7.

2 BUY-BACK OF SHARES
Introduction
By virtue of section 77(1) of the Companies Act, 1956, a company limited by shares could not
buy its own shares as the same would amount to illegal reduction of capital. This section spe-
cifically laid down that “no company limited by shares and no company limited by guarantee
and having a share capital, shall have power to buy its own shares, unless the consequent
reduction of capital is effected and sanction obtained in pursuance of sections 100 to 104 and
section 402”.
In response to the persistent demand from the corporate sector for buyback, the Central Gov-
ernment promulgated the Companies (Amendment) Ordinance, 1998, permitting companies
to buy-back their own shares. The Ordinance, which amended the Companies Act to become
Companies (Amendment) Act, 1999, made provision for the insertion of three new sections,
viz., section 77A, 77AA and 77B which authorize companies to buy-back their shares subject to
fulfillment of the conditions laid down therein. Besides that, SEBI has also issued its own
guidelines seeking to regulate buy-back of securities.
What is of buy-back?
Buy-back of securities is similar to a company purchasing its own debentures for cancellation
or redemption of preference shares.
In the case of buy-back, the company, which has issued shares to the public, repurchases its
own shares.
How buy-back?
As shares may be issued at par, at a premium or at a discount, re-purchase may also be done at
par, at a premium or at a discount.
talization may be avoided. This method may also be resorted to in order to increase the share
value, by enhancing the earning per share.
Conditions of buy-back.
As per Section 77A(2) of the Companies Act,1956 the conditions for buy-back are:
The company’s articles should authorize the buy-back. If not, the same has to be amended to
include a provision to that effect;
A special resolution should be passed in the general meeting authorizing the buy-back;
a. The buy-back should be less than 25% of the total paid-up capital and free reserves of the
company;
b. The buy-back of equity shares in any financial year should not exceed 25% of its total
paid-up equity capital in that financial year;
c. The Companies (Amendment) Act, 2001 has authorized the buy-back by means of a reso-
lution at the company’s Board provided the buy-back does not exceed 10% of the total
paid-up equity capital and free reserves of the company. But, there cannot be more than
one such buy-back in a period of 365 days.
d. Debt-equity ratio shall not exceed 2:1 after such buy-back. The Central Government may
however, prescribe a higher ratio for a class or classes of companies;

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e. All the shares or other specified securities are fully paid up;
f. The buy-back of the shares or other securities listed on any recognized stock exchange is
in accordance with the regulations made by the Securities and Exchange Board of India in
this behalf;
g. The buy-back of shares or other securities not listed on any recognized stock exchange is
in accordance with the guidelines as may be prescribed.
Notice of the meeting.
The notice of the meeting at which the special resolution on buy-back is proposed to be passed,
shall be accompanied by an explanatory statement mentioning:
A full and complete disclosure of all material facts regarding;
1) The necessity for the buy-back;
2) The class of security intended to be purchased under the buy-back;
3) The amount to be invested under the buy-back;
4) The time limit for completion of buy-back;
5) The price at which buy-back of shares is to be made;
6) If the promoters intend to offer their shares:
a) The quantum of shares proposed to be tendered, and
b) The details of their transactions and their holdings for the last six months prior to the
passing of the special resolution including information on the number of shares ac-
quired, the price and the date of acquisition.
7) Every buy-back should be completed within 12 months from the date of passing the spe-
cial resolution.
Where a company has passed a special resolution or the Board has passed a resolution to buy-
back its own shares or other securities, it shall before making such buyback,
a. File with the Registrar and the Securities and Exchange Board of India. a declaration
of solvency in the form as may be prescribed; and
b. verified by an affidavit to the effect that the Board has made a full inquiry into the
affairs of the company as a result of which they have formed an opinion that it is
capable of meeting its liabilities; and
c. will not be rendered insolvent within a period of one year of the date of declaration
adopted by the Board; and
d. signed by at least two directors of the company, one of whom shall be the managing
director, if any.
e. No such declaration of solvency need to be filed with the Securities and Exchange
Board of India by a company the shares of which are not listed on any recognized
stock exchange.
Another condition to be complied with by a company buying back its own shares is that the
company shall after buy-back extinguish and physically destroy the securities so bought within
seven days of the last date of completion of buy-back.
The SEBI guidelines in this regard stipulate that the securities bought back should be destroyed
in the presence of a Registrar/Merchant Banker, and the statutory auditor.

510 Financial Accounting

A certificate to this effect shall be furnished to the SEBI duly signed by two whole time direc-
tors including the managing director and verified by the Registrar/Merchant Banker and statu-
tory auditor.
No further issue within six months.
After completing buy back of shares or other securities. A Company can not make further
issue of the same kind of shares including by way of rights or other specified securities within
a period of six months.
However, this rule is not applicable in case of bonus issue or in the discharge of subsisting
obligations such as conversion of warrants; stock option schemes, sweat equity or conversion
of preference shares or debentures into equity shares.
Maintenance of Register.
The Company should maintain a register of the securities so bought under this scheme, the
consideration paid for Buy Back, the date of cancellation of securities, the date of extinguishing
and physically destroying the securities and such other particulars as may be prescribed.
A company shall after buy-back is completed under this section, file with the Registrar and the
Securities and Exchange Board of India a return containing such particulars relating to the
buy-back within thirty days of such completion as may be prescribed. No such return need be
filed with the SEBI if the company buying back is an unlisted company.
In case a company makes default in complying with the provisions of this section or any rules
and regulations made thereunder, the company or any officer of the company who is in de-
fault shall be punishable with imprisonment for a term which may extend to two years or with
fine which may extend to Rs. 50,000 or with both.
Prohibition of Buy-Back.
According to Section 77B of the Companies Act, no company shall directly or indirectly pur-
chase its own shares or other specified securities:
(a) through any subsidiary company including its own subsidiary companies; or
(b) through any investment company or group of investment companies; or
(c) if a default by the company, in repayment of deposit or interest payable thereon redemp-
tion of debentures or preference shares or payment of dividend to any shareholder or
repayment of any term loan or interest payable thereon to any financial institution or
bank is subsisting;
(d) in case it has not complied with the provisions of Section 159 with regard to annual re-
turn. Section 207 with regard to failure to distribute dividends within the specified time
and Section 211 with regard to the form and contents of balance sheet and profit and loss
account and compliance with the Accounting Standards.
In the following cases, however, a company is not considered to be purchased its own shares:
a. When redeemable preference shares are redeemed;
b. When shares are forfeited for non-payment of calls. Or
c. When it has accepted a valid surrender of shares.
Prohibition of Financial Assistance.
According to Section 77(2) a public company cannot give loan or provide financial assistance
to any person to enable him to purchase company’s own shares or shares of its holding com-
pany. However, this provision is not applicable in case of:

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(a) the lending of money, by a banking company in the ordinary course of its business or
(b) the provision of money by a company for the purchase of fully paid up shares in the
company or its holding company for the benefit of employees of the company including
any director holding a salaried office or employment in the company;
(c) the making by a company of loans to persons other than directors or managers bonafide
in the employment of the company to enable them to purchase fully paid up shares in the
company or its holding company to be held by themselves by way of beneficial owner-
ship.
However, the loan made to any employee for this purpose shall not exceed his salary or wages
at that time for a period of six months.
Sources of Buy-Back.
Section 77 A read with Section 77B(2) permits a company to buy its own shares or other speci-
fied securities out of:
(i) its free reserves: or
(ii) the securities premium account; or
(iii) the proceeds of any shares or other specified securities.
However, no buy-back shall be made out of the proceeds of an earlier issue of the same kind of
shares or same kind of other specified securities.
The expression ‘specified securities’ includes employees’ stock option or other securities as
may be notified by the Central Govemment from time to time. ‘Free reserves’ means those
reserves which, as per the latest audited balance sheet of the company, are free for distribution
as dividend and shall include balance to the credit of securities premium account but shall not
include share application money.
SEBI Guidelines.
The Securities and Exchange Board of India, has issued the following guidelines with regard to
buy-back of shares or other specified securities by companies, having been empowered to do
so by the Companies (Amendment) Act, 1999. These guidelines came into effect from 14-11-
1998.
Modes of buy-back.
Buy-back is permissible:
(a) from the existing security holders on a proportionate basis through the tender offer; or
(b) from the open market through
1. book-building process,
2. stock exchange;
(c) from odd lots, that is to say, where the lot of securities of a public company whose shares
are listed on a recognized stock exchange is smaller than such marketable lot as may be
specified by the stock exchange: or
(d) by purchasing the securities issued to employees of the company pursuant to a scheme of
stock option or sweat equity.

512 Financial Accounting

Where a company proposes to buy-back its own shares. it shall after passing the special resolu-
tion or resolution of its Board of Directors make a public announcement in at least one English
National Daily one Hindi National Daily and Regional Language Daily with wide circulation
at the place where the registered office of the company is located.
The public announcement shall specify a date which shall be the ‘specified date’ for the pur-
poses of determining the names of the shareholders to whom the letter of offer shall be sent.
The specified date cannot be earlier than 30 days and not later than 42 days from the date of
such public announcement. The letter of offer shall be despatched not earlier than 21 days
from the submission of its draft with SEBI through the merchant banker. The date of opening
of the offer shall not be earlier than 7 days or later than 30 days after the specified date. Com-
panies buying back through the tender offer have to open an escrow account.

A company cannot buy-back its shares from any person:

(a) through negotiated deals whether on or off the stock exchange; or
(b) through spot transactions; or
(c) through any private arrangements.

Price at which shares shall be bought back has to be determined by shareholders through a
special resolution. A copy of their resolution has to be filed with the SEBI as well as the stock
exchanges where the shares of the company are listed, within 7 days from the date of passing
the resolution. Companies buying back through stock exchanges should disclose purchases
daily. Buy-back offer shall remain open for not less than 15 days and not more than 30 days.
The verification of shares bought back has to be completed within 15 days of the closure of the
offer and payments made within 7 days. The onus of complying with the SEBI guidelines is on
the merchant banker who has to file a ‘due diligence certificate’ with the SEBI.
Escrow Account.
Regulation 10(1) of the Securities and Exchange Board of India provides that a company shall,
as and by way of security for performance of its obligations on or before the opening of the
offer of re-purchase, deposit in an escrow account such sum as is specified in 10(2), that is:
(i) If the consideration payable does not exceed Rs. 100 crores, 25% of the consid eration;
(ii) If the consideration payable exceeds Rs. 100’crores, 25% up to Rs. 100 crores, and 10%
thereafter.
Escrow account means an account in which money is held until a specified duty is performed,
i.e., till the consideration for buy-back of shares is paid to the shareholders. This account con-
sists of cash deposited with a scheduled commercial bank, or bank guarantee in favour of the
merchant banker, or deposit of acceptable securities with appropriate margin, with the mer-
chant banker, or combination of these.

Advantages of Buy-back.

Buy-back have the following advantages:

(i) A company with capital, which cannot be profitably employed, may get rid of it by resort-
ing to buy-back, and re-structure its capital.

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(ii) Free reserves which are utilized for buy-back instead of dividendenhance the value of the
company’s shares and improve earnings per share.
(iii) Surplus cash may be utilized by the company for buy-back and avoid the payment of
dividend tax.

(iv) Buy-back may be used as a weapon to frustrate any hostile take-over of the company by
undesirable persons.

Accounting for Buy-back.

Buy-back of shares is just the opposite of issue of shares. Just as shares may be issued at par, at
a premium or a discount, even buy-back may be at par, at a premium or at a discount. The basis
of accounting for buy-back is Section 77 A of the Amended Companies Act. This Section not
only permits a company to buy-back or redeem its equity shares, but also specifies the sources
from out of which re-purchase is to be effected.

According to this Section, a company may buy-back its shares or other specified securities
from out of

1. Its free reserves, or

2. The securities premium account, or
3. The proceeds of any shares or other specified securities like employees’ stock option.

However, no buy-back of shares shall be made out of the proceeds of an earlier issue of the
same kind of shares. This Section also lays down that all the shares or other specified securities
for buy-back are fully paid up.

As per to Section 77 AA, When a company purchases its own shares out of free reserves. then
a sum equal to the nominal value of the shares so purchased shall be transferred to the capital
redemption reserve account and details of such transfer should be disclosed in the balance
sheet.
Buy-back of Shares
Deermination of quantum for buy-back. Sec. 77A
The maximum number of shares to be bought back is determined as the least number of
shares arrived by performing the following tests :
(1) Share outstanding test
(2) Resource test
(3) Debt-Equity Ratio test.

514 Financial Accounting

 (1) Share Outstanding test :
(a) Ascertain the number of shares
(b) 25% of the number of shares is eligible for buy back with the approval of shareholders.
(2) Resource test :
(a) Ascertain sharehooders fund (Capital + Free Reserves)
(b) No. of shares held for buyback
Shareholders funds
= —————————---
Buy back price
Free Reserve includes Securities Premium, General
Reserve, Revenue Reserves, Profit & Loss A/c (Cr. Balance)
excludes Revaluation Reserve, any other specific reserves.
Accounting — Buy back of Shares
(i) Shares held for buy-back
Equity Share Capital A/c Dr.
Premium on Buyback A/c Dr.
To Equity Shareholders A/c
or Shares bought back A/c
(ii) Adjustment of premium on buyback
Securities Premium A/c Dr.
General Reserve A/c Dr.
To Premium on Buyback A/c
(iii) Transfering reserves to the extent of capital redeemed
Reserves A/c Dr.
Profit Loss A/c Dr.
To Capital Redemption Reserve
(iv) On buy-back of shares
Equity Shareholders A/c Dr.
or Shares bought back A/c Dr.
To Bank A/c
Illustration.

(Buy-back at par)

X Co. Ltd. buys back its own 2,00,000 equity shares of Rs. 10 each at par. The company has
sufficient profits otherwise available for dividend besides general reserve. No fresh issue of
shares is made for this purpose. The shares are fully paid up.

Journalise the transactions.

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JOINT STOCK COMPANIES

Solution.

In the Books of 'X Co. Ltd. JOURNAL ENTRIES

Date Particulars Debit Credit

Rs. Rs.
Equity Share Capital Alc Dr. 20,00,000
To Bank Alc 20,00,000
(Buying-back 2,00,000 equity shares of Rs. 10 each,
at par)

General Reserve Alc Dr. 20,00,000

To Capita! Redemption Reserve 20,00,000
(Transfer of nominal value of shares
bought back )

Illustration.

(Where shares are partly paid up).

The BCG Co. Ltd. resolved by a special resolution. to buy-back 2,00.000 of its equity shares of
the face value of Rs. 10 each on which Rs. 8 has been paid up. The general reserve balance of
the company stood at Rs. 50.00,000 and no fresh issue of shares was made.
2Journalize the transactions.

Solution.

In the Books of BCG Co. Ltd.

JOURNAL ENTRIES

Date Particulars Debit Credit

Rs. Rs.
Equity Share Final Call Alc Dr. 4,00,000
To Equity Share Capital Alc 4,00,000
(Final call of Rs. 2 per share due
on 2,00,000 equity shares as per
Board resolution)

Bank Alc Dr. 4,00,000

To Equity Share Final Call Alc 4,00,000
(Final call money on2,00,000 shares
received)

516 Financial Accounting

 Equity Share Capital Ale Dr. 20,00,000
To Equity Shareholders Ale 20,00,000
(Amount due to equity shareholders
transferred to their account for Buy
Back )

Equity Shareholders Alc Dr. 20,00,000

To Bank Alc 20,00,000
(Payment to shareholders towards
buy-back)

General Reserve Ale Dr. 20,00,000

To Capital Redemption Reserve Alc 20,00,000
(Transfer of nominal value of shares
Bought-back.)

Illustration.

(Where shares are bought-back at a premium).

The share capital of a Beta Co. Ltd consists of 100,000 equity shares of Rs. 10 each, and 25.000
preference shares of Rs. 100 each, fully called up. Besides, its security premium account shows
a balance of Rs. 40,000 and general reserve Rs. 7.00,000. The company decides to buy-back
30.000 equity shares of Rs. 12 each. For this purpose, it utilises the security premium in full and
general reserve to the extent necessary.
Pass the necessary journal entries.

Solution.

In the Books of Beta Co. Ltd.

JOURNAL ENTRIES

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JOINT STOCK COMPANIES

Illustration.
(Where shares are bought-back at a discount).

The PTC Co. Ltd. has a share capital of Rs. 15.00,000, comprising 1.00.000 equity shares of Rs.
10 each. and 50.0008% preference shares of Rs. 10 each, both of which fully called up and paid
up. The company has sufficient general reserve to its credit to enable it to comply with the
legal formalities connected with buy-back of shares. It decides to buy-back 20% of its equity
share capital at Rs. 9 per share. Record the transactions in the books of the company.

Solution.
In the Books PTC Co. Ltd.
JOURNAL ENTRIES

518 Financial Accounting

Illustration.

(Fresh issue of shares for purposes of buy-back).

Alpha Co. Ltd. has a paid up equity share capital of Rs. 20.00.000 in 2.00,000 shares of Rs. 10
each. It resolved to buy-back 50,000 equity shares at Rs. 15 per share. For this purpose. it issued
20,000 12% preference shares of Rs. 10 each, at par, payable along with application. The com-
pany has to its credit. Rs. 2.50,000 in securities premium account and Rs. 10.00,000 in the
general reserve account. The company utilized the whole of the securities premium and for the
balance, general reserve. Pass the necessary journal entries.

Solution.

In the Books of ABC Co. Ltd.

JOURNAL ENTRIES

D ate Particulars Debit Credit

Rs. Rs.
B ank Alc Dr. 2,00,000
To Preference Share Application A/c 2,00,000
(Application m oney on 20,000
preference shares at Rs. 10 each)

Preference Share Application A/c Dr. 2,00,000

To Preference Sh are Capital Alc 2,00,000
(Transfer of application m oney to preference
share capital account on shares
being allotted)

Equity Share C apital Alc Dr. 5,00,000

Securities Prem ium Alc Dr. 2,50,000
To Equity Shareh olders Alc 7,50,000
(Am ount due to equity shareholders
consequent upon buy-back of 50,000
Shares at Rs. 15)

Equity Shareholders Alc Dr. 7,50,000

To B ank Alc 7,50,000
(Paym ent to equity shareholders for
am ount due to them )

G eneral Reserve Account Dr. 3,00,000

To C apital Redem ption Reserve Alc 3,00,000
(Transfer of the nom inal value of shares
B ought back.)

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JOINT STOCK COMPANIES

Illustration.

(Buy-back at a premium and issue of bonus shares) .

On 31st March, 2007 following was the balance sheet of Ispat Ltd.:

(Rs. in lakhs)

Liabilities Rs. Assets Rs.

Equity share capital Machinery 3,600

(fully paid-up shares of
2,400 Furniture 452
Rs 10 each)
Securities Premium 350 Investments 148
General Reserve 930 Stock 1,200
Profit and Loss Account 340 Debtors 520
12% Debentures 1,500 Cash at bank 740
Sundry Creditors 750
Sundry Provisions 390 -
6,660 6,660

On 1st April, 2007. the company announced the buy-back of 25% of its equity shares @ Rs. 15
per share. For this purpose, it sold all of its investments for Rs. 150 lakhs and issued 2,00,000
14% preference shares of Rs. 100 each at par the entire amount being payable with application.
The issue was fully subscribed. The company achieved the target of the buy-back. Later, the
company issued one fully paid-up equity share of Rs. 10 by way of bonus share for every four
equity shares held by the equity shareholders.

Show journal entries for all the transactions including cash transactions.

520 Financial Accounting

Solution.
In the Books of New Era Ltd.
JOURNAL ENTRIES
(Rs in lakhs)

Date Particulars Debit Credit

Rs. Rs.
Bank Alc Dr. 150
To Investments Alc 148
To Profit and Loss Alc 2
(Sale of investments & Profit transfered)

Bank Alc Dr. 200

To 14% Preference Share Application Alc 200
(Application money on received 2,00,000
2,00,000 preference shares at Rs. 100 each)

Preference Share Application Alc Dr. 200

To 14% Preference Share Capital Alc 200
(Allotement of preference shares to all
applicants

Equity Share Capital Alc Dr. 600

Securities Premium Alc Dr. 300
To Equity Shareholders Alc 900
(Amount due to shareholders for buying back
of 25% of equity share capital @ Rs. 15 each)

Equity Shareholders Alc Dr. 900

To Bank Alc 900
Payment made against money due to equity
shareholders)

General Reserve Alc Dr. 400

To Capital Redemption Reserve Alc 400
(Nominal value of shares bught back and not
by fresh issue transferred.)

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JOINT STOCK COMPANIES

Capital Redemption Reserve Alc Dr. 400

Securities Premium Alc Dr. 50
To Bonus to Shareholders Alc 450
(Issue of bonus shares of one for every four
Equity shares)

Bonus to Shareholders Alc Dr. 450

To Equity Share Capital Alc 450
(Convertion of bonus shares into
into equity shares)

BALANCE SHEET As On 1-4-2007

(Rs in lakhs)

EXERCISE

1> State whether the following statements are ‘True’ or ‘False’:

(1) A buy-back may be affected only at part.
(2) No explanatory statement is required in a buy-back.
(3) A company can purchase own shares through its subsidiary.
(4) The total buy-back of shares In a financial year should not exceed 25% of total paid up
equity capital in that year.

522 Financial Accounting