The Companies (Amendment) Act 1999 has introduced Section 77A in the Companies Act, 1956 permitting companies to buy-back their own shares and other securities. Prior to the introduction of this Section, the buy-back of shares in India was totally prohibited. Buy-back of shares means the repurchase of its own shares by a company. A company having substantial cash resources may like to buy its own shares from the market particularly when the prevailing market price of its shares is much lower than its book value or what the company perceives to be its true value. This is called buy-back of shares.

A company can purchase its own shares out of its following sources:

1. 1.       Free Reserves*; or
2. 2.       Securities Premium Account; or
3. 3.       The proceeds of any shares or other specified securities:

Provided that no buy-back of any kind of shares or other specified securities shall be made out of the proceeds of an earlier issue of the same kind of shares or same kind of other specified securities.

*Explanation: "Free Reserves" mean those reserves which are tree for distribution as dividend and shall include balance to the credit of the securities premium account.

The various journal entries to be passed in the books of company to record buy-back of its shares are as follows:

(1)        For sale of investments:

Bank A/c                       Dr.       * * *                   (Amount realized on sale of investment)

Surplus A/c                    Dr.       * * *                            (Loss on sale of investment)

To Investment A/c           * * *                (Book value of investment)

To Capital Reserve A/c    * * *    (Profit on sale of investment)

(2)     For issue of any shares (excluding shares of the kind to be bought back) or other specified securities:

Bank A/c                         Dr.      

To Pref. Share Cap/Debentures A/c * * *

To Securities Premium A/c                      * * *

(3)        For cancellation of shares bought back:

Equity Share Capital A/c        Dr.         * * *                (With nominal value of shares                                       bought back)

Securities Premium/Free Reserves A/c * * *    (With additional amt payable, if any)

To Equity Shareholders A/c * * *    (With actual cost of shares bought back)

To Capital Reserve A/c    * * *                (With the amount of discount, if any)

(4)        For making payment to equity shareholders for shares bought back:

Equity Shareholders A/c                       Dr.       * * *

To Bank A/c                                                                    * * *

(5)     For transfer of free reserves (equivalent to the nominal value of shares bought back) to Capital Redemption Reserve A/c to meet the requirements of law for buy-back of shares:

Free Reserves A/c                                  Dr.       * * *

To Capital Redemption Reserve A/c                   * * *

1. According to Section 77A, the following conditions must be satisfied in order to buy-back the shares:
2. Shares for buy-back must be fully paid up: All the shares or other securities for buy­back must be fully paid-up. In other words, buy-back of partly paid up shares is not allowed.
3. Buy-back must be authorised by articles of association of the company: The buy­back of shares is permitted only if it is authorised by articles of association of the company.
4. Special Resolution: A special resolution must be passed in general meeting of the company authorizing the buy-back.
5. Limit on buy-back of shares: Companies are allowed to buy-back their own shares upto 25% of the total paid up capital and free reserves of the company provided that the buy-back of equity shares in any financial year shall not exceed 25% of its total paid up equity capital in that financial year.
6. Debt-Equity Ratio: The ratio of debt (secured and unsecured) owned by the company should not be more than twice the capital and free reserves of the company after such buy-back.
7. To comply with regulations made by SEBI: The buy-back of listed shares/securities must be in accordance with the regulations made by the SEBI in this behalf.
8. Time limit for buy-back: Every buy-back must be completed within 12 months from the date of passing the special resolution.
9. Sources of buy-back: A company can purchase its own shares out of its following sources:
   1. Free Reserves; or
   2. Securities Premium Account; or
   3. The proceeds of any shares or other specified securities:
10. Provided that no buy-back of any kind of shares or other specified securities shall be made out of the proceeds of an earlier issue of the same kind of shares or same kind of other specified securities.

Declaration of solvency: Where a company has passed a special resolution to buy­back its own shares, it shall, before making such buy-back, file with the Registrar and the Securities and Exchange Board of India a declaration of solvency in the form as may be prescribed and verified by an affidavit to the effect that the Board has made a full inquiry into the affairs of the company as a result of which they have formed an opinion that it is capable of meeting its liabilities and will not be rendered insolvent within a period of 1 year of the date of declaration adopted by the Board, and signed by at least 2 directors of the company, one of whom shall be the managing director, if any:

Provided that no declaration of solvency shall be filed with the SEBI by a company whose shares are not listed on any recognised stock exchange.

1. Transfer of free reserves (equivalent to the nominal value of shares bought back) to Capital Redemption Reserve A/c: Where a company purchases its own shares out of free reserves, a sum equal to the nominal value of the shares so purchased shall be transferred to the Capital Redemption Reserve A/c.
2. Physically destroy: The securities bought back should be physically destroyed within 7 days from the last date of completion of buy-back.
3. Restriction on further issue of same kind of shares or securities: After completion of buy-back, a company cannot make further issue of the same kind of shares or securities within a period of 24 months, except by way of bonus issue or in the discharge of subsisting obligations such as conversion of warrants, stock option schemes, sweat equity or conversion of preference shares or debentures into equity shares.

1. Buy back helps a company to reduce its excessive share capital that is not required for the time being.
2. Buy back helps a company to utilise its large sum of free reserves.
3. Buy back helps a company to improve its book Value, earnings per share (EPS), price earning (P/E) ratio & return on equity (ROE). The reason for improvement is that these ratios are based on the number of shares outstanding.
4. Companies may buy back shares its own shares as protection against unfriendly takeovers from other companies. Buy back reduces the number of shares in the open market which makes it more difficult for an invader to take control.
5. If a company has a large sum of cash and decides how to invest it, one of the options is to distribute part of it to the shareholders. Companies can do this either of two ways: as dividends or by buying-up outstanding shares. If the company chooses to buy back shares, shareholders benefit even if they don't sell by the reduction in outstanding shares
6. Buy back is relatively a quick method for reduction of share capital. It involves lower cost transaction.

Disadvantages/Limitations of Buy Back of Shares:

1. Rigid legal requirements.
2. Reduces cash surplus with the company.
3. Fear of share price manipulation.
4. It could divert away the company's funds from productive investments.
5. Post buy-back debt equity ratio not to exceed 2: 1.
6. Maximum number of equity shares to be bought back should not exceed 25% of the existing paid-up capital.
7. Maximum amount that can be expended on a buy-back should not exceed 25% of the Company's paid-up capital and free reserves.