Thinking of buying back shares in your company? Understanding the process and how to account for it correctly is essential to ensure compliance and avoid unintended tax or reporting consequences.
What is a share buy back?
A share buyback is when the company purchases its own shares back from one or more of its’shareholders. This reduces the number of allotted shares in the business. For an owner-managed business this can provide an exit route to a shareholder in cases where the remaining shareholders do not wish to have a new shareholder in the business, or where the existing shareholders are unable to fund the purchase of the shares themselves.
How do I account for a share buy back?
It is always advisable to seek confirmation of the correct accounting treatment for the share buy back, to ensure any specific complexities of the arrangement are correctly reflected in the accounts, for example where a share buy back is linked to a new share issue.
However, the following journal entries are required, for a standard buy-back agreement:
Example 1 – buy back of 100 shares at par value of £1 each:
Dr Share capital £100
Cr Cash £100 (or creditor if the cash is not immediately due)
The redemption of the share capital is funded from retained earnings, which reduces the distributable reserves of the business. The journal for this is as follows:
Dr Retained earnings £100
Cr Capital redemption reserve £100
The capital redemption reserve is only used on the redemption or buy-back of shares. It is a non-distributable reserve, and it can only be used to issue bonus shares to existing shareholders.
The balance sheet will therefore show a reduced equity position by £100, due to the share buy back.
Example 2 – buy back of 100 shares at a premium over par of £300 per share. The total price paid is therefore £30,100 (£301 per share).
Dr Share capital £100
(being the par value of the shares being bought-back)
Cr Cash £30,100
(being the total cash payable)
Dr Retained earnings £30,100
(being the reduction to distributable reserves, in order to fund the share buy-back)
Cr Capital redemption reserve £100
(being the share capital now ringfenced and only able to be issued to existing shareholders as bonus shares)
In this example, the equity on the balance sheet has reduced by £30,100 in order to fund the share buy back.
If you need help with this, or with other advice, then please get in touch with our accounting team.