Buyback of Shares — Accounting Entries and the Legal Limits

If a company earns healthy profits and has surplus cash, one smart move it can make is to buy back its own shares from existing shareholders. For CA students, this topic sits right at the intersection of Company Law and Accountancy — which makes it both important and slightly tricky. Let us break it down clearly.

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What Is Buyback of Shares?

Simply put, buyback (also called share repurchase) means a company purchases its own previously issued shares from the market or from shareholders. After the buyback, those shares are cancelled — they do not sit in the company's balance sheet as an asset.

The key law governing this in India is Section 68 of the Companies Act, 2013, along with the Companies (Share Capital and Debentures) Rules, 2014.

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Legal Limits You Must Know (Section 68)

Before a company can even begin a buyback, it must satisfy several conditions. Here are the most exam-relevant ones:

  • Sources of funds: Buyback can only be funded from free reserves, the securities premium account, or the proceeds of any earlier issue of shares or specified securities. A company cannot borrow money to fund a buyback.
  • Board vs. shareholder approval: Up to 10% of the total paid-up equity capital and free reserves can be bought back in a financial year through a Board resolution alone. Beyond that limit (up to 25%), a special resolution of shareholders is needed.
  • Overall ceiling: The buyback in any financial year cannot exceed 25% of the total paid-up capital and free reserves of the company. (Always verify the exact current thresholds in the latest ICAI study material / announcement, as limits may be updated.)
  • Debt-equity ratio: After the buyback, the ratio of secured and unsecured debt owed by the company must not exceed 2:1 (verify in the latest ICAI study material / announcement).
  • Fully paid shares only: A company can only buy back shares that are fully paid up.
  • Time gap between two buybacks: The company must wait at least one year between the closure of one buyback and the opening of the next.
  • Capital Redemption Reserve (CRR): After cancelling the bought-back shares, the company must transfer an amount equal to the nominal value of shares cancelled to a Capital Redemption Reserve. This reserve can later be used only for issuing fully paid bonus shares.

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Step-by-Step Accounting Entries

Let us walk through the logic with a constructed example.

Situation: A company buys back 1,000 equity shares of ₹10 each (face value) at ₹35 per share. The securities premium account has a sufficient balance.

Step 1 — Record the payment to shareholders

The company pays ₹35,000 (1,000 × ₹35) in total.

Equity Shares Buyback A/c Dr. 35,000 To Bank A/c 35,000 (Being payment made for buyback)

Step 2 — Cancel the share capital

Nominal value of shares cancelled = 1,000 × ₹10 = ₹10,000

Equity Share Capital A/c Dr. 10,000 To Equity Shares Buyback A/c 10,000 (Being nominal value of bought-back shares cancelled)

Step 3 — Adjust the premium paid

Amount paid above face value = ₹35,000 − ₹10,000 = ₹25,000. This premium is adjusted first against the Securities Premium Account and then, if insufficient, against Free Reserves.

Securities Premium A/c Dr. 25,000 To Equity Shares Buyback A/c 25,000 (Being premium on buyback charged to Securities Premium A/c)

At this point the Equity Shares Buyback A/c is fully settled (₹35,000 Dr. = ₹10,000 Cr. + ₹25,000 Cr.).

Step 4 — Create the Capital Redemption Reserve

This is mandatory under Section 69 of the Companies Act, 2013.

General Reserve A/c (or Free Reserves) Dr. 10,000 To Capital Redemption Reserve A/c 10,000 (Being CRR created equal to nominal value of shares cancelled)

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Key Logic Points for Your Exam

  • The Capital Redemption Reserve exists to protect creditors — it replaces the permanent capital that was cancelled.
  • The premium on buyback first hits Securities Premium, then Free Reserves. The sequence matters in problems where the Securities Premium balance is limited.
  • If the company uses Free Reserves (instead of Securities Premium) to fund the buyback, the same free reserve must be reduced before creating the CRR from the remaining balance.
  • Always check whether the buyback amount is within the 25% ceiling before starting your answer — examiners award marks for noting the legal compliance step.

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Quick Revision Checklist

  • [ ] Source of funds — free reserves / securities premium / earlier issue proceeds only
  • [ ] Board resolution limit vs. special resolution limit
  • [ ] 25% ceiling on paid-up capital + free reserves
  • [ ] Debt-equity ratio post-buyback
  • [ ] Only fully paid shares eligible
  • [ ] One-year cooling period between buybacks
  • [ ] CRR = nominal value of shares cancelled

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FAQs

Q1. Can a company use borrowed funds for buyback? No. Section 68 explicitly prohibits using borrowed money for a buyback. Funds must come from free reserves, securities premium, or proceeds of an earlier specified securities issue.

Q2. What happens to the Capital Redemption Reserve later? The CRR is a capital reserve and can only be utilised for issuing fully paid-up bonus shares to existing shareholders. It cannot be distributed as a dividend.

Q3. Is the buyback premium always debited to Securities Premium Account? Primarily, yes — the excess paid over face value is first adjusted against the Securities Premium Account. If that balance is insufficient, the remaining premium is then charged to Free Reserves (General Reserve or Profit & Loss Account balance). Always follow the order given in the problem or the relevant rules.

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Mastering buyback questions becomes much easier once you build a clear day-by-day revision schedule. Grab the free day-by-day study planner at caparveensharma.com/free-planner?src=article to organise topics like this one efficiently. For deeper case-scenario practice — where you work through multi-step buyback problems with varying reserve balances — explore the structured courses available at caparveensharma.com. CA Parveen Sharma's 36 years of teaching means every concept is explained the way an examiner thinks, not just the way a textbook reads.