CBSE Class XII Accounts Fundamental Concepts

 

Chapter 6

Accounting for Share Capital

 

 

 

Introduction

Joint Stock Company is the most practical form of organization for large scale business. In India the Indian Companies Act of 1956 governs joint stock companies. Owners of a company are known as shareholders, because they hold the shares of capital of the company.

 

Share and Share Capital: Meaning, Nature and Types

The most striking feature of a joint stock company is its ownership structure. The capital in a joint stock company is divided into small shares of fixed value. This facilitates easy investment. Shareholders do not directly mange the company. They elect directors who carry out management of a joint stock company. The shareholders have only limited liability in the event of extreme loss or liquidation with excessive outside liability. The face value of the shares held by a person is the maximum amount that he can lose in a joint stock company. If the shares are fully paid up he need not pay anything further even if the company is liquidated with heavy unpaid claims. If the shares held are partly paid up, the unpaid portion of the shares may be called up if the assets available in the company are not enough to pay off liabilities.

 

Shares can be sold and purchased in the stock exchange. By purchasing shares a person gets part ownership of the business. By becoming a share holder a person cannot immediately start managing the company. Directors are the people who manage the business. Directors are elected representatives of shareholders who carry out the management of a joint stock company. Thus a shareholder can vote to elect directors. He can also contest in the election to become director. A joint stock company is regarded as an artificial person. It is considered to have an identity apart from the shareholders. A company can enter into contract, buy or sell properties in its own name, file lawsuits or can be sued.

 

Types of share capital

Share capital is basically classified into equity and preference share capital. Equity capital is that part of the share capital whose fortunes are directly linked to the performance of the business. Preference shares on the other hand are the ones having priority in the payment of dividend and repayment of capital in the event of liquidation of a company. Divided for the preference shares are paid at a prescribed rate. Preference shareholders have fixed income irrespective of the performance of the business. Equity dividend is declared each year, which will vary according to the profit earned by the business. The equity shareholders are the ones who actually bear the risk in business. When the performance of the business is good, they get a high percentage of income. The value of shares will also increase in the market. Capital appreciation is the prime attraction of equity shares in a company having consistently good performance.

 

Apart from the basic classification of equity and preference share capital may be referred by different qualifying terms highlighting certain specific aspects of share capital. Following terms used to qualify share capital.

 

1. Authorized Capital or Registered Capital

This is the maximum amount of capital a company is authorised to raise from the public. This is specified in the Memorandum of Association of the company.

 

2. Issued Capital

Issued capital indicates that part of the authorised capital offered to public subscription.

 

3. Subscribed Capital

This is the part of the issued capital actually purchased or subscribed by the public.

 

4. Called up Capital

Called up capital indicates the portion of the subscribed capital called up by the company for payment.

 

5. Paid up Capital

This the amount of called up capital actually paid up by the public. Paid up capital becomes the liability of the company towards its shareholders.

 

6. Reserve Capital

Reserve capital is the part of the uncalled capital set aside as reserve, by the company to call up only in the event of liquidation of the company.

  

Accounting for Share Capital

Capital of joint stock companies is referred as share capital because it is divided into shares. Share capital is usually not collected in lump sum, but in instalments at various stages, such as application, allotment, 1^st call etc. For the purpose of convenient accounting, a temporary account representing each of these stages will be opened in the ledger which will be closed once the amounts expected on that stage is fully collected or the shares are cancelled for unpaid amounts.

 

Following are the journal entries for issue of share capital:

 

Share Application Stage

The first stage in issue of share is the application stage. At this point the company will give extensive publicity to the share issue and invite the public to apply for the shares. A prospectus which is official invitation to the public, containing details of the company, proposed number of shares, its type, value etc. will be issued to the pubic and registered with the registrar of companies.

 

In response to the invitation by the company, public will apply for the shares. A part of the value of shares will be specified as application money which is to be paid along with the application. This amount will be deposited in the bank account of the company. Application money cannot be less than 25% of the issue price. Following journal entries are passed at the collection and capitalisation of application money.

 

i.. When share application money is received

 

Bank Account       Dr.

              To Share Application Account

 

ii. Application money credited to Capital Account

 

Share Application Account Dr.

               To Share Capital

 

The second entry will close the Share Application Account, and in the ledger there will be Cash at Bank on one side and Share Capital on the other, provided the number of applications invited and the number of applications received are the same.

 

 Over-Subscription and Under-Subscription

 

Over-subscription: It is unlikely that the public apply for the exact number of shares invited by the company. When applications received exceed the number invited, the share is said to be over-subscribed. It also means that the company received more application money than what was originally invited. Now the company cannot conveniently increase the number of shares and keep the money as capital. Instead, it must refund the excess amount received or make a part allotment on applications from each individual, and adjust the money on the subsequent payments due from the same applicant.

 

Under-subscription: Under-subscription is a situation just the opposite of over-subscription. Here the company received less number of applications than what was invited. In case of under subscription the company will proceed to allotment and subsequent stages with the actual number of shares applied by the public.

 

When there is over subscription share capital account will not be closed by the transfer to capital alone (second entry above). This is because the company has received more money. This excess amount should either be paid off or adjusted to subsequent payments due by passing one of the following entries depending on what is decided by the directors.

 

i. If the excess amount is refunded to applicants

 

            Share Application Account Dr.

                        To Bank

 

ii. If the excess amount is adjusted to Allotment

 

            Share Application Account Dr.

                        Share Allotment

 

Share Allotment Stage

After the closure of share issue the directors proceed to the allotment of shares. An additional amount towards the capital on the allotted shares is collected at this stage. This amount is called allotment money.

 

Following journal entries are passed at allotment stage:

 

i.. Allotment money credited to capital

 

Share Allotment Account Dr.

            To Share Capital

 

ii. Collection of allotment money

 

            Bank Account Dr.

                        To share Allotment Account

 

 

Share 1^st Call

 

After the share allotment, the company will collect the remaining capital in one or two additional instalments which are known as calls on shares. Same accounting entries are passed for all calls.

 

Following are the typical entries:

 

i. Call money credited to capital

 

Share 1^st Call Dr.

                        To Share Capital

 

ii. Collection of call money

 

            Bank Account Dr.

                        To Share 1^st Call

 

Issue and Allotment of Preference Shares

Preference shares as also part of capital. But these shares as the name suggest are having some special privileges or preferences. Following are the important features of preference shares.

1. Preference shares are issued with a prescribed rate of dividend. Thus such shareholders have an assured income from their shares. When the company does not make huge profits there is an advantage to the Preference shareholder. But when the profit is high, a preference shareholder must satisfy with his prescribed rate of dividend.

2. In the event of liquidation of the company the preference shareholders get a priority over the equity shareholder in the repayment of capital.

3. Preference shareholders have less say in the management of the company. Equity shareholders who are the real risk bearing investors mainly control management.

 

Form the accounting point of view there is no much difference between the issue of equity shares or preference shares. The only difference is that the preference capital account will be clearly stated as “preference share capital” in the journal entry.  But there is no need to specify “equity capital” when it is issued.  The term capital is understood as equity capital.

 

Private Placement and Public Subscription of Share Capital

Issue of shares under private placement implies the issue of shares to a selected group of persons. Private placement is an issue that is not a public issue. In order to make private placement, a company should pass a special resolution to that effect. If the number of votes cast in favour of private placement is not sufficient to pass a special resolution, but more than the number of votes cast against, the directors can approach Central Government for approval, stating that the proposed private placement is most beneficial to the company.

 

1.     What is authorized capital? What is its significance? How does it differ from issued capital?

Authorized capital is also known as registered capital. This is the capital registered by stating it in the in the Memorandum of Association of a Joint Stock Company. It is the maximum amount of capital that a company is normally allowed to raise by way of share capital. If a company needs to raise more amount it must first alter the Memorandum of Association. Authorized capital is different from issued capital. Out of the authorized capital the portion that is issued to public is known as issued capital. Therefore issued capital can be equal or less than the authorized capital, but can never be more than the authorized capital.

 

2.     State the provisions of the Companies Act, 1956 for the issue of shares at discount.

Conditions regarding the issue of debentures at discount are stated in Section 79 of the Indian Companies Act, 1956. Following are the important conditions:

1. A new company cannot issue shares a discount. A company is allowed to issue shares at a discount only one year after commencement of business.

2. An ordinary resolution authorizing the issue of shares at a discount must be passed in the general meeting of shareholders.

3. A new class of share cannot be issued at a discount.

4. Rate of discount cannot exceed 10% of the face value, unless special permission from the Company Law Board is obtained.

5. The shares must be issued within two months of obtaining permission from the Company Law Board

 

3.     Distinguish between over-subscription and under-subscription. How is over subscription dealt with?

When a company issues shares to the public it is very unlikely that the public apply for the exact number of shares issued. Application can either beyond or below the actual number of shares issued, depending on the reputation of the company of attraction of the offer. When the application received exceed the issue it is said to be “over subscribed”. The company has the following options in dealing with the over-subscription.

1. The company can reject the excess application with refund of application money.

2. It can make a pro-rata allotment, which is proportionate allotment on the basis of number of applications and the number of shares issued.

3. It can work out a combination of the above two options.

 

5.     State any three purposes for which ‘securities premium’ can be used.

According to Section 78 of the companies Act 1956, amounts raised by way of securities premium can be utilized for the following purposes:

1. Issue of fully paid bonus shares

2. Writing off preliminary expenses

3. Writing off discount on issue of shares or debentures

4. Providing for the premium on redemption of debentures

5. Writing off the expenses incurred on the issue of shares or debentures.

 

6.      Write notes on ‘capital reserve’ and ‘reserve capital’.

Capital reserves are generated out of capital profits. A company is not allowed to utilize these reserves for paying dividends. Following are the common source of capital reserve in a company:

i) Profits prior to incorporation

ii) Profit on the reissue of forfeited shares

iii) Profit on sale or revaluation of fixed assets; and

iv) Profit on purchase of business.

 

Reserve Capital is not a generated reserve. This only a part of uncalled portion of issued capital, which a company has decided not to call unless it goes into liquidation. This arrangement indirectly assure the creditors that the shareholders shall be liable to pay additional amount in the event that the company does not have enough assets to settle the creditors claim in the event of liquidation of the company. However, this method is hardly practiced in real life, because the company can offer more meaningful assurance to creditors without keeping the shares partly paid up.

 

 

7.      Distinguish between Capital Reserve and Reserve Capital

 

Basis	Capital Reserve	Reserve Capital
1. Meaning      2. Disclosure      3. Availability     4. Application of reserve     5. Special Resolution	Capital reserve is generated out of capital profits     Capital reserve is disclosed in the balance sheet of the company   Capital reserve is readily available for writing off capital losses.     Capital reserve is retained in the existing assets of the company     Capital reserve is created without any resolution	Reserve capital is not a reserve generated. It is only capital not to be called up unless the company goes into liquidation.   Reserve Capital is not mentioned in the balance sheet.   Reserve capital is available only during liquidation process     Reserve capital is not retained in the existing assets of the company.     A special resolution should be passed to set aside reserve capital.

 

8.     Write a note on the issue of shares for consideration other than cash.

a. Normally shares are issued for cash. But a company can issue shares for consideration other than cash. For example a company purchases fixed assets and issues shares to the vendor instead of paying cash or issues shares in settlement of loans or other creditors. In these transactions the company does not receive cash directly but it receives benefits equivalent to cash by way of assets or settlement of liabilities.

 

Issue of shares in this case also can be made at par, premium or discount. The value of assets purchased or liabilities settled will be considered equivalent to cash received in normal transactions and the amount of discount premium or discount will be worked on that basis.

 

 8.     What is meant by private placement of shares?

Issue of shares under private placement implies the issue of shares to a selected group of persons. Private placement is an issue that is not a public issue. In order to make private placement, a company should pass a special resolution to that effect. If the number of votes cast in favour of private placement is not sufficient to pass a special resolution, but more than the number of votes cast against, the directors can approach Central Government for approval, stating that the proposed private placement is most beneficial to the company.

 

9.     Distinguish between equity and preference shares.

 

Equity Shares	Preference Shares
1. Equity shares do not carry any assurance as to dividend payment     2. Equity share holders have voting rights to elect directors   3. In the event of liquidation of the company, equity shareholders get what money left after settling all other claims   4. Equity shares are not redeemed or taken back by the company. Once they are issued, they remain permanently with the company	Preference shares are issued with a conditional assurance regarding and a prescribed rate of dividend   Preference shareholders have no voting rights     Preference shareholders get a priority over equity shareholders in repayment of capital in the event of liquidation of the company   There are redeemable preference shares, which the company can pay off

 

 

10.   Can forfeited shares be reissued at discount? If yes, to what extent?

A forfeited share can be reissued at discount. The amount of capital paid by the previous shareholder is retained in the share forfeiture account. A forfeited share can be reissued at discount to the extent of amount so retained on that share reissued. In case the share was originally issued at discount, the old discount can be allowed in addition to the amount available in the forfeiture account.

 

11.   Explain pro-rata allotment of shares

Pro-rata allotment means proportionate allotment. When there is over subscription of applications, the company has the option to either reject the excess applications or to issue lesser number of shares on the applications adjusting the excess application money in to the amounts due at subsequent stages. The second option is known as pro-rata allotment.

 

 

12.   What is meant by forfeiture of shares?

Normally a company is not allowed to cancel or take back its shares. But when a person fails to pay the allotment money or call money due on a share, the company is allowed to withdraw those shares and reissue them to another party. Forfeiture is withdrawal of shares due to non-payment of dues by the shareholder.

i.                   Capital representing the forfeited shares removed from share capital account

ii.                Unsettled balances in temporary accounts such as Share Allotment, Share Call etc. (or calls in arrears account) are wiped out from the books.

iii.             The paid up portion the forfeited shares is transferred from the capital account to a separate account called ‘Share Forfeiture Account”.

 

13.   Explain the accounting treatment of forfeiture of shares, when they have been issued at a discount.

Accounting treatment on forfeiture of shares will vary according to the conditions under which they have been issued. Shares issued at par, premium and discount are treated differently at the time of forfeiture.

When the shares have been issued at discount the capital representing the shares to be forfeited includes discount as well. When we reverse the capital the calls in arrears as well as the discount accounts have to be credited to clear those balances from the account. When the company reissues the shares issued at discount it is allowed to reinstate the discount that was originally allowed.

 

14.   Explain the accounting treatment of forfeiture of shares when they have been issued at premium.

Accounting treatment on forfeiture of shares will vary according to the conditions under which they have been issued. Shares issued at par, premium and discount are treated differently at the time of forfeiture.

 

When shares are issued at premium and the premium has been collected by the company before forfeiture, no special treatment is required for the premium portion. The shares can be treated as shares issued at par, on which the capital is debited and the portion of capital received is credited to share forfeiture account and capital not received credited to calls in arrears account.

However if the premium is not received, the premium account should be reversed along with the capital account at the time of forfeiture. This is because the premium not collected inflates the calls in arrears account and a mere reversal of capital account will not be enough to wipe out the calls in arrears account.

 

15.   Where will you show the ‘discount on issue of shares’ in the balance sheet?

Discount on issue of shares is treated as expenditure to be written off. This is placed on the assets side of the balance sheet under the heading Miscellaneous Expenditure, along with other fictitious assets such as preliminary expenses, commission and brokerage.

 

16.   What is meant by private placement of shares?

Issue of shares under private placement implies the issue of shares to a selected group of persons. Private placement is an issue that is not a public issue. In order to make private placement, a company should pass a special resolution to that effect. If the number of votes cast in favour of private placement is not sufficient to pass a special resolution, but more than the number of votes cast against, the directors can approach Central Government for approval, stating that the proposed private placement is most beneficial to the company.

 

Don’t waste your time reading the stuff below – Out of Syllabus Items from your Text Book

 

What is Escrow Account?

The word escrow means a contract or bond deposited with a third person, who is to deliver it to the party involved in a contract on fulfilment of certain conditions. In order to ensure that the company fulfils the obligation under buy back it is required to open an escrow account with a merchant banker with an amount equivalent 25% of the total obligation under buy-back scheme, where the total is not more than Rs.100 crores: and 10% of the obligations exceeding Rs.100 crores. This account can consist of (a) cash deposit with commercial bank (b) bank guarantee (c) deposit of acceptable securities with adequate margin against prince variance. This amount is kept as a guarantee, and after payment of all the amounts due on buy-back scheme, it will be released to the company. In case of non-fulfilment of obligation under buy-back, SEBI can forfeit the escrow account.

 

What is Preferential Allotment?

Preferential allotment is the bulk allotment to an individual, venture capitalist or a company. Preferential allotment is made to a pre-identified buyer at a predetermined price. SEBI prescribed that the price shall be the average of highs and lows of the last 26 weeks preceding the date on which the directors have resolved to make such preferential allotment. Preferential allotment is made to individuals or institutions wish to make a strategic investment in the company. They may or may not be existing shareholders. Preferential allotment can take place only if three-fourth of the existing shareholders approve such an allotment. Shares issued on preferential allotment are not to be sold in the open market for a period of three years. This period is known as lock in period.

 

What is Sweat Equity?

Sweat equity are shares issued to employees or directors of a company at reduced rate. They are issued for consideration other than cash for such as technical know how or intellectual property. Following are the conditions to be fulfilled for the issue of sweat equity:

1.       The company must have been in business for not less than 1 year.

2.       Sweat equity shares should belong to a class of shares already issued.

3.       Issue of sweat should be authorized by special resolution passed by shareholders.

4.       SEBI regulations should be followed where the shares are listed in a stock exchange.

 

What is ‘Rights Issue’?

When a company makes fresh issue of shares, the existing shareholders have the right to subscribe them in the proportion in which they are holding shares. This condition is a safeguard that enables existing shareholders to retain their control over the company. They have the option to accept the offer, reject the offer or to sell their rights.