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Practical application: The selected topic is the most practical topic in recent scenario and many companies use this as a tool for cost cutting measure Strategic importance: The topic gives us a hint of the various strategies and techniques used to manage the company and to give better returns to share holders.

What is a company?

The word company is derived from the Latin word com i.e. with or together and panis i.e. bread. Section 3(1) of the Companies Act, 1956 defines a company. Company means a company formed and registered under this Act or an existing company. A company is defined as An artificial person created by law having a separate legal entity distinct from its members with a perpetual succession and common seal and its capital divided into shares carrying limited liability

Finance

Shares Equity shares

Preference shares

Term loans
Debentures

SHARES

DEBENTURES

Only equity shares can be bought back by the company. These shares are brought back for the purpose of cancellation.

Sometimes article of association of company may empower directors of company to purchase its own debentures from open market: 1. either for immediate cancellation OR 2.for investment and cancellation at a subsequent stage

Equity shares do not enjoy any preferential rights in the matter of payments of dividend or repayment of capital. Equity shares carry voting rights at the general meetings of the company and have the right to control the management of the company The shares can be issued by a company either (i) for cash or (ii) for consideration other than cash.

The provisions regulating buy back of shares are contained in Section 77AA and 77AB of the Companies Act,1956. These were inserted by the Companies (Amendment) Act,1999.

The Securities and Exchange Board of India (SEBI) framed the SEBI(Buy Back of Securities) Regulations,1999 and the Department of Company Affairs framed the Private Limited Company and Unlisted Public company (Buy Back of Securities) rules,1999 pursuant to Section 77A(2)(f) and (g) respectively.

What is buyback? Buyback is reverse of issue of shares by a company where it offers to take back its shares owned by the investors at a specified price; this offer can be binding or optional to the investors.

Company

Buyback

Issue equity shares

Sharehol ders

Why does company buy back equity shares?

To return the surplus cash to the investors Show rosier financials At the time of Liquidation Increase promoter's stake

If the company has huge cash reserves with not many new profitable projects to invest in and if the company thinks the market price of its share is undervalued the company may return the surplus cash by buy backing the equity shares.

Companies try to use buyback method to show better financial ratios. For e.g. when a company uses its cash to buy stock, it reduces outstanding shares and also the assets on the balance sheet . If the company earnings are identical before and after the buyback earnings per share (EPS) and the P/E ratio would look better even though earnings did not improve. Since investors carefully scrutinize only EPS and P/E figures, an improvement could jump-start the stock.

The promoters of the company at the time of liquidation buy back the shares from the share holders and retain their majority share holding in the company. So after revaluation and closing the books of accounts, whatever excess profits earned are enjoyed by them.

Sometimes the promoters do not have majority shareholding in the company. So to increase their shareholding in the company they buy back the shares from the existing shareholder. However they retain their own shares as they were before buy back As a result they get comparative advantage and their share in company increases relatively.

The purchase of shares should be out of

free reserves securities premium account proceeds of any shares or other specified securities

(buy back of shares cannot be made out of earlier issue of same kind of shares)

Existing shareholders

Shares issued to employees

Company

Open market

Odd lots in stock exchanges

Buy back should be authorized by THE ARTICLES OF ASSOCIATION. If the article is silent then it needs to get amended. Company should pass a special resolution in general meeting authorizing the buyback.

Partly paid up equity shares cannot be bought back. In order to buy back. They have to be made fully paid up by making a final call.

Buy back should be completed within 12 months of passing special resolution. Shares/securities bought up should be physically destroyed within 7 days of completion of buy backing

After the completion of buyback the company cannot issue the same class of equity shares for a period of 24 months.

Shares can be bought back either at par, or at premium or at discount.

Rs.10 share Rs.10 share
Amount paid

Rs.10 (at Par) Rs.12 (at Premium)

Amount paid

Rs.10 share

Amount paid

Rs.9 (at discount)

Discount on buy back is a capital profit which should be transferred to Capital Reserve. Premium on buy back is a loss which should be adjusted from Free reserves. Amount utilized for buyback of nominal value if share out of free reserves should be transferred to a newly opened A/c known as Capital Redemption Reserve

The amount of buy back should not exceed 25% own funds (share holder fund) Own funds = 25% [ESC+PSC+A.R.-M.E] (share holder fund)
ESC= Equity share capital PSC=Preference share capital A.R.= All Reserves M.E.=Miscellaneous expenses

Post buy back, debt equity ration should not exceed 2:1 Debt equity ratio = own fund borrowed fund = Debt equity 1 2

i.e.

Own fund should be half of borrowed fund Money borrowed from banks and financial institutions cannot be utilized for the purpose of buy back.

Number of shares bought back should not exceed 25% of fully paid equity shares of the company. For e.g. A company has 30000 fully paid up equity shares of Rs.100 each. Then the no of shares that can be bought back by the company is 25% of 30000 =7500 shares

Info byte Ltd. resolved to buy back 30,000 of its fully paid equity shares of Rs 1o each at Rs 12 per share. For this purpose ,it issued 1,000 10% preference shares of 100 each at par. The total amount was payable on application. The company has Rs 85000 balance to the credit of security premium account ,which was used for buyback. The company has sufficient balance in general reserve to meet the legal requirement for buyback. Pass the necessary journal entries

New issue Bank A/c To 10% Preference share A/c Decision of buyback Equity share capital A/c Premium on issue A/c To Equity share Holder A/c Paid to shareholders Equity shareholders A/c To Bank A/c Dr 3,60,000 3,60,000 Dr 3,00,000 Dr 60,000 3,60,000 Dr 1,00,000 1,00,000

Transfer to capital reserve Securities premium A/c General reserve A/c Dr 25,000 Dr 1,75,000

To Capital Redemption reserve A/c

2,00,000

Adjusting premium on buyback

Securities premium A/c

To Premium on buyback

Dr 60,000
60,000

While scrutinizing a buy back offer, attention should be paid to size of the buyback relating to the companies free float and with the newly granted stock options.

The buy back announcement are a mere statement of company's intentions and need not be neccearily affected in actuality. However if the announcement is backed by the tender offer the possibility of fulfillment of buyback promise does exist.

Buy back of shares M.Siddharta IPCC Module

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