Redemption of Preference Shares and Debentures – Rules and Entries Explained Simply
If there is one topic that trips up CA Inter students in Accounts, it is redemption of preference shares and debentures. The entries look similar, the rules overlap a little, and yet the two topics have distinct logic. Let us walk through both carefully — the why first, then the how.
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Part 1 — Redemption of Preference Shares
Why Companies Redeem Preference Shares
Preference shares carry a fixed dividend and usually a fixed repayment date. When that date arrives, the company must pay back the face value (and sometimes a premium) to the preference shareholders. This is called redemption.
The Golden Rule — Protect the Equity Shareholders
The Companies Act insists that when a company redeems preference shares, it must either:
- Use fresh issue proceeds (new shares issued specifically for this purpose), or
- Transfer an amount equal to the nominal value of shares being redeemed to a Capital Redemption Reserve (CRR) — funded out of free reserves (like General Reserve, Profit & Loss credit balance, etc.).
Why? Because the share capital leaving the company must be replaced by something equally permanent — either fresh capital coming in, or a reserve that is locked away and cannot be paid out as dividend. This protects creditors and remaining shareholders.
> Key formula: Amount to be transferred to CRR = Nominal value of preference shares redeemed − Proceeds of fresh issue (if any) raised specifically for redemption.
Sources Allowed for Redemption Payment
The actual payment to preference shareholders can come from:
- Proceeds of fresh issue of shares
- Proceeds of fresh issue of debentures (verify in the latest ICAI study material for any restrictions)
- Free reserves / Securities Premium
- Combination of the above
Note: Securities Premium can be used to pay shareholders (it is a free resource for payment purposes here) but cannot replace the CRR obligation on the capital side.
Worked Logic — CRR Calculation
Suppose a company redeems ₹5,00,000 worth of 10% preference shares at par and issues fresh equity shares of ₹2,00,000 for this purpose.
- Nominal value redeemed = ₹5,00,000
- Fresh issue for redemption = ₹2,00,000
- CRR required = ₹5,00,000 − ₹2,00,000 = ₹3,00,000
This ₹3,00,000 is debited to General Reserve (or another free reserve) and credited to Capital Redemption Reserve.
Key Journal Entries
Step 1 — Fresh issue of equity shares (if any) Bank A/c Dr → Share Capital A/c Cr (and Securities Premium if issued at premium)
Step 2 — Transfer preference share capital to a redemption account Preference Share Capital A/c Dr → Preference Shareholders A/c Cr
Step 3 — Pay the shareholders Preference Shareholders A/c Dr → Bank A/c Cr
Step 4 — Create CRR from free reserves General Reserve A/c Dr → Capital Redemption Reserve A/c Cr
Step 5 — If redeemed at premium, the premium must be charged to Securities Premium or P&L (verify current rules in ICAI material)
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Part 2 — Redemption of Debentures
How Debentures Differ
Debentures are borrowed money — they are liabilities, not equity. So there is no CRR obligation for debentures. However, ICAI requires companies (for exam purposes) to build up a Debenture Redemption Reserve (DRR) and sometimes invest a portion of funds as Debenture Redemption Investment (DRI). Always verify current DRR and DRI requirements in the latest ICAI study material and Companies Act notifications because these rules have been amended over the years.
Common Methods of Redemption
- Lump-sum on maturity — Company pays all debenture holders at once on the due date.
- Annual draw of lots — A fixed number of debentures are redeemed each year by lottery.
- Purchase in open market — Company buys its own debentures from the market (at market price, which may be below face value — giving a capital gain to the company).
- Conversion into shares — Debentures are converted to equity or preference shares at agreed terms.
Worked Logic — Lump-Sum Redemption at Par
Company has ₹10,00,000, 9% debentures redeemable at par.
Step 1 — On redemption date, close debenture account 9% Debentures A/c Dr → Debenture holders A/c Cr
Step 2 — Use DRI (if any) to arrange cash Bank A/c Dr → Debenture Redemption Investment A/c Cr
Step 3 — Pay debenture holders Debenture Holders A/c Dr → Bank A/c Cr
Step 4 — Transfer DRR back to General Reserve (once debentures are fully redeemed) Debenture Redemption Reserve A/c Dr → General Reserve A/c Cr
Redemption at Premium
If debentures are redeemed at a premium, the premium is a finance cost. It is usually written off by debiting Loss on Redemption of Debentures A/c (or charged to P&L), and the credit goes to Premium on Redemption of Debentures A/c (a liability created earlier).
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Quick Comparison Table
| Feature | Preference Shares | Debentures | |---|---|---| | Nature | Equity (capital) | Debt (liability) | | Reserve required | CRR mandatory | DRR (verify current rules) | | Source of funds | Free reserves / fresh issue | Any source | | Premium charge | Securities Premium / P&L | P&L / Securities Premium |
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Tips from the Teaching Desk
- Always identify what is being redeemed (capital vs. debt) before writing a single entry.
- In problems involving partial redemption, calculate CRR for only the nominal value redeemed.
- Read the question twice — sometimes fresh issue proceeds are raised for general purposes, not specifically for redemption. In that case, they do not reduce the CRR obligation.
- Show workings clearly in the exam. Examiners award marks for the logic, not just the final number.
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FAQs
Q1. Can a company use Securities Premium to create CRR? No. Securities Premium can be used to make the actual payment to preference shareholders in some cases, but it cannot substitute the CRR. CRR must be created from free reserves (like General Reserve or P&L credit balance). Verify any current exceptions in the latest ICAI study material.
Q2. What happens if free reserves are not enough to create the full CRR? The company cannot redeem those shares without first building adequate free reserves or arranging a fresh issue of shares. The redemption would be legally incomplete.
Q3. Is DRR compulsory for all companies issuing debentures? DRR rules have been revised over time and differ based on type of company and listing status. Always verify the current position in the latest ICAI study material and Companies Act notifications before answering exam questions.
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Redemption topics reward students who understand the logic behind the rules — once you know why CRR exists or why DRR is built up, the entries follow naturally. To organise your entire CA Inter Accounts preparation day-by-day, grab the free study planner at caparveensharma.com/free-planner?src=article. And if you want to test yourself on case-based problems exactly like what ICAI sets, explore the free case-scenario practice sessions at caparveensharma.com — because reading alone is never enough!