Accounting for Shares and Debentures | CMA Inter Syllabus
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A company is described as a voluntary association of persons who have come together for carrying on some business and sharing the profits with capital divided into numerous transferable shares. It is an artificial person created by law to achieve the object for which it is formed.
Section 2(20) of the Companies Act, 2013 [hereinafter referred to as Act] defines a company as “Company formed and registered under this Act or an existing company.” An existing company means a company formed and registered under any of the former Companies Acts. Thus, a company is an abstract person, invisible, intangible and existing only in contemplation of law. It can hold, purchase or sell both movable and immovable property, incur and pay debts, open a bank account in its own name and sue and be sued in the same manner as an individual. Law creates it and law only can dissolve it. Its existence is altogether independent of the life of its members. Members may come and go but the company would go on forever. Transferability of shares has given perpetual succession to a company.
A company is a legal entity quite distinct and separate from the persons who are its members, also known as shareholders. A shareholder is not the agent of the company. He cannot incur any debt so as to bind the company. Moreover, the ownership is divorced from management because a joint stock company is managed by a Board of Directors elected by the shareholders.
Following are the main characteristics of a company:
Types of Companies
As per Companies Act, 2013, a company may be formed as –
Companies may also be classified as Private Company and Public Company.
A few other classes of companies defined under Companies Act, 2013 are:
Though accounting is a necessity in all forms of organisations, in companies, it assumes a pivotal role. In a company, the day-to-day business activities, both financial and non-financial, are managed by the Board of Directors, an elected group of mangers. Unlike a sole proprietorship or partnership organisation, the owners of company’s capital i.e., shareholders do not actively participate in the management of the company affairs. The Management acts as the stewards of the company and are responsible in managing its resources to achieve its stated objectives. Thus, there is a natural need for a mechanism to record and report how the activities undertaken by the Management are meeting such objectives. Accounting, in a company, helps managers to report to the shareholders how the resources entrusted with them have been utilized to enhance the surplus and the value of the shareholders’ wealth. In addition, the accounting information also meet the needs for other stakeholders as well.
Though the basic principles always remain the same, accounting in a company form of organisation has certain distinguishing features as follows:
In India, accounting in a company form of organisation is guided by the following regulatory sources:
However, for special classes of companies such as banking companies, insurance companies, electricity companies and NBFCs, separate Acts and Rules, in addition to or in suppression of Companies Act, 2013, also provides important guidelines in accounting of transactions and preparation of financial statements.
The Companies Act, 2013 requires every company to maintain proper books of accounts and relevant books and papers.
As per Section 2(12), “book and paper” and “book or paper” include books of account, deeds, vouchers, writings, documents, minutes and registers maintained on paper or in electronic form.
Again, Section 2(13) specifies that, “books of account” includes records maintained in respect of —
Accordingly, the company should maintain Cash Book and Ledger [for (i) above], Day Books, Registers and Ledger [for (ii) above], Assets registers, Schedules and Ledger [ for (iii) above] and Cost Books of Accounts [for (iv) above].
Note: Section 128 of the Act has provided further that the company may keep such books of account or other relevant papers in electronic mode in such manner as may be prescribed.
Statutory books are those which a limited company is under statutory obligation to maintain at its registered office as per the provisions of different Sections of the Act.
The most important statutory books are:
As per Section 92 of the Act, every company shall prepare a return (hereinafter referred to as the annual return) in the prescribed form containing the particulars as they stood on the close of the financial year regarding—
Provided that in relation to One Person Company and small company, the annual return shall be signed by the company secretary, or where there is no company secretary, by the director of the company.
Section 92(4) further specifies that, every company shall file with the Registrar a copy of the annual return, within sixty days from the date on which the annual general meeting is held or where no annual general meeting is held in any year within sixty days from the date on which the annual general meeting should have been held together with the statement specifying the reasons for not holding the annual general meeting, with such fees or additional fees as may be prescribed.
In order to finance procurement of resources and to run its operations, every company requires capital. In a company form of organisation, this capital is raised not only from the promoters but also from others in the society i.e., public at large and institutional investors etc. This allows a traditional company (other than a oneperson company) to raise huge amount of capital to finance operations at a larger scale.
The total capital of a company is split into small equal parts. Each part therefore represents a ‘share of the ownership’ of the company. Investors subscribing to the same becomes the owner of the company and is known as shareholders or members of the company. Each such part of capital is sold in form of a security or instrument known as Share and the capital procured in the process is called Share Capital.
Thus, Share refers to a financial instrument that is issued by a company to its owners. It represents the smallest unit of ownership of a company. As per Section 2(84) of the Act, “share” means a share in the share capital of a company and includes stock.
Note: Stock represents aggregate of fully paid-up shares which are legally consolidated.
Shares have the following features:
On the basis of the rights enjoyed by the shareholders, shares can be divided into two categories as follows:
Preference shares can further be classified into various types on different basis as shown below:
i. Redeemable Irredeemable Preference Shares
Redeemable preference shares are such where the capital is repaid on a fixed date after a period of time. In case of irredeemable preference shares, the capital is never repaid.
ii. Convertible Non-Convertible Preference Shares
Convertible preference shares are such which gives the preference shareholders to convert their shares into equity shares subject to the conditions specified. In case of non-convertible preference shares, the shareholders do not enjoy any such rights.
iii. Fixed Rate Increasing Rate Preference Shares
In case of fixed rate preference shares, the rate of dividend remain fixed throughout the term. However, in case of increasing rate1 preference shares, the dividend rate increases after a certain period of time.
iv. Cumulative Non-Cumulative Preference Shares
Cumulative preference shares are such which carry the right to accumulated dividend. Thus, if the dividend is not paid in any year, it accumulates and becomes payable on subsequent year. Non-cumulative preference shares do not enjoy any such right.
v. Participative Non-Participative Preference Shares
Participatory preference shares are such where the holders have the right to participate (i.e., claim) into the residual distributable profit after paying equity dividend and to participate into the residual asset in the event of liquidation. This participatory right is in addition to their usual right to dividend and capital repayment. Non-participatory preference shares do not enjoy any such right.
Share capital means the capital raised by a company through issue of shares. It is the amount invested by the shareholders against the face value of shares. It is basically a part of a company’s ‘net worth’ or ‘equity’.
Based on the type of shares used to raise the capital, share capital can be either Preference Share Capital or Equity Share Capital.
Again, on the basis of disclosure in the Balance Sheet, Share Capital is categorized as follows:
In the Balance Sheet of a company prepared under Schedule III, Share Capital is reported under the head Shareholders’ Fund in the section Equity and Liabilities with details given under Notes to Balance Sheet as follows:
| Particulars | (₹) |
| Share Capital: | |
| Authorized Capital | |
| …Equity Shares of ₹…..each | ***** |
| …. Preference Shares of ₹…. each | ***** |
| **** | |
| Issued and Subscribed Capital | |
| …Equity Shares of ₹…..each | ***** |
| …. Preference Shares of ₹…. each | ***** |
| **** | |
| Called-up Capital | |
| …Equity Shares of ₹…..each | ***** |
| …. Preference Shares of ₹…. each | ***** |
| Less: Calls-in-arrear | (*****) |
| Paid-up Capital | ***** |
Statement showing reconciliation of the Number and Amount of Shares
| Particulars | Equity Shares of ₹…..each | Preference Shares of ₹…..each | ||
| No. of Shares | (₹) | No. of Shares | (₹) | |
| Opening balance | ***** | ***** | ***** | ***** |
| Add: Fresh issue | ***** | ***** | ***** | ***** |
| Less: Buyback/Redemption | ***** | ***** | ***** | ***** |
| Closing balance | ***** | ***** | ***** | ***** |
Following are some of the common types of share issue.
The price at which the shares are offered for issue by a company may be either equal to, or above, or below the face value. Accordingly, shares can be issued at par, or at a premium, or at a discount.
Note: Relevant provisions of Companies Act, 2013 in this regard have been discussed later in this Module.
A company issues its shares to the public at a specified price. Such price, in case of an Initial Public Offer (IPO) is determined under any of the following two approaches –
Under Fixed Price Method, normally the proceeds are collected through the following stages.
Note: Premium payable on shares may be collected with any of the above three instalments.
1.1 Accounting for Issue of Shares
Accounting entries for issue of equity shares and that of preference shares are similar. Therefore, in the following discussion on accounting entries for issue of shares, the term ‘share’ shall mean equity as well as preference shares.
When shares are issued at par i.e., issue price equals to the face value per share, the journal entries for transactions relating to share issue will be as follows:
a. Shares issued in lump sum
i. On receipt of application money
Bank A/c......................................................... Dr.
To Share Application A/c
ii. For excess share application money refunded
Share Application A/c...................................... Dr.
To Bank A/c
iii. On allotment of shares
Share Application A/c........................................ Dr.
To Share Capital A/c
Consider the following illustration.
Illustration 1
AK Ltd. made an issue of 10,00,000 equity shares of ₹ 10 each, payable fully on application. Subscriptions were received for 12,00,000 shares. Application money in respect of 2,00,000 shares was refunded and shares were duly allotted to the rest. Pass journal entries to give effect to these transactions.
Solution:
b. Shares Issued in Installments
i. On receipt of application money
Bank A/c......................................................... Dr.
To Share Application A/c
ii. For excess share application money refunded
Share Application A/c...................................... Dr.
To Bank A/c
iii. For share application money transferred to share capital
Share Application A/c........................................ Dr.
To Share Capital A/c
iv. For share allotment money due
Share Allotment A/c............................................. Dr.
To Share Capital A/c
v. For share allotment money received
Bank A/c......................................................... Dr.
To Share Allotment A/c
vi. For share call money due
Share Call A/c............................................... Dr.
To Share Capital A/c
vii. For share call money received
Bank A/c......................................................... Dr.
To Share Call A/c
Consider the following illustration.
Illustration 2
BK Ltd. made an issue of 10,00,000 equity shares of ₹10 each, payable @ ₹2 on application, ₹4 on Allotment and ₹4 on first and final call. Subscriptions were received for 12,00,000 shares. Application money in respect of 2,00,000 shares was refunded and shares were duly allotted to the rest. All the amounts were duly received. Pass journal entries to give effect to these transactions.
Solution:
Issue of Shares at Premium
A company may issue shares at a premium, i.e., at a value greater than its face value. The power to issue shares at a premium need not be given in the Articles of Association. Premium so received shall be credited to a separate account called Securities Premium Account.
Section 52 of the Companies Act, 2013 gives the purposes for which share premium account may be applied by the company. These are:
When shares are issued at premium, the journal entries for transactions relating to share issue will be as follows:
a. Shares issued in lump sum
i. On receipt of application money (entire amount is received on application)
Bank A/c......................................................... Dr.
To Share Application A/c
ii. For excess share application money refunded
Share Application A/c...................................... Dr.
To Bank A/c
iii. On allotment of shares
Share Application A/c........................................ Dr.
To Share Capital A/c (Face Value x no. of shares allotted)
To Securities Premium A/c (Premium x no. of shares allotted)
Illustration 3
AB & Co. Ltd. issued 5,00,00,000 Equity shares of ₹10 each at a premium of ₹4 per share payable on application. The shares were all subscribed and all money due was received. Give the Journal entries to record the above transactions.
Solution:
b. Shares Issued in Installments
Note: Unless otherwise stated premium is considered to be a part of allotment money.
i. On receipt of application money
Bank A/c......................................................... Dr.
To Share Application A/c
ii. For excess share application money refunded
Share Application A/c...................................... Dr.
To Bank A/c
iii. For share application money transferred to share capital
Share Application A/c........................................ Dr.
To Share Capital A/c
iv. For share allotment money due
Share Allotment A/c............................................. Dr.
To Share Capital A/c
To Securities Premium A/c
v. For share allotment money received
Bank A/c......................................................... Dr.
To Share Allotment A/c
vi. For share call money due
Share Call A/c............................................... Dr.
To Share Capital A/c
vii. For share call money received
Bank A/c......................................................... Dr.
To Share Call A/c
Consider the following illustration.
Illustration 4
CD & Co. Ltd. issued 5,00,00,000 Equity shares of ₹10 each at a premium of ₹4 per share payable ₹1 per share on application, ₹6 per share on allotment (including premium), ₹3 on first call and the balance on final call. The shares were all subscribed and all money due was received. Give the Journal entries to record the above transactions.
Solution:
When the shareholders fail to pay any instalment (Allotment or call) that has been called up, the amount so unpaid is treated as calls-in-arrear and is accounted as such. If not ultimately received, the balance of Calls- in-arrear is deducted from Called-up Capital in the Notes to Balance Sheet (See Reporting of Share Capital in the Balance Sheet)
The accounting entry for calls-in-arrear is as follows:
Bank A/c............................... Dr. (Amount received)
Calls-in-arrear A/c…............... Dr. (instalment amount not received)
To Share Allotment/Share Call A/c
If received subsequently, the entry will be –
Bank A/c............................... Dr.
To Calls-in-arrear A/c
Illustration 5
EF & Co. Ltd. issued 5,00,00,000 Equity shares of ₹10 each at a premium of ₹4 per share payable ₹1 per share on application, ₹6 per share on allotment (including premium), ₹3 on first call and the balance on final call. The shares were all subscribed and all money due was received except the first call money on 1,00,000 shares and the Final call money on 1,50,000 shares. Give the Journal entries to record the above transactions.
Solution:
Section 50 of the Companies Act, 2013, states that –
Calls-in-advance generally arises when there is an over-subscription of shares. Here, the excess application money is adjusted against the amount due on allotment or calls. The excess application money, after adjustment against the allotment money due, is transferred to a separate account called ‘Calls-in-Advance A/c’. Sometimes, shareholders may also prefer to pay the entire amount of issue price at the time of allotment. In such a situation also calls-in-advance arises and the same is adjusted against call money due subsequently. Balance of Calls-in- Advance on the reporting date is shown under Other Current Liabilities.
The accounting entry for calls-in-advance are as follows:
i. For transferring excess application money
Share Application A/c............................. Dr.
To Calls-in-Advance A/c
ii. For money received in advance against call
Bank A/c............................ Dr.
To Calls-in-Advance A/c
iii. For adjustment of calls-in-advance
Calls-in-Advance A/c.................... Dr.
To Share Call A/c
Illustration 6
GH & Co. Ltd. issued 5,000 Equity shares of ₹10 each at par, payable ₹2 per share on application, ₹4 per share on allotment, ₹4 on first call and final call. The shares were all subscribed and all money due was received. One shareholder holding 200 shares paid the call money along with the allotment money. The amount was subsequently adjusted. Give the Journal entries to record the above transactions.
Solution:
Interest on calls-in-arrear may be collected by the directors from the shareholders, if the Articles of Association so permit. In the absence of any specification, the company needs to follow ‘Table F’ according to which interest @ 10% p.a. from the due date to the date of actual payment is payable by the shareholders unless the same is waived by the Board.
The accounting entries for the same are as follows:
i. For interest due
Shareholders A/c........................... Dr.
To Interest on Calls-in-Arrear A/c
ii. On realization of interest
Bank A/c................................... Dr.
To Shareholders A/c
iii. For transferring interest to Profit and Loss Account
Interest on Calls-in-Arrear A/c........................................................................... Dr.
To Profit and Loss A/c
Interest may be paid by a company on calls-in-advance is the Articles of Association so provide. In the absence of any specification, the company needs to follow ‘Table F’ according to which interest @ 12% p.a. from the date of receipt to the due date of the concerned installment is payable.
The accounting entries for the same are as follows:
i. For interest due on calls-in-advance
Interest on Calls-in-Arrear A/c............................ Dr.
To Shareholders A/c
ii. On payment of interest
Shareholders A/c.................................... Dr.
To Bank A/c
iii. For transferring interest to Profit and Loss Account
Profit and Loss A/c............................ Dr.
To Interest on Calls-in-Arrear A/c
Consider the following illustrations.
Illustration 7
B Ltd issued 2,000 shares of ₹ 100 each at a premium of 10% payable as follows:
On application ₹ 20 (1st April 2021). On allotment ₹ 40 (including premium) (1st June 2021). On First Call ₹ 30 (1st July 2021). On Second & Final call ₹ 20 (1st Aug 2021).
Applications were received for 1,800 shares and the directors made allotment in full. One shareholder to whom 40 shares were allotted paid the entire balance on his share holdings with allotment money and another share holder did not pay allotment and 1st call money on his 60 shares but which he paid with final call. Interest should be received @ 5% p.a. on calls-in-arrears and interest should be paid @ 6% p.a. on calls in Advance (as per Articles of the company).
Required: Calculated the amount of interest paid and received on calls-in-advance and calls in arrears respectively on 1st Aug. 2021.
Solution:
Illustration 8:
A limited Company was registered with a capital of ₹ 5,00,000 in share of ₹ 100 each and issued 2,000 such shares at a premium of ₹ 20 per share, payable as ₹ 20 per share on application, ₹ 50 per share on allotment (including premium) and ₹ 20 per share on first call made three months later. All the money payable on application, and allotment were duly received but when the first call was made, one shareholder paid the entire balance on his holding of 30 shares, and another shareholder holding 100 shares failed to pay the first call money.
Required: Give Journal entries to record the above transactions.
Solution:
If the shares have been allotted to any person or firm from whom the company has purchased any asset, the following entry will be passed:
Asset A/c.............................................. Dr.
To Share Capital A/c
(Being ... shares allotted……in consideration of purchase of an asset for the company)
If shares are issued to Promoters for their services, the following entry will be passed:
Goodwill A/c............................................... Dr.
To Share Capital A/c
Similarly, if shares are issued to Underwriters for underwriting commission, the following entry will be passed:
Underwriters A/c................................................ Dr.
To Share Capital A/c
Note: The fact should also be disclosed in the Balance Sheet while showing the issued, subscribed and paid-up capital.
Consider the following illustrations.
Illustration 9:
B Ltd purchase the assets of ₹ 10,80,000 from C Ltd. The consideration was payable in fully paid equity shares of ₹ 100 each.
Required: Show the necessary journal entries in books of B Ltd. assuming that —
Solution:
Illustration 10:
D Ltd. issued 2,000 shares of ₹100 each credited as fully paid to the promoters for their services and issued 1,000 shares of ₹100 each credited as fully paid to the underwriters for their underwriting services. Journalise these transactions.
Solution:
The common expenses associated with share issue are printing charges of prospectus and application forms, brokerage and commission, underwriting expenses, legal charges etc. These are written off against the profits of the company in the same year or over the years depending on the availability of profits and based on the pattern of benefit derivable from the same.
The accounting entries are:
i. Upon expenditure incurred
Share Issue Expenses A/c.................... Dr.
To Bank A/c
ii. When the expenses are written off
Profit and Loss A/c..................................... Dr.
To Share Issue Expenses A/c
Note: Accordingly, in the Statement of Profit and Loss, the same is included under the head Other Expense.
Sometimes a company may receive more number of applications than the shares actually offered for subscription. This is called Over Subscription. In such a situation, the company may choose a few applicants while rejecting the others fully. However, this selection is not justifiable. In such a case, the company may issue shares on a pro- rata basis where the all the investors applying for shares get a certain percentage of their applications actually accepted. For example, if the company offered 100,00,000 shares of ₹10 each but applications for 2,00,00,000 shares were received by company, the directors might send letters of regret to applicants of 50,00,000 shares and applicants of 150,00,000 shares were allotted the 100,00,000 shares on pro-rata basis. In such a case, application money of 50,00,000 shares will be adjusted either on allotment and on calls, if there is still surplus money after adjusting the allotment and call money due from shareholders, it will be refunded in cash.
Illustration 11
On 1st May 2021 Superman Ltd. issued 5,000 Equity Shares of ₹100 each payable as follows:
| ₹ | ₹ | |||
| On application | 20 | On 1st Call | 20 | (Last date fixed for payment 31st July) |
| On allotment | 30 | On Final Call | 30 | (Last date fixed for payment 30th August) |
Applications were received on 15th May 2021 for 6,000 shares and allotment was made on 1st June 2021. Applicants for 2,500 shares were allotted in full, those for 3,000 shares were allotted 2,500 shares and applications for 500 shares were rejected.
Balance of amount due on allotment was received on 15th June.
The calls were duly made on 1st July, 2021 and 1st August 2021 respectively. One shareholder did not pay the 1st Call money on 150 shares which he paid with the final call together with interest at 5% p.a. Another shareholder holding 100 shares did not pay the final call money till end of the accounting year which ends on 31st October.
Required: Show the Cash Book and Journal Entries.
Solution:
1.2 Forfeiture and Re-issue of Shares
Where issue proceeds on shares are collected in instalments, the shareholders are expected to pay the amount of allotment and subsequent call money as and when they become due. However, if the shareholder fails to pay the same, it results in calls-in-arrear. If the Articles of the company so permit, the company may confiscate the shares on the ground of non-payment of instalments. This is known as Forfeiture of Shares. On forfeiture, however, the amount received on shares till such date is not returnable and the same becomes a capital receipt for the company and transferred to Forfeited Shares A/c.
The shares so forfeited may again be re-issued by the company afresh to new shareholders. This process is called Re-issue of Forfeited Shares. These shares are generally re-issued at a price lower than the face value of shares. However, the minimum re-issue price must be equal to called up value less amount collected (capital portion) on each share before forfeiture. The resulting loss is adjusted against Forfeited Shares A/c. the balance of the Forfeited Shares A/c, representing the net profit on forfeiture and re-issue of shares, is transferred to Capital Reserve A/c.
In case the shares are re-issued at a price higher than the face value, the excess amount is not payable to the original shareholders. It is to be transferred to ‘Securities Premium A/c’. For shares forfeited but not yet re-issued, the balance of Forfeited Shares A/c should be shown under the head Share Capital in the Balance Sheet.
The accounting entries for forfeiture and re-issue are as follows:
i. On forfeiture of shares
Share Capital A/c........................................ Dr. (Called-up value)
Securities Premium A/c................................ Dr. (Premium due but not collected)
To Calls-in-Arrear A/c (Amount unpaid)
To Forfeited Shares A/c (Capital portion received on shares forfeited)
ii. On re-issue of shares
Bank A/c.......................................... Dr. (Proceeds from re-issue)
Forfeited Shares A/c............................. Dr. (Discount on re-issue)
To Share Capital A/c (Paid-up value of shares re-issued)
To Securities Premium A/c (Premium on shares re-issued, if any)
iii. On transfer of profit
Forfeited Shares A/c (Net profit on forfeiture and re-issue)
To Capital Reserve A/c
The net profit on forfeiture and re-issue of shares can be calculated as shown in the following statement.
| Profit on forfeiture { (Total profit on forfeiture of shares / No. of Shares Forfeited) x No. of Shares reissued | *** |
| Less: Discount on re-issue | *** |
| Net profit to be transferred to Capital Reserve | *** |
Consider the following illustrations
Illustration 12
ICC Ltd. forfeited 500 equity shares of ₹10 each fully called up which were issued at a premium 20%. Amount payable on shares were: on application ₹2; on allotment ₹5; on first and final call ₹5. Only application money was paid by the shareholders in respect of these shares. 300 shares out of the above were reissued at ₹9 per share fully paid. Pass journal entries for the forfeiture and re-issue.
Solution:
Illustration 13
Priyanka Industries Ltd. has an authorised capital ₹2,00,000 divided into shares of ₹100 each. Of these, 600 shares were issued as fully paid for payment of machinery purchased from Z Ltd. 800 shares were subscribed for by the public and during the first year ₹50 per share was called up payable ₹20 on application, ₹10 on allotment, ₹10 on the first call and ₹10 on second call.
The amounts received in respect of these shares were as follows:-
On 600 Shares Full amount called up
On 125 Shares ₹ 40 Per Share
On 50 Shares ₹ 30 Per Share
On 25 Shares ₹ 20 Per Share
The directors forfeited the 75 shares, on which less than ₹ 40 per share had been paid.
Required: Give Journal Entries recording the above transactions (including cash transactions) and show how Share Capital would appear in the Balance-Sheet of the Company, in accordance with Part 1 of Schedule III to the Companies Act.
Solution:
Illustration 14
SOS Limited issued a prospectus inviting applications for 6,000 shares of ₹10 each at a premium of ₹2 per share, payable as follows;
On application ₹2 per share; On allotment ₹5 per share (including premium): On 1st call ₹3 per share; On Second and Final Call ₹2 per share.,
Applications were receive for 9,000 shares and allotment was made prorate to the applicants of 7,500 shares, the remaining applicants were refused allotment. Money overpaid on applications were applied towards sums due on allotment.
D to whom 100 shares were allotted, failed to pay the allotment money and on his subsequent failure to pay the first call, his shares were forfeited. Z, the holder of 200 shares, failed to pay both the calls, and his shares were forfeited after the second and final call.
Of the shares forfeited 200 shares were sold to C credited as fully paid up for ₹8.50 per share, the whole of D’s shares being included.
Solution:
Illustration 15
Alpha Ltd issued a prospectus inviting applications for 2,000 shares of ₹10 each at a premium of ₹2 per share, payable as follows:
On Application ₹ 2, On Allotment ₹ 5 (including premium)
On First Call ₹ 3, On Second & Final Call ₹ 2
Applications were received for 3,000 shares and pro rata allotment was made on the applications for 2,400 shares. It was decided to utilise excess application money towards the amount due on allotment.
Mohit, to whom 40 shares allotted, failed to pay the allotment money and on his subsequent failure to pay the first call, his shares were forfeited.
Jagat, the holder of 60 shares failed to pay the two calls and on his such failure, his shares were forfeited. Of the shares forfeited, 80 shares were sold to Rishav credited as fully paid for ₹ 9 per share, the whole of Mohit’s shares being included.
Required: Give Journal Entries to record the above transactions (including cash transactions)
Solution:
Hero Limited issued 10,000 equity shares of ₹100 each at premium of ₹25 per share. Under the terms of the
isue, the shares were to be paid for as follows:
| 2015 January 1, on application (including ₹ 25 premium on issue per share) | 50 |
| February 1, on allotment | 50 |
| April 1, balance of | 25 |
The issue was oversubscribed. The applications received are summarised below:
| A | B | C | |
| Number of applicants in categories | 40 | 20 | 1 |
| Applied for by each applicant in the three categories | 200 | 2000 | 8000 |
| Issued to each applicant | 100 | 200 | 2000 |
One of the conditions of the issue was that amounts over-paid on application were to be retained by the company and used in reduction of further sums due on shares allotted. All surplus contributions were refunded on 1st February, 2014.
Ramesh who had subscribed 100 on an application for 200 shares was unable to meet the claim due on April 1. On May 5, the directors forfeited his shares. All other shareholders paid the sums requested on the due dates. On June 10, 2014 the directors re-issued the forfeited shares as fully paid to Mohan, on receiving a payment of ₹10,500.
To prepare a statement as on February 1, 2014, showing the over-payment, under-payment to in respect of category of applicants: and
To show how the above transactions would appear in the journal of the company.
Solution:
Illustration 17
JK Ltd is a company with an authorized capital of ₹10 lacs in equity shares of ₹10 each, of which 600000 shares had been issued and fully paid on 30th June, 2020. The company proposed to make a further issue of 100000 of these ₹ 10 shares at a price of ₹14 each the arrangements for payment being:
₹ 2 per share payable on application, to be received by 1st July 2020.
Allotment to be made on 10th July and a further ₹5 per shares (including the premium) to be payable.
The final call for the balance to be made, and the money received by 31st January 2021.
Applications were received for 355000 shares and were dealt with as follows:
Applicants for 5000 shares received allotment in full.
Applicants for 30000 shares received an allotment of one share for every 2 applied for, no money was returned to the applicant, the surplus on application being used to reduce the amount due on allotment.
Applicants for 320000 shares received an allotment of one share for every four applied for, the money due on allotment was retained by the company, the excess being returned to the applicant. The money due on final call was received on the due date.
You are required to record these transactions in the journal of JK Limited.
Solution:
Illustration 18:
A Company invited the public to subscribe for 100,00,000 Equity Shares of ₹100 each at a premium of ₹10 per share payable on allotment. Payments were to be made as follows: On application ₹20; on allotment ₹40; on first call ₹30 and on final call ₹20.
Applications were received for 130,00,000 shares; applications for 20,00,000 shares were rejected and allotment was made proportionately to the remaining applicants. Both the calls were made and all the moneys were received except the final call on 3,00,000 shares which are forfeited after due notice. Later 2,00,000 of the forfeited shares were re-issued as fully paid at ₹85 per share. Pass Journal entries.
Solution:
Illustration 19
Give journal entries for the following:
Solution:
Illustration 20:
X Ltd. issued 10,000 Equity shares of ₹10 each at a premium of ₹2 per share, payable : ₹3 on application (including premium of ₹1); ₹4 on allotment (including the balance of premium) and the balance in a call. Public subscribed for 12,000 shares. Excess application money was refunded. One shareholder Mr. A holding 50 shares paid the call money along with allotment. Another Mr. B failed to pay allotment & call on 30 shares.
These shares were forfeited after the call and 25 of those were reissued at ₹9 each. Pass Journals Entries.
Solution:
Illustration 21:
JB Ltd. issued 60000 equity shares of ₹10 each at a premium of ₹2.50 per share. The amount payable on application is ₹ 4.50 (including premium). The amount payable on allotment was fixed at ₹ 4 per share and an equivalent sum was due on a call to be made.
Total applications received were for 110000 shares and after consulting the stock exchange, the following scheme for allotment was decided upon:
| Category | A | B | C |
| Grouping of shares | 1 to 100 | 101 to 500 | Over 500 |
| No of applications received | 1200 | 175 | 5 |
| No of shares applied for | 70000 | 35000 | 5000 |
| No of shares allotted | 42000 | 14000 | 4000 |
It was decided that the excess amount received on applications would be utilised in payment of allotment money and surplus if any would be refunded to the applicant. Sanjay who was one of the applicants belonging to category A and had applied for 100 shares defaulted in payment of allotment money. Vivek, who belonged to category c, and who had been allotted 800 shares failed to pay the call money. Their shares were forfeited, after the respective calls were made and re-issued as fully paid up for ₹8 and ₹6 per share respectively. Show the necessary journal entries in the books of the company to record the above transactions.
Solution:
1.3 Follow-on public offer (FPO) and Right Issue
An issuance of stock following a company’s Initial Public Offer is called a Follow-on Public Offer. A company opts for the FPO route when it wishes to raise additional capital from the shareholders and new investors. An FPO is essentially a stock issue of supplementary shares made by a company that is already publicly listed and has gone through the IPO process.
FPOs are popular methods for companies to raise additional equity capital in the capital markets through a stock issue. Public companies can also take advantage of an FPO issuing an offer for sale to investors, which is made through an offer document. FPOs should not be confused with IPOs, as IPOs are the initial public offering of equity to the public while FPOs are supplementary issues made after a company has been established on an exchange.
FPO is when an already listed company makes either a fresh issue of securities to the public or an offer for sale to the public, through an offer document. An offer for sale in such scenario is allowed only if it is made to satisfy listing or continuous listing obligations.
A follow-on offering (often but incorrectly called secondary offering) is an issuance of stock subsequent to the company’s initial public offering. A follow-on offering can be either of two types (or a mixture of both): dilutive and non-dilutive. A secondary offering is an offering of securities by a shareholder of the company (as opposed to the company itself, which is a primary offering). A follow-on offering is preceded by release of prospectus similar to IPO. For example, Google’s initial public offering (IPO) included both a primary offering (issuance of Google stock by Google) and a secondary offering (sale of Google stock held by shareholders, including the founders).
Difference between Initial Public Offer and Follow on Public Offer
The term ‘rights issue’ has not been defined in the Companies Act, 2013. As per Regulation 2(1) (zg) of SEBI (Issue of Capital and Disclosure Requirements), 2009, “rights issue” means an offer of specified securities by a listed issuer to the shareholders of the issuer as on the record date fixed for the said purpose. The provisions relating to issue of rights shares are, however, covered in Section 62(1)(a) of the Companies Act, 2013.
Accordingly, where at any time, a company having a share capital proposes to increase its subscribed capital by the issue of further shares, such shares shall be offered to persons who, at the date of the offer, are holders of equity shares of the company in proportion, as nearly as circumstances admit, to the paid-up share capital on those shares by sending a letter of offer.
Such issue of shares shall be done subject to the following conditions:
Usually, a company offers rights issue at a price which is lower than the market price of the shares so that existing (i.e., old) shareholders may get the monetary benefit of being associated with the company for a long time. Existing shareholders who have been offered right shares and do not want to purchase these offered shares may renounce their right shares in favour of some other persons within the specified period as mentioned earlier. In such a case, the existing shareholders can make a profit by selling his right to such other person. This right can be valued in terms of money as below:
The accounting entries for issue of rights shares will be as follows:
i. On receipt of application money
Bank A/c.......................................................... Dr.
To Share Application A/c
ii. On allotment of shares
Share Application A/c........................................ Dr.
To Share Capital A/c (Face Value x no. of shares allotted)
To Securities Premium A/c (Premium x no. of shares allotted)
Consider the following illustrations
Illustration 22
A Company is planning to raise funds by making rights issue of equity shares to finance its expansion. The existing equity share capital of the company is ₹50,00,000. The market value of its share is ₹42. The company offers to its shareholders the right to buy 2 shares at ₹11 each for every 5 shares held. You are required to calculate:
Solution:
Illustration 23
NT Limited has an issued capital of 20000 equity shares of ₹10 each fully called up.
The following decisions are taken by the company:
To forfeit 100 shares on which ₹5 per share has been paid up and to be issue at ₹15 per share as fully paid up. To issue right shares in the ratio of 1 fully paid up shares for every 4 existing shares held, at ₹ 15 per share. Assuming that the company has sufficient to general reserve, the above through journal entries.
Solution:
1.4 Bonus Issue of Shares
Bonus shares are shares which are issued by a company free of cost to its existing members on a pro-rata basis. Established companies that have already built-up reserves sometimes decides to capitalize a part of these reserves by issuing bonus shares to existing shareholders, without requiring the shareholders to pay any consideration.
Since bonus shares requires capitalization of reserves, it leads to decrease in Reserve & Surplus and increase in the issued capital but does not bring any change in cash flow and net worth.
As per Section 63 of the Companies Act, 2013, provisions relating to bonus issue are as follows:
1. A company may issue fully paid-up bonus shares to its members, in any manner whatsoever, out of —
Provided that no issue of bonus shares shall be made by capitalising reserves created by the revaluation of assets.
2. No company shall capitalise its profits or reserves for the purpose of issuing fully paid-up bonus shares under sub-section (1), unless—
3. The bonus shares shall not be issued in lieu of dividend.
A listed company proposing to issue bonus shares shall comply with the following requirements:
As per Sec 2(43) of the Companies Act, 2013, “Free Reserves” mean such reserves which, as per the latest audited balance sheet of a company, are available for distribution as dividend.
Thus, the following are excluded from free reserves:
A company may utilize its reserves to convert its partly paid shares into fully paid without asking the shareholders to contribute further against the call money due. This may be termed as bonus dividend.
Unlike issue of fully paid bonus shares, the sources for bonus dividend shall be, however, free reserves only as Section 52 of Companies Act, 2013 allows utilization of ‘Securities Premium’ for issuing fully paid bonus shares only. Similarly, Section 55(4) of the Act prohibits the use of ‘Capital Redemption Reserve’ for purposes other than issue of fully paid-up bonus shares.
Note: Capital Reserve realized in cash can be a source of bonus dividend as well as issue of fully paid-up bonus shares.
The accounting entries for issue of rights shares will be as follows
a. Conversion of partly paid-up share to fully paid-up shares by bonus dividend
i. On declaration of bonus
Free Reserves A/c.................................... Dr.
To Bonus to Shareholders A/c
ii. On making final call
Share Final Call A/c............................. Dr.
To Share Capital A/c
iii. On adjustment of final call
Bonus to Shareholders A/c.................... Dr.
To Share Final Call A/c
b. Issue of fully paid-up bonus shares
i. On declaration of bonus
Capital Redemption Reserves A/c................................... Dr.
Securities Premium A/c........................................................ Dr.
Free Reserves A/c................................................................. Dr.
To Bonus to Shareholders A/c
ii. On issue of fully paid-up bonus shares
Bonus to Shareholders A/c.................... Dr.
To Share Capital A/c
To Securities Premium A/c (if any) Consider the following illustrations.
Illustration 24
Following items appear in the Trial Balance of M Ltd. as at 31st March, 2021:
| Particulars | (₹) |
| 60,000 Equity Shares of ₹ 10 each | 6,00,000 |
| Capital Redemption Reserve | 45,000 |
| Plant Revaluation Reserve | 15,000 |
| Securities Premium Account | 52,000 |
| General Reserve | 1,50,000 |
| Profit & Loss Account | 75,000 |
| Capital Reserve (including ₹ 37,500 being Profit on Sale of Machinery) | 1,12,500 |
The company decided to issue bonus shares to its shareholders at the rate of one share for every four shares held.
Required: Pass the necessary journal entries. It is desired that there should be minimum reduction in free reserves.
Solution:
Illustration 25
Following is the extract of the Balance Sheet of YY Ltd. as at 31st March, 2021:
| ₹ | |
| Authorised Capital | |
| 15,000 12% Preference shares of ₹10 each | 1,50,000 |
| 1,50,000 Equity shares of ₹10 each | 15,00,000 |
| 16,50,000 | |
| Issued and Subscribed Capital: | |
| 12,000 12% Preference Shares of ₹10 each fully paid | 1,20,000 |
| 1,35,000 Equity shares of ₹ 10 each, ₹ 8 paid up | 10,80,000 |
| Reserves and Surplus: | |
| Capital Redemption Reserve | 30,000 |
| General Reserve | 1,80,000 |
| Capital Reserve | 1,12,500 |
| Securities Premium | 37,500 |
| Profit and Loss Account | 2,70,000 |
| Secured Loans: | |
| 12% Partly Convertible Debentures @ ₹100 each | 7,50,000 |
On 1st April, 2021 the Company has made final call @ 2 each on 1,35,000 equity shares. The call money was received by 20th April, 2021. Thereafter the company decided to capitalise its reserves by way of bonus at the rate of one share for every four shares held. Securities premium of ₹37,500 includes a premium of ₹7,500 for shares issued to vendors pursuant to a scheme of amalgamation. Capital reserves include ₹60,0000, being profit on sales of plant and machinery. 20% of 12% Debentures are convertible into equity shares of ₹10 each fully paid on 1st June 2021.
Required: Show necessary entries in the books of the company and prepare the extract of the Balance Sheet immediately after bonus issue but before conversion of debentures. Are the convertible debenture holders entitled to bonus shares?
Solution:
Illustration 26
The following is the balance sheet of RR Company Ltd as on 31.12.2021
| Liabilities: | ₹ |
| Issued and paid up capital: 225000 equity shares of ₹10 each fully called up | 22,50,000 |
| Less: Calls in arrear (25000 shares of ₹2 each) | 50,000 |
| 100000 equity shares of ₹10 each, ₹4 paid up | 4,00,000 |
| P/L A/c | 12,50,000 |
| Dividend Equalization Reserve | 1,00,000 |
| General Reserve | 1,50,000 |
| Development Rebate reserve | 2,50,000 |
| Capital reserve | 1,50,000 |
| Securities premium | 2,50,000 |
| Capital redemption reserve | 4,00,000 |
| Current liability | 10,00,000 |
| Total | 61,50,000 |
| Assets: | (₹) |
| Non current assets | |
| Fixed assets | 30,00,000 |
| Current assets | 10,00,000 |
| Cash at bank | 21,50,000 |
| Total | 61,50,000 |
The board of directors of the company took the following decisions.
Note:
Pass necessary journal entries in the books of the company including cash transaction after the above decisions are implemented.
Solution:
Illustration 27
MG Limited was registered on 1st January 2021 with an authorised capital of ₹3,00,000 divided into 30000 equity shares of ₹10 each. During the next 12 months to 31st November 2021 following events occurred which related to the share capital of the company.
On 1st January 2021 the company offered for subscription of 10,000 equity shares at a price of rupees 19 each, to be paid as follows:
At the date of issue including premium ₹10
On allotment ₹4
On first and final call ₹5
On 30th June 2021 the company made right issue on 1 for 2 basis at ₹ 22.50 per share, payable in full on 10th July 2021.
Only 80% of the issue was subscribed for by the shareholders with a payment being made on the due date.
On 30th November 2021 Company decided to make a bonus issue of shares at par by utilising the entire balance of securities premium account.
Prepare the equity share capital account and the securities premium account of the company for the year ended 31st December 2021.
A share holder who had subscribed initially for 140 shares had subsequently taken up 80% of the right issue and then received the bonus shares to which he was entitled.
Calculate the ultimate number of shares owned by him and the total price paid by him for those shares.
Solution:
1.5 Issue of Sweat Equity Shares
When a company issues shares to its employees or directors for providing knowhow, intellectual properties etc., such an issue of shares is termed as issue of sweat equity shares.
As per Section 2(88) of the Companies Cat, 2013, “sweat equity shares” means such equity shares as are issued by a company to its Directors or employees at a discount or for consideration, other than cash, for providing their know-how or making available rights in the nature of intellectual property rights or value additions, by whatever name called.
The provisions relating to issue of sweat equity shares are covered under Section 54 of the Companies Act, 2013 and Rule 8 of the Companies (Share Capital and Debentures) rules, 2014.
Section 54 of the Act states that –
1. Notwithstanding anything contained in section 53, a company may issue sweat equity shares of a class of shares already issued, if the following conditions are fulfilled, namely: —
2. The rights, limitations, restrictions and provisions as are for the time being applicable to equity shares shall be applicable to the sweat equity shares issued under this section and the holders of such shares shall rank pari passu with other equity shareholders.
Rule 8 of the Companies (Share Capital and Debentures) Rules, 2014 further states that –
In addition to the above, SEBI (Share Based Employee Benefits and Sweat Equity) Regulations, 2021 provides the terms of conditions for issue of sweat equity shares by listed companies.
I. Issue of sweat equity shares for cash consideration at a discount
When sweat equity shares are issued for cash consideration at a discount, the difference between cash consideration and nominal value of sweat equity shares shall be considered as the value of intellectual property provided by the employee or director. The accounting entry shall be as follows:
Bank A/c............................... Dr.
Intellectual Property A/c ……Dr.
To Equity Share Capital A/c
Note: The details of issue of sweat equity shares shall be disclosed in the Notes to Balance Sheet on Equity Share Capital.
II. Issue of sweat equity shares for consideration other than cash
According to Rule 8(9) of Companies (Share Capital and Debentures) rules, 2014 –
Where sweat equity shares are issued for a non-cash consideration, such non-cash consideration shall be treated in the following manner in the books of account of the company-
Accordingly, the accounting entries for issue of sweat equity shares for consideration other than cash will be as follows:
i. Sweat equity shares issued in pursuant to acquisition of an asset
Intellectual Property A/c................................................................ Dr. (Value of asset)
Employee/Director’s Compensation Expenses A/c................. Dr. (Difference)
To Equity Share Capital A/c
ii. Sweat equity shares issued not in pursuant to acquisition of an asset
Employee/Director’s Compensation Expenses A/c................. Dr.
To Equity Share Capital A/c
Note: Employee/Director’s Compensation Expenses will be included in Employee Benefit Expenses in the Statement of Profit and Loss. The details of issue of sweat equity shares shall be disclosed in the Notes to Balance Sheet on Equity Share Capital.
Illustration 28
Show the accounting entries for the following.
Solution:
1.6 Employee Stock Option plan (ESOP) and Employee Stock Purchase plan (ESPP)
Now-a-days established companies, in order to retain quality human resources in the organisation, offer innovative compensation strategies to their employees including directors. One of such categories of innovative strategies involve paying compensation the value which is based on the value of the company’s stock (i.e., bundle of shares). This category of compensation scheme is popularly known as Stock Based Employee Benefit Scheme/Plan. The most common form of Stock Based Employee Benefit Scheme/Plans are (a) Employee Stock Option Plan/ Scheme (ESOP/ESOS) and (b) Employee Stock Purchase Plan/ Scheme (ESPP/ESPS).
I. Employee Stock Option Plan/ Scheme (ESOP/ESOS)
As per section 2(37) of the Companies Act, 2013, “employees’ stock option” means the option given to the Directors, officers or employees of a company or of its holding company or subsidiary company or companies, if any, which gives such Directors, officers or employees, the benefit or right to purchase, or to subscribe for, the shares of the company at a future date at a pre-determined price.
The general features of ESOP are as follows:
The sequential steps under an ESOP are depicted in the follwoing diagram:
As explained in the above diagram, a company initially grants the eligible employees the option to buy a stated number of shares/stocks for a pre-determined price at a future date. After granting the options are vested over a period of time or once the specific performance goal is achieved. If all the conditions are satisfied, the options are fully vested and the employee becomes eligible to exercise the option. Otherwise, the unvested options are cancelled at once. The employees get a maximum period for exercising the option. This is known as the exercise period. If the employee exercise ethe option, he or she get the share/stock at the predetermined price even if the actual market is much higher on such date of exercise. If the employee does not exercise the option, it is lapsed.
The statutory provisions relating to ESOP are governed by Section 62(1)(b) of the Companies Act, 2013 and Rule 12 of the Companies (Share Capital and Debentures) Rules, 2014.
According to Section 62(1)(b) of the Companies Act, 2013, any company having a share capital may proposes to increase its subscribed capital by the issue of further shares to employees under a scheme of employees’ stock option, subject to special resolution passed by company and subject to such conditions as may be prescribed.
In addition, Rule 12 of the Companies (Share Capital and Debentures) Rules, 2014 provides the terms and
conditions subject to which an unlisted company can issue shares to its employees under ESOP.
Additionally, SEBI (Share Based Employee Benefits and Sweat Equity) Regulations, 2021 provides terms and conditions for a number of share-based employee benefit schemes including ESOP and ESPP and also for issue of sweat equity shares by listed companies.
The accounting for ESOP (and also for ESPP discussed later in this Module) is guided by the Guidance Note on Accounting for Employee Share-based Payments issued by The Institute of Chartered Accountants of India.
The accounting entries at various stages of implementing the ESOP are as follows:
| Stage | Accounting Entries |
| a. Granting of Stock Option | At this stage no accounting entry is required |
| At the end of every year the company will estimate the number of | |
| options to be granted to the employees. | |
| b. Recognition of ESOP Expense | On recognition of Stock Option Expenses |
| This further involves the follwoing steps: | Employee Stock Option Expenses A/c ……Dr. |
| i. Determination of Intrinsic Value | To Employee Stock Option Outstanding A/c |
| Intrinsic Value = Market price per share - Exercise price per share | |
| ii. Determination of Gross value of employee compensation expenses | On transfer at the end of the period |
| GV = No. of options expected to vest x Intrinsic value | Profit and Loss A/c ....................................... Dr. |
| x (Expired Period / Test vesting Period) | To Employee Stock Option Expenses A/c |
| iii. Determine expenses to be recognized | |
| Expenses to be recognized = GV - of Cummulative expenses | |
| recognized up to earlier accounting period | |
| c. Calcellation of options during the vesting period | If cumulative expenses recognized up to earlier |
| accounting period < GV | |
| No Journal Entry is required | |
| If cumulative expenses recognized up to earlier | |
| accounting period < GV | |
| Employee Stock Option Outstanding A/c …Dr. | |
| To Employee Stock Option Expenses A/c | |
| ------------------- | |
| Employee Stock Option Expenses A/c…Dr. | |
| To Profit and Loss A/c | |
| d. Exercising of Stock Option | Bank A/c ..............................Dr |
| To Employee Stock Option Outstanding A/c | |
| ------------ | |
| Employee Stock Option Outstanding A/c …Dr. | |
| To Equity Share Capital A/c | |
| To Securities Premium A/c | |
| e. Lapse of unexercised option | Employee Stock Option Outstanding A/c …Dr. |
| To General Reserve A/c |
Note:
Consider the following Illustrations.
Illustration 29
ABC Ltd., a listed company, granted 2,000 options on 01.04.2019 at an exercise price of ₹50 per share. The market price at that time was of ₹100 per option (face value of each share being ₹10). The maximum exercise period and the vesting period are 1 year and 2 years respectively. On 01.04.2020, 600 unvested options were lapsed while 1,200 options were exercised on 30.06.2021. The remaining options were lapsed at the end of the exercise period. Show the journal entries to record the above transactions.
Solution:
Illustration 30
K Ltd. granted option for 16,000 equity shares on 01.10.16 at ₹80 when the market price was ₹170. the vesting period is 4 ½ years. 8,000 unvested options lapsed on 01.12.2021. 6,000 options are exercised on 30.09.21 and 2,000 vested options lapsed at the end of the exercise period. Pass journal entries to record the above transactions.
Solution:
II. Employee Stock Purchase Plan/ Scheme (ESPP/ESPS)
Employee Stock Purchase Scheme (ESPS) refers to a scheme under which the company offers shares to employees as part of a public issue or otherwise.
The fair value of ESPP shall be treated as a form of employee compensation in the financial statements of the company.
The fair value of ESPP = No. of shares to be issued under ESPP x (Fair value per share – issue price)
The accounting entries will be as follows:
i. For shares purchased under ESPP
Bank A/c........................................................................ Dr.
Employee Compensation Expense A/c.......................... Dr.
To Equity Share Capital Account
To Securities Premium Account
ii. For transfer of the balance Employee Compensation Expense A/c
Profit and Loss A/c................................................... Dr.
To Employee Compensation Expense A/c
Note:
Illustration 31
Y Ltd issued 2,000 shares on 1st April, 2021 under ESPP at ₹50 when the market price was ₹150 (face value being ₹10).
Pass necessary journal entries to record the above transactions.
Solution:
Illustration 32
On 1st April, 2019, X Ltd. offered 200 shares to each of its 400 employees at ₹25 per share. The employees are given a month to accept the shares. The shares issued under the plan shall be subject to lock-in to transfer for three years from the grant date, i.e., 30th April, 2019. The market price of shares of the company on the grant date is ₹30 per share. Due to post-vesting restrictions on transfer, the fair value of shares issued under the plan is estimated at ₹28 per share.
Up to 30th April, 2019, 50% of employees accepted the offer and paid ₹25 per share purchased. Nominal value of each share is ₹10. Record the issue of shares in the books of the company under the aforesaid plan.
Solution:
1.7 Buy-back of Equity Shares
In case of companies, equity shares represent the share of ownership of net worth and hence are supposed to be perpetual. However, over time this basic feature of equity shares has also been changed. Companies, across the globe are now allowed to return back the equity shares subject to certain conditions specified in the relevant statutes. This process is known as buy-back of equity shares. Technically, it is a means of capital restructuring.
A company generally undertakes buy-back of equity shares for varied reasons. Following are a few important reasons for adopting a buy-back strategy.
A company may buy-back its equity shares at par or at a premium or even at a discount. However, in most of the cases, buy-backs are found to be made at premium. Hence, in such cases, buy-back involves ‘payment of capital’ as well as ‘payment of premium’.
The regulatory framework of buy-back is provided by following three sources:
Section 67 of the Companies Act, 2013 states that no company limited by shares or by guarantee and having a share capital shall have power to buy its own shares unless the consequent reduction of share capital is effected under the provisions of this Act.
As per Section 68 of the Act,
a. a company may purchase its own shares or other specified securities hereinafter referred to as buy-back) out of—
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.
b. The buyback must be authorised by its articles.
c. A special resolution must be passed at a general meeting of the company authorising the buy-back unless –
d. The buy-back should be twenty-five per cent. or less of the aggregate of paid-up capital and free reserves of the Moreover, buy-back of equity shares in any financial year, shall not be more than twenty- five per cent. of the total paid-up equity capital.
e. The ratio of the aggregate of secured and unsecured debts owed by the company after buy-back is shall not be more than twice the paid-up capital and its free reserves.
f. All the shares or other specified securities for buy-back must be fully paid-up.
g. The buy-back of the shares or other specified securities listed on any recognized stock exchange should be done in accordance with the regulations made by the Securities and Exchange Board in this
h. The buy-back in respect of shares or other specified securities other than those specified shall be made in accordance with such rules as may be prescribed.
i. No offer of buy-back under section 68(2) shall be made within a period of one year reckoned from the date of the closure of the preceding offer of buy-back, if any.
j. Every buy-back shall be completed within a period of one year from the date of passing of the special resolution, or as the case may be, the resolution passed by the Board.
k. The buy-back under section 68(1) may be made -
l. Before making such buy-back, the company needs to file with the Registrar and the Securities and Exchange Board, a declaration of solvency signed by at least two Directors of the company. However, unlisted companies need not to file any such declaration to
m. Where a company buys back its own shares or other specified securities, it shall extinguish and physically destroy the shares or securities so bought back within seven days of the last date of completion of buy-back.
n. Where a company completes a buy-back of its shares or other specified securities under section 68, it shall not make a further issue of the same kind of shares or other securities including allotment of new shares under clause (a) of sub-section (1) of section 62 or other specified securities within a period of six months except by way of a 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
o. Where a company buys back its shares or other specified securities under this section, it shall maintain a register of the shares or securities so bought, the consideration paid for the shares or securities bought back, the date of cancellation of shares or securities, the date of extinguishing and physically destroying the shares or securities and such other particulars as may be prescribed.
p. A company shall, after the completion of the buy-back under this section, file with the Registrar and the Securities and Exchange Board a return containing such particulars relating to the buy-back within thirty days of such completion, as may be This is, however, not required for unlisted companies.
As per Section 69 of the Act,
the company to be issued to members of the company as fully paid bonus shares.
Section 70 of the Act further states that –
1. No company shall directly or indirectly purchase its own shares or other specified securities—
Provided that the buy-back is not prohibited, if the default is remedied and a period of three years has lapsed after such default ceased to subsist.
2. No company shall, directly or indirectly, purchase its own shares or other specified securities in case such company has not complied with the provisions of sections 92, 123, 127 and section 129.
Note: A company cannot utilize any borrowed fund for the purpose of buy-back. Such type of buy-backs are called leveraged buy-back which are not allowed in India.
Major provisions of SEBI (Buy-back) Regulations, 2018
1. A company may buy-back its shares or other specified securities by any one of the following methods:
Provided that no offer of buy-back for fifteen per cent or more of the paid-up capital and free reserves of the company shall be made from the open market.
2. The company shall, as and by way of security for performance of its obligations on or before the opening of the offer of re- purchase, deposit in an escrow account such sum as is specified in 10(2)
I. Important Issues relating to accounting of buy-back
a. Sources for payment on buy-back
The sources for payment of capital on buy-back are –
The sources for payment of premium on buy-back are –
Note: ‘Free Reserves’ include Surplus of Statement of Profit and Loss, General Reserve, Reserve Fund, Dividend Equalization Reserve, Capital reserve (if realized) and free portion of Workmen Compensation fund etc. Hence, it does not include Securities Premium, Capital reserve (unrealized), Reevaluation reserve, Capital redemption Reserve and any other statutory reserve.
Note: Companies that do not have adequate reserves may buy-back shares or other specified securities by making fresh issue of shares for this purpose. The fresh issue may be of equity shares or of preference shares. However, buy-back of any kind of shares or other specified securities shall not be made out of the proceeds of an earlier issue of the same kind of shares or same kind of other specified securities.
b. Determination of quantum for buy-back. 68 of Company Act, 2013
The maximum number of shares to be bought back is determined as the least number of shares arrived by performing the following tests:
The tests are discussed below:
The number of shares to be bought-back will be the least of the above three.
II. Accounting Entries for Buy-back
i. Due entry for buy-back
Share Capital A/c............................... Dr.
Premium on Buy-back A/c............... Dr. (if at premium)
To Shareholders A/c
To Gain on Buy-back A/c (if at discount)
ii. Payment made for buy-back
Shareholders A/c..................................... Dr.
To Bank A/c
iii. Provision for premium on buy-back
Securities Premium A/c............ ...................... Dr.
Free Reserves A/c.................................. Dr.
To Premium on Buy-back A/c
iv. Transfer of gain on buy-back (if any)
Gain on Buy-back A/c...................... Dr.
To Capital Reserve A/c
v. Transfer to Capital Redemption Reserve
Securities Premium A/c................................ Dr.
Free Reserves A/c.................................. Dr.
To Capital Redemption Reserve A/c
vi. Expenses on Buy-back
Expenses on Buy-back A/c.................. Dr.
To Bank A/c
viii. Transfer of expense on buy-back
Profit and Loss A/c.......................... Dr.
To Expenses on Buy-back A/c
Consider the following illustrations.
Illustration 33
X Co. Ltd. buys back its own 2,00,000 equity shares of ₹ 10 each at par. The company has sufficient profits otherwise available for dividend besides general reserve. No fresh issue of shares is made for this purpose. The shares are fully paid up.
Journalise the transactions.
Solution:
Illustration 34:
(Where shares are partly paid up)
The BCG Co. Ltd. resolved by a special resolution to buy-back 2,00,000 of its equity shares of the face value of ₹10 each on which ₹8 has been paid up. The general reserve balance of the company stood at ₹50,00,000 and no fresh issue of shares was made.
Journalize the transactions.
Solution:
Illustration 35:
(Where shares are bought-back at a premium)
The share capital of Beta Co. Ltd consists of 1,00,000 equity shares of ₹10 each, and 25,000 preference shares of ₹100 each, fully called up. Its securities premium account shows a balance of ₹40,000 and general reserve of ₹7,00,000. The company decides to buy-back 20,000 equity shares of ₹12 each.
Pass the necessary journal entries.
Solution:
Illustration 36:
(Where shares are bought-back at a discount)
The PTC Co. Ltd. has a share capital of ₹15,00,000, comprising 1,00,000 equity shares of ₹10 each and 50,000 8% preference shares of ₹10 each, both of which fully called up and paid up. The company has sufficient general reserve to its credit to enable it to comply with the legal formalities connected with buy-back of shares. It decides to buy-back 20% of its equity share capital at ₹9 per share. Record the transactions in the books of the company.
Solution:
Illustration 37:
(Fresh issue of shares for purposes of buy-back)
Alpha Co. Ltd. has a paid up equity share capital of ₹20,00,000 in 2,00,000 shares of ₹10 each. It resolved to buy-back 50,000 equity shares at ₹15 per share. For this purpose. it issued 20,000 12% preference shares of
₹10 each, at par, payable along with application. The company has to its credit ₹2,50,000 in securities premium account and ₹10,00,000 in the general reserve account. The company utilized the general reserve. Pass the necessary journal entries.
Solution:
Illustration 38
The following was the balance sheet of Diamond Ltd. as at 31st March, 2021.
| Liabilities | ₹ in lakhs |
| 10% Redeemable Preference Shares of ₹10 each, fully paid up | 2,500 |
| Equity Shares of ₹10 each fully paid up | 8,000 |
| Capital Redemption Reserve | 1,000 |
| Securities Premium | 800 |
| General Reserve | 6,000 |
| Profit and Loss Account | 300 |
| 9% Debentures | 5,000 |
| Sundry creditors | 2,300 |
| Sundry Provisions | 1,000 |
| 26,900 | |
| Assets | |
| Fixed assets | 14,000 |
| Investments | 3,000 |
| Cash at Bank | 1,650 |
| Other Current assets | 8,250 |
| 26,900 |
On 1st April, 2021 the company redeemed all of its preference shares at a premium of 10% and bought back 25% of its equity shares @ ₹15 per share. In order to make cash available, the company sold all the investments for ₹ 3,150 lakh and raised a bank loan amounting to ₹2,000 lakhs on the security of the company’s plant.
Pass journal entries for all the above mentioned transactions including cash transactions and prepare the company’s balance sheet immediately thereafter.
Solution :
Illustration 39:
XYZ Ltd. has the following capital structure on of 31st March 2021.
| Particulars | ₹ in Crores |
| a. Equity Share capital (Shares of ₹ 10 each) | 300 |
| b. Reserves : | |
| General reserve | 270 |
| Security Premium | 100 |
| Profit and Loss A/c | 50 |
| Export Reserve (Statutory reserve) | 80 |
| c. Loan Funds | 800 |
The shareholders have on recommendation of Board of Directors approved vide special resolution at their meeting on 10th April 2021 a proposal to buy back maximum permissible equity shares considering the huge cash surplus following A/c of one of its divisions.
The market price was hovering in the range of ₹25 and in order to induce existing shareholders to offer their shares for buy back, it was decided to offer a price of 20% above market.
Advice the company on maximum number of shares that can be bought back and record journal entries for the same assuming the buy back has been completed in full within the next 3 months.
If borrowed funds were ₹1200 crores, and 1500 crores respectively would your answer change?
Solution:
Solved Case 1 (Buyback of Equity Shares – Determination of Maximum Limit)
R Ltd. wants to buy back 100000 equity shares of ₹10 each at a price of ₹20 each on 01.04.2021. The buy back is allowed in its articles of association and the company has obtained necessary approval from the shareholders. The company has sufficient bank balance to make the payment for buy back of shares.
The following information is available as on 31.03.2021:
| ₹ | |
| Equity Share Capital (₹10 each fully paid) | 50,00,000 |
| General Reserve | 60,00,000 |
| Dividend Equalization Reserve | 10,00,000 |
| Balance of Profit and Loss (Cr.) | 5,00,000 |
| 10% Debentures (₹100 each) | 75,00,000 |
| Bank Loan | 40,00,000 |
| Current Liabilities | 66,00,000 |
You have been appointed as a legal expert to supervise the buyback process. Verify whether the buyback plan of the company meets the conditions specified by the Companies Act 2013 as regards to the maximum amount of buyback.
Solution:
2.1 Redemption of Prefernce Shares
Redeemable preference shares have a fixed term and hence are redeem at the end of such period. On redemption the shareholders are repaid the capital that they had invested in those shares.
The redemption may occur either ‘at par’ or ‘at premium’. When the company repays an amount equal to the face value or nominal value of the preference shares, it is called ‘redemption at par’. On the other hand, when a company repays more than the face value or nominal value of the preference shares, it is known as ‘redemption at premium’. Thus, under redemption at premium, the company makes payment for (a) preference share capital as well as for (b) premium.
The issue and redemption of preference shares are governed by Companies Act, 2013 and Companies (Share
Capital and Debentures) Rules, 2014. Section 55 of the Act states that –
Rule 10 of the Companies (Share Capital and Debentures) Rules, 2014 further states that company engaged in the setting up and dealing with of infrastructural projects may issue preference shares for a period exceeding twenty years but not exceeding thirty years, subject to the redemption of a minimum ten percent of such preference shares per year from the twenty first year onwards or earlier, on proportionate basis, at the option of the preference shareholders.
Moreover, as per Rule 9(6), a company may redeem its preference shares only on the terms on which they were issued or as varied after due approval of preference shareholders under section 48 of the Act and the preference shares may be redeemed:
Section 55(2) of the Companies Act, 2013, provides that –
Provided also that premium, if any, payable on redemption of any preference shares issued on or before the commencement of this Act by any such company shall be provided for out of the profits of the company or out of the company’s securities premium account, before such shares are redeemed.
(ii) in a case not falling under sub-clause (i) above, the premium, if any, payable on redemption shall be provided for out of the profits of the company or out of the company’s securities premium account, before such shares are redeemed.
Note: Deemed Redemption u/s 55(3) - Where a company is not in a position to redeem any preference shares or to pay dividend, if any, on such shares in accordance with the terms of issue (such shares hereinafter referred to as unredeemed preference shares), it may, with the consent of the holders of three-fourths in value of such preference shares and with the approval of the Tribunal on a petition made by it in this behalf, issue further redeemable preference shares equal to the amount due, including the dividend thereon, in respect of the unredeemed preference shares, and on the issue of such further redeemable preference shares, the unredeemed preference shares shall be deemed to have been redeemed:
Based on the above provisions, the following important points can be noted:
1. Only fully paid-up preference shares can be redeemed. Partly paid-up preference shares must be converted into fully paid-up by calling up the remaining instalment(s) before they can be eligible for
2. The repayment of capital portion can be done out of two sources –
3. The premium on redemption, if any, shall be provided as follows:
Note: For the purpose of payment of capital, the term ‘Profits of the Company which would otherwise be available for dividend’ shall mean ‘free reserves’. Hence, Securities Premium, Revaluation Reserve, Capital Reserve (unrealized) or any Statutory Reserve will not be eligible for this purpose. But free portion of Investment Allowance Reserve, Development Rebate Reserve, Workmen Compensation Fund will be allowed.
Note: For the purpose of payment of premium, the term ‘Profits of the Company’ (excluding the expression ‘which would otherwise be available for dividend’) means all profits of the company whether realized or not. Hence, Capital Reserve (whether released or not), all Statutory Reserve (free portion only), free portion of Investment Allowance Reserve, Development Rebate Reserve, Workmen Compensation Fund will be allowed.
d. Companies may also issue fresh equity or preference shares for redemption of existing preference In such a case –
e. A sum equal to the nominal amount of the shares to be redeemed out of profits should be transferred tom Capital Redemption Reserve (CRR). The balance of CRR so created shall only be utilized for issue of fully paid-up bonus shares.
i. On issue of new shares for the purpose of redemption
Bank A/c.................................... Dr.
To Equity Share Application A/c
(Being application money received on ... shares @ ₹..... each)
----------------------------------
Equity Share Application A/c ……Dr.
To Share Capital A/c
To Securities Premium A/c (if new shares are issued at premium)
(Being the issue of... shares of ₹ ...each at a premium of ₹ ...each for the purpose of redemption of preference shares as per Board’s Resolution No ... dated ...)
ii. Redemption due entry
Redeemable Preference Share Capital A/c................. Dr.
Premium on Redemption of Preference Shares A/c …Dr. (if redeemable at premium)
To Preference Shareholders A/c
iii. When payment is made to preference shareholders
Redeemable Preference Shareholders A/c............... Dr.
To Bank A/c
iv. Adjustment of premium on redemption
Profit and Loss A/c........................... Dr.
To Premium on Redemption of Preference Shares A/c
(Being the premium on redemption adjusted against profit and loss balance)
Note: In addition, the company may need to undertake transactions such as ‘sale of investment’ ‘sale of idle assets’ etc. at profit or at loss. The effect of such transaction shall also be taken into consideration while determining the required amount of fresh issue or profits to be transferred to CRR.
Consider the following illustrations.
Illustration 40:
T Ltd. furnishes you with the following Balance Sheet as at 31st March, 2021 : (₹ in Lakhs)
| Equity shares of ₹ 10 each fully paid | 400 | |
| 12% redeemable preference shares of ₹ 100 each fully paid | 200 | |
| Reserves and surplus: | ||
| - Capital reserve | 15 | |
| - Share Premium | 25 | |
| - Revenue reserves | 260 | 300 |
| Funds Employed in: | 900 | |
| Fixed assets less depreciation | 560 | |
| Current assets | ||
| 540 | ||
| Less : Current liabilities | 200 | 340 |
| 900 |
The company redeemed preference shares on 1st April 2021 at a premium of 10%. You are required to pass journal entries to record the above.
Solution :
Illustration 41:
Find out in each case what amount shall be transferred to capital redemption reserve account:
| Redeemable preference shares redeemed | Fresh issue of share capital |
| a. ₹ 10,00,000 at par | ₹ 10,00,000 at par |
| b. ₹ 10,00,000 at 5% premium | ₹ 800,000 at par |
| c. ₹ 10,00,000 at par | ₹ 800,000 at 10% premium |
| d. ₹ 10,00,000 at 5% premium | ₹ 800,000 at 10% premium |
Solution:
Illustration 42:
The Balance Sheet of Pixel Ltd. as on 31.12.2021 is given below:
| Liabilities | ₹ in Lakh | Assets | ₹ in Lakh |
| Share Capital: | Fixed Assets | 140 | |
| 10,00,000 Equity shares of ₹10 each | 100 | Investments | 40 |
| 1,00,000 Redeemable Pref. shares of ₹100 each | 100 | Stock | 46 |
| Less: Call-in-arrears on 20,000 shares | (4) | Debentures | 30 |
| Security premium account | 15 | Bank | 30 |
| Reserve | 30 | ||
| Profit and Loss account | 15 | ||
| Creditors | 30 | ||
| 286 | 286 |
On 1st Jan 2022, fixed assets costing ₹40 Lakh were sold for ₹32 Lakh. It was decided that on 1st Feb 2022, company issued sufficient number of equity shares at par so as to finance redemption and to leaving a balance of ₹10 Lakh in the reserve. All the payments were made except to a holder of 10,000 shares who could not be traced. The company also made bonus issue to the existing equity shareholders in the ratio of 1: 10 as on 31.12.2021. You are required to pass the necessary journal entries.
Solution:
Illustration 43:
The balance sheet of G Ltd as on 31.12.2018
| Liabilities: | (₹) |
| Equity shares of ₹10 each | 2,00,000 |
| Less: Calls in arrear @ ₹ 2 | 10,000 |
| 14% Preference Shares of ₹100 | 1,00,000 |
| Securities Premium | 10,000 |
| Investment Allowance Reserve | 40,000 |
| Development Rebate Reserve | 20,000 |
| Workmen Compensation Fund | 10,000 |
| Dividend Equalization Reserve | 12,000 |
| Profit and Loss Account | 38,000 |
| Unsecured Loans | 80,000 |
| 5,00,000 | |
| Assets | |
| Non Current Assets | 4,00,000 |
| Current Assets(including Bank balance ₹ 10,000) | 1,00,000 |
| 5,00,000 |
The board of directors decided to redeem the preference shares on 1st January 2019 on the following conditions.
Issue 4000 equity shares and ₹50,000 10% debentures.
Redeem preference shares at a premium of 10%.
Raise necessary bank loan to provide funds for redemption and to have ₹15,000 as balance.
Admit claim of ₹40,00 for workmen compensation.
Utilise ₹10,000 out of development rebate reserve for the purpose.
Necessary journal entries assuming that holders of 100 reference shares could not be traced by the company.
Solution:
Illustration 44:
| Books of M Limited show the following balances on 31st December 2020 | ₹ |
| 15000 present equity shares of ₹10 each fully paid | 1,50,000 |
| 2500 10% preference shares of ₹100 each fully paid | 2,50,000 |
| 500 8% redeemable preference shares pop ups ₹108, what is ₹70 paid up | 35,000 |
| General Reserve | 75,000 |
| Profit and Loss Account | 1,60,000 |
| Securities Premium | 15,000 |
| Investment | 1,20,000 |
| Cash at Bank | 39,600 |
On 1st January 2021 the board of directors decided to redeem the preference shares at a premium of 8%. In order to pay of preference shareholders the company also decided to sell the Investments and use companies fund and to raise the balance by issue of sufficient number of equity shares of ₹10 each at a premium of rupee 1 per share subject to leaving a minimum bank balance of ₹9,000 after search Redemption.
Investments web sold at ₹1,08,000
Show the necessary journal entries (without narration) to record the transactions.
Solution:
2.2 Issue and Redemption of Debentures
Share capital is the primary source of finance for every company. However, companies are often found to raise debt capital for additional financing requirement. A company raises the debt capital either through institutional financing i.e., loans from banks and other financial institutions or may issue structured debt instruments (such as debentures and bonds). Debentures happens to be the most popular debt instruments issued by a company to raise borrowed capital.
As per Section 2(30) of the Companies Act, 2013, “debenture” includes debenture stock, bonds or any other instrument of a company evidencing a debt, whether constituting a charge on the assets of the company or not.
Following are the features of debentures as a debt instrument.
The various types of debentures are shown in the following diagram.
a. Redeemable Irredeemable Debentures
Redeemable Debentures are debentures that are repayable by a company at the end of the pre-specified time period. Irredeemable debentures are not repayable during the life-time of the company.
b. Secured Unsecured Debentures
Secured Debentures are those debentures which create a charge on the assets of the company. These are also called Mortgage Debentures. Unsecured debentures are issued without the support of a collateral security. These are also called Naked Debentures.
c. Convertible Non-convertible Debentures
Debentures which are convertible into other securities viz. equity shares, preference shares or new debentures after a specified period are referred to as Convertible Debentures. They may fully convertible or partly convertible. On the other hand, Debentures which are not convertible into any other security are referred to as Non-convertible Debentures.
Note: In all the above cases, the debentures may be issued at par or at premium or at discount to the issue price.
The provisions relating to issue and redemption of debentures are covered by Section 71 of the Companies Act, 2013 and Rule 18 of the Companies (Share Capital and Debentures) Rules, 2014.
Section 71 of the Companies Act, 2013 states that -
1. A company may issue debentures with an option to convert such debentures into shares, either wholly or partly at the time of redemption:
Provided that the issue of debentures with an option to convert such debentures into shares, wholly or partly, shall be approved by a special resolution passed at a general meeting.
2. No company shall issue any debentures carrying any voting
3. Secured debentures may be issued by a company subject to such terms and conditions as may be
4. Where debentures are issued by a company under this section, the company shall create a debenture redemption reserve account out of the profits of the company available for payment of dividend and the amount credited to such account shall not be utilised by the company except for the redemption of
5. No company shall issue a prospectus or make an offer or invitation to the public or to its members exceeding five hundred for the subscription of its debentures, unless the company has, before such issue or offer, appointed one or more debenture trustees and the conditions governing the appointment of such trustees shall be such as may be prescribed.
6. A debenture trustee shall take steps to protect the interests of the debenture-holders and redress their grievances in accordance with such rules as may be prescribed.
7. Any provision contained in a trust deed for securing the issue of debentures, or in any contract with the debenture-holders secured by a trust deed, shall be void in so far as it would have the effect of exempting a trustee thereof from, or indemnifying him against, any liability for breach of trust, where he fails to show the degree of care and due diligence required of him as a trustee, having regard to the provisions of the trust deed conferring on him any power, authority or discretion:
Provided that the liability of the debenture trustee shall be subject to such exemptions as may be agreed upon by a majority of debenture-holders holding not less than three-fourths in value of the total debentures at a meeting held for the purpose.
8. A company shall pay interest and redeem the debentures in accordance with the terms and conditions of their issue.
*9. Where at any time the debenture trustee comes to a conclusion that the assets of the company are insufficient or are likely to become insufficient to discharge the principal amount as and when it becomes due, the debenture trustee may file a petition before the Tribunal and the Tribunal may, after hearing the company and any other person interested in the matter, by order, impose such restrictions on the incurring of any further liabilities by the company as the Tribunal may consider necessary in the interests of the debenture-holders.
*10. Where a company fails to redeem the debentures on the date of their maturity or fails to pay interest on the debentures when it is due, the Tribunal may, on the application of any or all of the debenture-holders, or debenture trustee and, after hearing the parties concerned, direct, by order, the company to redeem the debentures forthwith on payment of principal and interest due thereon.
11. A contract with the company to take up and pay for any debentures of the company may be enforced by a decree for specific performance.
12. The Central Government may prescribe the procedure, for securing the issue of debentures, the form of debenture trust deed, the procedure for the debenture-holders to inspect the trust deed and to obtain copies thereof, quantum of debenture redemption reserve required to be created and such other matters.
Additional conditions2 have been provided by the Companies (Share Capital and Debentures) Rules, 2014.
In addition to the above, SEBI (Issue and Listing of Non-Convertible Securities) Regulations, 2021 also provides important guidelines for debt securities3 to be issued by listed entities.
2.2.1 Accounting for Issue of Debentures - General Cases
Debentures can be issued at par or at premium or at discount. Moreover, the money can be collected in lump- sum or in instalments. The accounting entries for issue of debentures are as follows:
a. Debentures issued in lump sum
i. On receipt of application money
Bank A/c......................................................... Dr.
To Debenture Application A/c
ii. For excess debenture application money refunded
Debenture Application A/c...................................... Dr.
To Bank A/c
iii. On allotment of debentures
Debenture Application A/c........................................ Dr.
Discount on Issue of Debentures A/c....................... Dr. (if issued at discount)
To Debentures A/c
To Securities Premium A/c (if issued at premium)
b. Debentures issued in instalments
i. On receipt of application money
Bank A/c......................................................... Dr.
To Debenture Application A/c
ii. For excess debenture application money refunded
Debenture Application A/c...................................... Dr.
To Bank A/c
iii. For debenture application money transferred to share capital
Debenture Application A/c........................................ Dr.
To Share Capital A/c
iv. For debenture allotment money due
Debenture Allotment A/c............................................. Dr.
Discount on Issue of Debentures A/c....................... Dr. (if issued at discount)
To Debenture Capital A/c
To Securities Premium A/c (if issued at premium)
v. For debenture allotment money received
Bank A/c......................................................... Dr.
To Debenture Allotment A/c
vi. For debenture call money due
Debenture Call A/c............................................... Dr.
To Share Capital A/c
vii. For debenture call money received
Bank A/c.......................................................... Dr.
To Debenture Call A/c
Note: In case of issue of debentures at discount, the Discount will always be accounted in allotment. However, premium will be accounted with the instalment in which it is included. If nothing is mentioned specifically, it is accounted with allotment money.
Note: The premium on issue of debenture is included in Securities Premium A/c and the same is reflected under Reserve and Surplus in the Balance Sheet. The discount on issue of debentures is amortized over the life of the debentures on a proportionate basis. Accordingly, the amount amortized during the year is shown under Depreciation and Amortization in the Statement of Profit and Loss. The remaining amount is shown in the assets section of the Balance Sheet. The portion to be amortized over next 12 months is included in Other Current Assets while the portion that will not be amortized over next 12 months is shown in Other Non-current Assets. (Refer to illustration 58)
Consider the following illustration.
Illustration 45
P Ltd. issued 50,000, 8% Debentures of ₹100 each at a premium of ₹20 payable as follows:
₹30 on application; ₹40 on allotment (including premium); and ₹50 on first and final call.
Applications were received for all the debentures along with the application money and allotment was made Call money was also received on due date. Pass necessary journal entries to record the issue of debentures.
What will be the entries if the entire amount is received on application?
Solution:
2.2.2 Accounting for issue of Debentures - Special Cases
I. When terms of redemption are known and debentures are redeemable at premium
In this case the premium payable on redemption may be provided at the time of issue itself, by passing the following additional entry –
Loss on Issue of debentures A/c…........................... Dr.
To Premium on Redemption of Debentures A/c
Students may pass a combined entry at the time of allotment to record the above. Consider the following alternative situations (other entries remain the same).
| Situation | Combined entry on allotment |
| Issue at par, redemption at premium | Debenture Application A/c Dr. |
| Loss on Issue of debentures A/c… Dr | |
| To Debentures A/c | |
| To Premium on Redemption of Debentures A/c | |
| Issue at premium, redemption at premium | Debenture Application A/c Dr. |
| Loss on Issue of debentures A/c… Dr. | |
| To Debentures A/c | |
| To Securities Premium A/c | |
| To Premium on Redemption of Debentures A/ | |
| Issue at discount, redemption at premium | Debenture Application A/c Dr |
| Loss on Issue of Debentures A/c Dr | |
| To Debentures A/c | |
| To Premium on Redemption of Debentures A/c | |
| Note: Here, Loss on Issue of Debentures A/c includes both discount on issue | |
| of debentures and premium on redemption of debentures |
Consider the following illustration.
Ilustration 46
Journalize the following transactions. Narration is not required:
Issue of 12% 1,00,000 debentures of ₹100 each
Solution:
II. Issue of Debenture for Consideration other than Cash
Debentures may also be issued for consideration other than cash. Examples include allotment of debentures for purchase of asset or for technical services received. The accounting entries in such a case will be as follows:
i. On purchase of assets
Sundry Assets A/c................................ Dr.
To Vendor A/c
ii. On issue of debentures
Vendor A/c............................................ Dr.
Discount on Issue of Debentures A/c....................... Dr. (if issued at discount)
To Debenture Capital A/c
To Securities Premium A/c (if issued at premium) Consider the following illustration.
Illustration 47
Z Ltd. took over the assets of ₹6,00,000 and liabilities of ₹80,000 of C Ltd. for an agreed purchase consideration
of ₹5,40,000 to be satisfied by the issue of 10% Debentures of ₹1,000 each.
Required: Show the necessary journal entries in the books of Z Ltd, assuming that—
Case (a) Such Debentures are issued at par;
Case (b) Such Debentures are issued at 20% premium; and
Case (c) Such Debentures are issued at 10% discount;
Solution:
III. Debentures Issued as Collateral Security
The term ‘collateral’ means additional or secondary. When debentures are issued as additional security against a loan (for which there exists a primary security) it is called issue of debentures as collateral security. This type of issue is generally made when the lender feels that the primary security is inadequate. The borrower company, however, is not required to pay any interest on the debenture which are issued as collateral security. On full repayment of the loan, the debentures issued as collateral security are returned by the lender. However, if the company fails to repay the loan, the lender exercises its right on the debentures issued as collateral security.
Debentures issued as a collateral security can be dealt with in two ways in the books:
a. First Method
No entry is made in the books. On the liability side of the balance sheet below the item of loan a note that it has been secured by the issue of debentures is to be given.
b. Second Method
Sometimes issue of debentures as collateral security is recorded by making a journal entry as follows:
Debenture Suspense A/c......................... Dr.
To Debenture A/c
Note: Debenture Suspense A/c is shown as a deduction from Debenture A/c in the balance sheet. When the loan is paid the above entry is cancelled by means of a reverse entry.
IV. Interest on Debentures
The periodical interest paid on debentures is included in the Finance Cost in the Statement of Profit and Loss as it is a charge against profit. The accounting entries are:
i. On payment of interest
Interest A/c............................... Dr.
To Bank A/c
ii. On issue of debentures
Profit and Loss A/c.............................................. Dr.
To Interest A/c
Note: When the due dates for payment of debenture interest does not match with the accounting period,
the following two concepts emerge:
In the Balance Sheet, both ‘Debenture interest accrued and due’ as well as ‘Debenture interest accrued but not due’ are shown under ‘Other current liabilities’.
Consider the following illustration
Illustration 48
C Ltd. secured a loan of ₹ 8,00,000 from the Axis Bank by issuing 1,000, 12% Debentures of ₹ 1000 each as collateral security.
Required: How will you treat the issue of such debentures?
Solution:
2.2.3 Accounting for Redemption of Debentures
Redemption of debentures refers to the repayment of borrowed capital raised by a company through debentures. The condition of redemption is clearly specified in the prospectus inviting application for the issuance of debentures.
The common sources that may be utilized by the companies for the purpose of redemption of debentures are –
In India, redemption of debenture is guided by Section 71 of the Companies Act, 2013 and Rule 18 of the Companies (Share Capital and Debentures) Rules, 2014 which require mandatory creation of Debenture Redemption Reserve. Hence, the redemption happens to be partly out of profits and partly out of capital.
As per Section 71(4) of the Companies Act, 2013, where debentures are issued by a company under this section, the company shall create a debenture redemption reserve account out of the profits of the company available for payment of dividend and the amount credited to such account shall not be utilized by the company except for the redemption of debentures.
As per Rule 18 of The Companies (Share Capital and Debentures) Rules 2014, the company shall create a Debenture
Redemption Reserve for the purpose of redemption of debentures, in accordance with the conditions given below-
a. the Debenture Redemption Reserve shall be created out of the profits of the company available for payment of dividend;
b. the company shall create Debenture Redemption Reserve (DRR) in accordance with following conditions:
c. every company required to create Debenture Redemption Reserve shall on or before the 30th day of April in each year, invest or deposit, as the case may be, a sum which shall not be less than fifteen percent, of the amount of its debentures maturing during the year ending on the 31st day of March of the next year, in any one or more of the following methods, namely:-(i) in deposits with any scheduled bank, free from any charge or lien; (ii) in unencumbered securities of the Central Government or of any State Government; (iii) in unencumbered securities mentioned in sub-clauses (a) to (d) and (ee) of section 20 of the Indian Trusts Act, 1882; (iv) in unencumbered bonds issued by any other company which is notified under sub-clause (f) of section 20 of the Indian Trusts Act, 1882; (v) the amount invested or deposited as above shall not be used for any purpose other than for redemption of debentures maturing during the year referred above:
Provided that the amount remaining invested or deposited, as the case may be, shall not at any time fall below fifteen per cent of the amount of the debentures maturing during the year ending on the 31st day of March of that year;
d. in case of partly convertible debentures, Debenture Redemption Reserve shall be created in respect of non-convertible portion of debenture issue in accordance with this sub-rule.
e. the amount credited to the Debenture Redemption Reserve shall not be utilized by the company except for the purpose of redemption of debentures.
The above provisions may be summarized in the following points:
Note: It is to be noted that a company only requires to create DRR to the extent of 25% of the nominal value of the debentures. Then, effectively 75% of the nominal value of debentures is redeemed out of capital.
I. Redemption of Debentures in Lump Sum
Here debentures are redeemed at the expiry in one lump-sum. The redemption can be made at par, at premium or at discount. The company, as per the statutory provisions discussed earlier, needs to make statutory transfer to DRR and also to make necessary investment. After redemption DRR A/c should be closed to General Reserve.
The accounting entries are as follows:
| Particulars | Journal Entries | Remarks |
| Before Redemption | ||
| Transfer to DRR | Surplus A/c ..........Dr. | At least 25% of face value of debentures |
| To DRR A/ | issued at any time before expiration | |
| Note: Here Surplus refers to profits under | ||
| Statement of Profit and Loss | ||
| Making Investment | Deb. Red. Investment A/c ………Dr. | At least 15% of the face value debentures to be redeemed. |
| To Bank A/c | The investment has to be made on or before 30th April | |
| of the financial year in which the debentures are redeemed. | ||
| On redemption | ||
| Sale of Investment | Bank A/c ......................Dr. | |
| To Deb. Red. Investment A/c | ||
| Due entry for redemption | Debenture A/c… Dr. | Face Value |
| Premium on Redemption of Debentures | ||
| A/c ..........................Dr. | Premium payable | |
| To Debenture-holders A/c | Total amount payable | |
| Payament entry | Debenture-holders A/c Dr | |
| To Bank A/c | ||
| Transfer of DRR | Debenture-holders A/c Dr | |
| To General Reserve A/c |
Note: When the company maintains a Sinking Fund (for redemption of debentures)
Sometimes companies maintain a Sinking Fund for the purpose of repayment of the liability and invest the amount in readily marketable securities. The fund (called Sinking Fund) is created by annual contribution out of profits. The annual contribution is determined based on Annuity Table. The investment out of the fund is termed as Sinking Fund Investment.
This method is in practice for many years. Section 71(4) of the Companies Act, 2013 has provided a statutory recognition to it.
The accounting process, in this case, is as follows:
| Transaction | Journal Entry | Remarks |
| In the year of Debentures issue | ||
| Annual contribution | Surplus A/c ....Dr | Annual Contributon is calculated with the |
| To Sinking Fund A/c | help of the Annuity Table. | |
| Investment of the amount | Either equal to or less the amount of | |
| contribution. | ||
| In all subsequent years (expected the last year) | ||
| Receipt of Interest on | Interest is earned on the 'Normal (Face) Value' of | |
| Investment | Sinking Fund Investment | |
| Transferring of interest to Sinking Fund | Interest on Sinking Fund Investment A/c ..Dr. | |
| To Sinking Fund A/c | ||
| Providing Annual contribution | Surplus A/c | |
| To Sinking Fund A/c | ||
| Investment of the amount | Sinking Fund Investment A/c | Amount invested in Sinking Fund |
| To Bank A/c | Investment = Annual Contribution + | |
| Interest on Sinking Fund Investment | ||
| In the year of redemption | ||
| Receipt of Interest | This is reinvested as it is the last year. | |
| Annual contribution | The balancing figure to get the required amount | |
| of fund. | ||
| Disposal of Sinking Fund | Bank A/c Dr. | The sale proceeds |
| Investment | To Sinking Fund Investment A/c | |
| Sinking Fund Investment A/c Dr. | Profit on sale | |
| To Sinking Fund A/c | ||
| Bank A/c Dr. | Sale at a loss | |
| Sinking Fund A/c Dr. | ||
| To Sinking Fund Investment A/c | ||
| Due entry of redemption | Debenture A/c… Dr. | |
| Premium on Red. of Debentures A/c Dr | ||
| To Debenture-holders A/c | ||
| Payment entry | Debenture-holders A/c Dr. | |
| To Bank A/c | ||
| Transfering of Sinking Fund balance | To Sinking Fund A/c ....Dr. | Face value of debentures redeemed |
| To General Reserve A/c | ||
Consider the follwoing illustrations.
Illustration 49 (Redemption out of profits)
P Ltd. had issued ₹15,00,000, 10% Debentures which are due to be redeemed out of profits on Nov. 1, 2020 at a premium of 5%. The company had a Debenture Redemption Reserve of ₹6,21,000. It was decided to invest the required amount in Debenture Redemption Investment on 15.4.2020. Pass necessary journal entries for recording the transactions relating to redemption of debentures.
Solution:
Illustration 50 (Redemption of debentures of capital)
A company issued 100,000 15% debentures of ₹ 100 each at par redeemable at a premium of 15%. After 8 years the company served notice of redemption and redeemed all debentures as per the terms of issue. You are required to make entries at the time of issue and at the time of redemption.
Solution:
Illustration 51 (Redemption partly out of profit and partly out of capital)
The Balance Sheet of AB Ltd. as on March 31, 2020 reflected 10,000, 12% Debentures of ₹100 each outstanding. These debentures were due for redemption on July 31, 2021. The company decided to transfer ₹5,00,000 to Debenture Redemption Reserve on March 31, 2021 and invest ₹1,50,000 in fixed deposits with Bank of India on April 8, 2021. The investment was encashed as the debentures were redeemed on due date. Pass journal entries to record the above transactions (Ignore transactions relating to interest on debentures).
Solution:
Illustration 52 (Issue and Redemption at premium, Redemption partly out of profit and partly out of capital)
K Ltd. issued ₹6,00,000,13% Debentures of ₹100 each on April 1, 2017 at a premium of 6% redeemable at a premium of 10% on March 31, 2021. The debentures were redeemed on due date. Assume that the required minimum investment was made by the company in 10% Government Securities on the last due date meant for the purpose of this redemption. Pass journal entries to record the issue and redemption of debentures. (Ignore transactions relating to interest on debentures and writing-off loss on issue of debentures).
Solution:
Illustration 53 (Redemption at lump-sum with Sinking Fund)
On 1st April 2017. H Ltd. issued 442, 10% Debentures of ₹1000 each at a discount of 10% redeemable at a premium of 5% after 4 years. It was decided to create a Sinking Fund for the purposes of accumulating sufficient funds to redeem the Debentures and to invest in some radily convertible securities yielding 10% interest p.a. Reference to the table shows that ₹1.00 p.a. at 10% compound interest amounts to ₹4.641 in 4 years. Investments are to be made in the Bonds of ₹1000 each available at par.
On 31st March 2021, the investments realised ₹3,40,000 and debentures were redeemed. The bank balance as on that date was ₹50,000.
Required: Prepare Debenture Redemption Fund Account and Debenture Redemption Fund Investments Account for 4 years.
Solution:
II. Redemption of Debentures in Instalments by Drawing Lots
Under this method redemption is done in parts. When it is done in every year, it is called Redemption by Annual Drawing. Redemption may be done at par, at premium or at discount.
Under this approach, the statutory requirements are exactly similar to that discussed under lump-sum method. The recording of transactions is also similar to that explained under lump-sum method.
Consider the following illustration.
Illustration 54
X Ltd., a pharmaceutical company, has 20,000, 9% Debentures of ₹100 each outstanding. These are due for redemption in lots as follows:
On March 31, 2019 – 4,000 debentures; On March 31, 2020 – 6,000 debentures; On March 31, 2021 – Balance debentures.
You are required to ascertain the amount of balance that is required to be maintained in DRR A/c for each redemption. Also state the balance required to be transferred from DRR to General Reserve after each redemption.
Solution:
III. Redemption of Debentures by Conversion
Under this method debentures are converted into new debentures or equity shares or preference shares. However, in most of the cases, they are convertible into equity shares. Debentures may be fully convertible or partly convertible. New securities may be issued at par, at premium or at discount.
Since, DRR is required only for non-convertible debentures or non-convertible part of partly convertible debentures, under this method the provisions for DRR and DRI are not applicable.
The accounting entries are as follows:
| Particulars | Journal Entry | Remarks |
| Redemption due | Debentures A/c.......Dr. | Face value |
| Entry | Prem. on redemption of Debentures A/c ....Dr. | Premium payable, if any |
| To Debenture-holders A/c | Total amount due | |
| On issue of new securities | Debenture-holders A/c ...Dr | Total amount redeemed |
| 'at Par' | To Eq. Shares/ Pref. Shares/ Debentures A/c | FV of new securities issued |
| On issue of new | Debenture-holders A/c ...Dr | Total amount redeemed |
| securities 'at a | To Eq. Shares/ Pref. Shares/ Debentures A/c | FV of new securities issued |
| premium' | To Securities Premium A/c | Premium on issue |
| On issue of new | Debenture-holders A/c ...Dr | Total amount redeemed |
| debentures at a | Discount on issue of Debentures A/c ...Dr. | Discount on issue |
| discount' | To (New) Debentures A/c | FV of new securities issued |
Consider the following illustration.
Illustration 55
B Ltd. issued notice of its intention to redeem its outstanding ₹12,00,000, 8% Debentures at 102% and offered
the holders the following options to apply for the redemption moneys:
The holders of ₹4,80,000 debentures accepted proposal (i), and ₹7,20,000 debenture-holders accepted proposal (ii). Pass necessary journal entries to record the above-mentioned transactions.
Solution:
I. Redemption of Debentures by Purchase in the Open Market
A company may redeem the debentures by buying them form the open market (i.e., from the existing debenture- holders). The debentures so purchased may be immediately cancelled or may be held as investment and cancelled later. In the former, the debentures are immediately redeemed while in case of the latter they are redeemed after some time. Till the redemption, the debentures are considered as Investment.
If debentures are redeemed under this method, Debenture Redemption Investment (DRI), proportionate to the number of debentures purchased should be encashed. On cancellation of own debentures, minimum DRR associated with number of debentures cancelled should be transferred to General Reserve.
Note: Ex-interest and Cum-interest purchase price
If price quotation in the open market is available in form of ex-interest or cum-interest and debentures are purchased by the company on dates other than the interest date, consideration paid on purchase shall be segregated into price and interest and shall be recorded accordingly.
The accounting entries will be as follows.
a. When own debentures are purchased and immediately cancelled
i. Own debentures purchased and cancelled
Debentures A/c....................................................... Dr.
Loss on Cancellation of Debentures A/c........... Dr. (if there is a loss)
To Bank A/c
To Profit on Cancellation of Debentures A/c (if there is a profit )
ii. Transfer of profit or loss on cancellation
Profit on Cancellation of Debentures A/c................................. Dr.
To Capital Reserve A/c Or
Profit and Loss A/c......................................... Dr.
To Loss on Cancellation of Debentures A/c
Note: Profit or loss on cancellation is the difference between the face value of debentures cancelled and the purchase price of the debentures.
b. When own debentures are purchased and held as investment
i. Purchase of own debentures
Investment in Own Debentures A/c............................. Dr.
To Bank A/c
ii. Interest payment on debentures including own debentures
Debenture Interest A/c............................. Dr.
To Bank A/c
To Interest on Own Debentures A/c
iii. Resale of own debentures held as investment
Bank A/c........................................................................ Dr.
Loss on Sale of Own Debentures A/c........................ Dr.
To Investment in Own Debentures A/c
To Profit on Sale of Own Debentures A/c
iv. Cancellation of own debentures
Debentures A/c........................................................... Dr.
Loss on Cancellation of Debentures A/c........... Dr.
To Investment in Own Debentures A/c
To Profit on Cancellation of Own Debentures A/c
v. Transfer of profit or loss on cancellation
Profit on Cancellation of Debentures A/c................................. Dr.
To Capital Reserve A/c
Or
Profit and Loss A/c......................................... Dr.
To Loss on Cancellation of Debentures A/c
Note: When the company maintains a Sinking fund for redemption of debentures
A company which maintains a sinking fund and investment the proceeds to a Sinking Fund Investment may consider its own debentures as an investment avenue. The own debentures purchased may again be either retained as investment or cancelled immediately.
Illustration 56 (Purchase of own debentures and immediate cancellation)
A company purchased its own 12% Debentures in the open market for ₹25,00,000 (cum-interest). The interest amount included in the purchase price is ₹75,000. The face value of the debentures purchased is ₹26,00,000. The company immediately cancelled the debentures so purchased. Pass journal entries to record the purchase and immediate cancellation (ignoring transactions relating to Debenture Redemption Reserve and Debenture Redemption Investment).
Solution:
Illustration 57 (Purchase of own debentures and cancellation on a later date)
Draft journal entries in respect of the following since March 1, 2021:
In 2014 XY Ltd had issued 5,000, 7.5% Debentures of ₹100 each. On 1st March, 2018, the company purchased 500 of its own 7.5% Debentures at ₹ 47,500 cum-interest.
The debentures were held as investment until 30th June, 2021 when it was decided to cancel them. Interest is payable half yearly on 30th June and 31st December and the books are closed on 30th June each year. Assume absence of sinking fund.
Solution:
Illustration 58
On 01.01.2015 E Ltd. issued 500, 10% Debentures of ₹100 each, at a discount of 10% redeemable at a premium
of 10%.
Required: Show the ‘Loss on Issue of Debentures A/c’, if (i) such debentures are redeemable after 4 years, and (ii) such debentures are redeemable by equal annual drawings in 4 years. E Ltd. follows calendar year as it accounting year.
Solution:
A company issuing securities to the potential investors cannot completely rule out the possibility of an under-subscription where the number of shares applied falls short of the shares offered for issue. Whatever be the cause, this may lead to serious consequences for the company as its plan of raising capital may be jeopardized. Thus, companies, while issuing securities, often take help of a specialized service providers
who guarantee that no security remains unsubscribed. These service providers are known as Underwriters and their service is termed as Underwriting of Securities.
Underwriting of securities is an agreement, entered into by a company (issuing the security) with a financial agency to ensure that the entire issue of securities (shares, debentures etc.) gets fully subscribed. The concerned financial agency is known as ‘underwriter’. The underwriters provide their services against certain fees known as ‘underwriting commission’.
Underwriting agreements can be classified into various types on different basis. These are:
I. Based on the extent of underwriting
Based on the extent, underwriting can be of two types – full underwriting and partial underwriting.
When the entire issue is underwritten by the underwriters, it is called Full Underwriting or Complete Underwriting. On the other hand, when only a part of the total issue is underwritten by the underwriters, it is called partial underwriting. Here, the issuing company needs to take the responsibility of the remaining securities.
II. Based on the number of underwriters
Based on the number of underwriters involved, underwriting can be of two types – single underwriting and multiple underwriting.
When the entire issue is underwritten by a single underwriter, it is called a Single Underwriting. On the other hand, when entire issue is underwritten jointly by more than one financial agency, it is referred to as syndicate or Multiple Underwriting.
III. Based on the Degree of Commitment
Based on the commitment of underwriters, underwriting can be of two types – firm underwriting and regular underwriting.
In case of firm underwriting, the underwriter gives a specific commitment to take a specified number of shares, irrespective of the number of shares subscribed by the public. On the other hand, regular underwriting refers to the usual underwriting agreement in which the underwriters would be liable to take up the securities in the event of under-subscription.
Note: Sub-underwriting
In order to spread the risk of under-subscription, the principal underwriters may enter into subsidiary agreements in which the underwriter further gets a part of his commitment underwritten by another agency. This is known as Sub-underwriting. Such agreements are made between the underwriters alone, with the company not being a party thereto. As per agreement, the company pays commission at a prescribed rate to the principal underwriters, who in turn, disburse commission to the sub-underwriters. Sometimes an additional commission is paid to the principal underwriters to encourage sub-underwriting. This is known as over-riding commission. The payment of an over-riding commission enables the company to deal with one or two underwriters instead of a number of them. Sub-underwriting is not a separate type of underwriting but rather an extension of an existing underwriting arrangement.
‘Marked’ applications are those applications which bear the stamp of an underwriter. If the issue is not fully subscribed, ‘marked’ applications shall be applied in reduction of underwriter’s liability.
The ‘unmarked’ applications are those applications which bear no stamp of an underwriter. These applications are received by the company directly from the public. The distinction between marked and unmarked applications becomes immaterial when the whole issue is subscribed by only one underwriter. When there is more than one underwriter, the unmarked applications are divided amongst underwriters. Again, when the issue is fully subscribed, the distinction between marked and unmarked applications becomes immaterial.
The liability of an underwriter is the number of securities that has to be taken up by him. This liability may be of two types - Gross Liability and Net Liability.
Gross Liability refers to the total commitment of the underwriter as per the underwriting agreement.
Net Liability refers to the liability of taking up the unsubscribed securities after taking into consideration the gross liability as per the agreement of underwriting and applications received (both, marked applications and unmarked applications).
Thus, Net Liability = Gross Liability - (Marked applications + Proportion of Unmarked applications for which the underwriter has been given credit).
The price charged by the underwriter for his underwriting services rendered to the issuer company is called Underwriting Commission. It is payable to the underwriter for bearing the risk of under subscription, and not for subscribing the unsubscribed shares. The securities are eventually issued at the same price at which they are issued to other shareholders. This is why, the underwriters are entitled to commission even when the issue is fully subscribed by the public. The commission may be paid in cash or in fully paid-up shares or debentures or a combination of all these.
Underwriting commission is calculated on their total commitment, also known as gross liability, based on the issue price of the securities to the public. Accordingly,
Underwriting Commission = [Gross Liability (in no.) x Issue Price per security] x Rate of Commission.
Illustration 59 (Determination of underwriting commission)
XYZ Ltd. is issuing 20,00,000 shares of ₹10 each to the public. N Ltd. has been appointed as the underwriter for 5% of the issue size. The commission payable to the underwriter is 5% of the issue price. Calculate the amount of underwriting commission payable to N Ltd. if the shares are issued at par. How will your answer change if the shares are issued at 20% premium?
Solution:
As per the provision of Section 40 (6) of the Companies Act, 2013, read with Rule 13 of Companies (Prospectus and Allotment of Securities) Rules, 2014, a company may pay commission to any person in connection with the subscription or procurement of subscription to its securities, whether absolute or conditional, subject to the following conditions, namely:
The determination of liability of an underwriter in an issue of securities depend on the extent of underwriting arrangement i.e., whether the issue is underwritten in full or in part and the number of underwriters involved– single or multiple. Accordingly, there can be the following four possibilities:
I. When the Issue is Fully Underwritten by a Single Underwriter
Here, the underwriter is responsible for 100% of the unsubscribed issue. Since, the entire issue is underwritten by him, the distinction between marked and unmarked applications is irrelevant here. Further, the concept of firm underwriting is also not relevant in this case.
Underwriter’s liability is simply calculated as follows:
Underwriter’s liability = No. of Shares Issued (-) No. of shares subscribed by the public. Consider the following illustration.
Illustration 60 (Single Underwriter – Full Underwriting)
A Ltd. issued 1,00,000 equity shares of ₹100 each at par to the public, underwritten only by B & Co. The company received applications for 90,000 shares of which 80,000 shares were marked. Determine the liability of the B & Co.
Solution:
I. When the Issue is Fully Underwritten by Multiple Underwriters
Under this situation, the underwriters are jointly responsible for subscription of 100% of the issue size. Thus, individual uunderwriters are given credits for respective marked applications. The unmarked applications are shared between all the underwriters. The sharing is normally done in proportion of their ‘Gross Liability’. However, if the underwriting arrangement so provides, the same can be shared based on ‘Gross Liability (-) Marked Application’ also.
Thus, the distinction between marked applications and unmarked applications becomes relevant here.
Treatment of Firm Underwriting: The treatment of Firm Underwriting becomes significant as the underwriter must take up the number of securities underwritten ‘firm’ irrespective of its liability under the regular underwriting agreement.
For determining the liability of the underwriters, the shares underwritten firm may be treated in either of the following two ways:
Note: Students should note that unless otherwise stated, firm underwriting should preferably be treated as either ‘Marked applications’ or ‘Unmarked applications’ by stating the assumption clearly.
Thus, Underwriter’s Liability is finally calculated as –
Underwriter’s liability = Gross Liability (-) No. of Marked applications (-) Shares of Unmarked applications (+) Firm Underwriting.
Consider the following illustrations.
Illustration 61 (Full Underwriting, Multiple Underwriters, Without Firm Underwriting, Alternative Treatment w.r.t Unmarked Applications)
A Ltd. issued 4,00,000 equity shares. The whole issue was underwritten as: X - 40%; Y - 30%; and Z - 30%.
Applications for 3,20,000 shares were received in all, out of which applications for 80,000 shares had the stamp of X, those for 40,000 shares had that of Y and 80,000 shares had that of Z. The remaining applications for 1,20,000 shares did not bear any stamp.
Calculate the liability of underwriters.
Find out the liability of the individual underwriters in each of the following situations:
Solution:
Illustration 62 (Full Underwriting, Multiple Underwriters, Without Firm Underwriting, Alternative Treatment w.r.t Unmarked Applications, adjustment of surplus)
M Ltd., incorporated on April 1, 2021, issued a prospectus inviting applications for 5,00,000 equity shares of
₹10 each. The issue was fully underwritten by A, B, C and D as follows: A - 2,00,000; B - 1,50,000; C - 1,00,000; and D - 50,000.
The applications were received for 4,50,000 shares of which marked applications were as follows: A - 2,20,000; B- 90,000; C - 1,10,000; and D - 10,000.
Find out the liability of the individual underwriters in each of the following cases:
Solution:
Illustration 63 (Full Underwriting, Multiple underwriters, Firm underwriting with Alternative Treatment, Adjustment of Surplus)
The following underwriting took place for P Ltd. which invited applications for 10,000 shares of ₹ 10 each:
X: 6,000 shares Y: 2,500 shares Z: 1,500 shares
In addition, there were firm underwriting as follows:
X: 800 shares Y: 300 shares Z: 1,000 shares
Total subscription including firm underwriting was 7,100 shares, and the forms included the following marked forms:
X: 1,000 shares Y: 2,000 shares Z: 500 shares
Show the allocation of liability of the underwriters, if –
Solution:
III. When the Issue is Partially Underwritten by a Single Underwriter
In this situation, the concerned underwriter shall be responsible only for the agreed portion of the total issue. For the balance portion of the issue, the company itself shall be responsible.
The liability of the underwriter will be determined in the following manner:
Step 1: Gross Liability = Total Issue Size x % of underwriting
Step 2: No. of shares unsubscribed = Total no. of shares offered (–) No. of shares subscribed (including marked applications)
Step 3: Deficit of the underwriter = Gross Liability (-) Marked Applications Note: the deficit can never be negative
Step 4: Net Liability = Step 2 or Step 3 – whichever is lower.
Treatment of Firm Underwriting: In case the underwriter has underwritten ‘firm’, the liability of the underwriter should be determined by adding the number of shares underwritten ‘firm’ to the ‘Net Liability under the underwriting contract’ mentioned above.
In this context, there can be two possibilities as follows:
Consider the following illustration.
Illustration 64 (Partial underwriting, Sole underwriter, Abatement allowed)
Mr. X underwrites 60% of an issue of 20,000 shares of ₹100 each of ABC Ltd. He has also agreed for a firm underwriting for 1,600 shares. The company received applications for 13,600 shares out of which were 8,000 marked applications. Determine the number of shares to be taken up by Mr. X:
Solution:
IV. When the Issue is Partially Underwritten by Multiple Underwriters
Here, the underwriters together take the responsibility of a part of the total issue and the for the remining portion, the company itself is held responsible. The credit for marked applications is given to the individual underwriters. However, the credit for unmarked applications does not go to the underwriters.
Consider the following illustrations.
Illustration 65 (Partial underwriting, Multiple underwriters, Without Firm underwriting)
C Ltd. offered for the issue of 3,00,000 equity shares of ₹ 10 each. The issue was partially underwritten by M, N and O as follows: M - 40%; N - 30%; O - 20%. Applications were received for 2,40,000 shares of which marked applications were as follows: M – 1,05,600 shares; N - 78,000 shares; O - 50,000 shares. There was no firm underwriting.
Required: (a) Compute the liability of the underwriters, (b) Determine how many share-remain unissued.
Solution:
Following are the accounting entries required for underwriting transactions.
| Particulars | Journal Entries | Remarks |
| For shares | Underwriters A/c .....Dr. | Issue Price |
| taken up by the | To Share Capital A/ | Face Value |
| underwriters | To Securities Premium A/c | Premium on issue |
| Underwriting | Underwriting Commision A/c ....Dr. | Commission payable |
| commision | To Underwriters A/c | |
| Final Statement | Bank A/c ..................Dr | Diffrence between Net liability under |
| Underwriters A/c .......Dr. | underwriting contract and commision | |
| Or | payable. | |
| To Bank A/c |
Note: Underwriting commission written off during the year will be included in Finance Cost in the Statement of Profit and Loss. The portion of underwriting commission yet to be written off will appear in the balance sheet as follows –
Solved Case 2 (Accounting in the books of the company)
M Ltd., incorporated on April 1, 2021, issued a prospectus inviting applications for 2,50,000 equity shares of ₹10 each. The issue was fully underwritten by A, B, C and D as follows:
A - 1,00,000; B - 75,000; C - 50,000; and D - 25,000.
The applications were received for 2,25,000 shares of which marked applications were as follows:
A – 1,10,000; B- 45,000; C - 55,000; and D - 5,000.:
Unmarked applications are apportioned in the ratio of “Gross Liability”. Underwriters’ commission: 4% of the issue price.
Required:
Solution:
A. Theorectical Questions
1. The balance of Securities Premium A/C cannot be utilized for:
Answer: B. Payment dividend
2. Which of the following is not a Free Reserve?
Answer: C. Revaluation Reserve
3. Which of the following reserves cannot be used for the purpose of issuing bonus shares?
Answer: A. Revaluation Reserve
4. Which of the following is not a condition of buy-back of securities?
Answer: A. Both fully and partly paid-up securities can be bought back.
5. Which of the following is correct?
Answer: C. Unmarked applications are those applications that bear the stamp of the underwriter.
6. At present, a company can issue preference shares which is:
Answer: C. Redeemable before the expiry of 20 years from the date of issue
7. Partly paid-up preference shares can be redeemed:
Answer: B. After making them fully paid up
8. ________ of the Companies Act, 2013 prohibits issue of shares at a discount:
Answer: B. Section 54
9. The net profit on forfeiture and reissue of equity shares is transferred to ________:
Answer: A. Capital Reserve
10. Which of the following is/are statutory book(s) of a company?
Answer: D. All of the above
Answer:
Answer:
Answer:
Answer:
Answer:
Answer:
Answer:
Answer:
Answer:
Answer:
Answer:
B. Numerical Questions
Answer: A. ₹28,800
Answer: D. ₹3,00,000
1. A joint stock company resolved to issue 5 lakh equity shares of ₹10 each at a premium of ₹1 per 50000 of these shares were taken up by the directors and their relatives, the entire amount being received forthwith. The remaining shares were offered to the public, the entire amount being asked for with applications.
The issue was underwritten by P, Q and R for a commission of 2% of the issue price. 65% of the issue was underwritten by P, while Q and R’s share were 25% and 10% respectively.
Their firm underwriting was as follows:
P 15000 shares, Q 10000 shares and R 5000 shares. The underwriters were to submit unmarked applications for shares underwritten firm with full application money along with the members of the general public.
Marked applications were as follows: P 59750 shares, Q 28750 shares and R 5250 shares. Unmarked applications totaled 350000 shares.
Accounts with the underwriters were promptly settled.
You are required to:
Answer:
2. On 03.2016, the books of ABC Ltd showed the following balances:
|
30000 Equity shares of ₹10 each fully paid |
3,00,000 |
|
5000, 10% Redeemable Preference Shares of ₹100 each fully paid |
5,00,000 |
|
1000, 8% Redeemable Preference Shares of ₹100 each, ₹ 70 paid up |
70,000 |
|
General Reserve |
1,50,000 |
|
Balance of Profit |
3,20,000 |
|
Securities Premium |
30,000 |
|
Investment |
2,40,000 |
|
Cash at Bank |
79,200 |
On 1st April 2016, the Board decided to redeem the preference shares at a premium of 8%. In order to pay off the preference shareholders the company also decided to dispose of the investments, use company’s fund and to raise the balance by the issue of sufficient number of Equity Shares of ₹10 each at a premium of ₹1 per share subject to leaving a minimum bank balance ₹19,200 after such redemption. Investments were sold at ₹2,16,000.
Show the necessary journal entries to record the transactions.
Answer:
3. The following balances appeared in the books of P As on 31.03.2019:
13% Debentures Account ₹14,00,000
Debenture Redemption Fund Account ₹10,00,000
13% Debenture Redemption Fund Investment Account (Nominal = Cost) ₹10,00,000
The annual contribution to the Debenture Redemption Fund was ₹1,40,000. the company sold its investments for ₹14,00,000and redeemed the debentures on 31.03.2020. Prepare 13% Debentures Account, Debenture Redemption Fund Account and Debenture Redemption Fund Investment Account up to 31.03.2020.
Answer:
4. S issued 50,000 equity shares of ₹10 each at a premium of ₹2 per share. The share money is payable as follows:
On application: ₹5 per share; On allotment: ₹3 per share (including premium) and On Call: ₹4 per share. Applications were received for 70,000 shares. Allotment was made pro-rata to the applicants for 65,000 shares, the remaining applications being refused. Excess amounts paid on application are to be adjusted against amounts due on allotment.
Mr. X to whom 300 shares were allotted failed to pay the allotment money and call money and Mr. Y to whom 400 shares were allotted failed to pay the call. These shares were forfeited after the call was made. Subsequently only 500 shares (including all the shares held by Mr. X) were re-issued to Mr. Z as fully paid up at ₹9 per share. Pass the journal entries to record the above transactions.
Answer:
5. K Ltd. granted option for 16,000 equity shares on 01.10.16 at ₹80 when the market price was ₹170. the vesting period is 4 ½ years. 8,000 unvested options lapsed on 01.12.2018. 6,000 options are exercised on 30.09.21 and 2,000 vested options lapsed at the end of the exercise period. Pass journal entries to record the above transactions.
Answer:
Fast Forward Ltd. (a non-listed company) has the following capital structure as on March 31, 2021:
| Particulars | ₹ | ₹ |
| Equity Share Capital (Shares of ₹10 each fully paid) | ||
| Reserves & Surplus: | 60,00,000 | |
| General Reserve | 65,00,000 | |
| Security Premium Account | 12,00,000 | |
| Surplus in Statement of Profit and Loss | 8,60,000 | |
| Revaluation Reserve | 12,40,000 | 98,00,000 |
| Loan Funds | 42,00,000 |
The company is contemplating to undertake a buyback program for its equity shares. You have been appointed as a legal expert in this respect.
You are required to compute by Debt-Equity Ratio Test, the maximum number of shares that can be bought back in the light of above information, when the offer price for buy back is ₹30 pershare.
Answer:
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