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Questions and Answers
A company has both cumulative and non-cumulative preference shares outstanding. In a year where the company has limited profits, how are the dividends on these shares affected?
A company has both cumulative and non-cumulative preference shares outstanding. In a year where the company has limited profits, how are the dividends on these shares affected?
- Non-cumulative preference shareholders receive current year dividends, and cumulative shareholders receive a pro-rata dividend from the remaining profits.
- Neither cumulative nor non-cumulative shares receive a dividend payment.
- Both cumulative and non-cumulative shares receive a pro-rata dividend payment based on available profits.
- Cumulative preference shareholders receive all unpaid prior year dividends before dividends are paid for the current year, while non-cumulative shareholders forfeit the unpaid dividend. (correct)
What is the primary purpose of creating a Capital Redemption Reserve (CRR) account when redeeming preference shares out of profits?
What is the primary purpose of creating a Capital Redemption Reserve (CRR) account when redeeming preference shares out of profits?
- To provide a fund for paying the premium on redemption.
- To capitalize profits and restrict them for distribution as dividends, maintaining the company's capital base. (correct)
- To ensure sufficient cash is available for future dividend payments.
- To reduce the book value of outstanding preference shares.
A company decides to redeem preference shares using a combination of divisible profits and a fresh issue of shares. How is the Capital Redemption Reserve (CRR) affected in this scenario?
A company decides to redeem preference shares using a combination of divisible profits and a fresh issue of shares. How is the Capital Redemption Reserve (CRR) affected in this scenario?
- The CRR is not affected, as the fresh issue covers a part of the redemption.
- The CRR is credited with the total value of the preference shares being redeemed.
- The CRR is credited only with the portion of the redemption financed by divisible profits. (correct)
- The CRR is credited only with the portion of the redemption financed by the fresh issue of shares.
Which of the following statements accurately describes the difference between participating and non-participating preference shares?
Which of the following statements accurately describes the difference between participating and non-participating preference shares?
A company wishes to redeem its preference shares. Which condition must be met regarding the shares themselves before redemption can occur?
A company wishes to redeem its preference shares. Which condition must be met regarding the shares themselves before redemption can occur?
When redeeming preference shares at a premium, from where can the premium amount be paid?
When redeeming preference shares at a premium, from where can the premium amount be paid?
A company's articles of association are silent on the matter of preference share redemption. What implication does this have for the company?
A company's articles of association are silent on the matter of preference share redemption. What implication does this have for the company?
A company issues convertible preference shares. What is the primary benefit to the shareholder holding this type of share?
A company issues convertible preference shares. What is the primary benefit to the shareholder holding this type of share?
What is the correct accounting treatment for the premium paid on the redemption of preference shares?
What is the correct accounting treatment for the premium paid on the redemption of preference shares?
How are Irredeemable Preference Shares treated?
How are Irredeemable Preference Shares treated?
Flashcards
Redeemable Preference Shares
Redeemable Preference Shares
Preference shares that can be bought back by the issuing company, subject to conditions.
Cumulative Preference Shares
Cumulative Preference Shares
Shares where unpaid dividends accumulate and must be paid before equity dividends.
Non-Cumulative Preference Shares
Non-Cumulative Preference Shares
Shares where unpaid dividends are lost; they do not carry forward.
Participating Preference Shares
Participating Preference Shares
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Non-Participating Preference Shares
Non-Participating Preference Shares
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Convertible Preference Shares
Convertible Preference Shares
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Non-Convertible Preference Shares
Non-Convertible Preference Shares
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Capital Redemption Reserve (CRR)
Capital Redemption Reserve (CRR)
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Redemption out of Profits
Redemption out of Profits
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Redemption out of Fresh Issue
Redemption out of Fresh Issue
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Study Notes
- Preference shares can be redeemed (bought back) by the issuing company, subject to certain conditions and procedures
- Redemption involves repaying the shareholders the nominal value of their shares, plus any premium payable as per the terms of issue
Sources for Redemption
- Redemption can come from profits, specifically the company's divisible profits otherwise available for dividends; a sum equal to the nominal value of the shares redeemed must be transferred to a Capital Redemption Reserve Account (CRR).
- Alternatively, redemption can be funded by issuing new shares specifically for that purpose.
- A combination of profits and a fresh share issue can also be used.
Conditions for Redemption
- Preference shares must be fully paid before redemption.
- The company's articles of association must permit redemption.
- Redemption must adhere to the terms outlined when the shares were initially issued.
- If the shares were issued at a premium, the premium must be paid out of profits or the company's securities premium account.
Procedure for Redemption
- The board of directors must approve the redemption.
- Adequate notice must be given to preference shareholders regarding the redemption.
- Determine the funding source for redemption: profits, a fresh issue, or a combination.
- If redemption is from profits, transfer the nominal value of shares to the CRR account.
- The redemption payment must be made to the shareholders.
- Cancel the redeemed preference shares.
Accounting Treatment
- Redemption out of Profits:
- Debit the Profit and Loss Appropriation Account and credit the Capital Redemption Reserve Account (CRR).
- Debit the Preference Share Capital Account and credit the Preference Shareholders Account.
- Debit the Preference Shareholders Account and credit the Bank Account for the redemption payment.
- Redemption out of Fresh Issue:
- Debit the Bank Account and credit the Share Capital Account for the new issue.
- Debit the Preference Share Capital Account and credit the Preference Shareholders Account.
- Debit the Preference Shareholders Account and credit the Bank Account for the redemption payment.
- Premium on Redemption:
- If preference shares are redeemed at a premium, debit the Securities Premium Account or Profit and Loss Account.
- The accounting entry is Debit Securities Premium Account/Profit and Loss Account and Credit Premium on Redemption Account.
- The Premium on Redemption Account is closed by transferring the balance to the Preference Shareholders Account.
Capital Redemption Reserve Account (CRR)
- CRR can only be used to issue fully paid bonus shares to the company's existing shareholders.
- It represents capitalized profits restricted from distribution as dividends.
- Disclose the creation of CRR properly in the company's financial statements.
Impact on Financial Statements
- Balance Sheet:
- Preference Share Capital is reduced.
- CRR is created or increased.
- Cash/Bank balance is reduced.
- Share Capital is increased if new shares are issued.
- Statement of Profit and Loss:
- There will be an impact if the premium on redemption is charged to the Profit and Loss Account.
Types of Preference Shares
- Cumulative Preference Shares: Dividends accumulate if not paid and must be paid before any dividend to equity shareholders
- Non-Cumulative Preference Shares: Dividends do not accumulate if not paid in a particular year
- Participating Preference Shares: Entitled to participate in surplus profits in addition to their fixed dividend
- Non-Participating Preference Shares: Entitled only to a fixed rate of dividend
- Convertible Preference Shares: Can be converted into equity shares after a specified period
- Non-Convertible Preference Shares: Cannot be converted into equity shares
- Redeemable Preference Shares: Can be redeemed by the company after a specified period or event
- Irredeemable Preference Shares: Cannot be redeemed (though many jurisdictions limit or prohibit these)
Cumulative vs. Non-Cumulative
- Cumulative preference shares accrue unpaid dividends, which must be settled before equity dividends
- Non-cumulative shares lose any unpaid dividend for a year, and it is not carried forward
Participating vs. Non-Participating
- Participating shares may receive additional dividends if the company's profits exceed a certain level
- Non-participating shares have a fixed dividend rate
Convertible vs. Non-Convertible
- Convertible shares provide an option to convert into equity shares, adding potential value if the company performs well
- Non-convertible shares remain preference shares until redemption
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