Advanced Accounting · Buyback of Securities

Buyback of Securities: Meaning and Sources of Funds

Updated 4 October 2026 · Fact-checked

Buyback is when a company purchases its own shares or other specified securities and cancels them. Section 68 of the Companies Act, 2013 allows payment only out of free reserves, the securities premium account or the proceeds of a fresh issue of a different kind of security. Proceeds of an earlier same-kind issue are barred.

Understand Buyback of Securities: Meaning and Sources of Funds

Buyback means a company buys back its own shares or other specified securities from existing holders, paying them cash. The securities bought are then extinguished (cancelled). The company's share capital shrinks, and cash goes out.

Why do companies do it? Common reasons: to return surplus cash to shareholders, to support the market price of the share, to improve earnings per share because fewer shares remain, to increase promoters' holding percentage, and to fend off a hostile takeover. A company with idle cash and no good investment use often chooses buyback.

The law protects creditors, because money leaving the company reduces the cushion available to them. So Section 68 lets the company pay only from funds that are not part of the locked-in capital. The permitted sources are: free reserves, the securities premium account, and the proceeds of a fresh issue of shares or other specified securities (subject to the same-kind bar below).

Free reserves (defined in Section 2(43)) are those reserves that are available for distribution as dividend, as shown in the latest audited balance sheet. They include the credit balance in the Statement of Profit and Loss, the general reserve and any other reserve that can be distributed as dividend. They exclude unrealised gains, notional gains and revaluation reserve. They also exclude the securities premium account. Section 68 lists securities premium as a separate source, so you add it on top of free reserves without double counting. Capital redemption reserve is not a free reserve either, because it is not available for distribution as dividend.

One key restriction: a company cannot buy back any kind of shares or specified securities out of the proceeds of an earlier issue of the same kind of shares or same kind of other specified securities. For example, equity shares cannot be bought back out of the proceeds of an equity issue, but a fresh issue of a different kind, such as preference shares, is the permitted alternative. Conditions such as the size limits and board or shareholder approval are covered in the next topic.

Key rules to remember

Permitted sources (Section 68): Free reserves | Securities premium account | Proceeds of a fresh issue of shares or other specified securities; Any one or a combination can be used. Learn all three. Securities premium is a separate source, not part of free reserves.
Prohibited source: Buyback of a kind of security ≠ out of proceeds of an earlier issue of the same kind; Proceeds of an earlier issue of the same kind are barred. A fresh issue of a different kind is the permitted alternative, e.g. a preference issue to buy back equity.
Free reserves available: Credit balance of P&L + General reserve + other free reserves, excluding securities premium; Exclude securities premium (listed separately in Section 68), capital redemption reserve, revaluation reserve and unrealised or notional gains.
Securities bought back: Total buyback amount = Number of shares × Buyback price per share; Price per share includes premium over face value.

How to solve Buyback of Securities: Meaning and Sources of Funds questions

Use this method for any question on meaning or sources of funds for buyback.

1Read the question and note what is being bought back: equity shares, preference shares or other specified securities.
2Compute total buyback cost = number of shares × buyback price.
3List the balances given: P&L credit balance, general reserve, securities premium, capital redemption reserve, revaluation reserve.
4Separate free reserves from non-free items. Exclude capital redemption reserve and revaluation reserve. Keep securities premium aside as its own source.
5Check whether a fresh issue is proposed. Confirm it is of a different kind from the security bought back.
6Decide which source(s) cover the cost and state them clearly with a reason.
7Write the conclusion in one line: buyback is permitted or not from the chosen source, citing Section 68.

Quickest way: Three-source check

When to use it: Use for MCQs and short theory or numerical questions on permitted sources.

For MCQs, eliminate any option naming capital redemption reserve, revaluation reserve or proceeds of an earlier issue of the same kind as a source.
Remember the three-word list: free reserves, securities premium, fresh issue.
In written answers, state the rule, apply it to the figures in a line each, and give a conclusion. This earns step marks.
Add up eligible sources and compare with the buyback cost; if the total is enough, the source test is met.

Common mistakes in Buyback of Securities: Meaning and Sources of Funds

Treating capital redemption reserve as free reserve.
Both are called reserves in the balance sheet.
Fix: CRR is not available for distribution as dividend and cannot fund a buyback. Keep it out of free reserves.
Including revaluation reserve in free reserves.
It sits under Reserves and Surplus.
Fix: Unrealised gains are not free reserves. Exclude them.
Buying back equity shares from the proceeds of an equity issue.
Students think any issue of securities is an allowed source.
Fix: Proceeds of an issue of the same kind cannot be used. Use a fresh issue of a different kind, such as preference shares.
Forgetting premium in the buyback price.
Students multiply by face value only.
Fix: Use the buyback price per share, which includes premium, to get total cost.
Saying buyback only uses profits.
Confusion with dividend payment.
Fix: Securities premium and fresh issue proceeds of a different kind are also permitted sources.
Counting securities premium inside free reserves and then adding it again.
Students treat every credit balance under Reserves and Surplus as free reserve.
Fix: Free reserves exclude securities premium. Add premium once, as its own source.

Worked examples

Example 1

A company has 10,00,000 equity shares of ₹10 each. It plans to buy back 1,00,000 shares at ₹15 each. Balances: General reserve ₹8,00,000; Statement of P&L (credit) ₹4,00,000; Securities premium ₹2,00,000; Capital redemption reserve ₹3,00,000; Revaluation reserve ₹5,00,000. Identify the sources available for the buyback and check whether the cost can be met.

Show the solution

Buyback cost = 1,00,000 × ₹15 = ₹15,00,000. This is the face value of ₹10,00,000 (1,00,000 × ₹10) plus premium of ₹5,00,000 (1,00,000 × ₹5). The whole ₹15,00,000 must come from permitted sources, not just the premium.
Free reserves = General reserve ₹8,00,000 + P&L ₹4,00,000 = ₹12,00,000.
Capital redemption reserve and revaluation reserve are excluded.
Securities premium is not part of free reserves. Section 68 lists it as a separate source, so adding it creates no double counting. Securities premium available = ₹2,00,000.
Total permitted sources = ₹12,00,000 + ₹2,00,000 = ₹14,00,000.
₹14,00,000 is less than ₹15,00,000, so the cost cannot be met fully from these sources alone. Shortfall = ₹15,00,000 − ₹14,00,000 = ₹1,00,000.

Answer: Available sources are ₹14,00,000 (free reserves ₹12,00,000 plus securities premium ₹2,00,000), which is ₹1,00,000 short of the ₹15,00,000 cost. The shortfall can be met by a fresh issue of a different kind of security (such as preference shares) of at least ₹1,00,000, not by equity proceeds.

Example 2

A company wants to buy back 50,000 equity shares at ₹20 each. It proposes to fund it from the proceeds of an issue of 60,000 equity shares of ₹10 each at par. Is this permitted? Suggest an alternative.

Show the solution

Buyback cost = 50,000 × ₹20 = ₹10,00,000.
Proposed source is the proceeds of an equity share issue, which is the same kind as the securities being bought back.
Section 68 bars buyback of a kind of security out of the proceeds of an issue of the same kind.
So the proposal is not permitted.
Alternative: use free reserves or securities premium, or raise funds by a fresh issue of preference shares or another different kind of security.

Answer: Not permitted, because equity shares cannot be bought back out of proceeds of an equity issue. The company may use free reserves, securities premium or proceeds of a fresh issue of a different kind of security.

Exam tips

Questions often hide capital redemption reserve or revaluation reserve among the balances; strike them out first.
In theory answers, name all three sources and add the same-kind restriction. Examiners look for it.
Always compute total buyback cost using the buyback price, not face value.
Remember that securities premium is not part of free reserves; show it as a separate source line.
MCQs commonly test which item is not a permitted source; pick the option naming CRR or revaluation reserve.

Practice questions from Buyback of Securities

Buyback of Securities: Meaning and Sources of Funds in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Buyback of Securities: Meaning and Sources of Funds: frequently asked questions

What is buyback of shares?

It is when a company purchases its own shares or other specified securities from holders and cancels them. The company pays cash and its share capital reduces.

Which sources can be used for buyback under Section 68?

Free reserves, the securities premium account, and proceeds of a fresh issue of shares or other specified securities. The company cannot use the proceeds of an earlier issue of the same kind as the security being bought back. A fresh issue of a different kind is allowed.

Is capital redemption reserve a free reserve?

No. CRR is not available for distribution as dividend, so it is not a free reserve and cannot be used to fund a buyback. Exclude it when computing free reserves.

Is securities premium part of free reserves?

No. Free reserves under Section 2(43) exclude securities premium. Section 68 names the securities premium account as a separate source, so you add it on top of free reserves.

Why do companies buy back shares?

To return surplus cash, support the share price, improve earnings per share, raise promoters' percentage holding or discourage takeovers.