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While doing buyback of share, for what reason equivalent amount face value of buy back shares, transferred to capital reserve????
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Capital Reserve is not a free reserve i. e. it cannot be utilized for paying dividend. Consider this example A Ltd. has a share capital of 50 cr and Reserves and Surplus of 250 cr. In addition to this they also have creditors of 200 cr. Say it buys back 10% of its shares. See the impact: When Face value of shares bought back is NOT transferred to Capital Reserve: Current Security to creditors= Shareholders funds/Creditors =300/200=1.5 times Post Buyback security to creditors=250/200=1.25 times As you can see the security of creditors is depleted after buying back shares if an amount equivalent to the face value of shares bought back is NOT transferred to Capital Reserve. When Face value of shares bought back is transferred to Capital Reserve: Post buyback Security to creditors=(300-50+50)/200=1.5 times Here an amount equivalent to the face value of shares bought back is transferred to Capital Reserve. This preserves the Shareholders funds at the same level and the security to creditors does not change. *here reserves only include reserves which cannot be freely utilized for distribution of dividend.
Buyback of shares reduce Share capital.Many investors will hesitate to buy new shares since very low capital is available.To ensure them of their credibility, equivalent reserve is created
