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Buyback of shares

Dinesh Kumar (B.Com) (68 Points)

08 August 2016

How to calculate maximum permissible expenditure on buy back of equity shares? with example and logic

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5 Replies

Prathik Lenin (Chartered Accountant) (60 Points)
Replied 09 August 2016

Could you calrify your question, are you asking the 'Limit' on buyback in a financial year?

Dinesh Kumar (B.Com) (68 Points)
Replied 09 August 2016

Debt Equity Ratio Test: Loans cannot be in excess of twice the Equity Funds post Buy Back

As per Section 68 (2) (d) of the Companies Act 2013, the ratio of debt owed by the company should not be more than twice the capital and its free reserves after such buy-back. Further under Section 69 (1), on buy-back of shares out of free reserves a sum equal to the nominal value of the share bought back shall be transferred to Capital Redemption Reserve (CRR). As per section 69 (2) utilization of CRR is restricted to fully paying up unissued shares of the Company which are to be issued as fully paid-up bonus shares only. It means CRR is not available for distribution as dividend. Hence, CRR is not a free reserve. Therefore, for calculation of future equity i.e. shares capital and free reserves, amount transferred to CRR on buy-back has to be excluded from the present equity.

Pl clear this with example along with logic.

Prathik Lenin (Chartered Accountant) (60 Points)
Replied 10 August 2016

The limit on buyback of shares in a financial year and leverage is provided in 68(2) (c ) and 68(2)(d) respectively

Condition 1: 68(2)(c ) provides that the buyback can be made upto 25% of the paid up capital

Condition 2: 68(2)(d) (as you have pointed out) requires that the aggregate of the secured and unsecured debts owed by the company after buyback is not more than twice the paid up capital or reserves i.e. debt equity ratio should be 2:1 post buyback(this provision help to ensure that the company does not remain highly leveraged)

Further, the company is required to transfer a sum equal to the nominal value of shares so purchased to the CRR and disclose the details in the balance sheet.

EXAMPLE

Suppose equity shareholder’s funds is

Equity Capital = 500 Lakh (Rs 10 each)

Free Reserves = 200

Total = 700

Loans = 400, nominal value of a share is Rs 10 and the buyback price is say Rs 25.

Ans

Condition 1:

Limit of 25% of (700) = 175

Buyback price per share is Rs 25

Therefore no of shares that can be bought back 175/25 = 7 shares

Condition 2:

As per the provisions the minimum equity should be 400/2 = 200

Available 500, therefore buyback can be made

However, if buyback is made out of distributable profits or securities premium and amount equal to minimal value of shares need to be transferred (section 69)

Therefore even after buyback the debt equity ratio should be 2:1

Now, we know that CRR is not a free reserve and therefore it cannot be taken into account for computing D/E ratio.

To determine the amount available for buyback we need to do a simultaneous equation

Let amount available for buyback be x and amount transferred to CRR be y

Equation1

Amount available for buyback = {(present equity – amount trf to CRR) – Min equity}

X = {(700-y)}-200

Equation 2

Amount trf to CRR = (Amount available for buyback/buyback share price per share) * F.V per share

Y = (x/25)*10

By solving we get

X = 357

Y = 143

Therefore, number of shares eligible to be bought back = 357/25 = 14.28 shares

The maximum number of shares to be bought back is determined as the least of ‘number of shares’ arrived by performing the above tests, accordingly the least is 7 shares from condition 1.

Hope I have made clear the underlying idea.