What is a Capital Redemption Reserve?
A Capital Redemption Reserve (CRR) is a statutory reserve established by a company when it repurchases its own shares, resulting in a reduction of its share capital. This reserve is non-distributable, meaning it cannot be distributed to shareholders as dividends. The primary purpose of the capital redemption reserve is to ensure that, despite the reduction in share capital resulting from the buy-back of shares, the company’s capital base remains intact, thereby providing a safeguard to creditors and maintaining financial stability.
Examples
Example 1: Share Repurchase
A company repurchases 100,000 of its own shares at a nominal value of $1 per share. The repurchase leads to a reduction in share capital by $100,000. To comply with statutory requirements, the company must transfer this $100,000 from its distributable profits to the capital redemption reserve.
Example 2: Simplified Demonstration
If the initial share capital of a company was $500,000 and it buys back shares worth $50,000, then $50,000 must be moved from distributable profits to create a capital redemption reserve. In this way, the share capital that has been “redeemed” is supported by an equivalent amount in a non-distributable form preserving the overall capital.
Frequently Asked Questions (FAQs)
What is the primary purpose of establishing a Capital Redemption Reserve?
The primary purpose is to ensure that the company’s capital base is maintained after a share buy-back, protecting creditors by converting distributable profits into non-distributable reserves equivalent to the amount of the capital cancelled.
Can a Capital Redemption Reserve be used for any other purpose?
No, a capital redemption reserve cannot be distributed as dividends. However, it may be utilized to issue bonus shares to quicken the capital base.
How is a Capital Redemption Reserve represented in the financial statements?
It is typically presented under the “Reserves and Surpluses” section in the equity portion of the company’s balance sheet.
Is a Capital Redemption Reserve required by law?
Yes, creating a capital redemption reserve is generally a legal requirement in many jurisdictions when a company repurchases its own shares, to prevent companies from depleting their capital base.
Can a company avoid creating a Capital Redemption Reserve?
No, it is a mandatory requirement once the share capital is reduced through a buyback process. Not creating such a reserve may lead to non-compliance with corporate regulations.
Related Terms
Permissible Capital Payment
This refers to payments a company can make from its distributable reserves or other sources as legally permitted for redeeming or repurchasing its own shares.
Creditors’ Buffer
This refers to financial safeguards put in place by a company, such as reserves, to ensure creditors’ claims are protected and that the company maintains a healthy capital structure.
Share Buy-back
A process carried out by a company to purchase its own outstanding shares from shareholders, which can lead to the reduction of share capital and the increase of the capital redemption reserve.
Distributable Profits
Profits of a company that are legally available for distribution to shareholders as dividends.
Online References
- Capital Redemption Reserve on AccountingTools
- Share Buy-back and Capital Redemption Reserve Requirements
- Explanation on Corporate Share Buybacks and Reserves
Suggested Books for Further Studies
- “Corporate Finance: Principles & Practice” by Denzil Watson and Antony Head.
- “Principles of Corporate Finance” by Richard A. Brealey, Stewart C. Myers, and Franklin Allen.
- “Financial Accounting: An Integrated Approach” by Ken Trotman, Michael Gibbins, and Peter Richardson.
Accounting Basics: “Capital Redemption Reserve” Fundamentals Quiz
Thank you for embarking on this journey through our comprehensive accounting lexicon and tackling our challenging sample exam quiz questions. Keep striving for excellence in your financial knowledge!
