Buy Back of Securities CA Inter: Provisions, Entries & Practical Questions

Meaning of Buyback of Shares

A buyback means that a company purchases its own fully paid equity shares and cancels them permanently. After cancellation, these shares no longer exist in the market.

This process reduces the number of outstanding shares and impacts both the share capital and reserves of the company.

Key effects of buyback:

• Share capital decreases

• Cash or bank balance reduces

• Earnings per share (EPS) increase

• Ownership concentration improves

Difference Between Issue of Shares and Buyback

Understanding the difference helps in concept clarity:

• When a company issues shares, it receives money from investors, and its capital increases. 

• On the other hand, in a buyback, the company pays money to shareholders, and its capital is reduced.

In simple comparison:

• The issue of shares increases capital and bank balance.

• Buyback reduces capital and bank balance.

Similarly, the issue of shares expands ownership, while a buyback reduces the number of shareholders and increases promoter control.

Objectives of Buyback

Companies do not carry out buyback randomly. It is always a strategic decision. The main objectives are:

1. Improvement in Earnings Per Share

When the number of shares decreases, earnings per share automatically increases, assuming profit remains constant.

2. Increase in Promoter Holding

Buyback reduces public shareholding and increases the percentage holding of promoters, which strengthens control.

3. Prevention of Hostile Takeover

By reducing the number of shares in the market, it becomes difficult for outsiders to gain control of the company.

4. Utilization of Excess Cash

Companies with surplus funds use buyback as a way to return money to shareholders in a tax-efficient manner.

5. Market Signal

A buyback is often seen as a signal that management believes the shares are undervalued.

Legal Provisions of Buyback (Section 68)

The Companies Act provides strict rules to regulate buyback:

• Buyback must be authorized in the Articles of Association.

• Approval is required through Board Resolution or Special Resolution depending on size.

• Maximum buyback limit is 25% of paid-up capital and free reserves.

• Only fully paid shares can be bought back.

• Buyback must be completed within 12 months.

• A minimum gap of one year is required between two buybacks.

These rules ensure protection of shareholders and creditors.

Methods of Buyback

A company can carry out buyback through different methods:

• Tender Offer: Shares are bought from existing shareholders proportionately.

• Open Market Purchase: Shares are purchased from stock exchanges.

• Employee Scheme Buyback: Shares are bought from employees under ESOP or similar schemes.

Journal Entries in Buyback

Accounting treatment of buyback is a key exam area and must be understood step by step.

1. Making Shares Fully Paid (if required)

Share Final Call A/c → Share Capital A/c
Bank A/c → Share Final Call A/c

2. Funding for Buyback (if required)

Companies may arrange funds by:

• Selling investments

• Issuing preference shares or debentures

Equity shares cannot be issued for funding buyback of equity shares.

3. Core Buyback Entry

Equity Share Capital A/c (at face value)
Premium on Buyback A/c
→ Equity Share Buyback A/c

4. Payment Entry

Equity Share Buyback A/c
→ Bank A/c

5. Adjustment of Premium on Buyback

Securities Premium A/c / Free Reserves
→ Premium on Buyback A/c

Capital Redemption Reserve (CRR)

CRR is created to maintain capital stability after buyback and protect creditors.

It is created equal to the face value of shares bought back after necessary adjustments.

Important points:

• CRR ensures capital is not reduced without safeguard

• It can only be used for issuing bonus shares

• It cannot be used for dividend distribution

Three Important Tests for Buyback

To determine the maximum number of shares a company can buy back, three tests are applied. The lowest value obtained from these tests is considered final.

1. Share Outstanding Test

Under this test, a company can buy back a maximum of 25% of its total equity shares.

2. Resources Test

This test checks financial capacity. A company can buy back shares up to 25% of its paid-up capital and free reserves. The total amount is then divided by the buyback price to find the number of shares.

3. Debt-Equity Ratio Test

This test ensures that after buyback, the debt-equity ratio does not exceed 2:1. In simple terms, equity after buyback should not fall below half of total debt.

Final Decision Rule

The company can buy back only the lowest number of shares calculated from all three tests.

Important Practical Concepts

In advanced problems, buyback is often combined with other topics:

• Redemption of preference shares reduces free reserves and impacts buyback capacity.

• Debenture cancellation reduces debt and may improve buyback eligibility.

• Bonus shares may be issued using CRR after buyback.

These combinations are commonly tested in CA Inter exams.

Buyback of securities is an important and scoring topic in CA Inter because it combines theory, accounting treatment, and numerical application. If the concepts of Section 68, journal entries, CRR, and three tests are clearly understood, this chapter becomes very manageable in exams.

A proper step-by-step approach is always required while solving practical questions, especially those involving multiple adjustments.