Own Shares Purchase

Definition: The practice by which a company buys back or redeems its own shares from the shareholders. This process is subject to legal regulations to ensure that such actions do not harm the financial viability of the company or unfairly disadvantage remaining shareholders.

Detailed Explanation

The purchase of its own shares by a company is governed by strict legal regulations in various jurisdictions. These regulations are put in place to maintain corporate governance and financial stability. In the UK, for instance, the Companies Act 2006 outlines specific provisions that a company must follow to redeem or repurchase its shares.

Key Points:

Fully Paid Shares: In the UK, redeemable shares may only be redeemed if they are fully paid.
Capital Redemption Reserve: If the redemption or purchase of a company’s own shares leads to a reduction of its capital, a capital redemption reserve must be created. This ensures that the reduction is accounted for in the company’s financial statements.
Companies Act 2006: This act has simplified the process for private companies to reduce their capital, making it easier for them to buy back shares.

Examples

Example 1: A private UK company wishes to buy back 10,000 of its ordinary shares. Given that these shares are fully paid, the company is allowed to proceed. However, the purchase reduces the nominal capital of the company. Thus, a capital redemption reserve is created to reflect this reduction.
Example 2: A US corporation intends to increase shareholder value by repurchasing its outstanding shares. It uses excess cash to buy back shares in the open market, subsequently reducing the number of shares outstanding and potentially increasing the value of the remaining shares.

Frequently Asked Questions (FAQs)

Q1: What is a capital redemption reserve? A1: A capital redemption reserve is an accounting reserve created when a company purchases its own shares and the purchase leads to a reduction in nominal capital. It ensures that this reduction is accounted for in the company’s financial statements.

Q2: Can all companies repurchase their own shares? A2: No, the ability to repurchase shares depends on the jurisdiction and specific regulatory requirements within that jurisdiction. Companies must follow local laws that govern share buybacks.

Q3: How does buying back shares affect shareholders? A3: Share repurchases can benefit shareholders by potentially increasing the value of the remaining shares in circulation. However, buybacks must be conducted legally and with full transparency to avoid any negative financial impact on the company or its shareholders.

Q4: Does the Companies Act 2006 apply to all companies? A4: The Companies Act 2006 applies to companies registered in the United Kingdom, with specific provisions for both private and public companies.

Q5: Are there limits on the percentage of shares a company can repurchase? A5: Yes, many jurisdictions impose limits on the percentage of shares a company can repurchase to prevent significant reductions in capital that could affect financial stability.

Capital Redemption Reserve: An accounting reserve created to account for a reduction in nominal capital when a company repurchases its own shares.
Permissible Capital Payment: A payment allowed by law for the purpose of repurchasing shares, provided certain conditions are met.
Share Buyback: A corporate action wherein a company decides to buy back its shares from the marketplace.

Online References

Suggested Books for Further Studies

Corporate Finance: A Practical Approach by Michelle R. Clayman, Martin S. Fridson, and George H. Troughton
Financial Markets and Corporate Strategy by Mark Grinblatt and Sheridan Titman
Corporate Finance (The Mcgraw-hill/Irwin Series in Finance, Insurance, and Real Estate) by Stephen A. Ross, Randolph W. Westerfield, and Jeffrey Jaffe

Accounting Basics: Own Shares Purchase Fundamentals Quiz

### Is a company allowed to repurchase its own fully paid redeemable shares? - [x] Yes, fully paid redeemable shares may be repurchased. - [ ] No, companies cannot repurchase their own shares. - [ ] Only if they are partially paid. - [ ] Only during the first year of issuance. > **Explanation:** In the UK and many other jurisdictions, companies are permitted to repurchase their own fully paid redeemable shares, subject to specific regulatory conditions. ### What must be created if a share repurchase reduces the nominal capital of a company? - [x] A capital redemption reserve - [ ] An unsolicited asset fund - [ ] A shareholder equity reserve - [ ] A general reserve > **Explanation:** A capital redemption reserve must be created to reflect any reduction in nominal capital resulting from a share repurchase. ### Which act has simplified the process of share repurchase for private companies in the UK? - [x] Companies Act 2006 - [ ] Securities Act 1933 - [ ] Companies Act 1985 - [ ] Shareholders Act 1999 > **Explanation:** The Companies Act 2006 has simplified the process for private companies to repurchase their own shares, making it easier and more efficient for these companies to manage capital. ### What is a potential benefit for shareholders when a company buys back its own shares? - [x] Increase in value of remaining shares - [ ] Immediate bonus distribution - [ ] Reduction in overall company debt - [ ] Automatically receiving new shares > **Explanation:** Share buybacks can lead to an increase in the value of the remaining shares, as there are fewer shares outstanding, making each remaining share potentially more valuable. ### Is there a limit on the percentage of shares a company can repurchase? - [x] Yes, there are limits imposed by jurisdictions. - [ ] No, companies can repurchase as much as they want. - [ ] Only for publicly traded companies. - [ ] Only for private companies. > **Explanation:** Many jurisdictions impose limits on the percentage of shares a company can repurchase. These limits help maintain financial stability and protect shareholders. ### Under which condition can permissible capital payment be made? - [x] If certain legal conditions are met - [ ] Always, with no restrictions - [ ] Only during profitability - [ ] Only if directed by the board of directors > **Explanation:** Permissible capital payments can only be made if certain conditions specified by law are met, ensuring that share repurchases are conducted responsibly. ### What type of reserve needs to be created due to share repurchase? - [x] Capital redemption reserve - [ ] General reserve - [ ] Revenue reserve - [ ] Statutory reserve > **Explanation:** When a company repurchases its shares, a capital redemption reserve must be created to record the reduction in share capital. ### Which legislation typically governs the practice of share repurchase in companies? - [x] Local corporate laws and regulations - [ ] International trade laws - [ ] Employment laws - [ ] Environmental regulations > **Explanation:** Share repurchase practices are governed by local corporate laws and regulations specific to the company's registered location. ### Which factor justifies a significant reduction in a company’s capital due to share repurchase? - [x] Creation of a capital redemption reserve - [ ] Increase in shareholder meeting frequency - [ ] Restructuring of the board of directors - [ ] Acquisition of new assets > **Explanation:** The creation of a capital redemption reserve is necessary to justify and account for a significant reduction in a company's capital due to share repurchase. ### How does the buyback of shares generally impact the company's financial statement? - [x] Reducing the number of outstanding shares - [ ] Increasing debt levels - [ ] Increasing total liabilities - [ ] Decreasing cash flow > **Explanation:** The primary impact of a share buyback is the reduction in the number of outstanding shares, which can enhance earnings per share and increase the value of remaining shares.

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!

Own Shares Purchase