1. Concept & meaning of company, Types of companies, , Other concepts

Concept & Meaning

A company is a voluntary association of persons formed to carry on some purpose. It is an artificial person created by law. It has a separate legal entity and enjoys perpetual succession. It is a voluntary association of individuals for profit, having a capital divided into transferable shares, the ownership of which is the condition of membership. For a layman, the word refers to a business organization. But not all business organizations are companies. An organization becomes a company when it is registered or incorporated under the Companies Act.  A company can own property, have bank accounts, raise loans & also incur liabilities. The liability of a company is usually limited (except for unlimited companies). In the broad sense, there are various types of companies but in the narrow sense, It is basically of 3 types namely Public companies, Government companies & Private companies. As the company is an artificial person, it can act only through a human being acting as an agent. Such agents are called Directors of the company. They are the ultimate controller of the company & are vested with all the powers.

Promotion/Incorporation / Registration of a company

 A company is an artificial person that comes into existence only after incorporation. A company is incorporated under the Companies Act, 1956 (now 2013) and at the ‘Registrar of Companies (ROC).

The various steps for incorporation are as follows;

  1. Lawful Purpose – The first & foremost requirement to start a company is the presence of a lawful purpose. When the purpose is unlawful, the Registrar may refuse to register the company.
  2. Application for Approval of Name: In the first step, permission is obtained for the approval of the name. The name of the company should not be prohibited under ‘Emblems and Names Act, 1950’. The name should not resemble any existing or registered company. For that purpose, the applicant gives a panel of three to five names in order to avoid delay. The registration fee for this purpose is Rs.1000.

(ii)     Preparation of Memorandum of Association: The next step is to prepare the ‘Memorandum of Association’. A Memorandum of association is known as the constitution of a company & it describes its objectives and powers & scope. It should be properly stamped & signed by the members of the company.

(iii)    Preparation of Articles of Association: It is a document containing the rules and regulations relating to the internal management of the company. This is required for the private and public companies but a public company can adopt Table A, Schedule I of the Companies Act, 1956 (now 2013).

(iv)    Preparation of other documents: There are certain other documents which are required to be filed such as;

(i)     Consent of first directors.

(ii)   Power of Attorney executed by the promoter in favor of an advocate to carry out the legal formalities.

(iii)  Copies of preliminary agreements,

(iv)  Information regarding registered office.

(v)    A statutory declaration that all the legal formalities have been complied with.

(v)      Payment of Fees: The next step is the payment of requisite fees. The amount of fees varies in the case of companies with share capital and companies without share capital.

(vi)    Incorporation Certificate: After filing all the documents and payment of fees, scrutiny is made by the Registrar. If everything is in order, the name of the company is registered in ‘Register of Companies’ and an Incorporation Certificate is issued. A private company can start a business after getting certificate of incorporation.

CLASSIFICATION/TYPES OF COMPANIES

 According to Incorporation :

  • Chartered companies : These companies are incorporated or registered under the Royal Charter issued by the king or head of the state. These are given certain rights and privileges.

              Example :The East India company.

  • Statutory Companies :These companies are formed under a special act of parliament or a state legislative. They may or may not use the word limited. They are given wide powers.

      Example :Reserve Bank of India, Industrial Development Bank of India etc.

  • Registered Companies :These are the companies which are registered under the companies Act, 2013. They may be limited by shares or guarantee.

          According to Liability :

  • Companies Ltd by Shares : These companies have a share capital (i.e. capital divided into shares). The liability of shareholders of such companies is limited up to the investment or unpaid amount only.
  • Companies Ltd. by Guarantee :These companies have a stipulation  in the memorandum clause that the members guarantee to pay a certain amount of money in case of its winding up. The amount undertaken to pay is called guarantee money.
  • Unlimited Companies : These companies do not have a share capital & the liabilities of the shareholders of these companies is unlimited. Such companies are rare to find & they are not required to use the unlimited at the end of their name.

According to Transferability :

  • Private Company : A private company is a company which is formed with the association of at least two members and maximum  200. They use the word ‘Pvt. Ltd’ after their name. The shareholders are basically the family members and they can’t issue shares to the public directly.
  • Public Company :It is a type of company which requires at least 7 persons for incorporation & the maximum membership is unlimited. They use the word ‘Ltd.’ after their name and they are allowed to issue shares directly to the public.

On the basis of Ownership :

  • Government Companies : A company owned either by the State Government or central government or both is known as ‘Government Companies’ The government may invest either the whole capital or it may purchase majority of shares (i.e. 51%)

             Example : Steel Authority of India Ltd.(SAIL)

  • Holding Companies :It is a company which controls the policies and internal matters of any other company.
  • Subsidiary Companies : This  is a company whose policies and internal matters are controlled by another company.

On the basis of Nationality :

  • Indian Companies: A company which has been registered in India under the Company’s Act, 1956, is known as an Indian Company. It may or may not operate in India.
  • Foreign Companies :It is a company which has been incorporated outside India but has a place of business in India.

Two new companies were introduced in the companies act, of 2013

One Person Company - One Person Company (OPC) means a company formed with only one (single) person as a member, unlike the traditional manner of having at least two members. OPC under the Companies Act, 2013 is a separate legal entity having perpetual succession, which is required to be registered as per the provisions of the Companies Act, 2013. The liability to repay the loan availed by the OPC is limited only to the OPC, unlike, a sole proprietorship which is not a separate legal entity, thus making the sole proprietor personally liable for any loan or any credit facility availed. Further, registration of a sole proprietorship is not required.

Small Company - As per the new definition of small company provided under section 2(85) of the Companies Act, 2013, the small company means and covers the company which satisfies the following two conditions-

Condition 1 – Paid-up capital of the company should not exceed INR 2 Crores; and

Condition 2 – Turnover of the company should not exceed INR 20 Crores.

However, it is important to note here that the following companies, despite satisfying both the above conditions, are not eligible to qualify as a small company-

  • A public company,
  • A holding company,
  • A subsidiary company,
  • Company registered under section 8,
  • A company that is governed by any special act.

1. Concept & process

ACCOUNTING FOR SHARE CAPITAL – CONCEPT & PROCESS

One of the alternatives before him is to raise money by issuing shares to the general public.

All the  steps have been discussed as under:

1. Issue of prospectus: A prospectus is a document that may be a notice, circular or advertisement issued for inviting deposits from the public for the subscription of any shares or debentures of a company. It is properly dated and signed by every director of the company, a copy of which is also filed with the Registrar of Companies. Each prospectus contains a printed application form and also specifies the amount per share payable on application, on the allotment and on calls. It also specifies the amount of minimum subscriptions.

The issue of shares starts with the issue of a prospectus and ends with the receipt of calls from the shareholders. The detailed procedure for the issue of shares consists of the following five steps:

The minimum subscription is the minimum amount which, in the opinion of directors, must be raised in cash by the issue of shares to provide for:

(i)  The purchase of any property

(ii)  Any preliminary or formation expenses/commission.

(iii)   The repayment of any borrowings

(iv) Working Capital

 

2. Receipt of Application Money: After the publication of the prospectus, all investors who want to be the shareholders of a company have to fill in the prescribed application form and send it to the banker of the company with an Account Payee cheque for the amount payable on application. The application money per share cannot be less than 5% of the nominal / face value of a share. All money received on the application are kept deposited in a scheduled bank until the certificate of commencement (required for a public company) is received or until the receipt of the minimum subscription stated in the prospectus. If the minimum subscription is not received within 120 days of the issue of the prospectus, all the application money received must be refunded without interest to the applicants within the next 10 days.

 

3.  Allotment of Shares: After the last date of application, the company’s banker forward all the applications to the company. Then the Board of Directors starts the process of allotment.

  • Allotment is the act of accepting those applications which are genuine and fulfill the conditions laid down in the prospectus.
  • A letter of allotment is sent to all those applicants whose applications are accepted by the Board of Directors.
  • An applicant who receives the letter of allotment becomes a member/ shareholder of the company from the date of posting of the letter.
  • On the other hand, a letter of regret is sent to those applicants whose applications are rejected. The application money received from such applicants are also refunded.
  •    Here it is to be noted that, no shares can be allotted unless the minimum subscription stated in the prospectus has been received in full.
  •     Besides a company cannot allot more shares than those stated in the prospectus.
  •     On allotment, a shareholder is also required to pay the allotment money due on allotted shares.

4.  Issue of Share Certificate: A share certificate is issued to each person whose name appears in the Register of Members. It is issued under the seal of the company and specifies the name, address and occupation of the holder along with the number of shares held and the amount paid-up thereon. It is prima facie evidence that its holder is a shareholder of the company.

Note: The company must issue a share certificate within three months of the allotment of shares.

5.  Calls on Shares: After the payment of application and allotment money the balance amount due from the shareholder may be demanded by the company in the form of calls. A call is simply an installment of payment. Generally, the prospectus specifies the number, dates and amount of calls to be made by a company. In case the prospectus is silent, the directors have the discretion to decide the number and date of calls and the amount payable in each call.

Note (1): Usually calls are numbered as a first call, second call, third call etc. The last call is named as final call. For example,  if the second call is the last call, then it is termed as “Second and Final call”.

Note (2): A call is a demand by a company on its shareholders to pay the whole or part of the balance remaining unpaid on each share. It may be made at any time during the lifetime of the company or during its winding-up.

2. Types of companies

The Concept of SHARES & SHARE CAPITAL

Shares

Capital is the lifeblood of a business as it is required for earning revenue. The capital of a company is usually divided into different units of a fixed amount known as ‘shares’.

Each share is distinguished by its specific number and a certificate is issued to the shareholders under the common seal of the company. The certificate is known as‘Share Certificate’.

TYPES OF SHARES

Shares are basically of two types;

(i) Preference Shares

(ii) Equity Shares

Preference Shares :

Preference shares are those shares that carry preferential rights in respect of payment of dividend and return of capital in the event of liquidation of the company. The preference shareholders are paid dividend at a fixed rate before, dividend is paid to equity shareholders.

For example, 10% preference shares means dividends shall be paid at the rate of 10 percent on paid-up capital when the company distributes dividends to shareholders.

Types of Preference Shares:

There are different types of preference shares on the basis of (i) redemption,(ii) conversion into equity shares, (iii) accumulation of arrear of dividends, and (iv) participation in the surplus profit of the company.

On the basis of the accumulation of arrear dividends:

On this basis, preference shares may be cumulative or non-cumulative preference shares.

(i) Cumulative Preference Shares: These shares carry the right to arrear of dividend if the company had not paid dividend for any year. If the company declares dividend for a year, the cumulative preference shareholders are paid their arrear dividend first before any dividend is paid to equity shareholders. Thus, the arrear of dividend accumulates till it is paid by the company.

(ii) Non-cumulative Preference Shares: The non-cumulative preference shares are not entitled to arrear of dividend. In other words, the arrear of dividend do not accumulate and such shareholders are paid a dividend for the current year (if the company declares a dividend) before the dividend to equity shareholders is paid.

On the basis of redemption :

Preference shares may be redeemable or irredeemable on the basis of redemption (return of capital).

(i) Redeemable Preference Shares: Redeemable Preference Shares are those preference shares on which the amount is returned by the company to the shareholders after the expiry of a fixed term within the life of the company. Ordinarily, shares are not redeemable (refundable) unless the company goes into liquidation.

(ii) Irredeemable Preference Shares: The preference shares which are not redeemable within the life of the company or redeemed only at the time of liquidation of the company are called irredeemable preference shares.

On the basis of participation in surplus profit :

On the basis of participation in surplus profit of the company, preference shares may be participating or non-participating preference shares.

(i) Participating Preference Shares: The preference shares which carry the right to share the surplus profit of the company remaining after paying dividends to equity shareholders at a certain rate are called participating preference shares. The surplus profit is distributed between participating preference shareholders and equity shareholders on a certain agreed ratio.

(ii) Non-participating Preference Shares: Non-participating preference shares are entitled only to a fixed rate of dividend and do not share in the surplus profit or assets of the company.

On the basis of conversion :

On the basis of conversion into equity shares, preference shares may be convertible or non-convertible preference shares.

(i) Convertible Preference Shares: The preference shares which carry the right to be converted into equity shares within a specified period or at a specified date according to the terms of the issue are called convertible preference shares.

(ii) Non-convertible Preference: The preference shares which do not carry the right of conversion into equity shares are known as non-convertible preference shares.

 

Equity Shares :

Shares that are not preference shares are equity shares. Such shares are also known as ordinary shares.  These shares do not have any preferential right as to dividend or return of capital in the event of winding up of the company. The rate of dividend on such shares is not fixed. Equity shareholders are the real owners of the company because they bear the risk. They may not get any dividend in the year of the loss or insufficient profit and receive a relatively higher return in the year in which the company earns a higher profit. Equity shares carry voting rights on all matters and the shareholders have control over the affairs of the company.

Stock :

Stock is the aggregate of fully paid up shares. It can be considered as a set of shares put together in a bundle. Stock can be split into fractions of any amount without regard to the original face value of shares. The value of the stock depends upon the number of fully paid-up shares consolidated. Conversion of shares into stock is made provided the Articles of Association of the company permit.

Features of Preference Shares :

(i) Preference shares have priority over payment of dividends and repayment of capital.

(ii) The rate of dividend on preference shares is fixed. Only in the case of participating preference shares additional dividend may be paid if profits remain after paying equity dividend.

(iii) Except in the case of redeemable preference shares, the preference share capital remains with the company on a permanent basis.

(iv) Preference shares do not create any charge over the assets of the company.

(v) Preference shareholders do not hold voting rights.

Merits / Advantages :

(i) Rate of return is guaranteed. Investors who prefer safety on their capital and want to earn income with greater certainty, always prefer to invest in preference shares.

(ii) Helpful in raising long-term capital for a company.

(iii) Control of the company is vested with the management as preference shareholders have no voting rights.

(iv) Redeemable preference shares have the added advantage of repayment of capital whenever there is a surplus in the company.

(v) There is no need to mortgage property on these shares.

Disadvantages :

(i)  Permanent burden on the company to pay a fixed rate of dividend before paying anything on other shares.

(ii)  Not advantageous to investors from the point of view of control and management as preference shares do not carry voting rights.

(iii) Compared to other fixed interest-bearing securities such as debentures, usually the cost of raising the preference share capital is higher.

Features of Equity Shares

(i) Equity share capital remains permanently with the company. It is returned only when the company is wound up.

(ii) Equity shareholders have voting rights and elect the management of the company.

(iii) The rate of dividend on equity capital depends upon the availability of surplus funds. There is no fixed rate of dividend on equity capital.

Advantages

(i) Equity shares do not create any obligation to pay a fixed rate of dividend.

(ii) Equity shares can be issued without creating any charge over the assets of the company.

(iii) It is a permanent source of capital and the company has to repay it only under liquidation.

(iv) Equity shareholders are the real owners of the company who have voting rights.

(v) In the case of profits, equity shareholders are the real gainers by way of increased dividends and appreciation in the value of shares.

Disadvantages

(i) As equity capital cannot be redeemed, there is a danger of over-capitalization.

(ii) Investors who desire to invest in safe securities with a fixed income have no attraction for such shares.

Why do Companies issue Shares to the Public?

Companies issue shares to the public in order to raise capital or to finance their business operations, expand the business, and meet other financial needs. After the acceptance of shares by the company, the applicant becomes a shareholder in the company, and they get the right to receive dividends on their investments.

3. Meaning of share capital & types of share capital

TYPES OF SHARE CAPITAL

Authorized Share Capital

Authorized Share Capital is the total Capital that a company accepts from its investors by issuing shares that are mentioned in the official document of the company. It is also called Registered Capital or Nominal Capital because with this Capital a company is registered.

According to Section 2(8) of the Companies Act, 2013, the limit of Authorised Capital is given under the Capital Clause in the Memorandum of Association. The company has the discretion to take the required steps necessary to increase the limit of authorized capital with the purpose of issuing more shares, but the company is not allowed to issue shares that are exceeding the limit of authorized capital in any case.

Authorized Share = Issued Share + Unissued Share.

Issued Share Capital

Issued Share Capital is the part of Authorized Share Capital issued to the public for subscription. And this Act of issuing Shares is called Issuance, allocation, or allotment. In a simple way, you can say that Issued Share Capital is the subset of the Authorized Share Capital. After the allotment of shares, a subscriber becomes the shareholder.

Issued Capital = Subscribed + Unsubscribed Capital

Subscribed Capital

Subscribed Capital is the part of issued Capital that has been taken off by the public. It is not mandatory that the issued Capital is fully subscribed to by the public. It is that part of the issued Capital for which the application has been received by the company. Let’s understand this with an example – If a company offers 16000 shares of Rs. One hundred each and the public applies only for 12000 shares, then the issued Capital would be Rs 16 lakh, and Subscribed Capital would be Rs 12 lakh. Issued Share is equal to the sum total of share outstanding and treasury shares.

NOTE: Once the Share has been issued and purchased by investors, these shares are called Shares Outstanding. This issuing of shares gives the shareholders ownership of the corporation. The Unsubscribed Share Capital can be called the Treasury Shares.

Called-Up Capital

Called-up Capital is the part of the Subscribed Capital, which includes the amount paid by the shareholder. The company does not receive the entire amount of Capital at once. It calls upon the part of subscribed Capital when needed in installments. The remaining part of the Subscribed Capital is called Uncalled Capital.

Paid-Up Capital

The part of Called-up Capital that is paid by the shareholder is called Paid-up Capital. It is not mandatory that the amount called by the company is paid by the shareholder. The shareholder may pay half the amount of the called up Capital, which is called Reserved Capital.  As the name reserve means to keep some amount in the treasury of the company. This is quite useful in the case of winding- up the company.

The Companies Amendment Act 2015, has amended that minimum requirement of the paid-up capital is not required in the Company. That signifies that at present the formation of the Company can be done with even Rs.1000 as the company’s paid-up capital. The paid-up capital shall always be less than or can be equal to the authorized share capital at any point in time and the Company is not allowed to issue shares beyond the company’s authorized share capital.

What is the difference between Capital Reserves and Reserve Capital?

There is a clear difference between Capital Reserve and Reserve Capital. Capital Reserve is the part of profit reserved by the company for a particular business purpose or to finance long-term projects. Whereas, the Reserve Capital is the part of the Authorized Capital that has not yet been called up by the company and is available for drawing anytime when necessary.

4. Other concepts

OTHER CONCEPTS

important documents issued by a company

Memorandum of Association: It is the constitution as well as the foundation upon which the whole structure of the company is built. It is the principal document without which a company can’t be registered. It defines the company’s scope of activities as well as its relation with the outside world. The purpose of the memorandum is to enable the shareholders, creditors, and those who deal with the company to know what the permitted range of the enterprise is. A company cannot do anything contrary to the memorandum. It cannot enter into a contract or engage in any trade or business which is not permitted by the memorandum. If any action is done by the company which is not permitted by the memorandum, it is known as Ultravires (which means beyond the powers).

Importance

(i)       It defines the limitations of the company.

(ii)      It is the foundation upon which the whole structure of the company is built.

(iii)     It explains the scope of activities of the company.

(iv)     It is the constitution of a company.

(v)      It is a charter of the company.

CLAUSES

(1)      The Name Clause: The name of the company is mentioned in this clause. A company should select a name that does not violate the Emblems & Names Act, 1950. The words ‘Pvt Ltd’, “(P) Ltd” or only “Ltd’ must be attached after its name in the case of private or public companies respectively. The name of the company must be engraved on its official seal & also mentioned in the letterheads, bills & other official publications.

(2)      Registered Office Clause: This clause consists of the registered office address of the company. It is mandatory for every company to have a registered office where necessary documents like notices, letters etc may be sent. It is also important for inspection purposes. A company must have a registered office from the day on which it commences business. If the office is shifted within the town, a special resolution is passed but if the office is shifted from one town to another, it requires an alteration in the memorandum.

(3)      Object Clause: This clause determines the rights, powers and objectives of the company. The powers of the company are limited to the object clause in the memorandum. This clause enables the shareholders, creditors & all other members who deal with the company to know what its range of activities are. It should be decided carefully because it is difficult to change later on.             

(4)      Liability Clause: This clause mentions the shareholders liability. The liability may be up to the unpaid amount on shares or it may also be limited by a guarantee (in the case of a guarantee company). It also mentions the amount to be contributed by the members towards the assets of the company in case of its winding up. In the case of unlimited companies, the liability of the members is unlimited.

(5)      Capital Clause: This clause states the amount of total capital of the company. The maximum amount of capital that can be issued/raised by a company from the market is known as nominal or authorized capital.  This clause also mentions the division of capital into equity and preference shares.

(6)      Association Clause: This clause contains the names of signatories to the memorandum. The memorandum must be signed by at least 7 persons in case of public and 2 persons in case of a private company.

 (ii)    Articles of Association: This is a document in which the rules and regulations regarding the internal management of the company are framed. It cannot contain anything contrary to the companies, Act, 2013, as well as MOA. It contains all the provisions related to day to day working of the business. Any act done violating the provisions of articles can be ratified by passing a resolution in a general meeting. It contains provisions related procedure of issuing share capital, procedure for conducting a general meeting, minimum members required to be present (Quorum) in order to conduct a meeting etc. Every company limited by a guarantee or an unlimited company needs to register its articles along with the memorandum of association with the ROC. If a public company does not register its articles, the regulation contained in Table A would be applicable.

Contents

(i)       The amount of share capital issued, different types of shares, forfeiture of shares etc.

(ii)      Power to alter as well as reduce share capital.

(iii)     Appointment of directors, powers and their remuneration etc.

(iv)     Appointment of manager, managing directors

(v)      Procedure for holding a meeting.

2. Journal Entries

JOURNAL ENTRIES - ISSUE OF SHARES

A company may issue shares for different purposes such as the purchase of properties, meeting preliminary expenses, repayment of a loan, and fulfilling its working capital requirement. The purposes of the issue are mostly divided into two parts:

    1. For cash

    2. For consideration other than cash (i.e. purchase of properties etc.)

If the company is in immediate need of the entire proceeds (i.e. no. of shares issued * market price per share) of the issue, it may ask the investors to pay the full amount (i.e. market price) in one installment i.e. on application.

Where the entire proceeds are not required immediately, the company usually requests the investors to pay in 3 or 4 installments i.e. on application, on the allotment and on calls. Further calls may be divided into two or three parts e.g. first call, second call and third call etc. The last call is called the final call.

Thus, the issue of shares has been discussed in four parts as follows :

A.     Issue of shares for cash at par

B.     Issue of shares for cash at a premium

C.     Issue shares for cash at a discount

D.    Issue of shares for consideration other than cash by Rs.2. Thus the shares are issued at a premium of Rs.2 per share.

ACCOUNTING PROCEDURE:

The entire accounting procedure relating to the issue of shares usually consists of the following :

1.    Journalising the transactions.

2.    Preparation of ledger accounts.

3.    Preparations of the cash books (Bank Column only).

4.    Presentation of Balance Sheet.

STAGES IN SHARE ACCOUNTING:

The entire accounting procedures are to be maintained at five-stage of share accounting. These five stages are (a) Application (b) Allotment, (c) Calls, (d) Forfeiture, (e) Re-issue.

Note: If the company receives in full all its dues on application, allotment and calls, the questions of the last two stages i.e. forfeiture and re-issue do not arise. Thus, there will be three stages only.

SHARES MAY BE ISSUED AT PAR OR PREMIUM. LET US HAVE A LOOK AT BOTH THE CASES

(A) ISSUE OF SHARE FOR CASH AT PAR :

1. Journal: When shares are issued for cash at par value i.e. at nominal/ face value of a share, the following entries are passed at each stage of accounting.

(a) On Application:

Bank A/c                                                                                                                         Dr.

To Share Application A/c.

(Being application money received for…..shares @ Rs……each)

Note: The application money received will remain in the Share Application Account till the allotment of shares by the Board of Directors.

TREATMENT OF APPLICATION MONEY :

On allotment, it is the discretion of the directors to allot in full or in part the number of shares applied. Even some applications may be rejected by sending them a letter of regret.

there  are  four  possibilities:

(i) Transfer of application money on allotted shares to share capital account. The entry is:

Share Application A/c.                                                              Dr.

To share capital A/c.

(Being application money on………….shares @ Rs….each transferred to share capital account as per Director’s resolution No……dated………)

(ii) Adjustment of excess application money against money due on allotment if Directors allot less number of shares than applied for. The entry is :

Share Application A/c.                Dr.

To Share Allotment A/c.

(Being the excess application money adjusted against allotment)

For example, Mr. X had applied for 200 shares in a company but only 100 shares were allotted to him. If he is required to pay Rs.2 on the application, Rs.5 on the allotment and Rs.3 on calls, then out of Rs.400 ( i.e. Rs.2 * 200) application money Rs.200 (i.e. 100 * Rs.2)will be transferred to share capital account, and Rs.200 (i.e. excess application money) will be adjusted against his dues on allotment of Rs.500 (i.e. Rs.100 * 5) 

(iii) Transfer of surplus application money after adjustment against allotment to calls-in-advance account. The entry is:

Share Application A/c.                                                          Dr.

To Calls-in-advance A/c.

(Being the surplus after adjustment against dues on allotment transferred to the calls-in-advance account.)

For example, Mr. Y had applied for 300 shares in X Ltd to whom only 100 shares were allotted. If he is required to pay Rs.3 on the application, Rs.4 on the allotment and Rs.3 on calls then out of Rs.900 (Rs.3 * 300) application money, Rs.300 (i.e. 100 * 3) will be transferred to share capital account, Rs.400 (i.e. 100 * 4) will be adjusted in share allotment account and Rs.200, the surplus money, will be transferred to the calls-in-advance account.

Note: If there is no provision in the prospectus for the transfer of surplus money to the calls-in advance account, then it should be refunded.

(iv)Refund of application money on rejected applications. The entry will be:  

Share Application A/c.                                                          Dr.

To Bank A/c.

(Being application money on…………….shares @ Rs……………..each refunded as per Director’s Resolution No……….dated…………)

Alternatively: We can pass one compound journal entry against the four simple entries discussed above. The entry will be:

Share Application A/c.                         Dr.

To share capital A/c.     (application money  on allotted shares)

To share allotment A/c.     (adjusted in allotment)

To calls-in-advance            (adjusted in call)

To Bank A/c.                               (refunded)

( Being the transfer of application money to share capital, share allotment and calls in advance account and the refund of the balance on the allotment of shares as per Director’s Resolution No………..dated……….)

TREATMENT OF ALLOTMENT MONEY :

When shares are allotted, the applications to whom shares are allotted are sent the Letter of Allotment with a request to pay the allotment money due.

Some shareholders may pay the allotment money whereas some others may fail to pay it in time.

There are three possibilities.

(i) Amount due on the allotment: The amount due on the allotment is equal to the product of the number of shares allotted and the allotment money per share.  The entry will be :

Share Allotment A/c.                                                  Dr

To Share Capital A/c.

(Being the allotment money due on..... shares @ Rs.....each as per Director’s Resolution No.... dated......)

(ii) Amount received on the allotment: On receipt of the allotment money the following entry is passed :

Bank A/c.                                                                         Dr

       To Share Allotment A/c.

(Being allotment money received on....shares @ Rs.....each)

(iii) Amount not received on the allotment: This amount will be equal to the total amount due on an allotment less the amount adjusted against the allotment. It will be transferred to the calls-in-arrear account by passing the following entry.

Calls-in-Arrear A/c.                                        Dr.                         

To share allotment A/c

(Being the allotment money not received transferred to calls-in-arrear account)

Treatment of Call money :

After allotment of shares, the balance due from shareholders is demanded by the company by making calls. A company may demand the remaining amount due in one call or in two or more calls.

On each call, entries are made in respect of the following four aspects :

   (i) Amount due on the call.

  (ii) Amount received on the call.

(iii) Adjustment of calls in advance.

(iv)  Amount not received on the call.

(i) Amount due/receivable on the call: This amount is equal to the product of no. of shares allotted and the call money per share. The entry will be.

Share Call A/c.                                                              Dr

To share capital A/c

(Being call money due on.....shares @ Rs.......per share as per Director’s Resolution No......dated.........)

(ii) Amount received on the call: Whatever amount is received, the bank account is debited and the share call account is credited. The entry will be :

Bank A/c                                                                          Dr.

       To Share Call A/c

   (Being call money on......shares @Rs........each received)

(iii) On adjustment of call-in-advance: The amount received in advance on the application or on an allotment in respect of the particular call is now transferred from the calls-in-advance account to the share call account. The entry will be :

  Calls-in-advance.                                                           Dr.

To Share Call A/c

(Being the amount received in advance transferred to share call account)

(iv) Amount not received on the call: This amount can be calculated as follows :

Amount not received on the call = Amount due on the call minus  Amount received on the call minus calls – in–advance.

The entry will be :

Calls-in-Arrear A/c.                                     Dr.

To Share Call A/c

(Being call money due on.....shares @Rs......each transferred to the calls-in-arrear account, for non-payment)

UNDER SUBSCRIPTION AND OVER SUBSCRIPTION:

Where the number of applications received from the public is less than the number of shares to be issued, it is called under subscription. In this case, the company will allow only that number of shares applied by the public.

For example: If 1000 shares are to be issued but the public applied for only 900 shares, not 1000 shares, then the company can allot only 900 shares, not 1000 shares.

On the other hand, the issue is said to be oversubscribed if the number of applications received is more than the number of shares to be issued. In this case, the company will allow the number of shares which are to be issued.

For example: If 1,200 applications are received against 1000 shares to be issued, then only 1000 shares will be allotted.

OVERSUBSCRIPTION AND METHODS OF ALLOTMENT :

When a particular issue is oversubscribed, the Board of Directors of the Company may decide to allot the shares in different ways according to their discretion.

Mostly, there are three methods of allotment in case of oversubscription: These are :

(a) Simple Allotment: Where the issue is not oversubscribed to a large extent, the Board may allow the required number of shares by rejecting the applications to the extent it is oversubscribed, It is called a simple allotment.

For example, A company is to issue 10,000 shares for which 10,500 applications were received. In this case, the company may allot 10,000 shares by rejecting applications for 500 shares. In this case, the question of excess application money and calls-in-advance does not arise.

(b) Categorized Allotment: Where the issue is oversubscribed to a large extent and the minimum number of shares to be applied has been fixed in the prospectus, the Directors may decide to satisfy an unequally a maximum number of applicants. Here, they divide the total applications into two / three categories.

For example, the categories may be :

  (a)  Applicants for more than 5000 shares.

  (b) Applicants  for more than 2000 but less than 5000 shares

  (c)  Applicants for more than 1000 but less than2000 shares

  (d) Applicants for less than 1000 shares.

Each category is satisfied by allotting some shares except the applicants for less number of shares. Usually, more shares are allotted to the applicants applying for a maximum number of shares.

Example : X Ltd. issued 1,00,000 shares of Rs.10 each. The public applied for 1, 60,000 shares. The allotment was made as follows :

(a)  Applicants for 50,000 shares (in respect of applications for 2000 shares or more) were allotted 50,000 shares.

(b)  Applicants for 70,000 shares (in respect of applications for 1000 shares or more) were allotted 30,000 shares.

(c)  Applicants for 35,000 shares (in respect of applications for less than 1000 shares) were allotted 20,000 shares.

(d)  5,000 applications were rejected.

The above allotment can be put under the following four categories.

Category    No. of Applications No. of shares allotted

          1                           50,000                          50,000

          2                           70,000                          30,000

          3                           35,000                          20,000

          4                            5,000                               NIL

TOTAL                    1,60,000                    1,00,000

In this type of allotment, it is necessary to calculate excess application money under each category allotted and the amount to be adjusted on allotment and calls. Suppose the above issue is payable as Rs.5 on applications, Rs.3 on the allotment and Rs.2 on the final call, then the excess application money under each category and its adjustment on allotment and calls will be calculated.

 (c) Pro-rata Allotment: When the shares are oversubscribed to a very large extent, the company is unable to satisfy all the applicants. In such a situation the company has the following alternatives.

(i) It may allot proportionately to all the applicants.

(ii) Reject some applications and allot proportionately to the rest of the applicants.

Such an allotment is called “pro-rata allotment”. It means allotment in proportion to the shares applied for.

For example: If the applicants for 60,000 shares are allotted 20,000 shares (i.e. in the ratio of 3: 1), then an application for 3 shares will get one share.                              

The proportion in which the shares are allotted is very much essential to determine excess application money and the amount not paid in case of a defaulting shareholder.

For example, the Issue price of a share is Rs.10 payable as Rs.5 on the application; Rs.3 on the allotment and Rs.2 on calls, Mr. X, a shareholder who had been allotted 300 shares in the ratio of 5 : 3, could not pay his dues on final call. This case will be analyzed as follows :

(i) No. of shares applied = 300 shares × 5/3 = 500

(ii) Application Money paid = 500 shares × Rs.5 = Rs.2,500

(iii) Application money required = 300 shares × Rs.5 = Rs.1,500

(iv) Excess Application money received = Rs.2,500 – Rs.1500 = Rs.1,000

(v) Amount due on allotment = 300 shares × Rs.3 = Rs. 900

(vi) Amount adjusted on allotment = Rs.900

(vii) Calls-in-advance =  (Rs.1000 – Rs.900) Rs.100

(viii) Amount due on call = 300 shares × Rs.2 =  Rs.600

(ix) Amount unpaid on final call =  (Rs.600–Rs.100) Rs.500

(B) ISSUE  OF  SHARES  FOR  CASH  AT  A  PREMIUM :

When shares are issued at a price higher than their nominal or face value, it is said to be issued at a premium.

The aggregate amount received as premium shall be transferred to an account called “Share Premium Account”. It is in the nature of a “Capital Reserve”. It cannot be distributed as a dividend in cash.

Application/Utilisation of Share Premium ACCOUNT:

The share premium account can be utilized/ applied in the manner prescribed in Section 78 as follows :

(a) For the issue of fully paid bonus shares

(b) For writing off the preliminary / formation expenses of the company.

(c) for writing off the (i) expenses or (ii) commission paid or (iii) discount allowed on any issue of shares or debentures of the company.

(d) For providing for the premium payable on the redemption of (i) redeemable preference shares or (ii) debentures of the company.

The accounting procedure for recording the premium on the issue of shares depends on the stage of its collection. Premium may be collected with application money or with allotment money.

Note: When nothing is mentioned, it is presumed to have been collected along with the allotment money.

I.   When it is collected along with application money.

(a) Bank A/c.                                                          Dr.

To share application A/c (Total amount received on the application including premium)

(Being application money received on.....shares @ Rs........each including premium of Rs.....)

(b) When the premium is transferred to share capital account along with application money.

Share application A/c.                                               Dr.

To share Capital

To share Premium A/c.

(Being application money on.....shares @Rs....... each transferred to share capital account and share premium account as per Director’s Resolution No.....dated......)

II.     When the premium is received along with allotment money: Here, the premium is included with the amount due on allotment. The following entry will be passed.

Share Allotment A/c.                               Dr.

To share capital A/c.

To share premium A/c.

(Being allotment money due on.....shares @Rs......each including premium Rs...... each as per Director’s Resolution No......date......)

CALLS-IN-ARREAR:

The amount which remains unpaid on the allotment and /or calls are called calls-in-arrear. When the shareholders fail to pay their dues on the allotment and /or calls, then the allotment account and calls account show a debit balance which is transferred to the calls-in-arrear account by means of the following entry:

Calls-in-Arrear A/c.                                              Dr.

To share allotment A/c.

To share call A/c.

(Being the amount unpaid on the allotment and call transferred to calls-in-arrear account)

If money is collected from such defaulting shareholders, then it is credited to calls-in-arrear accounts as follows:

Bank A/c.                                                                        Dr.

To calls-in-Arrear A/c

(Being the amount collected from defaulting shareholders)

Note: Call-in-Arrear is the amount called up by the company at the allotment or call but not paid by the Shareholder.

Whatever balance remains in the “Calls-in-Arrear Account” at the end of the year, is shown as a deduction from the share capital account on the liabilities side of the Balance sheet. The company can charge interest on the calls-in-arrear if there is a provision in the Articles of Association. However, the rate of interest cannot exceed 5% per annum. The interest on calls-in-arrear is credited to the profit and loss account as an income.
When shares are issued at a discount, the entry for discount is generally made along with the amount due on allotment. The entry will be revised as follows :

Share Allotment A/c.                                           Dr.

Discount on Issue of Shares A/c/                  Dr.

To share Capital A/c.

(Being allotment due on.......shares @Rs......each as per

Director’s Resolution No......dated.........)

Note. A separate account entitled “Discount on issue of Shares Account” is opened in the ledger the balance of which is shown under the head Miscellaneous Expenditure on the asset side of the Balance sheet.

The following entries are made in case of calls in advance.

(a)  For transferring excess application money

Share Application A/c.                            Dr

To Calls-in-Advance A/c.

(Being excess application money transferred to calls-in-advance account)

(b)  For Calls-in-advance received along with allotment money.

Bank A/c.                                                      Dr.

To call-in-Advance A/c.

(Being call money for.....shares@ Rs.....each received in advance)

(c)  For adjusting calls in advance with the calls (s)

Call-in-advance A/c. Dr.

To Call A/c.

(Being calls received in advance adjusted with call)

If it is necessary to provide interest on calls in advance, the entries will be made as follows :

(a)  For interest due.

Interest in calls-in-advance A/c..      Dr.

To shareholder A/c

(Being interest due on calls-in-advance@....%p.a.)

(b)  For payment of interest.

Shareholders A/c.                                                 Dr.

To bank A/c.

(Being interested on calls-in-advance paid)

(c)  For transferring interest on calls-in-advance to the profit and loss account.

Profit and Loss A/c.                                 Dr.

To Interest on Calls-in-Advance A/c.

(Being interest on calls-in-advance transferred to profit and loss account)

1. Concept & meaning, Different types of Debentures

CONCEPT & MEANING

An acknowledgment of a debt is called a debenture. In India, debentures and bonds are treated as same. The difference lies in its issuance. When it is issued by private companies, it is called debentures but when it is issued by government companies, it is called bonds. Debentures basically include debenture stock, bonds and any other securities of a company whether contributing a charge on the company’s assets or not.

The debenture holders are paid a fixed rate of interest on their investments. If the debentures are secured, then they are given priority over other creditors in terms of payment of interest.

DebentureA debenture is an acknowledgment of a debt. It is a source of long-term finance for the company. The debenture holders are treated as creditors of the company and are paid interest on their investment.

What Are Debentures?

The word ‘debenture’ is derived from the Latin word debate which refers to borrow. A debenture is a written tool acknowledging a debt under the general authentication of the enterprise. It comprises an agreement for repayment of principal after a specific period or at the option of the enterprise and for payment of interest at a fixed rate, usually either yearly on fixed dates. According to section 2(30) of The Companies Act, 2013 ‘Debenture’ comprises – Debenture Inventory, Bonds and any other securities of an enterprise whether comprising a charge on the assets of the enterprise or not.

Different Types of Debentures:

1. From the Point of view of Security

  • Secured Debentures: Secured debentures are the kind of debentures where a charge is being established on the properties or assets of the enterprise for the purpose of any payment. The charge might be either floating or fixed. The fixed charge is established against those assets which come under the enterprises possession for the purpose to use in activities not meant for sale whereas the floating charge comprises all assets excluding those accredited to the secured creditors. A fixed charge is established on a particular asset whereas a floating charge is on the general assets of the enterprise.
  • Unsecured Debentures: They do not have a particular charge on the assets of the enterprise. However, a floating charge may be established on these debentures by default. Usually, these types of debentures are not circulated.

2. From the Point of view of Tenure

  • Redeemable Debentures: These debentures are those debentures that are due on the cessation of the time frame either in a lump sum or in installments during the lifetime of the enterprise. Debentures can be reclaimed either at a premium or at par.
  • Irredeemable Debentures: These debentures are also called Perpetual Debentures as the company doesn’t give any attempt the repayment money acquired or borrowed by circulating such debentures. These debentures are repayable on the closing up of an enterprise or on the expiry (cessation) of a long period.

3. From the Point of view of Convertibility

  • Convertible Debentures: Debentures that are changeable to equity shares or in any other security either at the choice of the enterprise or the debenture holders are called convertible debentures. These debentures are either entirely convertible or partly changeable.
  • Non-Convertible Debentures: The debentures which can’t be changed into shares or in other securities are called Non-Convertible Debentures. Most debentures circulated by enterprises fall in this class.

4. From a Coupon Rate Point of view

  • Specific Coupon Rate Debentures: Such debentures are circulated with a mentioned rate of interest, and it is known as the coupon rate.
  • Zero-Coupon Rate Debentures: These debentures don’t normally carry a particular rate of interest. In order to restore the investors, such types of debentures are circulated at a considerable discount and the difference between the nominal value and the circulated price is treated as the amount of interest associated with the duration of the debentures.

5. From the view Point of Registration

  • Registered Debentures: These debentures are such debentures within which all details comprising addresses, names and particulars of holding of the debenture holders are filed in a register kept by the enterprise. Such debentures can be moved only by performing a normal transfer deed.
  • Bearer Debentures: These debentures are debentures that can be transferred by way of delivery and the company does not keep any record of the debenture holders Interest on debentures is paid to a person who produces the interest coupon attached to such debentures.

1. Meaning, The concept of DRR & DRI

Redemption of Debentures means repayment of the amount of debentures to the debenture holders. It implies the principal amount as well as interest due on debentures to the debenture holders. In other words, it refers to the discharge of liability on debentures in accordance with the terms of the issue.

 Journal entries at the time of redemption of debentures:

Redemption of Debentures at Par

Debentures A/C Dr

To Debentureholders’ A/C

(Being debentures due for redemption)

Debentureholders’A/C Dr

To Bank A/C

 (Being amount paid on redemption)

Redemption of Debentures at Premium

 Debentures A/C Dr

 Premium on Redemption of Debentures A/C Dr

To Debentureholders’A/C

(Being debentures due for redemption at a premium)

(b) Debentureholders’ A/C Dr

To Bank A/C

 (Being amount paid on redemption)

 TIME OF REDEMPTION

 Debentures are normally redeemed at the expiry of their time period by making payments to the debenture holders as per the term of issue.

AMOUNT OF REDEMPTION

The amount to be paid on the redemption of debentures depends upon the terms and conditions as stated in the debenture certificate.

THE CONCEPT OF DRR & DRI

Debenture Redemption Reserve (DRR) - According to section 71(4) of the Companies Act 2013 and the Securities and Exchange Board of India (SEBI) guidelines requiring the creation of a Debenture Redemption Reserve equivalent to at least 25% of the amount of debentures issued before redemption commences, it is not possible to redeem debentures purely out of capital. Hence, a Company cannot redeem its debentures purely out of capital. At least 25% of debentures issued must be redeemed out of profits by creating a “Debentures Redemption Reserve” and the balance of debentures issued may be redeemed out of profits or out of capital.

Conditions of Investing 15% of Debentures maturing during the year:

 As per Rule 18 (7) (C) of the Companies Rules 2014, every company required to create DRR shall before the 30th day of April of each year, deposit or invest, a sum which shall not be less than 15% of the amount of its debentures to be redeemed during the year ending on the 31st March of the next year. The amount so invested is known as Debenture Redemption Investment (DRI).

Journal entries:

For transfer of profit to Debenture Redemption Reserve

Surplus, i.e. Balance in Statement of Profit and Loss Dr

To Debenture Redemption Reserve A/C

 (Being profit equal to 25% of debentures transferred to DRR)

 For making an investment or deposits in specified securities

Debenture Redemption Investment A/C Dr

To Bank A/C

 (Being investment equal to 15% of debentures made in specified securities)

 At the time of redemption for encashment of Investment

 Bank A/C Dr

To Debenture Redemption Investment A/C

 (Being investment encashed consequent upon redemption of debentures)

 When all Debentures are redeemed

Debenture Redemption Reserve A/C Dr

 To General Reserve A/C

(Being DRR transferred to General Reserve)

1. Financial statement analysis of a company

TOOLS FOR FINANCIAL STATEMENT ANALYSIS:

1. Common Size Financial Statements

2. Trend Analysis

3. Comparative Financial Statements

4. Cash Flow Statement

5. Fund Flow Statement

6. Ratio Analysis

The distinction between Vertical and Horizontal Analysis of financial data.

What is the meaning of Analysis and Interpretation?

Analysis and interpretation is all about presenting financial data which is self-explanatory and easy to understand. It helps users of accounting information in assessing the status of financial performance of the business for a time period and enables them to take proper decisions regarding the fiscal policy of the firm.

Importance of Financial Analysis?

Financial statements such as Balance Sheets, Income sheets and other sources of financial data provide ample information on the various expenses and sources of profit, loss and income which is helpful in determining the financial status of a business. Financial data is not making any meaningful contribution until it is analyzed. There are various methods that help in analyzing financial statements and make it useful for various accounting users.

Following reasons are essential for financial analysis of accounts

1. It is very helpful in determining the financial viability and profit earning capacity of the firm.

2. It is helpful in evaluating the business solvency in the long term

3. It is useful in comparing the financial status of a firm in comparison to other competitor firms

3. Forfeiture of shares

FORFEITURE OF SHARES :

         Forfeiture means cancellation of share capital and membership of the shareholder of a company due to non-payment of premium or dues on allotment and/or calls. If some of the shareholders fail to pay their dues on the allotment and/or calls, the Board of Directors may forfeit such shares according to the provisions of the Articles of Association by passing a resolution to that effect.

Causes of Forfeiture: The shares may be forfeited due to :

(i) Non-payment of the allotment money.

(ii) Non-payment of the call money.

(iii) Non-payment of premium in case of issue of shares at a premium.

(iv) Non-payment of any other amount due from the shareholder.       

Effects of forfeitureWhen the shares are forfeited, it results in the following :

(i)  The holder of the shares ceases to be a member/shareholder of the company.

(ii) The amount paid to date is not refunded to the shareholder. It becomes the property of the company.

(iii) The share capital account is canceled to the extent called up to date.

(iv) The amount so forfeited is kept in a separate account called “Forfeited Share.

Account”. This account is added to the share capital account in the Balance Sheet.

(v) The share premium account is debited to the extent unpaid in case forfeited shares were issued at a premium.

(vi) The discount, if any, allowed at the time of issue is also canceled to the extent of shares forfeited by crediting to Discount on Issue of Shares A/c.

 

JOURNAL ENTRIES

(a) If the unpaid amount has not been transferred to the calls-in-arrear account.

Share Capital A/c                                                   Dr.

(i.e. No  of shares  forfeited × called up value per share) 

Share Premium A/c                                             Dr.

(Unpaid premium on forfeited shares)

To Share allotment A/c. (Unpaid amount on allotment)

To Share First Call A/c. (Unpaid amount on 1st call)

To Share Final Call A/c.  (Unpaid amount on final call)

To Discount on Issue of Shares A/c.

(Discount originally allowed on the issue of shares)

To Forfeited Shares A/c. (Amount received)

(Being the forfeiture of......Shares for non-payment of allotment/calls/premium as per Director’s Resolution No......dated......)

(b) If the unpaid amount has been transferred to the calls-in-arrear account.

Share Capital A/c.                                                Dr.

(No. of shares forfeited × called-up value per share)

Share Premium A/c.                                           Dr.

(Unpaid premium, if any)

To Call-in-Arrear A/c.                                           (Total amount unpaid)

To Discount on Issue of Shares A/c.                (Discount allowed if any)

To Forfeited Shares A/c.                                    (Amount received)

(Being forfeiture of.....shares for non-payment of dues as per Director’s Resolution No.... date......)

RE-ISSUE OF FORFEITED SHARES :

As we know that on forfeiture, the share capital is canceled and the defaulter ceases to be a member/shareholder of the company. It means such forfeited shares can be offered to a new shareholder at a new price. It is called the re-issue of forfeited shares.

The company can re-issue these forfeited shares at any price, i.e. at par, at a premium, or at a discount. But they are usually offered at a discount.

If forfeited shares are re-issued at a discount, then the company has to fulfill a condition. The condition is that the discount allowed at the time of re-issue cannot exceed the forfeited amount. In other words, the discount on re-issue must be less than the amount forfeited.

In case a part of the total shares forfeited is re-issued, then this condition must be satisfied for that part of shares re-issued.

For example, A company forfeited 300 shares of Rs.10 each, Rs.7 called up and the forfeited amount was Rs.600 (i.e. Rs.2 per share). It means the company can re-issue these shares at a maximum discount of Rs.2 per share i.e. at Rs.5 per share. The discount allowed on the re-issue of these shares cannot be more than Rs.600. If the company re-issued a part, say 100 shares, at a discount, then the discount on re-issue cannot be more than Rs.200 (i.e. 1/3 of Rs.600).

PROFIT ON RE-ISSUE:

If the discount on the re-issue of forfeited shares is less than the amount forfeited, then there is a profit. This profit is in the nature of capital profit. Hence, it is transferred to the “Capital Reserve Account”. The Capital Reserve Account is shown under the head“Reserves and Surplus” on the Liabilities side of the Balance Sheet.

For example: If 300 shares were re-issued at a discount of Rs.1.50 per share. The share forfeited account shows a balance of Rs.600. Then the capital profit of Rs.150 [i.e. Rs.600 – (300 shares × Rs.1.50)] is to be transferred to Capital Reserve Account.

The entry will be :

Forfeited shares A/c.                                     Dr.

To Capital Reserve A/c.

(Being the profit on re-issue transferred to capital reserve)

So we have the following four alternatives for the re-issue of forfeited shares.

JOURNAL :

1.    On Re-issue :

(a) If forfeited shares were re-issued at par.

Bank A/c.                                                                                             Dr.

To share capital A/c.

(Being the re-issue of....shares @Rs....each as per Director’s Resolution No.....dated.....)

(b)        If forfeited shares are re-issued at a premium.

Bank A/c.                                                                                             Dr. .......)

To Share Capital A/c.

To Share Premium A/c.

(Being the re-issue of.......shares @ Rs......each as per Director’s Resolution No.....dated

(c) If forfeited shares are re-issued at a discount.

Bank A/c.                                                                 Dr.          (Actual amount  received)

Forfeited Shares A/c.                                            Dr.          (Discount on re-issue)

To Share Capital A/c.                                 

(Being the re-issue of.....shares @  Rs....... each as per Director’s Resolution No.......dated)

(d) If shares originally issued at a discount are re-issued at a discount also :

Bank A/c.                                                                                         Dr.

Discount on Issue of Shares A/c.                                               Dr.          (Original Discount)

Forfeited Shares A/c.                                                                     Dr.          (Discount on re-issue)

To Share Capital A/c.

(Being the re-issue of......shares of Rs.........each @Rs......each as per  Director’s Resolution No.....dated......)

Note: Where a part of the forfeited shares are re-issued, the capital profit to be transferred to capital reserve may be calculated as Capital Reserve = (Forfeited amount per share – Discount on re-issue per share) × No. of shares re-issued.

FORFEITURE AND RE-ISSUE IN CASE OF PRO-RATA ALLOTMENT :

In such a case, it is essential to know the amount paid and not paid for recording the forfeiture of shares. In the case of categorized allotment and pro-rata allotment, it is, therefore, necessary to determine the number of shares applied by the defaulting shareholder on the basis of which the amount paid and not paid can be calculated. It means the excess amount adjusted at a particular stage of the issue can help to determine the net amount not paid at that stage.

 

D. ISSUE OF SHARES FOR CONSIDERATION OTHER THAN CASH :

Sometimes, a company can issue shares to buy various assets such as land, building, machinery etc. needed at the time of formation.

Sometimes, it may be necessary to issue shares to the promoters, lawyers, etc. for their services rendered in the formation of the company.

The consideration for such shares is not cash but it is other than cash i.e. assets or services. When such shares are issued, those are shown separately under the head “Issued Capital” on the liabilities side of the Balance Sheet with prior information to the Registrar of Companies.

(a) Where the shares are issued for the purchase of Assets

Assets A/c.                             Dr.

To Share Capital A/c.

(Being an issue of.....shares @Rs......each in exchange of assets purchased as per Director’s Resolution No......dated......)

(b) Where the Shares are issued to promoters

Goodwill A/c.

To share Capital A/c.

(Being an issue of......shares of Rs.......each to promoters as per agreement as per Director Resolution No.....dated.......)

SUMMARY OF JOURNAL ENTRIES

1. For application money received

Bank A/c.                                                       Dr.

To Share Application A/c.

2. For the transfer of application money

Share Application A/c.                             Dr.

To Share Capital A/c.

To Share Allotment A/c.

To Calls-in-advance A/c.

To Bank A/c.

3. For allotment money due

Share Allotment A/c.                                Dr.

Discount on Issue of Shares A/c.         Dr.

To Share Capital A/c.

To Share Premium A/c.

4. For allotment money received

Bank A/c.                                                       Dr.

To Share Allotment A/c.        

5. For call money due

Share Call A/c.                                             Dr.

To Share Capital A/c.

6. For adjustment of calls-in-advance

Calls-in-advance A/c.                               Dr.

To Share Call A/c.

7. For call money received

Bank A/c.                                                       Dr.

To Share Call A/c.

8. For the amount not received on allotment and calls

Calls-in-arrear A/c.                                    Dr

To Share Allotment A/c.

To Share Call A/c.

9. For the Calls-in-arrear received

Bank A/c.                                                       Dr.

To Calls-in-Arrear A/c.

10. For interest received on Calls-in arrear

Bank A/c.                                                       Dr.

To Interest on Calls-in-arrear A/c.

11. For Interest paid on Calls-in-Advance

Interest on Calls-in-Advance A/c.       Dr.

To Bank A/c

12. For the shares forfeited

Share capital A/c.                                       Dr.

Share Premium A/c.                                 Dr.

To Share Allotment A/c.                 

To Share Call A/c.

To Discount on Issue of Shares A/c

To Forfeited Shares A/c.

13. For the re-issue of forfeited shares

Bank A/c.                                                       Dr.

Discount on Issue of Shares A/c.             Dr.

Forfeited Shares A/c.                                Dr.

To Share Capital A/c.

To Share Premium A/c.

PREPARATION OF CASHBOOK :

In case of issue share for cash, all transactions are made through the bank. Hence, a cash book will be prepared taking bank columns only. It is debited with cash received at various stages of the issue and credited with the payment of cash in case of a refund. It is balanced to find out the net cash received from the issue of shares which is shown on the asset side of the Balance Sheet.

PRESENTATION IN THE BALANCE SHEET :

While preparing the Balance Sheet, the various components of the capital such as authorized capital, issued capital, subscribed capital, etc. are shown on the liabilities side of the Balance sheet under the head ‘share capital’ describing the number of shares and their amounts under each category. The balance of the share capital account in the ledger is put under the head “paid-up share capital” after deducting the amount of calls-in-arrear from subscribed capital. The amount of bank balance (in cash book) is shown under the head “current asset” on the asset side of the Balance Sheet. The calls-in-advance are shown under current liabilities till they are adjusted.

 

2. Issue of debentures at a discount

ISSUE OF DEBENTURES – JOURNAL ENTRIES

(A) Issue of Debenture for Cash:

The issuing procedure with regard to debentures is the same as that of shares. The amount due on debentures may be paid in installments, such as Applications, Allotments and Calls. When debentures are issued at premium, the amount of premium is credited to Debenture Premium Account. Debenture Premium Account is a capital profit and is transferred to Capital Reserve Account.

When debentures are issued at discount, the amount of discount is debited to ‘Discount on Issue of Debentures Account. The amount of discount should be shown on the asset side of the Balance Sheet, under the head ‘Miscellaneous Expenditure, until written off.

A company issued 1,000 10% debentures of Rs 100 each at par, payable Rs 40 on application and the balance on allotment. The public applied for 800 debentures. These applications were accepted. All money were received. Give journal entries.

Solution:

Illustration 2 (Issue of Debentures at Premium):

A company issued 10,000 9% Debentures of Rs. 100 each at a premium of Rs. 5, payable as follows:

On application Rs. 40 (including premium)

On allotment Rs. 65

All the Debentures were subscribed for and the money was duly received. Pass necessary journal entries.

Solution:

Illustration 3 (Issue of Debentures at Discount):

A company issued 5,000 13% Debentures of Rs. 100 each at a discount of 10% payable Rs. 25 on application. Rs. 40 on allotment and Rs. 25 on the first and final call account. The debentures were fully subscribed and the money due was duly received.

Solution:  

(B) Issue of Debentures for Consideration other than Cash:

Illustration 4:

X Ltd. acquired assets of Rs. 5,00,000 and took over the liabilities amounted to Rs. 50,000 at an agreed value of Rs. 4,00,000 of Y Ltd., issued 12% Debentures at a discount of 20% in full satisfaction of the purchase price. Show the entries.

Solution:

Illustration 5:

Prem Ltd. purchased assets from Ram Ltd. for a book value of Rs 1, 00,000 and liabilities worth Rs. 15,000 for a purchase consideration of Rs. 90,000. The two companies agreed to settle the purchase consideration by the issue of 13% debentures of Rs. 100 each.

Pass necessary journal entries in the books of Prem Ltd assuming that:

(a) Debentures are issued at par.

 (b) Debentures are issued at a 20% discount.

(c) Debentures are issued at 25% Premium. 

Solution:

B.. Issue of Debenture as Collateral Security:

A Company can issue debentures to serve as collateral security for a loan or for Bank Overdraft. Collateral security can be realized by its possessor if the original loan is not paid on the due date. Such Debentures are by nature a contingent liability against the issuing Company though they become a definite liability in the event of the breach of the agreement. The holder of such Debenture is not entitled to any interest. On the payment of the concerned loan, such Debenture reverts back to the Company.

There are two ways to deal with such an issue of Debenture in the books of accounts:

(A) No entry need be made in the books of accounts. However, a note is made in the Balance Sheet. For instance, Indian Limited secures an overdraft for Rs 1, 00,000 from the Bank by depositing Debentures worth Rs 1, 50,000 as collateral security.

This will appear in the Balance Sheet as follows:

Discount on Debentures:

The loss on issue of Debentures – Discount on Issue of Debentures or Premium Payable on Redemption – appears in the Balance Sheet. This is because they are losses – treated as Capital Losses. It is a fictitious asset that must be written off as early as possible.

There are two methods by which the loss or discount on the issue of Debenture Account is to be written off:

(a) Equal Annual Writing off of Debenture Discount:

When debentures are to be redeemed after a fixed period, say 5 years, then the amount of discount on the issue of debentures can be transferred to Profit and Loss Account by equal installments. For example, a Company issued 1,000 Debentures of Rs 100 each at a discount of Rs 2,000. Then the amount of discount to be transferred to Profit and Loss Account is Rs 400 i.e. 2,000/5.

(b) Writing off the Discount when Debentures are Paid Back by Instalments:

When the debentures are repaid by installments, the amount to be written off each year should be in proportion to the amount outstanding against debentures.

That is, the amount to be debited to Profit and Loss Account on the basis of calculation, based on outstanding debentures:

Illustration 6:

A Company issued Rs 1, 00,000 10% Debentures at 96%. The terms of issue provide the repayment of the debentures at the end of the 5th year. Show the amount of discount that should be written off in each of the five years.

 Rs. 800 to be written off against Profit and Loss Account i.e. equal annual installments. This is because each year has the benefit of the whole of the debentures.

Issue of Debentures With Terms of Redemption & Writing off the losses:

Debentures may be issued at par, at premium or at a discount. Further, the repayment of the Debentures i.e. its redemption may also be at par or at premium. The loss arising on account of the liability of premium payable on redemption is of the same nature as discount allowed at the time of issue.

The loss on account of premium payable on redemption should also be written off over the lifetime of the debenture and should be computed precisely the same way as the provision for writing off the discount. Debentures are issued with certain conditions at which redemption can be made. Conditions of redemption will be coupled with the conditions of issue.

Such terms and their journal entries are given below:

Illustration 7:

A Company issued Rs 5, 00,000 12% Debentures at 94%. The terms of the issue include the repayment of the debentures in five equal installments beginning with the end of the first year of the issue. Show the amount of discount that should be equitably written off in each of the five years.

Solution:

Discount on Debenture represents a loss of capital nature. It may not be possible to write off the entire loss against the Profit and Loss Account in the year in which the discount is allowed. As such the amount of discount is written off gradually over a number of years against Profit and Loss Account i.e. distributable profits. By doing so, the reported profits can be reduced otherwise it would be appropriated for dividends to shareholders and by the way, the cash can also be retained in the business.

Illustration 8:

The following illustrations explain the various possibilities:

Discount on Issue of Debenture is a capital loss and should be written off over a number of years against the Profit and Loss Account and in the meantime, it should be shown in the Balance Sheet to the extent not written off. Debentures are credited with the face value at the time of issue and the calculation of interest is always with reference to the face value.

Illustration 9:

Journalize the following transactions and also show how they appear in Balance Sheets:

(a) A Ltd. issued 5,000 10% Debentures of Rs. 100 each at a discount of 5% and redeemable at the end of 5 years at par.

(b) B Ltd. issued 5,000 12% Debentures of Rs. 100 each at par and redeemable at the end of 5 years at a premium of 5%.

(c) C Ltd. issued 5,000 14% Debentures of Rs. 100 at a discount of 5% and redeemable at the end of 5 years at a premium of 5%.

Solution:

An interest paid is an award to all the debenture holders for investing in the debentures of an enterprise. Usually, interest is paid in a periodical systematic manner at a fixed rate of interest on the face value of the debentures and is being treated as a charge on the profits.

Accounting Treatment for Interest on Debentures :

When interest is due and tax is deducted at source:

Interest on Debentures A/c     Dr.

To Debentureholders’ A/c       Cr.

To TDS Payable A/c                 Cr.

(Amount of interest due on debenture and tax deducted at source)

For payment of interest to debenture holders :

Debenture holders A/c   Dr.

To Bank A/c                     Cr.

(Amount of interest paid to debenture holders)

On transfer debenture Interest Account to the statement of Profit and Loss :

Statement of Profit and Loss        Dr.

To Interest on Debentures A/c    Cr.

(Debenture interest transferred to profit and loss A/c)

On payment of tax deducted at source to the Government :

TDS Payable A/c   Dr.

To Bank A/c           Cr.

(Payment of tax deducted at source on interest on debentures)

The loss or discount on the issue of debentures is typically a capital loss or a fictitious asset and, hence, has to be written-off during the debentures’ lifetime. The amount of loss or discount on issue of debentures has to be not be written-off during the year of its issue since the benefit of the debentures would accumulate to the enterprise till their restitution or redemption.

The loss or discount is, hence, considered as a capital loss. The discount might be charged to either Securities Premium A/c or might be written-off over three to five years via the statement of Profit and Loss as per guidance circulated by ICAI (The Institute of Chartered Accountants of India).

If there are no capital profits or if the capital profits are insufficient, the amount of such loss or discount can be written-off against the revenue profits each year by passing the below-mentioned journal entry :

Statement of Profit and Loss Dr.

To Discount/Loss on Issue of Debentures A/c

(Discount/loss on issue of debentures written-off)

There are two procedures, which can be accepted for writing off loss or discount on the issue of debentures against the revenue profits. They are as follows :

  • Fixed Instalment Method: When the debentures are recovered during the end of a particular period, the amount of the discount must be written off in equivalent installments of fixed amount over that time frame.
  • Fluctuating Instalment Method: When debentures are paid back in installments or by annual drawings, the discount must be written off in the ratio of debentures that is outstanding during the closure of each accounting year. The amount of the discount goes on reducing year by year, under this method. Hence, this method is referred to as Reducing Instalment Method.

2. Journal Entries, Methods of Redemption

METHODS OF REDEMPTION OF DEBENTURES

  1. Redemption of Debentures in Lump-sum at Maturity:

In this case, debentures are redeemed in one lump sum at the end of the stipulated period.

The basic accounting entries for the redemption of debentures are:

 

Debentures may be redeemed at par, at a premium or at a discount. When debentures are redeemed at par, the above two entries are passed. When debentures are redeemed at premium, the following accounting entries are passed.

 

It may be noted here that ‘premium on redemption of debentures a/c’ may have opened and credited at the time of issue of debentures. If so, then premium payable on redemption of debentures has only to be transferred to the debenture holder accounts as per the first entry. If it has not been opened earlier, it will be debited now and later closed by transferring it to securities premium a/c or profit and loss account.
Debentures may be redeemed at a discount though it is an unreal situation and not found in practice.
However, in such a case the following entries are passed:

Profit on redemption of debentures is a capital profit. It is used to write-off discount on the issue of debentures/shares; otherwise, it will be transferred to capital reserve. Debentures may be redeemed out of capital or out of profits. Prudent companies make arrangements for the redemption of debentures from the very beginning. They set aside a certain sum of money out of profits every year and invest an equivalent amount in first-class securities so that necessary funds are available for the redemption of debentures at the appropriate time.
For investing funds outside the business, the company may follow any of the following two methods are followed:

(a) Sinking fund method/debenture redemption fund method

(b) Insurance policy method

(a) Sinking Fund Method/Debenture Redemption Fund Method:

Under this method every year the company sets aside a certain part of profits and credits the same to the debenture redemption fund. To collect the required funds at the time of redemption, it invests the same in first-class securities. The interest earned in the investments is also invested when the debentures fall due for redemption; investments are sold and sale proceeds are utilized for redeeming the debentures.
Under this method, the following accounting entries are passed:

 

 Last year's entry for the purchase of investments will not be passed as investments are not purchasedInstead, entry for the sale of investment and redemption of debentures will be passed which are as follows:

For loss on the sale of investments, reverse entry will be passed. On redemption of debentures, the following entries will be passed.

 

The credit balance in DRF a/c will be transferred to a general reserve account. It may be noted here that profit on sales of investment which was earlier transferred to DRF account will be transferred to capital reserve from DRF, these facts are recorded by means of following accounting entry.

(b) Insurance policy method:              

Under this method, the company instead of purchasing investments takes an insurance policy for an amount that would be adequate for the redemption of debentures.

Accounting entries, under this method, are as follows:

First-year and subsequent years (including last year)

In the last year, when policy amount is realized and debentures are redeemed, the

following accounting entries are passed.

 

II. Redemption of Debentures by Draw of Lots:

Under this method, the company redeems debentures each year. The debentures to be redeemed are selected by the draw of lots. Accounting entries for the redemption of debentures are the same as passed in case debentures are redeemed out of profits.
They are as follows:

 

When all the debentures are redeemed, the balance in DRR account will be transferred to the general reserve.

III. Redemption of Debentures by purchasing them in the Open Market:
Sometimes the company purchases the debentures in the open market at its convenience and redeems them. The company may purchase the debentures at par or at a premium or at discount.
Accounting entries for the purchase of debentures at par will be as follows:

 

If the company purchases the debentures at a premium, the amount paid in excess of the face value will be debited to ‘loss on redemption of debentures which will be transferred to the profit and loss account and closed, and the entry will be

 

If the company pays a price that is less than the nominal value of the debentures, the company will make a profit. The entry will be

 

The concept of Own Debentures:
Sometimes the company may purchase its debentures from the market and, instead of canceling them, may keep them as investments. In such a case, the cost price of debentures purchased is debited to a new account known as ‘own debentures account’. Own debentures may be utilized for reissue when needed afterward.

Accounting entries for own debentures are:

 

On Cancellation of Own Debentures:
When the actual price paid on purchase of own debentures is less than the face value of debentures, there will be profit on the cancellation of own debentures.

Accounting entry will be:

 

However, if the price paid on its own debentures is more than the face value of debentures, the company will make a loss on cancellations of its own debentures.
Accounting entry will be as under:

 

Loss on cancellation of own debentures will be transferred to the P&L account.
IV. Redemption of Debentures by Conversion:
Sometimes a company redeems debentures by converting them into a new class of shares or debentures. If new debentures are issued in place of old debentures, the accounting entry will be

 

In case debentures are redeemed by converting them into equity shares, the entry will be

 

If the debentures are converted into equity shares at a premium the accounting entry will be

 

2. Comparative Statements & Common size statements

THE CONCEPT OF COMPARATIVE & COMMON SIZE STATEMENTS

What do you mean by Comparative Financial Statements?

These are the statements that help various users of accounting information in evaluating the financial progress of a firm in relative terms. These statements express the data in absolute figures or as percentage change and absolute change that occurs in the item of the financial statement over a period of time. The data presented in financial statements are self-explanatory and easy to understand. When items of the financial statement are treated with the same accounting policies and practices over a fixed period of time, then the comparative data derived from such statements bear meaningful comparisons.

Two common types are:

1. Comparative Income Statement

2. Comparative Balance Sheet

What do you mean by Common Size Statements?

Common Size Statements are those statements where the items are displayed as percentages of a common base figure instead of absolute figures. It is helpful for proper analysis between companies (inter-firm comparison) or between time periods of the same company (intra-firm comparison). In these statements, the relationship between items present in financial statements and common items like balance sheet total and net sales are highlighted in percentages. The analysis based on these statements is called as Vertical Analysis.

Two types are:

1. Common Size Income Statements

2. Common Size Balance Sheet

What are the different techniques of financial analysis and explain the limitations of financial analysis?

1. Cash Flow Analysis: This analysis focuses on the inflow and outflow of cash and cash equivalents from the various activities of a business name, investing, operating and financing activities during an accounting period. This helps in analyzing cash payments and reason of receipt and the respective changes in cash balances during the accounting year.

2. Ratio Analysis: This method highlights the relationship between items of Balance Sheet and Income Statements. It is helpful in determining the efficiency, profitability and solvency of a firm. This analysis expresses the financial items as fractions, percentages or proportions. Also, it determines the qualitative relationship among different financial variables. It also serves as a source of information regarding the performance, viability and financial position of a firm.

3. Trend Analysis: This technique studies the trends in operating performance and financial position of the business over a period of many years in succession. In such a study, any particular year is considered a base year and the rest years are expressed as a percentage of the base year’s figures. It helps in identifying problems and inefficiency along with detecting the operating efficiency and financial position of the firm.

4. Comparative Statements: These statements use figures from two accounting periods that help determine financial position and profitability. It also enables to do intra and inter-firm comparisons and therefore determines the efficiency of a firm in relative terms. It uses both percentages as well as absolute terms. This analysis is known as Horizontal analysis.

5. Common size Statements: Common Size Statements are those statements where the items are displayed as percentages of a common base figure instead of absolute figures. It is helpful for proper analysis between companies (inter-firm comparison) or between time periods of the same company (intra-firm comparison). In these statements, the relationship between items present in financial statements and common items like balance sheet total and net sales are highlighted in percentages. The analysis based on these statements is called as Vertical Analysis.

Explain the usefulness of trend percentages in interpretation of financial performance of a company.

Trend analysis is a form of analyzing financial data and it is expressed as a percentage for each year. It helps the accounting user in evaluating the financial performance of the business and also form an opinion of various tendencies by which businesses can predict future trends.

Importance of trend analysis:

1. Predicting of the trends of business which is forecasting of future trends in business.

2. Trends are expressed as percentages which is less time-consuming and easy to follow.

3. It becomes a popular financial analysis method due to trends being expressed in percentages which makes evaluating the financial performance and operating efficiency of the firm relatively simpler.

4. It presents a broader picture of the performance of company in terms of finance, viability and efficiency.

What is the importance of comparative statements? Illustrate your answer with particular reference to the comparative income statement.

Comparative statements have the following importance:

1. It presents financial data in a simple form, with year-wise data being presented in side by side fashion making the presentation neat and enabling intra and inter-firm comparisons more conclusive.

2. Presentation is very effective for drawing insights quickly and easily

3. It assists the management in drafting future plans and forecast trends which is achieved by analyzing the profitability and operating efficiency of a business over time.

4. Comparative analysis helps easy detection of problems. Early detection helps take corrective measures and align the business in meeting the desired target.

What do you understand by analysis and interpretation of financial statements? Discuss its importance.

Financial analysis is of great importance for the various users of accounting information. Financial statements such as Balance Sheets, Income sheets and other sources of financial data provide ample information on the various expenses and sources of profit, loss and income which is helpful in determining the financial status of a business. Financial data is not making any meaningful contribution until it is analyzed. There are various methods that help in analyzing financial statements and make it useful for various accounting users.

The following reasons are essential for performing financial analysis:

1. It is very helpful in determining the financial viability and profit earning capacity of the firm.

2. It is helpful in evaluating the solvency of the business in the long term

3. It is useful in comparing the financial status of a firm in comparison to other competitor firms

4. It helps management in decision making, drafting plans and also in establishing a robust and effective control mechanism.

Explain how common size statements are prepared giving an example.

Common size statements are of two types:

1. Common Size Income Statements

2. Common Size Balance Sheet

A common size statement is prepared as a columnar form for performing analysis. In such a statement each item of the available financial statement is compared to a common item. Such analysis is called as vertical analysis.

The following columns are present:

1. Particulars: It shows the various financial item under each respective heading

2. Amount Columns: Under these columns, the amount of each item is depicted along with sub-totals and the gross total of a particular year.

3. Percentage/Ratio Columns: Under these columns, the proportion of each item is shown as a percentage or ratio with reference to the common item.

It is prepared in the following two ways:

EXAMPLE

Working Note:

For example,

Numerical Questions

1. Following are the balance sheets of Alpha Ltd. as at March 31st, 2016 and 2017:

2. Following are the balance sheets of Beta Ltd. at March 31st, 2016 and 2017:

3. Prepare Comparative Income Statement from the following information:

Working Notes:

1. Calculation of Net Sales

Net Sales = Cost of Goods Sold + Gross Profit – Sales Return

or, Net Sales = Purchases + Manufacturing Expenses + Change in Inventory + Gross Profit – Sales Return

Net Sales (2016) = 80,000 + 20,000 +30,000 + 90,000 – 4,000 = ₹ 2, 16,000

Net Sales (2017) = 1, 40,000 + 50,000 – 60,000 – 30,000 – 80,000 = ₹ 92,000

2. Calculation of Finance Cost

Finance Cost = Interest on short-term loans + Interest on 10% Debentures

Finance Cost (2016) = 20,000 + 1,000 = ₹ 21,000

Finance Cost (2017) = 20,000 + 2,000 = ₹ 22,000

3. Calculation of Other Expenses

Other Expenses = Freight Outward + Carriage Outward + Loss on sale of office car

Other Expenses (2016) = 10,000 + 10,000 + 60,000 = ₹ 80,000

Other Expenses (2017) = 20,000 + 20,000 + 90,000 = ₹ 1, 30,000

4. Prepare a Comparative Income Statement from the following information:

*There is a misprint in the book, this should be 2, 00,000

Working Notes:

1. Calculation of Net Purchases and Change in Inventory

2. Calculation of Finance Cost

Finance Cost = Interest on Bank Overdraft + Interest on Debentures

Finance Cost (2016) = 5,000 + 20,000 = ₹ 25,000

Finance Cost (2017) = 0 + 20,000 = ₹ 20,000

3. Calculation of Other Expenses

Other Expenses = Carriage outward + other operating expenses

Other Expenses (2016) = 10,000 + 20,000 = ₹ 30,000

Other Expenses (2017) = 30,000 + 10,000 = ₹ 40,000

5. Prepare a Common size statement of profit and loss of Shefali Ltd. with the help of

following information:

Working Notes:

1. Calculation of expenses

Other Expenses = Indirect Expenses = % of Gross Profit

Gross Profit = Net Sales −- Revenue from Operations

For 2016, Gross Profit = ₹(6,00,000 −- 4,28,000) = ₹1,72,000

For 2017, Gross Profit = ₹(8,00,000 −- 7,28,000) = ₹72,000

2016=1,72,000×25%=₹43,000

2017=72,000×25%=₹18,000

2016=1, 72,000×25%=₹43,000

2017=72,000×25%=₹18,000

1. Meaning, objectives & preparation of Cash Flow as per AS- 3

MEANING –

A cash flow statement is a statement showing the changes in the financial position of a business concern during different intervals of time in terms of cash and cash equivalents.
The Revised Accounting Standard-3 has made it mandatory for all listed companies to prepare and present a cash flow statement along with other financial statements on annual basis.
Cash flows are inflows and outflows of cash and cash equivalent. It implies movement in and moves out of cash and cash equivalents. Receipt of cash from a non-cash item is termed as ‘cash inflow’, while cash payment in respect of such item is termed as ‘cash outflow’.

Cash comprises cash in hand and demand deposits with the bank.
Cash Equivalents Cash equivalents are ‘short-term highly liquid investments that are j readily convertible into known amount of cash and which are subjected to an insignificant risk of change in value’.


Objectives of Cash Flow Statement
(i) Useful in short-term financial planning.
(ii) Useful inefficient cash management.
(iii) Helpful in formulation of business policies.
(iv) Assists in preparation of cash budget.
(v) Used for assessment of cash flow from various activities, viz operating, investing and financing activities.

Limitations of Cash Flow Statement
(i) Based on the historical cost principle.
(ii) Based on secondary data.
(iii) Ignores non-cash transactions.
(iv) No adherence to basic accounting principles.
(v) Cash flow statement is not a substitute for an income statement.


PREPARATION OF CASH FLOW STATEMENT

In order to prepare a Cash Flow Statement, we need to classify the business activities into 3 categories. The classification is shown below

Classification of Business Activities Accounting Standard-3 (Revised)

  1. Cash flow from operating activities.
    (ii) Cash flow from investing activities.
    (iii) Cash flow from financing activities.

     
  • Cash Flow from Operating Activities Operating activities are the principal revenue-producing activities of the enterprise and other activities that are not investing or financing activities.
  • Cash Flow from Investing Activities As per AS-3, investing activities are the acquisition and disposal of long-term assets and other investments, not included in cash equivalents.
  • Cash Flow from Financing Activities Financing activities are the activities that result in a change in the size and composition of the owner’s capital (including preference share capital) and borrowings (including debentures) of the enterprise from other sources.

 

1. Liquidity Ratios

LIQUIDITY RATIOS

Ratio analysis is the quantitative interpretation of the company’s financial performance. It provides valuable information about the organization’s profitability, solvency, operational efficiency and liquidity positions as represented by the financial statements.

The following are the different types of ratios that are considered;

A liquidity ratio is a type of financial ratio used to determine a company’s ability to pay its short-term debt obligations. The metric helps determine if a company can use its current, or liquid, assets to cover its current liabilities 

Types of Liquidity Ratios

 1. Current Ratio

Current Ratio = Current Assets / Current Liabilities

The current ratio is the simplest liquidity ratio to calculate and interpret. Anyone can easily find the current assets and current liabilities line items on a company’s balance sheet. Divide current assets by current liabilities, and you will arrive at the current ratio. 

2. Quick Ratio

Quick Ratio = (Cash + Accounts Receivables + Marketable Securities) / Current Liabilities

The quick ratio is a stricter test of liquidity than the current ratio. Both are similar in the sense

that current assets is the numerator, and current liabilities is the denominator.

However, the quick ratio only considers certain current assets. It considers more liquid assets such as cash, accounts receivables, and marketable securities. It leaves out current assets such as inventory and prepaid expenses because the two are less liquid. So, the quick ratio is more of a true test of a company’s ability to cover its short-term obligations.

 3. Cash Ratio

Cash Ratio = (Cash + Marketable Securities) / Current Liabilities

The cash ratio takes the test of liquidity even further. This ratio only considers a company’s most liquid assets – cash and marketable securities. They are the assets that are most readily available to a company to pay short-term obligations.

In terms of how strict the tests of liquidity are, you can view the current ratio, quick ratio, and cash ratio as easy, medium, and hard.

Important Notes

Since the three ratios vary by what is used in the numerator of the equation, an acceptable ratio will differ between the three. It is logical because the cash ratio only considers cash and marketable securities in the numerator, whereas the current ratio considers all current assets.

Therefore, an acceptable current ratio will be higher than an acceptable quick ratio. Both will be higher than an acceptable cash ratio. For example, a company may have a current ratio of 3.9, a quick ratio of 1.9, and a cash ratio of 0.94. All three may be considered healthy by analysts and investors, depending on the company.

Importance of Liquidity Ratios

 1. Determine the ability to cover short-term obligations

Liquidity ratios are important to investors and creditors to determine if a company can cover their short-term obligations, and to what degree. A ratio of 1 is better than a ratio of less than 1, but it isn’t ideal.

Creditors and investors like to see higher liquidity ratios, such as 2 or 3. The higher the ratio is, the more likely a company is able to pay its short-term bills. A ratio of less than 1 means the company faces a negative working capital and can be experiencing a liquidity crisis.

2. Determine creditworthiness

Creditors analyze liquidity ratios when deciding whether or not they should extend credit to a company. They want to be sure that the company they lend to have the ability to pay them back. Any hint of financial instability may disqualify a company from obtaining loans.

Solvency ratios should not be confused with liquidity ratios. They are totally different. Liquidity ratios determine the capability of a business to manage its short-term liabilities while the solvency ratios are used to measure a company’s ability to pay long-term debts.

2. Adjustments relating to depreciation & amortization

 

3. Profit or loss on sale of assets including investments

TREATMENT OF PROFIT/ LOSS ON THE SALE OF ASSETS OR INVESTMENTS

In order to understand the concept of profit/loss on sale of assets or investments, we need to explore the concept of investment activity in more detail.

Investing activities can include:

  • Purchase of property plant, and equipment (PP&E), also known as Capital Expenditure
  • Proceeds from the sale of PP&E
  • Acquisitions of other businesses or companies
  • Proceeds from the sale of other businesses (divestitures)
  • Purchases of marketable securities (i.e., stocks, bonds, etc.)
  • Proceeds from the sale of marketable securities 

There are more items than just those listed above that can be included, and every company is different. The only sure way to know what’s included is to look at the balance sheet and analyze any differences between non-current assets over the two periods. Any changes in the values of these long-term assets (other than the impact of depreciation) mean there will be investing items to display on the cash flow statement.

 Cash Flow from Investing Activities Example

Let’s look at an example using Amazon’s 2017 financial statements.

Amazon’s investing activities include:

  • Outflow: purchase of PP&E including software and website development
  • Outflow: purchase of marketable securities
  • Outflow: acquisitions, net of cash acquired
  • Inflow: proceeds from the sale of property and equipment
  • Inflow: proceeds from the sale of marketable securities
  •  

Treatment - If the business sustains a loss from the sale of an asset, the amount so received from the sale appear in the cash flow statement & is added. The gain on the sale of assets is included in the net income, the gain is shown as a deduction from the net income reported in the operating activities section of the cash flow statement (under the indirect method).

2. Solvency Ratios, Activity Ratios

SOLVENCY RATIOS

The solvency ratio is calculated from the components of the balance sheet and income statement elements. Solvency ratios help in determining whether the organization is able to repay its long-term debt. It is very important for the investors to know about this ratio as it helps in knowing about the solvency of a company or an organization.

Let us see in detail the various types of solvency ratios.

1. Debt to equity ratio

Debt to equity is one of the most used debt solvency ratios. It is also represented as the D/E ratio. Debt to equity ratio is calculated by dividing a company’s total liabilities with the shareholder’s equity. These values are obtained from the balance sheet of the company’s financial statements.

It is an important metric that is used to evaluate a company’s financial leverage. This ratio helps understand if the shareholder’s equity has the ability to cover all the debts in case the business is experiencing a rough time.

It is represented as

Debt to equity ratio = Long-term debt / shareholder’s funds

Or

Debt to equity ratio = total liabilities / shareholders’ equity

A high debt-to-equity ratio is associated with a higher risk for the business as it indicates that the company is using debt for fuelling its growth. It also indicates lower solvency of the business.

2. Debt Ratio

calculated by taking the total liabilities and dividing it by total capital. If the debt ratio is higher, it represents the company is riskier.

The debt ratio is a financial ratio that is used in measuring a company’s financial leverage. It is

The long-term debts include bank loans, bonds payable, notes payable etc.

The debt ratio is represented as

Debt Ratio = Long Term Debt / Capital or Debt Ratio = Long Term Debt / Net Assets

Low debt to capital ratio is indicative of a business that is stable while a higher ratio casts doubt about a firm’s long-term stability. Trading on equity is possible with a higher ratio of debt to capital which helps generate more income for the shareholders of the company.

3. Proprietary Ratio or Equity Ratio

Proprietary ratios is also known as equity ratio. It establishes a relationship between the proprietor's funds and the net assets or capital.

It is expressed as

Equity Ratio = Shareholder’s funds / Capital or   Shareholder’s funds / Total Assets

4. Interest Coverage Ratio

The interest coverage ratio is used to determine whether the company is able to pay interest on the outstanding debt obligations. It is calculated by dividing the company’s EBIT (Earnings before interest and taxes) by the interest payment due on debts for the accounting period.

It is represented as

Interest coverage ratio = EBIT / interest on long term debt

Where EBIT = Earnings before interest and taxes or Net Profit before interest and tax.

A higher coverage ratio is better for the solvency of the business while a lower coverage ratio indicates a debt burden on the business.

ACTIVITY RATIOS

The role of activity ratio or turnover ratio is in the evaluation of the efficiency of a business by careful analysis of the inventories, fixed assets and accounts receivables.

Let us discuss the types of activity ratios.

Types of Activity Ratios

  1. Stock Turnover ratio or Inventory Turnover Ratio
  2. Debtors' Turnover ratio or Accounts Receivable Turnover Ratio
  3. Creditors Turnover ratio or Accounts Payable Turnover Ratio
  4. Working Capital turnover ratio.
  5. Investment Turnover Ratio

Stock Turnover Ratio

This is one of the most important turnover ratios which highlights the relationship between the inventory or stock in the business and the cost of the goods sold. It shows how fast the inventory gets cleared in an accounting period or in other words, the number of times the inventory or the stock gets sold or consumed. For this reason, it is also known as the inventory turnover ratio.

It is calculated by the following formula

Stock Turnover Ratio = Cost of Goods Sold / Average Inventory

A high stock turnover ratio is indicative of fast-moving goods in a company while a low stock turnover ratio indicates that goods are not getting sold and are being stored at warehouses for an extended period of time.

Debtor Turnover Ratio

This ratio is an important indicator of a company which shows how well a company is able to provide credit facilities to its customers and at the same time is also able to recover the due amount within the payment period.

It is also known as the accounts receivable turnover ratio as the payments for credit sales that will be received in the future are known as accounts receivables.

The formula for calculating the Debtor Turnover ratio is

Debtor Turnover Ratio = Credit Sales / Average Debtors

A higher ratio indicates that the credit policy of the company is sound, while a lower ratio shows a weak credit policy.

Creditors Turnover Ratio

The creditors turnover ratio is a measure of the capability of the company to pay off the amount for credit purchases successfully in an accounting period.

It shows the number of times the account payables are cleared by the company in an accounting period. For this reason, it is also known as the Accounts payable turnover ratio.

The formula for calculating creditors turnover ratio is

Creditors Turnover ratio = Net Credit Purchases / Average Creditors

Where average creditors are also known as average accounts payable.

A high ratio is indicative that a company is able to finance all the credit purchases and vice versa.

Working Capital Turnover Ratio

This ratio is helpful in determining the effectiveness with which a company is able to utilize its working capital for generating sales of its goods.

The formula for calculating the working capital turnover ratio is

Working capital turnover ratio = Sale or Costs of Goods Sold / Working Capital

If a company has a higher level of working capital it shows that the working capital of the business is utilized properly and on the other hand, a low working capital suggests that the business has too many debtors and the inventory is unused.

Investment Turnover Ratio or Net Asset Turnover Ratio

The investment Turnover Ratio is related to the sales taking place in the business and the net assets or the capital employed. It determines the ability of the business to generate sales revenue by the use of the net assets of the business. The ratio is calculated using the following formula

Investment Turnover Ratio = Net Sales/ Capital Employed

Importance of Activity Ratios

Activity ratios are very important indicators of the operating efficiency of the business. It also shows the way in which revenue is generated in a company and the way in which the elements of the balance sheet are utilized for managing the business.

Profitability ratios are a type of accounting ratio that helps in determining the financial performance of a business at the end of an accounting period. Profitability ratios show how well a company is able to make profits from its operations.

3. Profitability Ratios

PROFITABILITY RATIOS

The following are the types of profitability ratios discussed below

  1. Gross Profit Ratio
  2. Operating Ratio
  3. Operating Profit Ratio
  4. Net Profit Ratio
  5. Return on Investment (ROI)
  6. Return on Net Worth
  7. Earnings per share
  8. Book Value per share
  9. Dividend Payout Ratio
  10. Price Earnings Ratio

Gross Profit Ratio

The gross Profit Ratio is a profitability ratio that measures the relationship between the gross profit and net sales revenue. When it is expressed as a percentage, it is also known as the Gross Profit Margin.

The formula for Gross Profit ratio is

Gross Profit Ratio = Gross Profit/Net Revenue of Operations × 100 

A fluctuating gross profit ratio is indicative of inferior product or management practices.

Operating Ratio

 The operating ratio is calculated to determine the cost of operation in relation to the revenue earned from the operations.

The formula for the operating ratio is as follows

Operating Ratio      =       (Cost of Revenue from Operations + Operating Expenses)/

Net Revenue from Operations ×100

Operating Profit Ratio

The operating profit ratio is a type of profitability ratio that is used for determining the operating profit and net revenue generated from the operations. It is expressed as a percentage.

The formula for calculating the operating profit ratio is:

Operating Profit Ratio = Operating Profit/ Revenue from Operations × 100 

Or 

Operating Profit Ratio = 100 – Operating ratio 

Net Profit Ratio

The net profit ratio is an important profitability ratio that shows the relationship between net sales and net profit after tax. When expressed as a percentage, it is known as net profit margin.

The formula for the net profit ratio is

Net Profit Ratio = Net Profit after tax ÷ Net sales

Or

Net Profit Ratio = Net profit/Revenue from Operations × 100

It helps investors in determining whether the company’s management is able to generate profit from the sales and how well the operating costs and costs related to overhead are contained.

Return on Capital Employed (ROCE) or Return on Investment (ROI)

Return on capital employed (ROCE) or Return on Investment is a profitability ratio that measures how well a company is able to generate profits from its capital. It is an important ratio that is mostly used by investors while screening for companies to invest.

The formula for calculating Return on Capital Employed is :

ROCE or ROI = EBIT ÷ Capital Employed × 100

Where EBIT = Earnings before interest and taxes or Profit before interest and taxes

Capital Employed = Total Assets – Current Liabilities

Return on Net Worth

 This is also known as Return on shareholders' funds and is used for determining whether the investment done by the shareholders are able to generate profitable returns or not. 

It should always be higher than the return on investment which otherwise would indicate that the company funds are not utilized properly.

The formula for Return on Net Worth is calculated as :

Return on Shareholders’ Fund =  Profit after Tax / Shareholders’ Funds × 100

Or

Return on Net Worth = Profit after Tax / Shareholders’ Funds × 100

Earnings Per Share (EPS)

Earnings per share or EPS is a profitability ratio that measures the extent to which a company earns a profit. It is calculated by dividing the net profit earned by outstanding shares.

The formula for calculating EPS is:

Earnings per share = Net Profit ÷ Total no. of shares outstanding

Having higher EPS translates into more profitability for the company.

Book Value Per Share

Book value per share is referred to as the equity that is available to the common shareholders divided by the number of outstanding shares

Equity can be calculated by:

Equity funds = Shareholders funds – Preference share capital

The formula for calculating book value per share is:

Book Value per Share = (Shareholders’ Equity – Preferred Equity) / Total Outstanding Common Shares.

Dividend Payout Ratio

The dividend payout ratio calculates the amount paid to shareholders as dividends in relation to the amount of net income generated by the business.

It can be calculated as follows:

Dividend Payout Ratio (DPR): Dividends per share / Earnings per share

Price Earning Ratio

This is also known as P/E Ratio. It establishes a relationship between the stock (share) price of a company and the earnings per share. It is very helpful for investors as they will be more interested in knowing the profitability of the shares of the company and how much profitable it will be in the future.

The P/E ratio is calculated as follows:

P/E Ratio = Market value per share ÷ Earnings per share

It shows if the company’s stock is overvalued or undervalued.

Related Unit Name