Share Redemption A/c	4,20,000	Equity Share Capital A/c	To record the issuance of 42,000 equity shares of ₹10 each
1st July 2020	Profit & Loss A/c	1,00,000	Capital Redemption Reserve A/c	Transfer of P&L balance to CRR
1st July 2020	Capital Reserve A/c	20,000	Capital Redemption Reserve A/c	Transfer of Capital Reserve to CRR

Further Details and Considerations

Legal and Accounting Norms

The process of redeeming preference shares is governed by the Companies Act and relevant accounting standards. The transfer of balances from the Profit & Loss Account and Capital Reserve into the Capital Redemption Reserve (CRR) ensures that the company's capital is adequately maintained. This is a legal requirement in many jurisdictions to protect the creditors' interests and sustain the financial integrity of the company.

Moreover, issuing equity shares to raise funds for redemption is a financial strategy that helps maintain the company’s capital structure while fulfilling the redemption obligation. The issuance price, share face value, and the number of shares issued must be accurately computed and recorded, as demonstrated above.

Implications for Financial Statements

The journal entries impact several financial statements:

Balance Sheet: Reduction in liabilities through reversal of the preference share capital and premium, and an increase in equity via the issuance of new shares.
Profit & Loss Statement: Transfer of retained earnings (or surplus) to the Capital Redemption Reserve to comply with statutory requirements.
Equity Section: The overall change in the composition of shareholders’ funds, with preference share capital being extinguished and equity share capital expanding.

Additional Insights and Best Practices

Reviewing the Transactions

While the journal entries provided are compliant with the established accounting norms, it is essential for companies to review these transactions for accuracy. Auditors and management should verify that:

The preference shares are fully paid up before redemption.
The premium on redemption is correctly computed and recorded.
The equity shares issuance is fully subscribed as per the authorized capital and properly recorded.
Transfers to the Capital Redemption Reserve are made strictly in line with legal provisions.

Documentation and Disclosure

In addition to recording journal entries, companies should ensure adequate documentation and disclosure in their financial statements. This includes a detailed note on:

The redemption process and the basis for calculating the redemption premium.
The rationale behind utilizing profits and capital reserve for transferring amounts to CRR.
The terms of the equity shares issued to finance the redemption.
Any impacts on shareholders’ equity arising from these entries.