Importance of Capital Redemption Reserve
1. Safeguard the Interest: The Capital Redemption Reserve(CRR) is created to safeguard the financial position of the company by setting aside an amount out of its profit for the redemption of its preference shares. It is also established to safeguard the interests of the creditors by maintaining a reasonable level of capital within the company.
2. Redemption of Preference Shares: Section 55 of the Companies Act, 2013 makes it mandatory for companies limited by shares proposing to redeem their preference shares out of profits, to transfer the sum equal to the nominal value of preference shares which are to be redeemed to a capital redemption reserve account.
3. Compliance: Section 55 of the Companies Act,2013 makes it mandatory for companies limited by shares proposing to redeem their preference shares out of profits, to transfer the sum equal to the nominal value of preference shares which are to be redeemed to the capital redemption reserve account. Establishing a capital redemption reserve account is important to ensure compliance with the act.
4. Buy-Back of Shares: When a company decides to purchase its shares, the capital redemption reserve acts as a source of funding. The company needs to transfer an amount equal to the face value of the shares so bought back to the capital redemption reserve account. Details of such transfers shall be disclosed in its balance sheet.
5. Stability of the Company: The capital redemption reserve account is created by setting aside some of the company’s profits. It ensures that the company has enough funds to meet any future losses and helps maintain the financial stability of the company and its integrity.
6. Dividend Policy: The creation of a capital redemption reserve affects the company’s dividend policy. The amount of CRR is not allowed to be distributed among the shareholders in the form of dividends which encourages the company to allocate the profits carefully between the dividends and reserve. This ensures a balance between rewarding shareholders and maintaining financial flexibility.