Self Learning Material

Corporate Accounting -I
(BCOP 301)

Course: Bachelor of Commerce

Semester-III

Distance Education Programme

I.K. Gujral Punjab Technical University
Jalandhar
 Syllabus
OBJECTIVE AND EXPECTED OUTCOME OF THE COURSE:To develop students’ knowledge of
accountancy, particularly in relation to company accounts through a more in-depth and broader study of its contents.
UNIT I
Concept and Scope of Corporate Accounting; Share Capital and its types; Shares: Types, Issue, forfeiture and
re-issue of forfeited shares; Buy back of shares; Book building; Sweat equity; Employee stock option
scheme; Rights issue; Bonus shares; Redemption of preference shares.
UNIT II
Debentures: Types, issue and redemption of debentures; Underwriting of shares and debentures including firm
underwriting; Calculation of the liability of the underwriter; Sub- underwriting; Broker and brokerage;
Acquisition of business and Profit prior to incorporation.
UNIT III
Goodwill: Meaning; Types; Factors determining goodwill; Need for valuation of goodwill; Methods for the
valuation of goodwill. Valuation of shares: Need and methods.
UNIT IV
Preparation of final accounts of a corporate body as per the latest version of Schedule VI (Simple problems
only); Main difference between the old format and the new one; Notable corporate scandals with special
reference to India.
 Table of Content
Lesson Title Page
Number Number
1. Introduction to Corporate Accounting 1

2. Accounting for share capital Issue, forfeiture and 15

reissue of shares
3 Redemption Of Preference Shares and Buy Back 35
of Shares
4 Issue of Debentures 52
5 Redemption of Debentures 67
6 Underwriting of Shares and Debentures 87
7 Acquisition of business and Profit prior to 96
incorporation
8 Valuation of Goodwill 109
9 Valuation of Shares 121
10 Final accounts of Companies - I 135
11 Final accounts of Companies - II 151

Written By:
Dr.Kanwaldeep Bedi, Professor,
Hans Raj Mahila Maha Vidyalaya ,Jalandhar City

Reviewed By:
Dr.R.K.Gupta ,Head University School of Open Learning ,
Panjab University Chandigarh

© IK Gujral Punjab Technical University Jalandhar

All rights reserved with IK Gujral Punjab Technical University Jalandhar
 LESSON 1
INTRODUCTION TO CORPORATE ACCOUNTING

STRUCTURE

1.0 Objectives

1.1 Meaning of corporate accounting

1.2 Scope of corporate accounting
1.3 Meaning of shares and types of shares
1.4 Difference between equity shares and preference shares
1.5 Meaning of share capital and types of share capital
1.6 Sweat equity shares
1.7 Employees stock option scheme
1.8 Book building
1.9 Rights issue
1.10 Bonus issue
1.11 Summary
1.12 Suggested readings
1.13 Model questions

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1.0 OBJECTIVES
After reading this lesson, you should be able to:
 Understand the meaning and scope of corporate accounting
 Understand the meaning of share and its types
 Differentiate between equity shares and preference shares
 Understand the meaning of share capital and its types
 Know about sweat equity shares and their related legal provisions.
 Learn about Employees Stock Option Scheme
 Learn about book building
 Understand rights issue and valuation of rights
 Learn about bonus shares and the legal provisions related to bonus shares
 Understand accounting treatment of bonus shares

1.1 MEANING OF CORPORATE ACCOUNTING

Corporate accounting means recording, classifying, summarizing, and communicating the results of
financial transactions of company form of organisations. A company is an association of persons who
contribute money or money’s worth to a common stock and uses it for a common purpose. A company is
an artificial person, created by law, having a separate legal entity, common seal and perpetual succession.
Companies Act 2013 defines a company as “company formed and registered under this Act or an existing
company”.

CHARACTERISTICS OF A COMPANY

1. It is a voluntary association of persons.

2. It has a separate legal entity distinct from its members.
3. Since it is an artificial person created by law, it signs on official documents with a common seal.
4. It has a perpetual succession. Members may come amd members may go but the company goes
forever.

KINDS OF COMPANIES

 ON THE BASIS OF FORMATION

1. CHARTERED COMPANIES: Those companies which are incorporated under a Special

Charter by the king or sovereign such as East India Company.
2. STATUTORY COMPANIES: These companies are formed by the special Act of
legislature or parliament like banking companies, insurance companies.
3. REGISTERED COMPANIES: Such companies are incorporated under the Companies Act.

 ON THE BASIS OF LIABILITY

1. LIMITED COMPANIES: In these companies, the liability of each member is limited. A limited

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 company can be further classified as a company limited by shares or company limited by
guarantee.
2. COMPANY LIMITED BY SHARES: In this company, liability of its members is limited to the
extent of face value of shares held by them.
3. Company Limited by guarantee: In this company, the liability of its members is limited to the
amount they have undertaken to contribute to the assets of the company in the event of its
winding up.
4. UNLIMITED COMPANIES: In these companies, the liability of the members is unlimited and
members are personally liable to the creditors of the company for making up the deficiency. Such
companies are rare these days.

 ON THE BASIS OF OWNERSHIP

1. GOVERNMENT COMPANY: Government company is accompany in which atleast fifty one

percent of the share capital is held by either central government or state government or jointly by
both.
2. NON-GOVERNMENT COMPANY: A company which is not a government company is a non
government company. It can be a private company or a public company.
(i) Private Company: A private company is a company which has minimum paid up share
capital of Rupees 1,00,000 and which (i) Except a one person company, limits the
number of members to 200, (ii) prohibits the invitation to the public to subscribe for its
shares or debentures, and (iii) restricts the transferability of their shares.
(ii) One person Company: Companies Act, 2013 has introduced ONE PERSON
COMPANY in which there is only one member.
(iii) Public company: A company which is not a private company and which has minimum
paid up share capital of rupees five lakhs or more, is a public company.

 ON THE BASIS OF CONTROL

1. HOLDING COMPANY: Holding company is a company which holds all or more than fifty
percent shares in some other company.
2. SUBSIDIARY COMPANY: It is a company in which minimum fifty one percent of the shares
are held by some other company.

1.2 SCOPE OF CORPORATE ACCOUNTING

Corporate accounting includes recording, classifying and communicating the results of business
operations of companies to various stakeholders who need such information to take economic decisions.
It includes the following areas:

ACCOUNTING OF SHARE CAPITAL

Total capital of a company is divided into units of small denomination. One such unit is called a
share. As per Section 43 of the Companies Act, 2013, the shares of a company limited by shares can be
of two kinds only: equity shares and preference shares. Companies Act, 2013 regulates the issue and

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redemption of such shares. So corporate accounting includes the accounting and redemption of shares,
including bonus shares, rights shares.
ACCOUNTING OF DEBENTURES
The company can meet its requirement of finance by issue of debentures. Debenture is an
acknowledgement of debt by the company. Again, Companies Act has contained provisions in respect of
issue and redemption of such debentures in order to protect the interest of debenture holders. So corporate
accounting includes accounting treatment of issue and redemption of debentures.
ACCOUNTING FOR MERGERS AND ACQUISITIONS
Companies keep on acquiring rival companies in order to grow and expand. Accounting for such
mergers and acquisitions needs to carried out as per accounting standards formulates for this purpose.
ACCOUNTING OF BANKING COMPANIES
Banking companies are registered under Banking Companies Act. Their accounting has also been
prescribed under their statutes.
ACCOUNTING OF INSURANCE COMPANIES
Insurance companies are also registered under special acts of parliament which govern the
functioning and accounting of such companies.
PREPARATION OF FINANCIAL STATEMENTS
The preparation of financial statements of companies registered under Companies Act is prescribed
in the companies Act. Therefore, while preparing their financial statements, the prescribed format and
general instructions have to be followed.
CONSOLIDATED FINANCIAL STATEMENTS
Holding companies are required to present their financial statements for the group as a whole. This
necessitates combining the financial statements of its subsidiaries with the financial statements of the
holding company.
LIQUIDATION ACCOUNTS
Company is a legal entity created by law, therefore, its winding up takes place by the operation of
law. The closure of the books of accounts after the closure of business of the company
Is again a matter of legal and accounting concern which forms an integral part of corporate accounting.

1.3 MEANING OF SHARE

SHARE
Total capital of a company is divided into units of small denomination. One such unit is called a
share. According to Section 2 (84) of the Companies Act, 2013, ‘share’ means share in the share capital
of a company and includes stock except where a distinction between stock and share is expressed or
implied. Suppose a company has Rs. 8, 00,000 as share capital which is divided into 80,000 units, then
one unit is called a share and value of that unit is Rs.10.
CLASSES OF SHARES
As per Section 43 of the Companies Act, 2013, the shares of a company limited by shares can be of
two kinds only: equity shares and preference shares.
PREFERENCE SHARE

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 According to Section 43 of the Companies Act, 2013, a preference share carries both the following
preferential rights: –
(i) the payment of dividend at a fixed rate before any payment of equity dividend; and
(ii) the return of capital on winding up of the company before payment of equity capital.
If the Articles of the company so provide, the preference shareholders may also be given the following
rights in addition to the preferential rights mentioned above:
(a) To participate in the surplus profits remaining after the equity shareholders have received
dividend at a fixed rate.
(b) To receive premium on redemption of preference shares.
(c) To participate in the surplus remaining after the equity shares are redeemed in winding up.
(d) To receive arrears of dividend at the time of winding up.
(e) Preference shareholders have no voting rights except when dividend is outstanding for more
than two years.

EQUITY SHARE
A share which is not a preference share is an equity share. Equity shares do not carry any
preferential right in respect of dividend or repayment of capital. So these are known as ordinary shares.
There is no fixed rate of dividend to be paid on equity shares and this rate may vary from year to year. In
winding up, the equity capital is repaid last. However, equity shareholders get voting power.

TYPES OF PREFERENCE SHARES

The preference shares may be classified into following categories:
1. REDEEMABLE PREFERENCE SHARES: The shares which can be redeemed after a fixed
period or as desired by the company are called redeemable preference shares. According to Section 55(2)
of Companies Act, 2013 a company limited by shares can issue preference shares which would be
redeemed within a period not exceeding 20 years from the date of their issue.
2. IRREDEEMABLE PREFERENCE SHARES: Irredeemable preference shares are those which are
not to be redeemed unless the company goes into liquidation. As a result of Companies Act, 2013, no
company limited by shares can issue preference shares which are irredeemable or which are
redeemable after the expiry of 20 years from the date of its issue.

3. CUMULATIVE PREFERENCE SHARES: These are the shares on which dividend goes on
accumulating till it is fully paid off. The arrears of any year’s dividend are carried forward to coming
years till paid off. So when the company wants to pay any dividend to equity shareholders, it must first
pay arrears of such dividend to cumulative preference shareholders.
4. NON-CUMULATIVE PREFERENCE SHARES: Non-cumulative preference shares are those
shares on which the dividend does not go on accumulating. If dividend is not paid for any year, the right
to receive dividend for that year lapses.

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5. PARTICIPATING PREFERENCE SHARES: The holder of these shares are entitled to
(a) a fixed dividend, and
(b) a share in the surplus profits remaining after paying dividend to the equity shareholders up to a
specified rate.
(c) Participating preference shares may also be given the right to participate in the surplus of assets left
after paying equity shares in the event of winding up.

6. NON-PARTICIPATING PREFERENCE SHARES: These shares are entitled to only a fixed rate
of dividend. The holders of these shares do not carry any right to share in the surplus profits or surplus
assets of the company.

7. CONVERTIBLE PREFERENCE SHARES: A convertible preference share is one which can be

converted into an equity share within a specified period.
8. NON-CONVERTIBLE PREFERENCE SHARES: These are the shares which do not confer on
their holder a right of conversion into equity shares.

1.4 DISTINCTION BETWEEN EQUITY SHARES AND PREFERENCE SHARES

Basis of Preference Shares Equity Shares

Difference
1. Payment of Preference shares are paid dividend Dividend on equity shares are paid
Dividend before any dividend is paid on only after the payment of
equity shares. preferences dividend.
2. Repayment of In the event of winding up, Repayment of equity capital in
Capital preference shares are repaid before winding up is made only after the
the repayment of equity capital. repayment of preferential shares.
3. Rate of Dividend on preference share is The rate of dividend on equity
Dividend paid at a predetermined fixed rate. shares vary from year to year
depending on the availability of
divisible profits and future fund
requirements of the company.
4. Accumulation If the preference shares are The dividend on equity share is not
of Dividend cumulative, the dividend not paid in cumulative.
any year is accumulated till such
arrears of dividend are paid.
5.Convertability The preference shares may be An equity share is not convertible.
convertible to equity shares or new
preference shares or debentures.

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 6. Redemption Redeemable preference shares are Equity shares are generally issued
redeemed by the company on the for the entire life of the company
expiry of the stipulated period. but it may be bought back and
cancelled any time during the life of
company at its discretion.

1.5 MEANING OF SHARE CAPITAL

The sum total of the nominal value of shares of a company is called as share capital. The share capital of a
company can be:
Equity share capital: Capital raised through issue of equity shares is called equity share capital.
Preference share capital: Capital raised through preference shares is called preference share capital.
There are different terms used for share capitals which are discussed below:
1. AUTHORISED SHARE CAPITAL: It is the maximum amount of share capital which the
Memorandum of Association allows the company to issue. It is also termed as “Nominal” or
“Registered” capital.
2. ISSUED SHARE CAPITAL: Issued share capital refers to that part of authorised capital which
has actually been offered to the public for subscription. The difference between the authorised capital and
issued capital is called unissued capital.
3. SUBSCRIBED SHARE CAPITAL: It is that part of issued capital which is applied by the
public and subsequently allotted in shares by the company.
4. CALLED-UP SHARE CAPITAL: It is that part of the face value of the subscribed share capital
for which payment has been demanded by the company. The company need not call the whole of full
value at once. The amount can be called in installments from time to time. For example, if on 20,000
shares of ` 100 subscribed by the public ` 60 have been demanded, then called up capital will be `
12,00,000 i.e., (20,000  60).
If the full value of the shares is called up on application, then the subscribed capital and called up
capital will be the same.
5. PAID-UP SHARE CAPITAL: It refers to that portion of called-up capital which has actually
been paid by the shareholders. This is the actual capital of the company which is included in the total of
the Balance Sheet. That part of the capital which has not been received is called calls in arrears. Thus,
Paid-up capital = Called-up capital-Calls in arrear
6. RESERVE CAPITAL: It is that part of the uncalled capital which the company can call up only
in the event of its winding up. A limited company may, by a special resolution, determine that a portion
of its uncalled capital shall not be called up, except in the event of winding up.

Example
ABC Ltd. company has an authorised capital of ` 1,00,00,000 in shares of ` 100 each. It offered to the

public 60,000 shares. The public subscribed for 50,000 shares & duly allotted. ` 80 per share has been

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called up. All money received except the call of ` 20 on 4,000 shares. Give the various kinds of share
capital.
Solution
Authorised Capital `

1,00,000 shares of ` 100 each 1,00,00,000

Issued Capital :
60,000 shares of ` 100 each issued to public as fully paid 60,00,000

Subscribed Capital :
50,000 shares allotted to public @ `100 each 50,00,000

Called up Capital :
50,000 shares to public @ ` 80 each 40,00,000

Paid up Capital :
50,000 shares to public @ ` 80 called up 40,00,000

Less : Calls in arrear on 4,000 shares @ `` 20 each 80,000 39,20,000

1.6 SWEAT EQUITY SHARES

The sweat equity is a new equity instrument which is issued to reward directors and employees who
contribute intellectual property right to the company. As per Section 2(88) of the Companies Act, 2013,
Sweat Equity means equity shares issued by a company to its employees or directors at discount or for
consideration other than cash for providing know-how or making available rights in the nature of
intellectual property rights or value additions by whatever named called.
A company which is incorporated, formed and registered under the Companies Act, 2013 or any
previous Act can issue sweat equity shares. A subsidiary of such a company which is incorporated outside
India is also allowed to issue sweat equity.
Lock in period for Sweat equity shares issued to directors or employees is 3 years from the date of
allotment i. e. these shares cannot be transferred before the expiry of 3 years from the date of allotment.
CONDITIONS FOR ISSUING SWEAT EQUITY SHARES
According to Section 54 of Companies Act, 2013 a company may issue sweat equity shares if the
following conditions are fulfilled:
(a) Sweat equity shares to be issued should be of a class of shares already issued
(b) The issue of sweat equity shares is authorised by a resolution passed by the company in the
general meeting;
(b) The resolution should specify the number of shares to be issued, current market price,
consideration, if any, and the class or classes of directors or employees to whom such equity
share are to be issued.
(c) Not less than one year has elapsed since the date on which the company was entitled to
commence business; and

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 (d) The sweat equity shares are issued in accordance with the regulations made by the Securities
and Exchange Board of India in this behalf, in case of a listed company. However, in the case of
a company whose equity shares are not listed, the same must be issued in accordance with the
guidelines as may be prescribed.
MAXIMUM AMOUNT OF SWEAT EQUITY SHARES
The Company shall not issue sweat equity shares for more than 15% of the existing paid-up equity
share capital in a year or shares of the issue value of rupees five crores, whichever is higher. The issuance
of sweat equity shares in the company shall not exceed 25% of the paid-up equity capital of the company
at any time.

1.7 EMPLOYEES STOCK OPTION SCHEME (ESOS)

In order to encourage employees’ participation in the company, employee stock option
scheme has been introduced. This is an employee benefit plan which motivates the employee to
be the stakeholder of the company. Under this scheme, the company grants option to the whole
time directors, officers or employees of a company to apply for shares of the company at a pre-
determined price. The employee can exercise the option after expiry of vesting period which is
specified in the scheme.
‘Vesting period’ is the period during which the option cannot be exercised. Vesting
period acts as a motivation to the employee not to leave the company before exercising the
option. This is done so that employee does not leave the company. In case he leaves the company
before exercising the option, the option lapses. In case of death of employee during the period of
his employment in the company, the option can be exercised by the legal heirs of the employee.
The employee usually exercises the option if he finds the market price of the shares more than
the option price.
Suppose, a company offers on Ist April, 2012 the option to buy 500 shares of the
company at a price of Rs. 50 per share. Vesting period is 3 years. This means the employee can
buy the shares of the company on or after Ist April, 2015 if he finds the market price of the share
higher than Rs. 50 offered by the company.

CONDITIONS FOR ISSUE OF EMPLOYEE STOCK OPTIONS

A listed company is required to comply with Securities and Exchange Board of India
Employee Stock Option Scheme Guidelines. A company which is not listed on stock exchange
will have to comply with the requirements:
a) The issue of Employees Stock Option Scheme has been approved by the shareholders of
the company by passing a special resolution.
b) The company may by special resolution, vary the terms of ESOP not yet exercised by the
employees. The notice for passing special resolution for variation of terms of ESOP shall
disclose full details of the variation, the rationale therefore, and the details of the
employees who are beneficiaries of such variation.
c) There shall be a minimum period of one year between the grant of options and vesting of
option.

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 d) The company shall have the freedom to specify the lock-in period for the shares issued
pursuant to exercise of option.
e) The Employees shall not have right to receive any dividend or to vote or in any manner
enjoy the benefits of a shareholder in respect of option granted to them, till shares are
issued on exercise of option.
f) The amount, payable by the employees, at the time of grant of option may be forfeited by
the company if the option is not exercised by the employees within the exercise period; or
g) The option granted to employees shall not be transferable.

1.8 BOOK-BUILDING
Book building is a price discovery mechanism and has become a popular method of issuing capital.
It is a process used for marketing a public offer of equity shares of a company and is a common practice
in most developed countries. However, it is of recent origin for the Indian Capital Market. It has been
introduced by SEBI to provide for greater transparency in determination of price of securities being
issued.
In the book building process, the Lead Managers known as the Book Runner appointed by the
issuing company files prospectus and forms a syndicate of brokers, merchant bankers and other financial
institutions who in turn procure bids from the clients. The record of bids is then consolidated with
reference to number of shares, prices and list of bidders. On the basis of the careful evaluation of bids
received from the investors, the issue price is determined by the book runner and the issuing company.
The issue price is fixed after bid closing date. Once a price is determined, the applicants who have applied
at that price or a higher price are allotted shares at the price fixed for the issue.

1.9 RIGHTS ISSUE

When an existing company wants to raise additional capital through further issue of shares, it is
under a legal obligation to first offer the fresh issue of shares to the existing shareholders unless the
company has resolved otherwise by a special resolution. This right of the existing shareholders to apply
for the further issue of shares by the company is known as privileged subscription or right issue.
Section 62 of the Companies Act 2013 dealing with Rights Issue provides that when an existing
company wants to raise additional capital through further issue of shares, then :
(a) Such further shares must be offered to the existing holders of equity shares in the company in
proportion to the capital paid-up on those shares at the date of offer.
(b) A notice must be given to the existing shareholder specifying the number of shares offered.
(c) Minimum 15 days and maximum 30 days from the date of the offer must be given to accept the
offer. In case of private company, the time limit is minimum 7 days and maximum 15 days from
the date of offer.
(d) The notice must also inform the shareholders that if the offer is not accepted within the specified
time, it shall be deemed to have been declined.
(e) Unless the Articles of the company otherwise provide, the rights offer shall also give the right
to renounce the shares offered to him in favour of another person ; and this should be stated in
the notice.

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 (e) After the expiry of the time specified in the notice aforesaid or on receipt of earlier intimation
from the person to whom such notice is given that he declines to accept shares offered, the
Board of Directors may dispose them off in such a manner which is not disadvantageous to the
shareholders and the company.
Thus, the company is under legal obligation to first offer the further issue of shares to its existing
shareholders. But these holders are not liable to necessarily accept the offer. They have the options of
rejection and the renunciation.
In the earlier Companies Act, 1956, it was not necessary for a private company to issue shares on right
basis, however in Companies Act, 2013 even private companies have to issue further shares on right basis.

OBJECTIVES OR ADVANTAGES OF RIGHT SHARES

Issue of shares to existing shareholders on a preferential basis serves the following objectives :
1. It preserves the power of control of the present shareholders.
2. It prevents the loss to the existing shareholders on account of dilution of the value of their
shareholders because value of the shares is likely to fall with fresh issues. The decrease in the
value of the shares will be compensated by getting new shares at a price lower than the market
price.
3. The cost of raising capital (floatation cost) through rights issue is less as compared to the public
issue.
4. Issue of right shares has the positive impact on the shareholders. It depicts the future prosperity of
the company. It also shows the management’s concern towards its shareholders.
5. Rights issue avoids the misuse of position by the directors. It prevents them to issue further shares
to their friends and relatives.

VALUATION OF RIGHTS
Valuation of rights means the average gain made by the shareholder if he subscribes to the right
offer. It is important to note that the value of rights is calculated with reference to the market value of
shares. The following procedure is followed to value rights in terms of money:
(a) Calculate the market value of the shares held by a shareholder.
(b) Calculate the price of the new shares which is required to be paid to the company.
(c) Add the market value of shares held with the price of the new shares to ascertain the total price
of all the shares.
(d) Find out the average price (theoretical market price) of one share by dividing the total value of
all the shares by the number of shares.
(e) The value of right is calculated by deducting the average price of the shares from the market
value of the shares.

Example: A company offers 4 new shares for every 5 old shares as right to its shareholders. You are
required to calculate the value of the right if the market price of the share is ` 320. The company decides
to issue the new shares at a price of `180 per share.

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Solution : Computation of Value of Rights `
Market Value of 5 old share @ ` 320 each 1,600

Add : Price to be paid for acquiring 4 rights shares @ ` 180 each 720

Total Price for 9 shares 2,320

` 2,320
Average Price = = `25778
9
Values of Rights = Market Price – Average Price
= `320 – ` 25778 = `6222

1.10 BONUS SHARES

Bonus shares are the shares issued to existing shareholders of the company free of cost. When company
has huge amount of accumulated reserves which is much in excess of the needs of the company, it can
distribute the excess amount among the existing shareholders of the company as bonus shares. Issue of
bonus shares is a process of capitalization of reserves i.e. converting reserves into paid up share capital.

CONDITIONS OF BONUS ISSUE

Section 63 of the Companies Act, 2013 allows the companies to issue bonus shares only when the
following conditions are satisfied:
(i) The company’s Articles of Association permits issue of bonus shares.
(ii) The Board of Directors has recommended the bonus issue.
(iii) The proposal of the board of directors regarding bonus issue has been duly approved by the
shareholders in the annual general meeting.
(iii) The company has not defaulted in payment of interest or principal in respect of fixed deposits or
debt securities issued by it.
(iv) The company has not defaulted in respect of the payment of statutory dues of the employees,
such as, contribution to provident fund, gratuity and bonus.
(v) The party paid shares, if any outstanding on the date of allotment, are made fully paid-up.
(vi) Bonus issue once recommended by the Board cannot be withdrawn.
(vii) The declaration of bonus issue, in lieu of dividend, is not allowed.

SOURCES OF BONUS SHARES

Section 63 of the Companies Act, 2013 provides that a company can issue fully paid bonus shares
out of:
(a) its free reserves ;
(b) the securities premium account ; or
(c) the capital redemption reserve account
Section 63 provides that no issue of bonus shares shall be made by capitalising reserves created
by the revaluation of assets.

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ACCOUNTING TREATMENT OF BONUS SHARES

(a) When fully paid bonus shares are declared

Capital Redemption Reserve Account Dr.
Securities Premium Account Dr.
General Reserve Account . Dr.
Profit & Loss Account . Dr.
To Bonus to Equity Shareholders Account

(b) When fully paid bonus shares are issued

Bonus to Equity Shareholders Account Dr.
To Equity Share Capital Account

Example.
A company had the following balances in share capital and reserves as on March 31, 2014.
Share capital 1,00, 000 shares of Rs. 10 each ` 10,00,000

Security Premium ` 70,000

General Reserve ` 4, 50, 000

Revaluation Reserve ` 2, 70,000

The company passed a resolution for issue of 1 bonus share for every 4 shares held. Pass necessary
journal entries for the issue of bonus shares.
Solution
Journal
2014 ` `
Mar 31 Securities Premium Account Dr. 70,000
General Reserve Account Dr. 1,80.000
To Bonus to Shareholders Account 2,50,000
(Being declaration of bonus in the ratio of 1 shares for
every 4 held)
Mar 31 Bonus to Shareholders Account Dr. 2,50,000
To Equity Share Capital Account 2,50,000
(Being issue of 25,000 equity share of `10 each as
bonus)
Note: Students should note that revaluation reserve has not been used for issue of bonus shares as this is
not allowed under section 63 of the Companies Act, 2013.
No. of bonus shares= 1 for every 4; So against 100,000 shares, bonus shares issued are 25,000.

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1.11 SUMMARY
Corporate accounting means recording, classifying, summarizing, and communicating the results of
financial transactions of company form of organisations. Corporate accounting includes accounting for
companies registered under Companies Act or special acts of Parliament. It encompasses accounting for
share capital, debentures, mergers and acquisitions, accounting for holding companies etc. The shares of
a company limited by shares can be of two kinds only; equity shares and preference shares. Companies
can also issue sweat equity shares to its directors and employees. Employees can also be given options to
purchase shares under ESOS as an incentive to stay longer in the company. Shares can be issued at a fixed
price or price can be discovered through book building process. Whenever company wants to raise
additional capital through fresh issue of shares, it will have to first offer them to existing shareholders.
This is called Rights Issue. If accompany finds excess amount of accumulated reserves, it can capitalize
them by issuing bonus shares to the current equity shareholders.

1.12 SUGGESTED READINGS

 R. L. Gupta and Radhaswamy, Advanced Accountancy, Volume II, Sultan Chand and Sons, New
Delhi.
 Maheshwari and Maheshwari, Advanced Accountancy, Volume II, Vikas Publishing House, New
Delhi
 Shukla, Grewal and Gupta, Advanced Accounts, Volume II, S Chand and Company, New Delhi
 Tulsian, P.C., Corporate Accounting, Tata McGraw Hill Education Pvt. Ltd., New Delhi
1.13 ANSWER THE FOLLOWING QUESTIONS
1. What is corporate accounting? Discuss its scope.
2. Explain the meaning of different types of share capital.
3. State the legal requirements and accounting treatment of issue of bonus shares.
4. Explain different types of shares.
5. What do you mean by rights issue? How right is valued?
6. Explain briefly the provisions of Companies Act regarding Sweat Equity shares.
7. Discuss (i) Employees Stock Option Plan (ESOP) (ii) Book Building

Page 14 of 167
 LESSON 2
ACCOUNTING FOR SHARE CAPITAL
ISSUE, FORFEITURE AND REISSUE OF SHARES

STRUCTURE

2.0 Objectives

2.1 Legal procedure for issue of shares

2.2 Accounting treatment of issue of equity shares and preference shares

2.3 Legal provisions related to forfeiture of shares

2.4 Accounting treatment of forfeited shares

2.5 Summary

2.6 Suggested readings

2.7 Model questions

2.0 OBJECTIVES
After reading this lesson, you should be able to:
 Understand the legal procedure for issue of shares
 Understand the accounting treatment for issue of equity as well as preference shares
 Know about the journal entries on forfeiture of shares
 Understand the accounting treatment of reissue of shares
2.1 LEGAL PROCEDURE FOR ISSUE OF SHARES BY PUBLIC COMPANIES
In the case of public issue of shares by a company, the following procedure is adopted:
1. ISSUE OF PROSPECTUS: First of all, public company issues the prospectus inviting offers from the
public for the subscription or purchase of its shares. The prospectus contains the general information
about the company and details of the amount which the applicant has to pay as application and
allotment moneys.
2. APPLICATION FOR SHARES: In response to the issue of prospectus, applications for subscription
of shares are submitted by prospective shareholders to the company. The company has to keep the
amount of share application money in a scheduled bank under the name “Share Application Account.”
3. ALLOTMENT OF SHARES: After the last day fixed for receipt of share applications, the
directors of the company will process the applications and then allot shares to the applicants on some
scientific basis.

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 4. MAKING CALLS ON SHARES: The directors may call the entire nominal value of the shares
applied along with applications and allotment or may demand the amount in two or more installments
termed as first call, second call and so on. There can be maximum of three calls only.

ACCOUNTING TREATMENT FOR ISSUE OF SHARES

Shares are said to be issued at par when the issue price of the shares is equal to the face value of shares.
THE FOLLOWING JOURNAL ENTRIES ARE PASSED:

I ON RECEIPT OF APPLICATION MONEY

Bank Account Dr. With number of shares applied
To Share Application Account  application money per share

II ALLOTMENT OF SHARES
(a) After allotment, application money being a part of share capital is transferred to share
capital account by passing the following journal entry :
Share Application Account Dr. With the amount of application
To Share Capital Account money on allotted shares

(b) If additional amount is payable by shareholders on

allotment, then the entry will be :
Share Allotment Account Dr. Number of shares allotted
To Share Capital Account  allotment money per share

(c) Receipt of allotment money due.

Bank Account Dr.
To Share Allotment Account

(d) Refund of application money on rejected applications

when shares are over-subscribed :
Share Application Account Dr.
To Bank Account

Note: Students must note that the Board of Directors cannot allot shares more than the number of
shares offered to public in the prospectus even if it has received applications for a larger number.

III MAKING CALLS ON SHARES

(a) On making call money due :
Share First/Second/Third and Final Call Account Dr. Number of shares  call money

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 To Share Capital Account per shares

(b) Receipt of call money :

Bank Account Dr.
To Share First/Second/Third and Final Call Account
Note: Students must note that if the question requires the preparation of “Cash Book”, in that
case, ‘Bank’ transactions are not journalized, rather they are recorded in the “Cash Book” directly.

WHEN BOTH EQUITY AND PREFERENCE SHARES ARE ISSUED

When a company issues both type of share capital i.e. equity as well as preference, then it is
desirable that separate entries should be passed for equity shares and preference shares. The journal
entries as discussed earlier will be same for both types of shares except that the word “Equity” or
“Preference” is prefixed with equity and preference share capital respectively. Students must note that
it is customary to prefix the fixed rate of dividend with preference shares. This will be clear from the
following illustration.
Illustration 1
A company issued 25,000, 12% preference shares of ` 20 each payable as follows:

On application `8

On allotment `7

On First call `5

The company also issued 50,000 equity shares of ` 100 each payable as follows:

On application ` 30

On allotment ` 40

On First call ` 30
Applications were received for whole of preference shares and equity shares. All the money due on
shares was paid except the amount due on calls on 700 equity shares.
Show the cash book and journal entries.
Solution:
Journal

` `

1. 12% Preference Share Application Account ................ Dr. 2,00,000

To 12% Preference Share Capital Account 2,00,000
(Transfer of application money to 12% preference share capital

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 account)
2. Equity Share Application Account ............................... Dr. 15,00,000
To Equity Share Capital Account 15,00,000
(Transfer of equity share application money to equity share
capital account)
3. 12% Preference Share Allotment Account .................. Dr. 1,75,000
To 12% Preference Share Capital Account 1,75,000

(Amount due on allotment on 25,000 preference shares @ `7

each)
4. Equity Share Allotment Account.................................. Dr. 20,00,000
To Equity Share Capital Account 20,00,000

(Amount due on allotment on 50,000 Equity shares @`` 40

each)
5. 12% Preference Shares First and Final call Account .... Dr. 1,25,000
To 12% Preference Share Capital Account 1,25,000

(Amount due on call on 25,000 preference shares @ ` 5 each)

6. Equity Share First and final Call Account ..................... Dr. 15,00,000
To Equity Share capital Account 15,00,000

(Amount due on call on 30,000 equity shares @ ` 30 each)

Cash Book (Bank Column)

Particulars ` Particulars `
To 12% Preference Shares 2,00,000 By Balance c/d 54,79,000
Application Account
(Amount received on 25,000
shares @ each)
To Equity Share Application 15,00,000
Account
(Amount received on 50,000
shares @` 30 each)
To 12% Preference Share
Allotment Account 1,75,000
(Amount received on 25,000

Page 18 of 167
shares @` 7 each)
To Equity Share Allotment Account 20,00,000
(Amount received on 50,000
shares @ ` 40 each)
To 12% Preference Share First and
Final Call Account 1,25,000
(Amount received on 25,000
shares @ ` 5 each)
To Equity Shares First and final Call
Account 14,79,000
(Being amount received on 49,300
shares @ ` 30 each)
54,79,000 54,79,000

Note: Students must note that the entries recorded directly in “Cash Book” have not been
journalized.

UNDER-SUBSCRIPTION
A company may not receive applications for all the shares offered by it to the public. Thus
applications received for less number of shares than offered to the public is known as under-subscription.
In such a case, the company has to allot only that number of shares which have been actually applied by
the public.

OVER-SUBSCRIPTION
A company may receive applications for a larger number of shares than offered by it to the public for
subscription. Such a situation is termed as “over subscription”. For example, a company offers 5,000
shares to the public, but applications are received for 8,000 shares. There is ‘over subscription’ to the
extent of 3,000 shares. The company may treat the excess applications received in either of the following
ways:
(a) Rejection of Excess Applications: The company straight way rejects all the excess applications
received and full allotment is made to the balance of applicants. Application money has to be refunded
in full to unsuccessful applicants at the time of allotment.
(b) Allotment on Pro-rata Basis: Pro-rata allotment means that allotment is made to applicants on
a proportionate basis. In such a case, excess application money received is adjusted towards amount
due on allotment, on calls etc.

Illustration 2

Page 19 of 167
 X Ltd. was registered with an authorised capital of ` 10, 00,000 divided into 1, 00,000 shares of ` 10
each. Out of this, the company offered 60,000 shares to the public which were payable as to `2 per
share on application ; ` 4 per share each on allotment and the balance on first and final call. Applications
for 92,000 shares were received which were allotted as follows:
Applicants for 40,000 shares – Full
Applicants for 50,000 shares – 40%
Applicants for 2,000 shares – Nil
` 1, 72,000 were realized on account of allotment money (excluding the amount carried from
application money) and ` 2, 28,000 on first and final call.
Show the Journal entries recording the above.

Solution

Journal
Date Particulars L.F. ` `

Bank Account......................................................Dr. 1,84,000

To Share Application Account 1,84,000
(Being application money received for 92,000
shares )
Share Application Account ................................. Dr. 1,84,000
To Share Capital Account 1,20,000
To Share Allotment Account 60,000
To Bank Account 4,000
(Being the transfer of application money on 60,000
shares @ ` 2 per share to Share Capital Account,
surplus application money on 30,000 shares to
Share allotment Account and the refund on 2,000
shares)
Share Allotment Account ................................... Dr. 2,40,000
To Share Capital Account 2,40,000
(Being the allotment amount due on 60,000 shares
@ ` 4 per share)

Bank Account......................................................Dr. 1,72,000

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 To Share Allotment Account 1,72,000
(Being the amount received on allotment)
Share First and Final Call Account ......................Dr. 2,40,000
To Share Capital Account 2,40,000
(Being the first and final call amount due on 60,000
shares @ ` 4 per share)

Bank Account......................................................Dr. 2,28,000

To Share First and Final Call Account 2,28,000
(Being the amount received on first and final call
on 57,000 shares)

ISSUE OF SHARES AT A PREMIUM [SECTION 52]

Shares are said to be issued at premium when the issue price of shares is higher than the face value
(or par value) of the shares. For example, if a share of `50 is issued for ` 60, then ` 10 is the amount of
premium. Section 52 of the Companies Act 2013 provides that where a company issues securities at a
premium, a sum equal to the aggregate amount of premiums on those securities shall be transferred to
the Securities Premium Account. The amount of premium received represents capital profit and thus
Securities Premium Account must be shown separately on the liabilities side of balance sheet under the
head “Reserves and Surplus”.
As per recent guidelines issued by SEBI, a new company set up by entrepreneurs without a track
record, will not be permitted to issue capital to public at premium.

APPLICATION OF SECURITIES PREMIUM ACCOUNT

According to Section 52 of Companies Act, 2013 Securities Premium Account can be applied by the
company for:
(a) Issuing fully paid bonus shares to the members;
(b) Writing off the preliminary expenses of the company;
(c) Writing off the expenses or the commission paid or discount allowed on any issue of securities
or debentures of the company; or
(d) Providing for the premium payable on the redemption of any redeemable preference shares or
of any debentures of the company.
(e) Buying back its own shares or securities.
If the company wants to utilize the premium for any other purpose, it will have to obtain the consent
of the court.

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ACCOUNTING TREATMENT OF SECURITIES PREMIUM
CASE (A) IF PREMIUM AMOUNT IS COLLECTED AT THE TIME OF APPLICATION
(i) RECEIPT OF APPLICATION MONEY
Bank Account Dr. Amount
To Share Application Account Including
premium
(ii) TRANSFER OF APPLICATION MONEY
Share Application Account Dr.
To Share Capital Account (with nominal value)
To Securities Premium Account (with premium)

CASE (B) IF PREMIUM AMOUNT IS COLLECTED AT THE TIME OF ALLOTMENT

(i) ALLOTMENT MONEY DUE:
Share Allotment Account Dr.
To Share Capital Account (with nominal value)
To Securities Premium Account (with premium)

(ii) ALLOTMENT MONEY RECEIVED:

Bank Account Dr. Including
To Share Allotment Account premium
CASE (C) IF PREMIUM AMOUNT IS COLLECTED AT THE TIME OF A CALL
(i) CALL MONEY DUE
Share First/Second/Final Call Account Dr.
To Share Capital Account
To Securities Premium Account
(ii) CALL MONEY RECEIVED
Bank Account Dr. Includin
To Share First/Second/Final Call Account g
Premiu
ISSUE OF SHARES AT A DISCOUNT m
When shares are issued at a price lower than the face value, they are said to be issued at discount. For
example, if a share of ` 10 is issued at ` 9 then it is said to be issued at 10% discount. Section 53 the
Companies Act, 2013 prohibits issue of shares at discount except in case of sweat equity shares where
in shares are issued to employees in lieu of their services. Any shares issued by a company at a
discounted price shall be void.

Page 22 of 167
CALLS IN ARREARS
Some shareholders may not pay allotment money or call money within the date fixed for such
payment. The amount thus not paid is called “Calls in Arrears”. The company may accept late payment
of allotment money or call money with interest for late payment as per the provisions in this regard in
Articles. But if the Articles of Association is silent, Table F of the Companies Act, 2013 will apply which
states that a company can charge interest on all such Calls in Arrears from the last date fixed for
payment to the time of actual payment @10% per annum.

CALLS IN ADVANCE
When a company receives from shareholders the amount remaining unpaid on shares held by them
even though the amount has not been called up, the amount so received is called “calls-in-advance.” Such
a call-in- advance, according to Section 50 of Companies Act, 2013 can be accepted only when company
is so authorised by its Articles. If the company has adopted Table F, then it is required to pay interest
@12% per annum on such calls-in-advance from the date of receipt to the due date of call. The
shareholder is not entitled to any dividend on the amount paid as call-in-advance.

ACCOUNTING ENTRIES FOR CALLS IN ARREARS AND CALLS IN ADVANCE:

(i) When call money or allotment money is in arrears
Generally no entry is passed and entries for receipt of allotment money and call money is passed
with the amount actually received.

(ii) On receipt of unpaid allotment or call money on a later date

Bank Account Dr.
To Share Allotment Account/Share Call Account
(iii) Receiving interest on calls in arrears
Bank Account Dr.
To Interest on Calls in Arrears Account
(iv) On receipt of Call money in advance
Bank Account Dr. with amount of money
To Calls-in-Advance Account received in advance
(v) When calls are made and calls in advance is adjusted
Share Call Account Dr. (with net amount due)
Calls in Advance Account Dr. (with calls in advance)
To Share Capital Account (with total-amount due)
(vi) On payment of interest on calls-in-advance
Interest on Calls in Advance Account Dr.
To Bank Account

Page 23 of 167
Illustration 4
A limited company invited applications for 5,000 Equity shares of ` 100 each payable as follows:

On application ` 30

On allotment (Ist. April, 2014) ` 20

On Ist Call (Ist July, 2014) ` 30

On IInd call (Ist October, 2014) ` 20

All the shares were applied and allotted. A shareholder holding 200 shares paid the whole of the
amount due along with allotment. Another shareholder did not pay the allotment money on his 300 shares
but which he paid with first call. Directors have decided to adopt Table F. Journalise the transactions.
Solution
Journal
2014 ` `
? Bank Account ............................................................Dr. 1,50,000
To Equity Share Application Account 1,50,000
[Being application money received]
April 1 Equity Share Application Account.............................Dr. 1,50,000
To Equity Share Capital Account 1,50,000
[Being application money transferred to share capital on
allotment]
April 1 Equity Share Allotment Account...............................Dr. 1,00,000
To Equity Share Capital Account 1,00,000
[Being allotment money due]
April 1 Bank Account ............................................................Dr. 1,04,000
To Equity Share Allotment Account 94,000
To Calls in Advance Account 10,000
[Being allotment money received on 4,700 shares @ ` 20
each and calls in advance received on 200 shares @ ` 50
each]
July 1 Equity Share First Call Account ................................Dr. 1,50,000
To Equity Share Capital Account 1,50,000
[Being first call money due]
July 1 Bank Account ............................................................Dr. 1,44,000
Calls in Advance Account .......................................... Dr. 6,000
To Equity Share First Call Account 1,50,000

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 [Being first call money received on 4800 shares and calls in
advance on 200 shares @ ` 30 adjusted]
July 1 Bank Account ............................................................Dr. 6,000
To Equity Share Allotment Account 6,000
(Being allotment money received on 300 shares @ ` 20 per
share)
Oct. 1 Equity Share Second and Final Call Account ............ Dr. 1,00,000
To Equity Share Capital Account 1,00,000
[Being second and final call money due]

Oct. 1 Bank Account ............................................................Dr. 96,000

Calls in Advance Account ......................................... Dr. 4,000
To Equity Share Second and Final Call Account 1,00,000
[Being final call money received and calls in advance
adjusted]
Oct. 1 Bank Account ............................................................Dr. 150
To Interest on Calls in Arrears Account 150

[Being interest received on calls in arrears on ` 6,000 for 3

months @ 5% p.a]
Oct. 1 Interest on Calls in Advance Account .......................Dr. 420
To Bank Account 420
[Being Interest paid on calls in advance @ 6% p.a.]
Working Notes:
Calculation of Interest On Calls in Advance

On First Call in Advance of ` 6,000 for 3 month (Ist April to Ist July) @ 12% 180

On Second and Final Calls in Advance of ` 4,000 for 6 months (Ist April to Ist Oct.) @ 240
10%
Total Interest On Calls in Advance 420

2.3 FORFEITURE OF SHARES

A member is liable to pay the full issue price of his shares as and when called by the company. If a
member of the company does not pay the allotment or call money on the day fixed for payment thereof,
the Board may at any time thereafter, forfeit those shares and the amount received thereon. However,
the following conditions must be satisfied before the directors proceed to forfeit the shares:
(a) There should be a default by the shareholder in payment of a valid call.

Page 25 of 167
 (b) A notice must be served upon the shareholder to pay calls including interest and expenses
within the specified period. Atleast 14 days must be given to the defaulting shareholder to
pay the called money.
(c) The notice must mention that if the payment is not received within the specified period, the
shares would be forfeited.
(d) The power to forfeit shares must be expressly given by the company’s Articles of Association.
(e) The Board of Directors must pass a resolution for forfeiture of shares.
(f) The power to forfeit the shares must be exercised bonafide and in the interest of the
company.

The shareholder, whose shares have been forfeited, shall cease to be the member of the company.
He/she also loses whatever amount he has already paid to the company.

2.4 ACCOUNTING TREATMENT OF FORFEITURE OF SHARES

The amount already received from the defaulting shareholder stands forfeited, so the amount
forfeited is a gain to the company and is credited to a special account called “Share Forfeited Account”.

FORFEITURE OF SHARES ISSUED AT PAR

The journal entry in this case will be as follows:
Share Capital Account Dr. (With number of shares forfeited  Called up amount
per share).
To Unpaid Calls Account (With unpaid amount)
To Share Forfeited Account (With amount already paid by shareholders)
Note: Students must note that Share Capital Account is debited with called-up amount only and not
with the face value of shares. Face value is debited only if full face value has been called up

FORFEITURE OF SHARES ISSUED AT PREMIUM

(A) WHEN PREMIUM MONEY HAS NOT BEEN RECEIVED ON FORFEITED SHARES
In case Securities Premium money has not been received on the shares to be forfeited, then any
credit already given to “Securities Premium Account” at the time of making the allotment or call must be
cancelled at the time of forfeiture of shares by debiting “Securities Premium Account”.
The accounting entry will be as follows:
Share Capital Account Dr. (With number of shares forfeited  called up amount per
share) Securities Premium AccountDr. (With premium amount unpaid on shares forfeited)
To Shares Unpaid Call Account (With unpaid call)
To Shares Forfeited Account (With amount already paid)

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(B) WHEN PREMIUM MONEY HAS ALREADY BEEN RECEIVED ON FORFEITED SHARES
When premium money was duly received on the shares to be forfeited, then the “Securities
Premium Account” already credited at the time of making allotment or call will not be debited at the
time of forfeiture of shares.

Note: The accounting entry on forfeiture when the premium has already been received on
forfeited shares would be the same as the one passed in the case of forfeiture of shares
issued at par.

Illustration 5
ABC Limited issued shares of ` 10 each at a premium of `2 per share payable as ` 3 on application; ` 4
on allotment (including premium) ; `` 2 on first call and ` 3 on final call. Sunder, holder of 100 shares,
failed to pay the allotment money and first call. Binder, holder of 200 shares failed to pay the first call,
Their shares are forfeited after first call. Pass the journal entries of forfeiture.

Solution:
Journal Entries
Date Particulars Debit Credit

` `

Share Capital Account ............................................ Dr. 700

Securities Premium Account.................................. Dr. 200
To Share Allotment Account 400
To Share First Call Account 200
To Share Forfeiture Account 300
[Being forfeiture of 100 shares of Sunder for non
payment of allotment and first call]
Share Capital Account ............................................ Dr. 1,400
To Share First Call Account 400
To Share Forfeiture Account 1,000
Being forfeiture of 200 shares held by Binder for
non-payment of first call]

Note: Students are advised to note the difference between the two entries. In the first
case, the amount of premium is not received; hence the Securities Premium Account has
been debited. In the second case, the amount of premium has been realised, hence
FORFEITURE OF SHARES IN CASE OF PRO-RATA ALLOTMENT
Securities Premium Account is not debited.

Page 27 of 167
Illustration 6
AC Ltd. issued for public subscription 30,000 equity shares of ` 10 each at a premium of ` 2 per
share payable as under:
On Application ` 2 per share

On Allotment `5 per share (including premium)

On First Call ` 2 per share

On Second Call `3 per share

Applications were received for 50,000 equity shares. Allotment was made pro-rata to the
applicants for 40,000 shares and the remaining applications were rejected. Money overpaid on
application was applied towards sums due on allotment.
X to whom 750 shares were allotted failed to pay the allotment money and two calls. Y to whom
1,000 shares were allotted failed to pay the two calls. These shares were forfeited after the second call
was made.
Pass journal entries in the books of the company to record the above transactions.

Solution:
JOURNAL
Date Particulars L.F. Debit Credit
Amount Amount

(a) Bank Account ......................................................... Dr. 1,00,000

To Equity Share Application Account 1,00,000
(Being application money received on 50,000 equity
shares @ Rs. 2 each)
(b) Equity Share Application Account.......................... Dr. 1,00,000
To Equity Share Capital Account 60,000
To Equity Share Allotment Account 20,000
To Bank Account 20,000
(Being shares allotted and excess amount adjusted on
allotment and balance refunded to rejected
applicants for 10,000 shares)
(c) Equity Share Allotment Account ............................ Dr. 1,50,000
To Equity Share Capital Account 90,000
To Securities Premium Account 60,000
(Being allotment money due on 30,000 equity shares

Page 28 of 167
 @ Rs. 5 per share including Rs. 2 per share as
premium)
(d) Bank Account ......................................................... Dr. 1,26,750
To Equity Share Allotment Account 1,26,750
(Being allotment money received except on 750
shares hold by X)
(e) Equity Share First Call Account ............................. Dr. 60,000
To Equity Share Capital Account 60,000
(Being first call money due on 30,000 equity shares @
Rs. 2 per share)
(f ) Bank Account ......................................................... Dr. 56,500
To Equity Share First Call Account 56,500
(Being first call money received except on 1,750
shares hold by X and Y)
(g) Equity Share Second and Final Call Account .......... Dr. 90,000
To Equity Share Capital Account 90,000
(Being second and final call money due)
(h) Bank Account ......................................................... Dr. 84,750
To Equity Share Second and Final Call Account 84,750
(Being final call money received except on 1,750
shares held by X and Y)
(i) Equity Share Capital Account ................................. Dr. 17,500
Securities Premium Account .................................. Dr. 1,500
To Equity Share Allotment Account 3,250
To Equity Share First Call Account 3,500
To Equity Share Second and Final Call Account 5,250
To Share Forfeited Account 7,000
(Being shares of X and Y forfeited)

Working Notes
1. CALCULATION OF AMOUNT RECEIVED ON ALLOTMENT
`
Gross Allotment money due 1, 50,000
Less: Surplus application money adjusted on allotment 20,000
Net Allotment Money Due 1,30,000
Less: Allotment money unpaid by X:

Page 29 of 167
 Gross Allotment money due (750 shares @ ` 5) 3,750
Less: Excess Rs.2 per share received on 250 shares from X 500 3,250
Amount Received on Allotment 1,26,750
Shares Applied by X 1,000
 40,000 
 750  
 30,000 
Share Allotted 750
Excess Shares Applied 250

REISSUE OF FORFEITED SHARES

The Companies Act allows the reissue of forfeited shares subject to the provisions of the
Articles of Association. These shares may be issued at par or at premium or at a discount.
However, the maximum amount of discount on reissue cannot exceed the amount already
received from defaulting shareholders. In other words, there cannot be any loss on account of
reissue of forfeited shares.
NOTE: Reissue of forfeited shares is a sale of shares and it does not amount to allotment.
This implies that Section 53 of Companies Act, 2013 which prohibits issue of shares at a
discount will not be applicable on reissue of forfeited shares. Thus, reissue of forfeited shares
can be made a price lower than face price.

JOURNAL ENTRIES FOR REISSUE OF FORFEITED SHARES

CASE I: WHEN THE ENTIRE FORFEITED SHARES ARE REISSUED :
(i) ON REISSUE OF SHARES
Bank Account Dr.(with amount received on reissue)
Share Forfeited Account Dr.(with discount allowed on reissue)
To Share Capital Account (with paid up value of share)
To Securities Premium Account (if reissued at premium)
(ii)TRANSFER OF BALANCE IN SHARE FORFEITED ACCOUNT TO CAPITAL
RESERVE
ANY BALANCE LEFT IN SHARE FORFEITED ACCOUNT WILL BE TRANSFERRED TO CAPITAL RESERVE
ACCOUNT BECAUSE IT IS A PROFIT OF CAPITAL NATURE

Share Forfeited Account Dr. with net gain on

To Capital Reserve Account shares reissued

Page 30 of 167
CASE II: WHEN ONLY A PART OF FORFEITED SHARES ARE REISSUED
When only part of forfeited shares are reissued, only the proportionate amount representing
the net gain on the shares reissued should be transferred to Capital Reserve Account and the
balance representing the amount received on forfeited shares not yet reissued should be left in
the Shares Forfeited Account itself. This amount is shown as addition to the paid up capital on
the liabilities side of the balance sheet.

CALCULATION OF PROPORTIONATE AMOUNT TO BE TRANSFERRED TO CAPITAL RESERVE:

Step I: Calculate proportionate profit as :
Total Forfeited Amount
 Number of Shares Reissued
Total Shares Forfeited

Step II: Capital Reserve = Proportionate Profit – Discount on Reissue

Illustration 7
Give journal entries to record the forfeiture of shares and their reissue:
a. Z. Ltd. forfeited 100 shares of ` 100 each, `` 70 per share called up on which ` 50 per share has
been paid by Akash, the amount of first call of ` 20 per share being unpaid. The directors
reissued the forfeited shares to Shama crediting ` 70 per share paid for a payment of `50 per
share.
b. The directors of A Ltd. forfeited 500 shares of `50 each, `40 being called up, on which Rakesh,
a shareholder paid application and allotment money of ` 25 per share but did not pay first call
money of `15 per share. Of these forfeited shares, the company subsequently reissued 350
shares as fully paid up for ` 40 per share.

c. The directors of D. Ltd. forfeited 100 shares of `100 each, fully called up for non-payment of
final call money of ` 50 per share. Half of these shares were subsequently reissued at ` 120 per
share as fully paid.
d. Y. Ltd. forfeited 200 shares of ` 100 each (issued at a premium of 10%) for non-payment of
first call of `25 and final call of `15. Of these 150 shares were reissued for ` 90 per share.

Page 31 of 167
Solution
Journal Entries
` `
a) Share Capital Account (100  `70) .............................. Dr. 7,000

To Share Forfeited Account (100  `50) 5,000

To Share First Call Account (100  `20) 2,000

[Forfeiture of 100 shares of `100 each, ` 70 being called up

for non-payment of first call money at ` 20 per share]

Bank Account (100  `50)............................................ Dr. 5,000

Share Forfeited Account (100  `20)........................... Dr. 2,000

To Share Capital Account 7.000

[Reissue of 100 forfeited shares of ` 100 each, ` 70 paid up

at ` 50 per share]

Share Forfeited Account .............................................. Dr. 3,000

To Capital Reserve Account 3,000
[Being capital profit on reissue of forfeited shares
transferred to Capital reserve Account]
b) Share Capital Account (500  ` 40) .............................. Dr. 20,000

To Share Forfeited Account (500  ` 25) 12,500

To Share First Call Account (500 `15) 7,500

[Forfeiture of 500 shares of `50 each, ` 40 being called up

for non-payment of first call money of ` 15 per share]

Bank Account (350  ` 40)............................................ Dr. 14,000

Share Forfeited Account (350  ` 10)........................... Dr. 3,500

To Share Capital Account 17,500

[Reissue of 350 forfeited shares of ` 50 fully paid at ` 40

giving a discount of ` 10 per share]

Share Forfeited Account .............................................. Dr. 5,250

To Capital Reserve Account 5,250

Page 32 of 167
 [Transfer of capital profit proportionate to forfeited shares
reissued i.e., on 350 shares @ ` 15 each to Capital Reserve
Account]
c) Share Capital Account (100  ` 100) ............................ Dr. 10,000

To Share Forfeited Account 5,000

To Share Final Call Account 5,000

[Forfeiture of 100 shares at `100 called up for non-payment

of final call of ` 50 per share]

Bank Account ............................................................... Dr. 6,000

To Share Capital Account 5,000
To Securities Premium Account 1,000

[Reissue of 50 forfeited shares of ` 100 each at a premium of

` 20]

Share Forfeited Account .............................................. Dr. 2,500

To Capital Reserve Account 2,500
[Transfer of proportionate capital profit on reissue of
forfeited shares to Capital Reserve Account]
d) Share Capital Account (200  ` 100) ............................ Dr. 20,000

To Share First Call Account (200  ` 25) 5,000

To Share Second and Final Call Account (200  ` 15) 3,000

To Share Forfeited Account (200  ` 60) 12,000

[Forfeiture of 200 shares for non-payment of first call and

final call respectively]

Bank Account (150  ` 90)............................................ Dr. 13,500

Share Forfeited Account (150  ` 10)........................... Dr. 1,500

To Share Capital Account (150  `100) 15,000

[Reissue of forfeited shares of ` 100 each at ` 90 per share]

Share Forfeited Account (150  ` 50)........................... Dr. 7,500

To Capital Reserve Account 7,500

[Profit on reissue of shares transferred to Capital reserve

Page 33 of 167
 Account]

2.5 SUMMARY
A joint stock company can raise funds by issue of share capital. Share capital can be equity share capital
or preference share capital. Amount to be raised through share capital is based on the authorized
capital. A company firstly invites share applications with application money, then allots shares and
receives allotment money. Finally, calls are made for balance of the amount. Interest can be paid on
calls in advance and can be received on calls in arrears. In case of default in payment, shares can be
forfeited and reissued to someone else. Preference shares are generally issued for fixed period, after
which these are redeemed.

2.6 SUGGESTED READINGS/BOOKS:

 R. L. Gupta and Radhaswamy, Advanced Accountancy, Volume II, Sultan Chand and Sons, New
Delhi.
 Maheshwari and Maheshwari, Advanced Accountancy, Volume II, Vikas Publishing House, New
Delhi
 Shukla, Grewal and Gupta, Advanced Accounts, Volume II, S Chand and Company, New Delhi
 Tulsian, P.C., Corporate Accounting, Tata McGraw Hill Education Pvt. Ltd., New Delhi

2.7 ANSWER THE FOLLOWING QUESTIONS

1. Can a company issue shares at discount?
2. State the legal requirements and accounting treatment of issue of shares at premium.
3. How does a company deal in accounts with?
(i) Calls in arrears (ii) Calls in advance.
4. What do you mean by forfeiture of shares? Can forfeited shares be issued at a discount and to
what extent?
5. Explain briefly the provisions of Companies Act regarding the following:
(i) Forfeiture of shares (ii) Reissue of Forfeited shares
6. What is forfeiture of shares? What are the legal requirements necessarily followed by the Board
before forfeiture of shares? What are the effects of forfeiture? How forfeited shares can be
reissued? Show journal entries for recording forfeiture and reissue of forfeited shares.

Page 34 of 167
 LESSON 3
Redemption Of Preference Shares

and BUY BACK OF SHARES

STRUCTURE

3.0 Objectives

3.1 Legal provisions for redemption of preference shares

3.2 Accounting treatment of redemption of preference shares

3.3 Legal provisions regarding buy back of shares

3.4 Accounting treatment for buy back of shares

3.5 Summary

3.6 Suggested readings

3.7 Model questions

3.0 OBJECTIVES
After reading this lesson, you should be able to:
 Understand the legal procedure for redemption of preference shares
 Understand the accounting treatment for redemption of preference shares
 Learn about the meaning of buy back of shares
 Understand the accounting treatment of buy back of shares

INTRODUCTION
Redemption of preference shares means repayment of capital to the preference shareholders.
Section 55 of Companies Act, 2013 provides that a company limited by shares has the power to issue
Redeemable Preference Shares provided it is so authorised by its Articles. Such shares can be redeemed
either at the option of the company or after the expiry of the fixed period of time stipulated at the time
of issue. The period of redemption, however, cannot exceed 20 years from the date of issue of such
shares. However, a company engaged in the setting up and dealing with of infrastructural projects may
issue preference shares for a period exceeding twenty years but not exceeding thirty years.

Page 35 of 167
3.1 LEGAL PROVISIONS REGARDING REDEMPTION OF PREFERENCE SHARES
Section 55 of the Companies Act, 2013 prescribes the following legal restrictions with regard to the
redemption of preference shares:
(a) Shares can be redeemed out of :
(i) out of profits of the company which would otherwise be available for dividend, or
(ii) out of the proceeds of a fresh issue of shares made for the purpose of redemption,or
(iii) partly out of profits and partly out of fresh issue of shares.
(b) Only fully paid preference shares can be redeemed. If they are partly paid, then first of final call
should be made to make them fully paid.
(c) If they are to be redeemed at premium, then such premium must be provided for out of the
profits of the company or out of the security premium account.
(d) If such shares are redeemed out of profits, then a sum equal to the nominal amount of the
shares so redeemed must be transferred out of the profits of the company to a reserve called “Capital
Redemption Reserve Account”.
(e) The Capital Redemption Reserve Account can only be used for the purpose of issue of fully paid
bonus shares. Otherwise, capital redemption reserve account must be maintained intact unless
otherwise sanctioned by the court.

INTERPRETATION OF “PROCEEDS OF A FRESH ISSUE”

The term proceeds of a fresh issue of shares has not been defined in Section 55 or elsewhere in the
Companies Act. Consensus view upon this point is that nominal value shall constitute proceeds when
new shares are issued at premium or at par.

PROFITS THAT CAN BE USED FOR REDEMPTION

Since Section 55 permits the redemption of preference shares out of profits which would
otherwise be available for dividend, hence Capital Redemption Reserve Account must be created only
out of such divisible profits. The following table gives some instances of profits which are available for
redemption and which are not available for redemption:

Profits available for Redemption Profits not available for Redemption

1. General Reserve 1. Security Premium Account
2. Reserve Fund 2. Share Forfeited Account
3. Profit & Loss Account (credit) 3. Profits Prior to Incorporation
4. Dividend Equalization Fund 4. Capital Reserve
5. Insurance Fund
6. Workmen Compensation Fund (if there is
no specific liability)

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7. Workmen Accident Fund (if there is no
specific liability)
8. Voluntary Debenture Sinking Fund
9. Debenture Redemption Reserve
10. Investment Reserve

AMOUNT TO BE CREDITED TO CAPITAL REDEMPTION RESERVE ACCOUNT

The amount to be credited to Capital Redemption Reserve Account is arrived as follows:
(a) When the redeemable preference shares are redeemed wholly out of profits:
Capital Redemption Reserve Account = Nominal value of redeemable preference shares so
redeemed.
(b) When the redeemable preference shares are redeemed partly out of profits and partly out of
proceeds of fresh issue of shares:
In such a case, Capital Redemption Reserve Account= Nominal value of redeemable preference
shares redeemed- Nominal value of fresh issue of shares

3.2 ACCOUNTING TREATMENT ON REDEMPTION OF PREFERENCE SHARES

The following accounting procedure is followed on redemption of preference shares:
1. MAKING PREFERENCE SHARES FULLY PAID:
If preference shares which are to be redeemed are partly paid, then following entries are passed to
make them fully paid:
(a) MAKING FINAL CALL ON PREFERENCE SHARES
Preference Shares Final Call Account Dr.
To Redeemable Preference Share Capital Account
(b) RECEIPT OF FINAL CALL MONEY
Bank Account Dr.
To Preference Share Final Call Account
2. ENTRY FOR FRESH ISSUE OF SHARES
Bank Account Dr. (with actual amount received)
To Share Capital Account (with nominal value)
To Security Premium Account (if issued at premium)

3. TRANSFER OF PREMIUM ON REDEMPTION ACCOUNT

Security Premium Account Dr.
General Reserve Account Dr.
Profit & Loss Account Dr.
To Premium on Redemption of Preference Shares Account

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4. TRANSFER TO CAPITAL REDEMPTION RESERVE ACCOUNT
If whole or some of the preference shares are redeemed out of profit, then as per law, an amount
equal to face value of shares so redeemed will be transferred to capital redemption reserve account from
divisible profits. The journal entry will be
Profit & Loss Account Dr.
General Reserve Account Dr.
Dividend Equalisation Reserve Account etc. Dr.
To Capital Redemption Reserve Account

5. SALE OF ASSET TO PROVIDE CASH FOR REDEMPTION

If sufficient cash or bank balance is not available for making payment to preference shareholders,
then some assets can be sold to arrange funds for redemption. The requisite journal entry will be
Bank Account Dr.
To Concerned Asset Account (With book value of asset)
To Profit & Loss Account (Selling Price-book value)
Note: If asset is sold at a loss then such loss will be debited to Profit & Loss Account.

6. ENTRY FOR AMOUNT DUE TO PREFERENCE SHAREHOLDERS

Redeemable Preference Share Capital Account Dr. (with nominal value)
Premium on Redemption of Preference Shares Account Dr. (with the premium)
To Preference Shareholders Account (with total amount due)
7. PAYMENT TO PREFERENCE SHAREHOLDERS
Preference Shareholders Account Dr.
To Bank Account

8. DECLARATION OF BONUS SHARES

(a) When fully paid bonus shares are declared
Capital Redemption Reserve Account Dr.
Securities Premium Account Dr.
Profit & Loss Account/ General Reserve Account etc. Dr.
To Bonus to Equity Shareholders Account
(b) When fully paid bonus shares are issued
Bonus to Equity Shareholders Account Dr.
To Equity Share Capital Account

Page 38 of 167
Illustration 1
A company has 25,000, 11% redeemable preference shares of ` 100 each, fully paid. The company
now decides to redeem the shares at a premium of 20 per cent. The company makes the following issues
of shares and debentures:–
(a) 10,000 equity shares of ` 100 each at a premium of 10 per cent.

(b) 8,000, 12 % debentures of ` 100 each.

The issue was fully subscribed and the entire amount was received. The redemption was duly
carried out. The company has sufficient profits. Give journal entries.
Solution:
Journal
Date Particulars Dr. Cr.

` `
1. Bank Account..................................................................Dr. 11,00,000
To Equity Share Capital Account 10,00,000
To Securities Premium Account 1,00,000
[Being fresh issue of equity shares at a premium]
2. Bank Account..................................................................Dr. 8,00,000
To 12% Debentures Account 8,00,000

[Being issue of 8,000, 12% Debentures of ` 100 each]

3. Securities Premium Account ..........................................Dr. 1,00,000
Profit & Loss Account .....................................................Dr. 4,00,000
To Premium on Redemption of Preference Shares 15,00,000
Account
[Being premium on redemption provided out of Securities
Premium Account & Profit & Loss Account]
4. Profit & Loss Account .....................................................Dr. 15,00,000
To Capital Redemption Reserve Account 15,00,000
[Being nominal value of shares redeemed out profit
transferred to capital redemption reserve account]
5. 11% Redeemable Preference Share Capital Account.....Dr. 25,00,000
Premium on Redemption of Preference Shares AccountDr. 5,00,000
To Preference Shareholders Account 30,00,000
[Being amount due to preference shareholders @ 20%
premium]

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6. Preference Shareholders Account..................................Dr. 30,00,000
To Bank Account 30,00,000
[Being amount due to preference shareholder paid].
Note: Since proceeds from issue of debentures cannot be used for redemption of preference
shares, hence only proceeds from issue of equity shares are used for redemption & the balance
amount of preference shares are redeemed out of profit.

Illustration 2
Markanda Ltd. had as part of its share capital 40,000, 12% Redeemable Preference shares of ` 25
each fully paid up to be redeemable at a premium of 8%. When the shares become due for redemption,
the company had ` 6,00,000 in the reserve fund. The company issued necessary equity shares of ` 10
specifically for the purpose of redemption and received cash in full. The redeemable preference shares
were then paid out of the new issue, the balance being met from the reserve fund.
Make necessary journal entries recording the above transactions.

Solution
Journal

` `

(a) Reserve Fund Account Dr. 80,000

To Premium on Redemption of Preference Shares 80,000
[Being use of reserve fund to provide premium on
redemption of preference shares.]
(b) Reserve Fund Account Dr. 5,20,000
To Capital Redemption Reserve Account 5,20,000

[Being transfer of ` 5,20,000 from reserve fund to capital

redemption reserve being redemption out of profit]
(c) Bank Account Dr. 4,80,000
To Equity Share Capital Account 4,80,000

[Being issue of 48,000 shares of ` 10 each fully paid]

(d) 12% Redeemable Preference Share Capital Dr. 10,00,000

Premium on Redemption of Preference Shares Dr. 80,000
To Redeemable Preference Shareholders Account 10,80,000

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 [Being amount due on redemption]
(e) Redemption Preference Shareholders Account Dr. 10,80,000
To Bank Account 10,80,000
[Being redemption of preference shares]

Working Notes:
Calculation of amount and number of fresh shares to be issued

Amount of redeemable preference shares 10,00000

Less : Amount available in reserve fund (after adjusting premium on 5,20,000
redemption)
Balance amount to be collected from the fresh issue of shares 4,80,000

Amount Required ` 4,80,000

Number of Shares to be issued = =
Issue Price per Share ` 10

= 48,000
Illustration 3
The following is the Balance Sheet of B Limited as at 31st March, 2014
Liabilities Amount Assets Amount

` `
Share Capital :

1,000 Equity Shares of ` 100 each 1,00,000 Investment 40,000

8,000, 10% Preference Shares of ` Patents 1,00,000

10

each ` 8 paid up 64,000 Other Fixed Assets 1,60,000

Securities Premium Account 3,000 Bank Balance 60,000

Profit & Loss Account 10,000
General Reserve 40,000
Capital Reserve 50,000
Sundry Creditors 93,000
3,60,000 3,60,000

Page 41 of 167
 The company decided to redeem the preference shares at a premium of 5 %. In order to finance the
redemption, the company sold all its investment for ` 42,000. The preference shares are duly redeemed
partly out of available funds (profits) and partly out of fresh issue of equity shares of ` 100 each at par.
Pass Journal entries and prepare Balance Sheet after redemption.

Solution:
Journal Entries

` `

Preferences Share Final Call Account Dr. 16,000

To Preference Shares Capital Account 16,000
[Being Final call money due on 8,000 preference shares @
` 2 per share]

Bank Account Dr. 16,000

To Preference Share Final Call Account 16,000
[Being final call money received]
Bank Account Dr. 42,000
To Investment Account 40,000
To Profit & Loss Account 2,000

[Being investment sold at a profit of ` 2,000]

Securities Premium Account Dr. 3,000

Profit & Loss Account Dr. 1,000
To Premium on Redemption of Preference Shares 4,000
Account
[Being premium on redemption provided out of securities
premium & profit & loss account]
Profit & Loss Account Dr. 11,000
General Reserve Account Dr. 40,000
To Capital Redemption Reserve Account 51,000
[Being profit and reserve transferred to capital
redemption reserve Account]
Bank Account Dr. 29,000
To Equity Share Capital Account 29,000
[Being 290 new equity shares issued at par]

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 10% Redeemable Preference Share Capital Account Dr. 80,000
Premium on Redemption of Preference Shares Dr. 4,000
To Redeemable Preference Shareholders Account 84,000
[Being amount due on redemption]
Redeemable Preference Shareholders Dr. 84,000
To Bank Account 84,000
[Being payment made to preference shareholders]
Working Note:
Calculation of equity shares to be issued for redemption:
`
Amount of preference shares to be redeemed (after fully paid) 80,000
Less : Amount available in funds :
Profit & Loss Account (10,000 + 2,000 – 1,000) 11,000
General Reserve 40,000 51,000
Balance to be raised by issue of equity shares 29,000

Balance Sheet of B Ltd. As at April 1, 2014

Particulars Note No. Amount
`

A Equity and liabilities

1. SHAREHOLDER’S FUNDS
(A) SHARE CAPITAL

1,290 EQUITY SHARES OF ` 100 EACH 1,29,000

(B) RESERVES AND SURPLUS :

CAPITAL REDEMPTION RESERVE 51,000
CAPITAL RESERVE 50,000
2. CURRENT LIABILITIES

(A) TRADE PAYABLES :

SUNDRY CREDITORS 93,000

TOTAL 3,23,000

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B Assets

1. Non-current Assets
(a) Fixed Assets :
(i) Tangible Assets :
Other Fixed Assets 1,60,000
(ii) Intangible Assets :
Patents 1,00,000
2. Current Assets
(a) Cash and Cash Equivalents :
Cash at Bank 63,000
TOTAL 3,23,000
Note: Students should note that Balance Sheet has to be prepared as per prescribed format given in
Companies Act, 2013.
Illustration 4
D Limited has the following Balance Sheet as on March 31, 2014.
Liabilities ` Assets `
Subscribed Share Capital : Furniture & Fixture 4,15,000
30,000 Equity Shares of ` 100 Stock 40,65,000
30,00,000 Debtors 12,30,000
each fully paid
20,000, 10% Redeemable Cash at Bank 33,60,000
Preference Shares of ` 100 each, 20,00,000
fully paid
Capital Reserve 25,000
Securities Premium 10,000
General Reserve 10,00,000
Profit & Loss Account 20,000
Sundry Creditors 18,05,000
Provision for Taxation 12,10,000
90,70,000 90,70,000
The company decided to redeem all the preference shares at a premium of 10%. For this purpose, it
issued new equity shares of ` 100 each at a premium of 5% to the minimum possible extent utilising the
accumulated profits to the maximum possible extent.
Pass journal entries. Show your working clearly.

Solution:

Page 44 of 167
Journal
Dr. Cr.

` `
1. Bank Account Dr. 11,70,015
To Equity Share Capital Account 11,14,300
To Securities Premium Account 55,715
[Being issue of 11,143 equity shares of ` 100 each at a premium
of 5%]
2. Securities Premium Account Dr. 65,715
General Reserve Account Dr. 1,34,285
To Premium on Redemption of Preference Shares 2,00,000
Account
[Being use of securities premium & general reserve to
provide premium on redemption of preference shares]
3. General Reserve Account Dr. 8,65,700
Profit & Loss Account Dr. 20,000
To Capital Redemption Reserve Account 8,85,700
[Being creation of capital redemption reserve being
redemption partly out of profit]
4. 10% Redeemable Preference Share Capital Account Dr. 20,00,000
Premium on Redemption of Preference Shares AccountDr. 2,00,000
To Preference Shareholders Account 22,00,000
[Being amount due to preference shareholder]
5. Preference Shareholders Account Dr. 22,00,000
To Bank Account 22,00,000
[Being payment to preference shareholders on redemption]

Working Notes :
The students should note that whenever in a question, it is mentioned that “minimum number of
shares” to be issued for the purpose of redemption and the amount of premium to be received on
minimum new shares together with the existing share premium amount is insufficient to fully provide
for premium on redemption of redeemable preference shares then following method should be
followed:
Minimum number of equity shares to be issued for the purpose of redemption

Page 45 of 167
 can be obtained with the help of an equation as follows :
 Reddemable Preference   Profits available for 
   Premium in the   
Shares +    Balance Sheet    redemption in the   [ x ]  [ x  Rate of Premium]
 Premium on Redemption     Balance Sheet 
   
Where, x stands for value of fresh shares to be issued.
Using the values given in illustration in the equation, we get,
5
` 20,00,000 + ` 2,00,000 = ` 10,000 + ` 10,20,000 + x + x 
100
105x
or = ` 11,70,000
100
` 11,70,000  100
or x = = ` 11,14,286 (approx.)
105
` 11,14,286
and No. of equity shares to be issued = = 1114286 or 11143 shares (approx.)
100

BUY-BACK OF SHARES
Buy-back of shares means the repurchase of its own securities by a company. Section 68 of the
Companies Act, 2013 empowers a company to purchase its own shares or other specified securities in
certain cases. Specified securities may include Employees Stock Option or other securities as may be
notified by the Central Government.
3.3 Legal Provisions FOR Buy-back
The following terms and conditions are required to be fulfilled by company in order to become
eligible to buy-back its own securities:
(a) There must be a provision in the Articles of Association authorizing the company to buy-back
its own shares; otherwise the articles must be amended by a special resolution to incorporate a suitable
provision in this regard.
(b) The buy-back of equity shares in any financial year shall not exceed 25% of its total paid-up
capital in that financial year.
(c) As per provisions of Section 68(1) of the Companies Act, 2013, the buy-back of shares and
securities can be made:
(i) out of its free reserves, or
(ii) out of the securities premium account, or
(iii) out of the proceeds of fresh issue of shares or other specified securities.
(d) The ratio of the aggregate secured and unsecured debts owned by the company after buy-back
is not more than twice the paid-up capital and its free reserves i.e. the debt equity ratio, after the buy-
back, should not be more than 2 : 1.
(e) The existing shares or other securities for buy-back should be fully paid.

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 (f) The buy-back of the shares or other specified securities, if listed in stock exchange must be
carried out is in accordance with the SEBI guidelines.
(g) No offer of buy-back under this section shall be made within a period of one year from the
date of the closure of the preceding offer of buy-back, if any.
(h) Every buy-back shall be completed within 12 months from the date of passing the special
resolution mentioned above.
(i) Shares bought back shall be extinguished & physically destroyed within 7 days from the date of
buy-back.

Prohibition on Buy-Back of Shares

Section 70 of Companies Act, 2013 has imposed some restrictions on buy back of shares which
are given below:
(a) No company is allowed to purchase directly or indirectly its own shares or other
specified securities, through any subsidiary company, or any investment company; or
(c) If the company commits a default in
 the repayment of deposits or
 payment of interest, or
 redemption of debentures or preference shares, or
 payment of dividend to any shareholder, or
 repayment of any term loans, or
 payment of interest to any financial institution or banking company,
Then, it cannot buy back its shares. However, the buy-back is not prohibited, if the default is
remedied and a period of three years has lapsed after such default ceased to subsist.
(d) A company shall not be allowed to buy back its own shares if it has not complied with the
provisions of Section 92 regarding non-filing of annual return; Section 123 regarding transfer of
the amount to unpaid dividend account; Section 127 regarding failure to pay dividend within
30 days of declaration and section 129 regarding disclosure of true and fair view in the balance
sheet.
Methods of Buy-Back of Shares
Section 68(5) of Companies Act, 2013 states that a company may buy-back its shares by any of the
following methods:
(a) from the existing shareholders or security holders on a proportionate basis ;
(b) from the open market ;
(c) by purchasing the securities issued to employees of the company under a scheme of
stock option or sweat equity.
However, if the company wants to buy back fifteen percent or more of the paid-up capital and
reserves of the company then it will have to buy from the open market.

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3.4 ACCOUNTING TREATMENT OF BUY_BACK OF SHARES
Before resorting to buy-back of shares and its accounting treatment the following points are to be
kept in mind by a company :
(a) The securities which are to be bought-back must be fully paid. If they are not fully paid, then
they should be made fully paid by making a final call.
(b) There must be sufficient balance in free reserves if buy-back is not made through fresh issue.
(c) If buy-back is made out of free reserves, then an amount equal to nominal values of shares
bought back must be transferred to “Capital Redemption Reserve Account”.
(d) The balance of “Capital Redemption Reserve Account” can be used only for issuing fully paid
bonus shares.
(e) If buy-back of securities is done at a premium, then such premium must be written off to
securities premium account or free reserves.
(f) If buy-back of securities is done at a discount, then such discount earned must be transferred
to “Capital Reserve Account”.

The following accounting entries are passed on buy-back of shares :

I. SALE OF INVESTMENTS FOR BUY-BACK OF SHARES
Bank Account Dr. With nominal Value
Profit and Loss Account Dr. (If sold at a loss)
To Investment Account
To Capital Reserve Account (If sold at a profit)
II. ISSUE OF DEBENTURES OR OTHER SPECIFIED SECURITIES FOR BUY-BACK OF
SHARES
Bank Account Dr.
To Debentures Account
To Specified Securities Account
III. ENTRY FOR PAYMENT FOR BUY-BACK OF SHARES
(i) When the buy-back of shares is at a par
Equity Share Capital Account Dr. With nominal Value
To Bank Account
(ii) When the buy-back of shares is at a premium
Equity Share Capital Account Dr. (With nominal Value)
Premium on Buy-back Account Dr. (With the additional amount
paid)
To Bank Account (With total amount paid)
(iii) When the buy-back of shares is at a discount
Equity Share Capital Account Dr. (With nominal Value)

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 To Bank Account (With amount paid)
To Capital Reserve Account (With amount of discount)
IV. CREATION OF CAPITAL REDEMPTION RESERVE :
If buy-back is out of free reserves or out of securities premium account, then following entry will be
passed :
General Reserve Account Dr.
Profit & Loss Account etc. Dr.
To Capital Redemption Reserve Account
V. WRITING OFF PREMIUM ON BUY-BACK ACCOUNT
Securities Premium Account Dr.
General Reserve Account Dr.
Profit & Loss Account etc. Dr.
To Premium on Buy-back Account
Illustration 5
The following figures have been extracted from the books of ABC Ltd. as on 31-3-2015.
`
Paid up capital 1,80,000
18,000 equity shares of Rs. 10 each
General Reserve 30,000
Profit and Loss Account 10,000
Securities Premium 6,000
14% Debentures 20,000
Bank Balance 40,000
The company decided to buyback 25% of the paid up equity share capital at Rs. 13per share. It was
also decided to issue further 14% debentures of Rs. 20,000 at par for the purpose of buyback of shares.
Journalise the above transactions relating to buyback of shares.
Solution:
. Journal
Date Particulars L.F. Amount Amount
2014
Mar.31 Bank Account ......................................................... Dr. 20,000
To 14% Debentures Account 20,000
(Being issue of debentures of ` 20,000 at par for the
purpose of buyback of shares)

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 Equity Share Capital Account ................................. Dr. 45,000
Premium on Buy Back Account……………….Dr. 13,500
To Equity Shareholders Account 58,500
(Being cancellation of 25% of the paid up capital on
account of 25% shares bought back)
General Reserve Account....................................... Dr. 25,000
To Capital Redemption Reserve Account 25,000
(Being transfer of general reserve to Capital
Redemption Reserve Account to meet the
requirement of law for buyback of shares)
Security Premium Account……………………Dr. 6,000
Profit & Loss Account…………………………Dr. 7,500
To Premium on Buy Back Account 13,500
( Being premium paid on buy back written off out of
security premium and free reserves)

Equity Shareholders Account................................. Dr. 58,500

To Bank account 58,500
( Being payment made for shares bought back)

Working Note :
`
Total Face Values of Share Bought Back 45,000
Less : Issue of Debentures for buyback 20,000
Balance amount to be transferred from General Reserve 25,000
Premium on buy back = Rs. 3 on 4500 shares=Rs.13,500

3.5 SUMMARY

Redemption of preference shares means repayment of capital to the preference shareholders.

The period of redemption, however, cannot exceed 20 years from the date of issue of such shares.
Section 55 of the Companies Act, 2013 prescribes the legal restrictions with regard to the redemption
of preference shares: Shares can be redeemed out of profits of the company which would otherwise be
available for dividend, or out of the proceeds of a fresh issue of shares made for the purpose of
redemption,Only fully paid preference shares can be redeemed. If they are partly paid, then first of final
call should be made to make them fully paid. If they are to be redeemed at premium, then such premium
must be provided for out of the profits of the company or out of the security premium account. If such
shares are redeemed out of profits, then a sum equal to the nominal amount of the shares so redeemed

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must be transferred out of the profits of the company to a reserve called “Capital Redemption Reserve
Account”. The Capital Redemption Reserve Account can only be used for the purpose of issue of fully
paid bonus shares.
Buy-back of shares means the repurchase of its own securities by a company. Section 68 of
the Companies Act, 2013 empowers a company to purchase its own shares or other specified
securities in certain cases. Only fully paid shares can be bought back. Listed companies should
follow SEBI guidelines for buy back. The buy-back of shares and securities can be made: (i) out
of its free reserves, or (ii) out of the securities premium account, or (iii) out of the proceeds of
fresh issue of shares or other specified securities. If buy-back is made out of free reserves,
then an amount equal to nominal values of shares bought back must be transferred to
“Capital Redemption Reserve Account”. The balance of “Capital Redemption Reserve Account”
can be used only for issuing fully paid bonus shares. Some restrictions have been imposed on
buy back of shares in case of default in the payment of debt or interest thereon.

3.6 SUGGESTED READINGS/BOOKS:

 R. L. Gupta and Radhaswamy, Advanced Accountancy, Volume II, Sultan Chand and Sons, New
Delhi.
 Maheshwari and Maheshwari, Advanced Accountancy, Volume II, Vikas Publishing House, New
Delhi
 Shukla, Grewal and Gupta, Advanced Accounts, Volume II, S Chand and Company, New Delhi
 Tulsian, P.C., Corporate Accounting, Tata McGraw Hill Education Pvt. Ltd., New Delhi

3.7 ANSWER THE FOLLOWING QUESTIONS

1. What do you mean by Preference Shares? What procedure is adopted by the company for the
redemption of Preference Shares?
2. Explain the accounting treatment (along with the journal entries) for redemption of Preference
Shares.
3. Explain clearly the legal requirements for the redemption of preference shares as laid down in
Section 55 of the Companies Act, 2013.
4. Explain the following terms with the help of suitable examples:
(i) “Proceeds” of the fresh issue of share capital
(ii) Profits which would otherwise be available for redemption.
5. What is Capital Redemption Reserve? How is it created? How it can be utilised?
6. Define buy-back of shares? What are the provisions of Companies Act, 2013 for buy-back of
shares?
7. What do you mean by buy-back of shares? State the accounting treatment for buy back of
shares.

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 LESSON 4
Issue of Debentures

STRUCTURE

4.0Objectives

4.1 Meaning and characteristics, and types of debentures

4.2 Difference between share and debenture

4.3 Accounting treatment for issue of debentures for cash

4.4 Accounting treatment for issue debentures for consideration other than cash

4.5 Accounting treatment for debentures issued as collateral security

4.6 Journal entries for issue of shares from the view point of terms of issue and redemption of
debentures

4.7 Summary

4.8 Suggested readings

4.9 Model questions

4.0 OBJECTIVES

After reading this lesson, you should be able to:

 Understand the meaning and various types of debentures
 Differentiate between share and debenture

 Understand the accounting treatment for issue of debentures for cash

 Learn accounting treatment for issue debentures for consideration other than cash

 Understand the meaning accounting treatment for debentures issued as collateral security

 Learn journal entries for issue of shares from the view point of terms of issue and redemption of
debentures

4.1 MEANING OF DEBENTURE

The term ‘debenture’ has been derived from the Latin word ‘debere’, which means ‘to
borrow’. Debenture is an instrument in writing given by a company acknowledging debt received
from the holder of the instrument. According to Section 2 (30) of Companies Act, 2013, “Debenture

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 includes debenture stock, bonds and any other securities of the company whether constituting a
charge on the company’s assets or not”. Debenture represents loaned capital. Hence, the company
has to pay interest to debenture holders at the agreed rate on or after a specified date.

CHARACTERISTICS OR FEATURES OF DEBENTURES

The characteristic features of a debenture are as follows:
1. It is a written acknowledgement of debt taken by the company.
2. It is issued under the common seal of the company.
3. It contains a contract for the repayment of the principal sum on a specified date.
5. Interest is paid on debentures at a fixed rate on specified dates even if there is no profit or
insufficient profit.
6. Debentures are issued for long term.
7. Debenture holders are loan creditors of the company.

KINDS OF DEBENTURES
Debentures may be classified according to the following characteristics, viz., (1) Negotiability,
(2) Priority, (3) Permanence, (4) Security and (5) Convertibility.
1. FROM NEGOTIATION POINT OF VIEW:
(a) REGISTERED DEBENTURES: A registered debenture is one which is only payable to the
registered holder i.e. those persons whose name, address, particulars of holdings etc. are recorded
in the Register of debenture-holders.
(b) BEARER DEBENTURES: A bearer debenture is one which is payable to its bearer or
holder. Bearer debentures are transferable by mere delivery because the company keeps no record
of their holders.
2. FROM PRIORITY POINT OF VIEW:
(a) FIRST DEBENTURES: The debenture which is repayable in priority to other debentures is
termed as First Debenture.
(b) SECOND DEBENTURES: The debentures which will be paid and on which interest will be
paid after the first debentures have been dealt with are known as Second Debentures.
3. FROM PERMANENCE POINT OF VIEW:
(a) REDEEMABLE DEBENTURES: A debenture which can be redeemed or the payment of
which is made after a specified time is called a redeemable debenture.
(b) IRREDEEMABLE DEBENTURES: Irredeemable debentures are those debentures that are
not repayable during the life time of the company and hence will be repaid only when the company goes
into liquidation. This type of debenture, however, is not common.
4. FROM SECURITY POINT OF VIEW:
(a) SECURED OR MORTGAGE DEBENTURES: Secured or Mortgage debentures are those
debentures on which a charge is created on the assets of the company in favour of debenture
holders. This charge may be fixed or floating.

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 (b) UNSECURED DEBENTURES: These debentures are not secured as the company does not
give any security to its holder for the payment of interest and the repayment of the loan. However,
such a debenture is not very common.
5. FROM CONVERTIBILITY POINT OF VIEW:
(a) CONVERTIBLE DEBENTURES: Convertible debentures are those debentures which are
convertible into shares according to the terms of the issue. When only a part of the debenture amount is
convertible into equity shares, such debentures are known as ‘Partly Convertible Debentures’ and when
full amount of debentures is convertible into equity shares, then such debentures are known as ‘Fully
Convertible Debentures’.
(b) NON-CONVERTIBLE DEBENTURES: Non-convertible debenture is not exchangeable with
any share over its entire life.
4.2 DIFFERENCE BETWEEN SHARE AND DEBENTURE
The main differences between Share and Debenture are as under :
Point of Difference Share Debenture
1. Meaning Share is part of owned capital. The Debenture is part of borrowed
subscribers to the shares are called capital. The subscribers to the
shareholders. debentures are called debenture
holders.
2. Status The shareholder is one of the A debenture holder is a loan
owners or proprietors of the creditor of the company.
company.
3. Return Dividend is paid on shares out of Interest is paid on debentures.
profits of the company.
4. Regularity of A shareholder may not get dividend Interest on debentures must be
Return if the company suffers from losses paid whether the company earns
or profit is inadequate. the profit or not.
5. Voting Rights Shareholders have voting rights. A debenture holder does not have
any voting rights.
6. Priority of At the time of liquidation of the Debenture holders have a priority
Refund company, share-holders are paid of the refund of their loan prior to
after meeting all outside liabilities. payment to shareholders.
7. Security A share is always unsecured. A debenture is generally secured.

ISSUE OF DEBENTURES
The procedure for issuing debentures by a company is very much similar to that of an issue of
shares. Applications for debentures are invited from the public through the prospectus and letters of
allotment are issued. The applicants may be required to pay the whole of the amount along with the
application or by installments.

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 The debentures may be issued by a company in the following ways:
(1) for cash,
(2) for consideration other than cash, and
(3) as collateral security
4.3 ISSUE OF DEBENTURES FOR CASH
When the debentures are issued for cash, the amount to be collected on them may be payable
in installments or in lump sum. When debenture money is received in installments, the journal
entries are similar to entries passed on issue of shares. Instead of share capital account, Debentures
Account will be opened. Rate of interest payable on debentures is always prefixed to the Debenture
Account like 12% Debentures Account.

IF DEBENTURES ARE ISSUED AT PAR

(i) On receipt of Application Money
Bank Account Dr. with total money received on applications
To Debentures Application Account
(ii) On Allotment i.e. Acceptance of Applications
Debenture Application Account Dr. with application money on allotted
To Debentures Account debentures
(iii) On making Allotment Money due
Debenture Allotment Account Dr.
To Debentures Account
(iv) On receipt of Allotment Money
Bank Account Dr. with money received on allotment
To Debentures Allotment Account
(v) On making calls
Debenture First / Second / Final Call Account Dr.
To Debentures Account
(vi) On receipt of Call Money
Bank Account Dr.
To Debentures First/ Second / Final Call Account

Illustration 1
ABC Ltd. issued 1,000 14% debentures of ` 100 each, payable as to ` 20 on application and balance
on allotment. Applications were received for 1,500 debentures out of which applications for 900 were
allotted fully, applications for 400 were allotted 100 debentures and the remaining rejected. All sums
due were received. Joumalise.
Solution :

Journal

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 Date Particulars L.F. Amount Amount
Dr. Cr.

` `
Bank Account ......................................................... Dr. 30,000
To Debenture Application Account 30,000
(Being receipt of application money on 1,500
Debentures @ ` 20 per debentures)

Debenture Application Account............................. Dr. 30,000

To 14% Debentures Account 20,000
To Debenture Allotment Account 6,000
To Bank Account 4,000
(Being Application money transferred to debenture
account, allotment account & application money of
200 rejected applicants refunded)
Debenture Allotment Account............................... Dr. 80,000
To 14% Debentures Account 80,000
(Being allotment money due on 1,000 debentures @ `
80 per debenture)
Bank Account ......................................................... Dr. 74,000
To Debenture Allotment Account 74,000
(Being balance of allotment money received)

IF DEBENTURES ARE ISSUED A PREMIUM

The accounting treatment of issue of debentures at a premium depends whether the premium
amount is received along with application money or at the time of allotment.
(a) IF PREMIUM IS RECEIVED ALONG WITH APPLICATION
(i) Receipt of Application Money

Bank Account Including Premium

Dr.

To Debenture Application Account

(ii) Transfer of Debenture Application

Debenture Application Account Dr.

To Debenture Account
To Debenture Premium Account

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(b) IF PREMIUM IS RECEIVED ON ALLOTMENT
(i) Allotment Money Due
Debenture Allotment Account Dr.
To Debenture Account
To Debenture Premium Account

(ii) Receipt of Allotment Money

Bank Account Dr.
To Debenture Allotment Account

Illustration 2.
XYZ Ltd. issued 50,000, 15% Debentures of ` 100 each at a premium of 10% payable ` 30 on
Application due on 15th Jan. 2014) ; ` 50 on Allotment due on 10th Feb. 2014 and balance on final
call payable on 28th April, 2014). The public applied for 60,000 debentures. The directors rejected
applications for 10,000 debentures. All amount due is received except final call on 200 debentures.
Journalise the above transactions.
Solution :
JOURNAL
Debit Credit
Amount Amount
2014 ` `
Jan. 15 Bank Account ...........................................................Dr. 18,00,000
To Debenture Application Account 18,00,000
(Being application money received on 60,000
debentures @ ` 30 per debenture)
Feb. 10 Debentures Application Account .............................Dr. 18,00,000
To 15% Debenture Account 15,00,000
To Bank Account 3,00,000
(Being transfer of application money and refund of
application money on rejected application)
Feb. 10 Debenture Allotment Account .................................Dr. 25,00,000
To 15% Debenture Account 20,00,000
To Debenture Premium Account 5,00,000
(Being allotment money due on 50,000 debentures @ `

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 50 including ` 10 for premium per debentures)
Feb. 10 Bank Account ...........................................................Dr. 25,00,000
To Debenture Allotment Account 25,00,000
(Being allotment money received)
April 28 Debenture First and Final Call Account....................Dr. 15,00,000
To 15% Debenture Account 15,00,000
(Being first and final call money due on 50,000
debentures @ ` 30 per debentures)
April 28 Bank Account ...........................................................Dr. 14,94,000
To Debenture First and Final Call Account 14,94,000
(Being first and final call money received except on 200
debentures)

IF DEBENTURES ARE ISSUED AT A DISCOUNT

There is no prohibition on issue of debentures at a discount. When debentures are issued at a
discount, the amount of discount is debited to an account termed as “Discount on Issue of Debentures
Account”.

The discount on issue of debentures is always treated on allotment if not otherwise stated.
(i) ALLOTMENT MONEY DUE
Debenture Allotment Account Dr.
Discount on Issue of Debenture Account Dr.
To Debenture Account
(ii) ALLOTMENT MONEY RECEIVED
Bank Account Dr.
To Debenture Allotment Account

Illustration3
ABC Ltd. issued 1,000 debentures of ` 100 each at a discount of 10%. The amount was payable as follows :
On Application ` 25

On Allotment ` 35
On First & Final Call ` 30

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 Applications for 1,200 debentures were received. Applications for 600 debentures were
accepted in full. One applicant who had applied for 500 debentures was allotted 400 debentures and
rests of the applications were rejected. The entire amount due were received in time.
Give journal entries in the books of company.

Solution :

JOURNAL
Date Particulars L.F. Dr. Cr.
` `
(a) Bank Account ......................................................... Dr. 30,000
To Debenture Application Account 30,000
(Being receipt of application money @ ` 25 on 1,200
debentures)
(b) Debenture Application Account............................. Dr. 30,000
To Debenture Account 25,000
To Debenture Allotment Account 2,500
To Bank Account 2,500
(Being application money of 1,000 debentures
transferred to debentures account, allotment
account and excess amount to 100 debentures
refunded)
(c) Debenture Allotment Account............................... Dr. 35,000
Discount on issue of Debentures Account............. Dr. 10,000
To Debenture Account 45,000
(Being allotment due & discount on issue credited to
debentures Account)
(d) Bank Account .......................................................... Dr. 32,500
To Debenture Allotment Account 32,500
(Being allotment money received)
(e) Debenture First & Final Call Account ...................... Dr. 30,000
To Debenture Account 30,000
(Being first call money due)
(f) Bank Account .......................................................... Dr. 30,000
To Debentures First & Final Call Account 30,000
(Being First & Final call money received)

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4.4. DEBENTURES ISSUED FOR CONSIDERATION OTHER THAN CASH
Just like shares, the debentures may be issued to vendors for consideration other than cash. It may
so happen that the company acquires some assets from the vendor and issues debentures in payment
of purchase consideration. In such a case, the following journal entries are made to record the
transactions:
1. ON PURCHASE OF ASSETS
Sundry Assets (Individually) Account Dr. (With cost price)
To Vendor’s Account (With purchase consideration)
Note: If the amount of purchase consideration is more than the value of the assets acquired, the
difference is to be treated as capital loss and should be debited to Goodwill Account. On the other
hand, if the amount of purchase consideration to be paid is less than the value of net assets acquired,
the difference will be treated as capital gain & hence credited to Capital Reserve Account.
2. ON ALLOTMENT OF DEBENTURES
Vendor’s Account Dr. (With purchase consideration)
Discount on Issue of Debentures Account Dr. (If issued at discount)
To Debentures Account (With nominal value)
To Debentures Premium Account (If issued at a premium)
Illustration 4
Journalise the following transactions:
(a) ABC Limited purchased Stock worth `21, 000, plant and machinery worth ` 19,000 and
furniture for ` 7,000 from Sham & Co and took over the liabilities of ` 7,000 for a purchase
consideration of ` 46000. The company paid the purchase consideration by issuing sufficient
12% debentures of `100 each at a premium of 15%.

(b) XYZ Limited purchased assets of `1,82,000 and took over liabilities of `17,000 at an agreed
value of ` 1,61,500. The company issued 10% debentures of ` 100 each at a discount of 5% in
full satisfaction of the purchase price.

Solution.
Books of ABC Ltd.
(a) Journal Entries
Dr. Cr.
1. Stock Account Dr. 2,1,000
Plant and Machinery Account Dr. 19,000
Furniture Account Dr. 7000
Goodwill Account Dr. 6000

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 To Liabilities Account 7,000
To Raj & Co. 46,000
[Being the purchase of assets & taking over the liabilities of
Raj & Co.]
2. Raj & Co. Dr. 46000
To 12% Debentures Account 40000
To Debenture Premium Account 6000
[Being issue of debentures at a premium of 15%]
Notes.
1. Since the value of net assets taken i.e. ` 40,000 (`47,000 – ` 7,000) is less than the purchase
consideration `46,000, hence difference i.e., `6000 has been debited to Goodwill Account.
2. Calculation of face value of debentures to be issued to discharge purchase consideration:
`
Purchase Consideration Due 46000
Issue Price per debenture (`100 + 15) 115
Total Purchase Consideration due
 Number of debentures to be issued =
Issue Price per debenture
` 46000
= ` 115
= 400

 Face value of debentures to be issued = 400 @ ` 100 = `40,000

(b)
Journal Entries in the books of XYZ Ltd.
Dr. Cr.
1. Assets Account ........................................................ Dr. 18,20,000
To Liabilities 1,70,000
To Vendors Account 16,15,000
To Capital Reserve Account 35,000
[Being the purchase of assets & taking over of liabilities]
2. Vendors Account. .................................................... Dr. 16,15,000
Discount on Issue of Debentures Account .............. Dr. 85,000
To 10% Debentures Account 17,00,000
[Being issue of 17,000 debentures @ ` 100 each at 5%
discount to discharge purchase consideration]

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Notes : (i) Since value of net assets i.e., `16,50,000 ( 18,20,000 – 1,70,000) more than the purchase
consideration i.e., ` 16,15,000, hence the difference `5,000 being capital gain transferred to Capital
Reserve Account.
(ii) Number of debentures to be issued has been calculated as follows :
`
Purchase Consideration due `16,15,000
Issue price per debenture [ 100 –5] ` 95
` 16,15,000
 Number of debentures to be issued =
` 95
= 17,000
Face value of debentures to be issued = 17,000  100
= ` 17,00,000

4.5 ISSUE OF DEBENTURES AS A COLLATERAL SECURITY

A collateral security means additional security in addition to the principal security. When a company
takes a loan or overdraft from a bank or from other financial institutions, it may deposit its own
debentures with the lending agency as collateral security in addition to any other security that it may give.
When the loan is paid back, the debentures issued as collateral security are returned to the company. But
in case, the loan is not repaid by the company on due date or in the event of any other breach of
agreement, the lender has the right to retain these debentures and to realise them in the market. The holder
of debentures held as collateral security is not entitled to receive any interest on debentures.
No accounting entry is required at the time of issue of such type of debentures. However, the fact
of such debentures issued as collateral security has to be mentioned by way of a note on the liability
side of Balance Sheet of the company under the specific loan account.

4.6 ISSUE OF DEBENTURES FROM THE POINT OF VIEW OF TERMS OF REDEMPTION

A company is free to issue debentures on any term or specific condition as to its redemption which
it likes. There may be the following five possibilities:
CASE NO. CONDITIONS OF ISSUE CONDITIONS OF REDEMPTION
(i) Issue at Par Redeemable at Par
(ii) Issue at Discount Redeemable at Par
(iii) Issue at Premium Redeemable at Par
(iv) Issue at Par Redeemable at Premium
(v) Issue at Discount Redeemable at Premium

Journal entries for different terms of issue and redemption are as follows:

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 Case (i) WHEN DEBENTURES ARE ISSUED AT PAR AND REDEEMABLE AT PAR
(a) On issue of debentures
(i) Bank Account Dr. with the nominal
To Debentures Application and Allotment Account value

(ii) Debenture Application & Allotment Account Dr.

To Debentures Account
(b) On redemption of debentures
Debentures Account Dr. with the nominal
value
To Bank Account
Case (ii) WHEN DEBENTURES ARE ISSUED AT DISCOUNT AND REDEEMABLE AT
PAR
(a) On issue of debentures
(i) Bank Account Dr. With Net Amount
To Debenture Application & Allotment Account
(ii) Debenture Application & Allotment Account Dr.
Discount on Issue of Debentures Account Dr. With discount
To Debentures Account With nominal value
(b) On redemption of debentures
Debentures Account Dr. with nominal value
To Bank Account
Case (iii) WHEN DEBENTURES ARE ISSUED AT PREMIUM AND REDEEMABLE AT
PAR
(a) On issue of debenture
(i) Bank Account Dr. Including Premium
To Debentures Application & Allotment Account
(ii) Debenture Application & Allotment Account Dr.
To Debentures Account
To Debenture Premium Account
(b) On redemption of debentures
Debentures Account Dr. with the nominal value of
To Bank Account debentures

Case (iv) WHEN DEBENTURES ARE ISSUED AT PAR & REDEEMABLE AT PREMIUM
(a) On issue of debentures
(i) Bank Account Dr. With nominal value

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 To Debenture Application & Allotment Account
(ii) Debenture Application & Allotment Account Dr. (with the amount received)
Loss on Issue of Debentures Account Dr. (with premium on redemption)
To Debentures Account (with nominal value)
To Premium on Redemption of Debentures Account
(with premium on redemption)
(b) On redemption of debentures
Debentures Account Dr. (with nominal value)
Premium on Redemption of Debentures Account Dr. (with premium on
redemption)
To Bank Account (with total amount)
Case (v) WHEN DEBENTURES ARE ISSUED AT DISCOUNT AND REDEEMABLE AT
PREMIUM
(a) On issue of debentures
(i) Bank Account Dr. With Amount received
To Debenture Application & Allotment Account
(ii) Debenture Application & Allotment Account Dr. (with the amount received)
Loss on issue of Debentures Account Dr.(discount and premium on redemption)
To Debentures Account (with nominal value)
To Premium on Redemption of Debentures Account(with premium on redemption)

(b) On redemption of debentures

Debentures Account Dr. (with the nominal value)
Premium on Redemption of Debentures Account Dr. (with premium on redemption)
To Bank Account (with total amount paid)
NOTES: (i) Premium on redemption of debentures account is shown on the liabilities side until the
debentures are repaid.
(ii) Loss on issue of debenture account is written off gradually every year during the life of the
debentures.
Illustration 15.
(a) What journal entries would be made at the time of issue of debentures in the following cases:
(i) A company issued ` 1,00,000 6% debentures at par redeemable at par.

(ii) A company issued ` 1,00,000 6% debentures at a discount of 10% redeemable at par.

(iii) A company issued ` 1,00,000 6% debentures at a premium of 5% redeemable at par.

(iv) A company issued ` 1,00,000 6% debentures at par redeemable at 10% premium.

(v) A company issued ` 1,00,000 6% debentures at a discount of 5% redeemable at 5% premium.

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 (b) What journal entries will you make (in the above case) at the time of redemption ?
Solution.
(a) ENTRIES TO BE MADE AT THE TIME OF ISSUE OF DEBENTURES
JOURNAL ENTRIES
Dr. Cr.
(i) Bank Account ............................................................... Dr. 1,00,000
To 6% Debentures Application & Allotment Account 1,00,000
(Being receipt of application money)
Debenture Application & Allotment Account ............... Dr. 1,00,000
To 6% Debentures Account 1,00,000
(Being application and allotment money transferred)
(ii) Bank Account ............................................................... Dr. 90,000
To Debenture Application & Allotment Account 90,000
(Being application money received)
Debenture Application & Allotment Account ............... Dr. 90,000
Discount on issue on Debentures Account ................... Dr. 10,000
To 6% Debentures Account 1,00,000
(Being issue of debentures at a discount of 10%)
(iii) Bank Account ..................................................................... 1,05,000
Dr.
To Debenture Application & Allotment Account 1,05,000
(Being application money received)
Debenture Application & Allotment Account ............... Dr. 1,05,000
To 6% Debentures Account 1,00,000
To Debentures Premium Account 5,000
(Being issue of debentures at a premium of 5%)
(iv) Bank Account ..................................................................... 1,00,000
Dr.
To Debenture Application & Allotment Account 1,00,000
(Being application money received)
Debenture Application & Allotment Account ............... Dr. 1,00,000
Loss on issue of Debentures Account ........................... Dr. 10,000
To 6% Debenture Account 1,00,000
To Premium on Redemption of Debentures Account 10,000
(Being issue of debentures at par but redeemable at 10%

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 premium)
(v) Bank Account ..................................................................... 95,000
Dr.
To Debenture Application & Allotment Account 95,000
(Being application money received)
Debenture Application & Allotment Account ............... Dr. 95,000
Loss on issue of Debentures Account ........................... Dr. 10,000
To 6% Debentures Account 1,00,000
To Premium on Redemption of Debentures Account 5,000
(Being issue of debentures at a discount and redeemable at
premium)

4.7 SUMMARY
Debenture is an instrument in writing given by a company acknowledging debt received from the
holder of the instrument. Debenture represents loaned capital. Hence, the company has to pay
interest to debenture holders at a fixed rate on specified dates even if there is no profit or
insufficient profit. Debentures may be classified according to the following characteristics, viz., (1)
Negotiability, (2) Priority, (3) Permanence, (4) Security, and (5) Convertibility. The procedure
for issuing debentures by a company is very much similar to that of an issue of shares. Applications
for debentures are invited from the public through the prospectus and letters of allotment are
issued. The applicants may be required to pay the whole of the amount along with the applicationor
by installments. The debentures may be issued by a company (1) for cash, or (2) for consideration
other than cash, and (3) as collateral security. Accounting treatment of debentures also
depenupon the terms of issue and redemption of debentures.
4.8 SUGGESTED READINGS
 R. L. Gupta and Radhaswamy, Advanced Accountancy, Volume II, Sultan Chand and Sons, New
Delhi.
 Maheshwari and Maheshwari, Advanced Accountancy, Volume II, Vikas Publishing House, New
Delhi
 Shukla, Grewal and Gupta, Advanced Accounts, Volume II, S Chand and Company, New Delhi
 Tulsian, P.C., Corporate Accounting, Tata McGraw Hill Education Pvt. Ltd., New Delhi
4.9 ANSWER THE FOLLOWING QUESTIONS
1. Define debentures. Explain briefly different types of debentures.
2. What is meant by the issue of debentures as a collateral security ? Give its accounting
treatment.
3. Describe the various ways of issuing debentures.

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 LESSON 5
REDEMPTION of Debentures

STRUCTURE

5.0 Objectives

5.1 Methods of redemption of debentures

5.2 Sources of redemption of debentures

5.3 Accounting treatment for redemption of debentures

5.4 Summary

5.5 Suggested readings

5.6 Model questions

5.0 OBJECTIVES
After reading this lesson, you should be able to:
 Learn about the methods of redemption of debentures
 Know the sources of redemption of debentures

 Understand the accounting treatment for redemption of debentures

REDEMPTION OF DEBENTURES
Redemption of debentures means the payment of amount due on debentures to the debenture
holders. Debentures are normally redeemed at the expiry of the period for which they were originally
issued. But the company may also, it so authorized by its Articles of Association, and the terms of issue
as stated in the prospectus, redeem the debentures before the expiry of the fixed period either by
instalments or by purchasing them in the open market.
5.1 METHODS OF REDEMPTION OF DEBENTURES
The company may adopt any one of the following methods for redeeming debentures:
1. The company may redeem all the debentures in one lot at the expiry of a specified period.
2. The debentures may be redeemed in installments by drawing lots annually.
3. The company can redeem its debentures by purchasing them in the open market if it seems to
be profitable to the company.
5.2 SOURCES OF REDEMPTION
Debentures can be redeemed out of the following sources:
1. Redemption out of profit.

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 2. Redemption out of capital.
3. Redemption by conversion.
4. Redemption out of provisions.
1. REDEMPTION OUT OF PROFITS: Redemption of debentures out of profits means that the
amount equal to the nominal value of debentures redeemed will be transferred from Profit & Loss
Appropriation Account to a newly opened account called Debenture Redemption Reserve Account. This
will reduce the amount of profit which can be distributed as dividend. The required journal entries
under this method will be as follows:-

(a) ENTRY FOR REDEMPTION

Debentures Account Dr.
To Debenture holders Account
(b) Debenture holders Account Dr.
To Bank Account
(c) ENTRY FOR TRANSFER OF PROFITS
Profit & Loss Appropriation Account Dr.
To Debenture Redemption Reserve Account
Debenture redemption reserve account is shown on the liabilities side of the balance sheet and will
go on increasing with each redemption. When all the debentures are redeemed, this account is closed
by passing the following entry:
(d) Debenture Redemption Reserve Account Dr.
To General Reserve Account
Illustration 1
On 1.1.2010 a public limited company issued 25,000, 10% Debentures of ` 100 each at par which were
repayable at a premium of 10% on 31.12.2014. On the date of maturity, the company decided to
redeem the above mentioned 10% Debentures as per the terms of issue, out of profits. The Profit and
Loss Account shows a credit balance of ` 30,00,000 on this date. The offer was accepted by all the
debenture-holders and all the debentures were redeemed.
Pass the necessary journal entries in the books of the company only for the redemption of
debentures.

Solution:
JOURNAL
Date Particulars F. Dr. ( `) Cr. (`)
31.12.14 Profit and Loss Appropriation Account.................. Dr. 25,00,000
To Debenture Redemption Reserve Account 25,00,000
(Being adequate reserve created out of profits as per
Sec. 117 C)
31.12.14 10% Debentures Account....................................... Dr. 25,00,000

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 Premium on Redemption of Debentures Account Dr. 2,50,000
To Debenture holders Account 27,50,000
(Being amount payable to debentureholders on
redemption)
31.12.14 Debenture holders Account................................... Dr. 27,50,000
To Bank Account 27,50,000
(Being payment made to debentureholders)
31.12.14 Debenture Redemption Reserve Account ............. Dr. 25,00,000
To General Reserve Account 25,00,000
[Being Debenture redemption reserve account
closed]

2. REDEMPTION OUT OF CAPITAL: When profits are not utilized for the purpose of redemption,
redemption is said to be out of capital. However, in view of the recent SEBI’s guidelines, it will not be
possible for a company to redeem debenture purely out of capital. A company has to create Debenture
Redemption Reserve equivalent to 25% of the amount of debenture issue before debenture
redemption commences.

However, creation of Debenture Redemption Reserve is not required in the following cases:
(i) Debentures with a maturity of 18 months or less.
(ii) Fully convertible debentures. However, in case of partly convertible debentures, Debenture
Redemption Reserve is to be created for the non-convertible part on the same lines as
applicable for fully non-convertible debentures.

Illustration 2
Y Ltd. has 6,000, 15% Debentures of ` 100 each due for redemption out of capital on 31.3.2014. The
company has a debenture redemption reserve of ` 2,00,000 on that date. Assuming that no interest is due,
pass the necessary journal entries at the time of redemption of debentures.
Solution.
JOURNAL
Date Particulars Dr. (`) Cr. (`)

31.3.14 15% Debentures Account....................................... Dr. 6,00,000

To Debenture holders Account 6,00,000
(Being redemption of debentures due to
debenture holders)
31.3.14 Debenture holders Account................................... Dr. 6,00,000

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 To Bank Account 6,00,000
(Being payment made to debenture-holders)
31.3.14 Debenture Redemption Reserve Account ............. Dr. 3,00,000
To General Reserve Account 3,00,000
(Being Debenture Redemption Reserve balance
transferred to General Reserve Account after
redemption)
NOTE: Students should note that company already has more than 25% in Debenture Redemption
Reserve

3. REDEMPTION BY CONVERSION: Generally, companies redeem their debentures in cash. But

sometimes the company issues convertible debentures which may be redeemed by converting them
into shares. The option to convert the debentures into equity or preference shares would obviously be
exercised by the debenture holders only if the offer is beneficial to them.
The following journal entry will be made at the time of conversion:
Debentures Account (old) Dr. (With nominal value)
Discount on Issue of Shares Debentures Account (If new shares or debentures issued at
Dr. discount)
To Share Capital Account (new) (With nominal value)
To Securities Premium Account (If new shares are issued at a premium)

Illustration 2
On January, 2011 a company had issued 10,000 debentures of ` 100 each at ` 110, bearing interest
11% p.a. One of the terms of the issue was that debentures could be reclaimed after three years at a
premium of 2%.
The necessary notice was given on January 1, 2014, informing the debenture holders about the
intention of the company to redeem debentures on July 1, 2014, either payment of cash or by allotment of
10% preference shares of ` 100 each at ` 120 per share.
Holders of 2,000 debentures accepted the offer of preference shares, and rest demanded cash.
Give journal entries.
Solution.
Journal
Date Particulars L.F. Debit Credit
2014 ` `

July 1 11% Debentures Account........................................ Dr. 10,00,000

Premium on Redemption of Debentures Account... Dr. 20,000

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 To Debenture holders Account 10,20,000
[Being amount due on redemption of 10,000
debentures of ` 100 each at a premium of 2%]
July 1 Debenture holders Account ..................................... Dr. 2,04,000
To 10 % Preference Share Capital Account 1,70,000
To Securities Premium Account 34,000
[Being issue of 1,700 preference shares @20%
premium to the holder of 2,000 debentures]
July 1 Debenture holders Account ..................................... Dr. 8,16,000
To Bank Account 8,16,000
[Being payment of cash to remaining
debentureholders]
Working Notes :
1. Calculation of number of 10% preference shares to be issued for redemption
Amount due on 2000 debentures @`102 = ` 2,04,000

Issue price per preference shares = ` 120

Amount Due
Number of preference shares to be issued =
Issue price per share
` 2,04,000
= = 1,700
120

4. REDEMPTION OUT OF PROVISION: Sometimes the company creates provision to make

necessary arrangement from the very beginning to ensure the availability of sufficient cash required for
the redemption of debentures at the end of stipulated period for which debentures are issued. In the
absence of such a provision, it becomes difficult for the company to find lump sum funds to repay the
debentures. This provision can be made by adopting any of the following two methods:
(a) Sinking Fund Method
(b) Insurance Policy Method

SINKING FUND METHOD

To provide adequate funds for the redemption of debentures on a specified date, a company
usually creates a sinking fund out of profits every year and invests it in securities carrying a fixed rate of
interest. The amount to be appropriated every year is determined by the sinking fund table. Interest
received from Sinking Fund Investment is credited to Sinking Fund Account and is also invested. Thus
investment to be made in sinking fund investment is equal to annual appropriation plus interest
received from investment. At the time of redemption of debentures, investment is sold and the funds
received from their sale are utilised for redemption of debentures.

The following is the accounting treatment in case of redemption out of Sinking Fund:

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ENTRIES AT THE END OF THE FIRST YEAR
(1) ON TRANSFER OF PROFIT TO SINKING FUND
Profit & Loss Appropriation Account Dr. With the annual appropriation of
To Sinking Fund Account profit

(2) ON INVESTMENT OF SINKING FUND

Sinking Fund Investment Account Dr. With the amount invested
To Bank Account

SECOND AND SUBSEQUENT YEARS EXCEPT THE LAST YEAR (AT THE END)
(1) ON RECEIPT OF INTEREST ON SINKING FUND INVESTMENT
Bank Account
Dr.
To Interest on Sinking Fund Investment
Account
(2) ON TRANSFER OF INTEREST TO SINKING FUND
Interest on Sinking Fund Investment Account Dr.
To Sinking Fund Account
(3) ON TRANSFER OF PROFIT TO SINKING FUND
Profit & Loss Appropriation Account Dr. With the annual appropriation of
To Sinking Fund Account profit
(4) ON INVESTMENT OF ANNUAL APPROPRIATION OF PROFIT AND INTEREST
RECEIVED ON INVESTMENT
Sinking Fund Investment Account Dr. With the annual appropriation plus
To Bank Account interest received on investment

LAST YEAR i.e. YEAR OF REDEMPTION (AT THE END)

(1), (2), (3) entries are same as above
(4) ON SALE OF INVESTMENT
Bank Account Dr. With amount realised on investment
To Sinking Fund Investment Account
(5) IF THERE IS ANY PROFIT OR LOSS ON REALISATION OF INVESTMENTS, THE
SAME HAS TO BE TRANSFERRED TO SINKING FUND ACCOUNT.
(a) IF THERE IS A PROFIT
Sinking Fund Investment Account Dr. With the amount of profit
To Sinking Fund Account
(b) IF THERE IS A LOSS
Sinking Fund Account Dr. With the amount of loss

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 To Sinking Fund investment Account
(6) ON REDEMPTION OF DEBENTURES
Debentures Account Dr.
Premium on Redemption of Debenture Dr.
To Bank Account
(7) TRANSFER OF PREMIUM ON REDEMPTION
Sinking Fund Account Dr.
To Premium on Redemption of Debenture
OR
Loss on Issue of Debenture Account
(if entry is passed at the time of issue)
(8) ON TRANSFER OF THE BALANCE OF SINKING FUND ACCOUNT
Sinking Fund Account Dr.
To General Reserve Account (with revenue profits)
To Capital Reserve Account (with capital profits)

sinking fund account is also known as debenture redemption fund account and sinking fund
investment account is also called as debenture redemption fund investment account.

Note: The students should note that profit on redemption of debentures is transferred to the
credit side of Sinking Fund Account. Since this profit is of capital nature, hence at the time of
transferring the balance of sinking fund amount, the amount of this capital profit, viz. profit on
redemption of debentures should be transferred to Capital Reserve Account and the remaining
balance representing revenue profits to be transferred to General Reserve Account.

Illustration 3
On 1st April, 2011, ABC Limited issued `4, 00,000 debentures redeemable at the end of three years
at a premium of 10 per cent. A sinking fund was formed and invested in 5% tax free Government
securities. At the end of 3rd year, investments were realized at a loss of ` 500 and debentures were duly
redeemed.
You are required to give journal entries and ledger accounts to deal with the redemption assuming
investments to be made to the nearest hundred rupees. Sinking fund table shows that ` .31720856
invested every year at 5% compound interest will amount to `1 at the end of three year.
Solution.
Total amount required for redemption = `4,40,000 (including premium)
Annual appropriation (provision) required = 4, 40,000  0.31720856
= `1, 39,571.77 or ` 1, 39,572 (approximately)

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 Journal
Debit Credit
2011 ` `
April 1 Bank Account ...................................................................... Dr. 4,00,000
Loss on Issue of Debentures Account ................................ Dr. 40,000
To Debentures Account 4,00,000
To Premium on Redemption of Debenture Account 40,000

(Being issue of ` 4,00,000 debenture at par redeemable at

premium)
2012
March Profit & Loss Appropriation Account .................................. Dr. 1,39,572
31 To Sinking Fund Account 1,39.572
(Being annual provision required for redemption of
debentures)
2012
March Sinking Fund Investment Account ...................................... Dr. 1,39,600
31 To Bank Account 1,39,600
(Being amount invested in tax free Government securities to
the nearest hundred rupees)
2013
March Bank Account ...................................................................... Dr. 6,980
31 To Interest on Sinking Fund Investment Account 6,980
(Being interest received on `1,39,600 investment @ 5
percent for one year)
2013
March Interest On Sinking Fund Investment Account ................... Dr. 6,980
31 To Sinking Fund Account 6,980
(Being the transfer of interest to sinking fund Account)
2013
March Profit & Loss Appropriation Account .................................. Dr. 1,39,572
31 To Sinking Fund Account 1,39,572
(Being annual provision made)
2013
March Sinking Fund Investment Account ..................................... Dr. 1,46,600
31 To Bank Account 1,46,600
(Being amount Invested in tax free Government securities to

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 the nearest rupees)
2014
March Bank Account ...................................................................... Dr. 14,310
31 To Interest on Sinking Fund Investment Account 14,310
(Being Interest received on ` 2,86,200 investment @5% p.a.
for one year)
2014
March Interest on Sinking Fund Investment Account.................... Dr. 14,310
31 To Sinking Fund Account 14,310
(Being interest received on investment transferred)
2014
March Profit & Loss Appropriation Account .................................. Dr. 1,39,572
31 To Sinking Fund Account 1,39,572
(Being annual provision made)
2014
March Bank Account ...................................................................... Dr. 2,85,700
31 Sinking Fund Account.......................................................... Dr. 500
To Sinking Fund Investment Account 2,86,200
(Being sale of investment and loss transferred to sinking
fund account)
2014
March Debentures Account ........................................................... Dr. 4,00,000
31 Premium on Redemption of Debentures Account ............. Dr. 40,000
To Bank Account 4,40,000
(Being debentures redeemed at a premium on due date)
2014
March Sinking Fund Account.......................................................... Dr. 40,000
31 To Loss on Issue of Debentures Account 40,000
(Being loss on issue of debenture transferred)
2014
March Sinking Fund Account.......................................................... Dr. 3,99,506
31 To General Reserve Account 3,99,506
(Being balance of sinking fund account transferred)

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 Debentures Account .
Date PARTICULARS Amount Date Particulars Amount
` `
2012 2011
March To Balance c/d 4,00,000 April 1 By Bank Account 4,00,000
31
4,00,000 4,00,000
2013 2012
March To Balance c/d 4,00,000 April 1 By Balance b/d 4,00,000
31
4,00,000 4,00,000
2014 2013
March To Bank Account 4,00,000 April 1 By Balance b/d 4,00,000
31 (Redemption)
4,00,000 4,00,000

Sinking Fund Account

2012 2012
March To Balance c/d 1,39,572 March By Profit & Loss
31 31 Appropriation Account 1,39,572
1,39,572 1,39,572
2013 2012
March To Balance c/d 2,86,124 April 1 By Balance b/d 1,39,572
31 2013
March By Interest on Sinking
31 Fund Investment 6,980
Account
March By Profit & Loss 1,39,572
31 Appropriation Account
2,86,124 2,86,124

2014 2012
March To Sinking Fund April 1 By Balance b/d 2,86,124
31 Investment Account 500 2014
(loss on sale)
March By Interest on Sinking 14,310
March To Loss on Issue of 40,000 31 Fund Investment

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 31 Debentures Account By Profit & Loss 1,39,572
To General Reserve 3,99,506 March Appropriation Account
Account (transfer) 31
March
31
4,40,006 4,40,006

Sinking Fund Investment Account

2012 2012
March To Bank Account 1,39,600 March By Balance c/d 1,39,600
31 31
1,39,600 1,39,600
2012 2013
April 1 To Balance b/d 1,39,600 Mar. 31 By Balance c/d 2,86,200
2013
March To Bank Account 1,46,600
31
2,86,200 2,86,200
2013 2014
April 1 To Balance b/d 2,86,200 March By Bank Account 2,85,700
31
2014 By Sinking Fund Account
March (Loss on Sale) 500
31
2,86,200 2,86,200
Calculation of Interest:
At the end of second year, Interest on `139600@5%=`6980

At the end of third year, interest on `286200@5%=`14310

INSURANCE POLICY METHOD

Under this method, an insurance policy for an amount necessary to pay off debentures after the fixed
period is taken out. The company pays the premium annually or six monthly to the insurance company.
After the expiry of certain specified period, the policy matures and insurance company repays the insured
amount to the company. The debentures are, thus, redeemed from the proceeds received from insurance
company.
When insurance policy method is adopted, the procedure of book-keeping entries becomes
somewhat different from the procedures adopted under the Sinking Fund method. This is because,
insurance premium is paid at the commencement of the year and appropriation from profits is made at

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the end of the year. Further, unlike sinking fund method, interest is never paid by the insurance
company on the premium paid.

5.3 ACCOUNTING TREATMENT

I. FIRST YEAR & SUBSEQUENT YEARS (EXCEPT LAST YEAR)
(a) ON PAYMENT OF INSURANCE PREMIUM IN THE BEGINNING OR DURING THE
YEAR
Debenture Redemption Fund Policy Account Dr. With the Amount of Annual
To Bank Account Premium

(b) FOR ANNUAL APPROPRIATION OF PROFIT AT THE END OF THE YEAR

Profit & Loss Appropriation Account Dr. With the Amount of Profit Set
To Debenture Redemption Fund Account Aside

IN THE LAST YEAR

In addition to the above two entries, the following entries are also required on maturity of the policy at
the end of the last year:
(c) ON REALISATION OF POLICY AMOUNT FROM THE INSURANCE COMPANY
Bank Account Dr. With the Amount of Policy
To Debenture Redemption Fund Policy Account
(d) FOR THE TRANSFER OF PROFIT ON REALIZATION

Debenture Redemption Policy A/c Dr

To Debenture Redemption Fund A/c

(e) ON REDEMPTION OF DEBENTURES

Debentures Account Dr.
To Bank Account
(f) ON TRANSFER OF THE BALANCE OF DEBENTURE REDEMPTION FUND ACCOUNT
Debenture Redemption Fund Account Dr.
To General Reserve Account

Illustration 4
A Ltd. has made an issue of ` 5,00,000, 9% debentures on 1st April, 2010 the terms of which include
that the company must take a 4 years sinking fund insurance policy of the same amount for the
redemption of debentures at a premium of 5%. The annual premium is ` 1,15,000. Give journal entries
for four years and also show Sinking Fund Insurance Policy Account.

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Solution
Books of A Ltd.
JOURNAL
Date Particulars L.F. Debit Credit
Amount Amount
2010 ` `
April 1 Bank Account ......................................................... Dr. 5,00,000
To 9% Debentures Account 5,00,000
(Being amount received from issue of debentures)
April 1 Sinking Fund Insurance Policy Account.................. Dr. 1,15,000
To Bank Account 1,15,000
(Being payment of premium on sinking fund
insurance policy)
2011
Mar. 31 Profit & Loss Appropriation Account ..................... Dr. 1,15,000
To Sinking Fund Account 1,15,000
(Being annual appropriation of profit equal to annual
premium paid)
April 1 Sinking Fund Insurance Policy Account.................. Dr. 1,15,000
To Bank Account 1,15,000
(Being payment of annual premium)
2012
Mar. 31 Profit & Loss Appropriation Account ..................... Dr. 1,15,000
To Sinking Fund Account 1,15,000
(Being annual appropriation of profit)
April 1 Sinking Fund Insurance Policy Account.................. Dr. 1,15,000
To Bank Account 1,15,000
(Being payment of annual premium)
2013
Mar. 31 Profit & Loss Appropriation Account ..................... Dr. 1,15,000
To Sinking Fund Account 1,15,000
(Being annual appropriation of profit)
April 1 Sinking Fund Insurance Policy Account.................. Dr. 1,15,000
To Bank Account 1,15,000
(Being payment of annual premium)

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 2014
Mar. 31 Profit & Loss Appropriation Account ..................... Dr. 1,15,000
To Sinking Fund Account 1,15,000
(Being annual appropriation of profit)
Mar. 31 Bank Account ......................................................... Dr. 5,00,000
To Sinking Fund Insurance Policy Account 5,00,000
(Being amount received on maturing of sinking fund
insurance policy)
Mar. 31 9% Debentures Account......................................... Dr. 5,00,000
To Bank Account 5,00,000
(Being redemption of debentures)
Mar. 31 Sinking Fund Account............................................. Dr. 5,00,000
To General Reserve Account 5,00,000
(Being balance of sinking fund account transferred to
General Reserve Account)

Dr. Sinking Fund Insurance Policy Account Cr.

Date Particulars Amount Date Particulars Amount
2010 ` 2010 `
April 1 To Bank Account 1,15,000 Mar. By Balance c/d 1,15,000
31
1,15,000 1,15,000
2011 2012
April 1 To Balance b/d 1,15,000 Mar. By Balance c/d 2,30,000
31
April 1 To Bank Account 1,15,000
2012
2,30,000 2,30,000
2012 2013
April 1 To Balance b/d 2,30, 000 Mar. By Balance c/d 3,45,000
31
April 1 To Bank Account 1,15,000
2013
3,45,000 3,45,000
2013 2014

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April 1 To Balance b/d 3,45,000 Mar. By Bank Account 5,00,000
31
April 1 To Bank Account 1,15,000 (Policy matured)
2014
Mar. To Sinking Fund 40,000
31 Account
(Excess of policy
amount over premium
paid i.e. 5,00,000-
4,60,000)
5,00,000 5,00,000

PURCHASE OF DEBENTURES FROM THE OPEN MARKET

If authorised by its Articles, a company can buy its own debentures in the open market for
immediate cancellation or keeping them as investment. The debenture may be so purchased with the
following objectives in mind:
(a) for immediate cancellation or redemption
(b) for investment
(a) PURCHASE OF DEBENTURES FOR IMMEDIATE CANCELLATION OR REDEMPTION
When debentures are to be redeemed at maturity, the company must redeem them either at par
or at premium as per the terms of the issue. When company finds that its debentures are available
below par, it makes a considerable saving by purchasing them from open market and cancel them at any
date before the date on which debentures become due.
ACCOUNTING TREATMENT FOR PURCHASE OF DEBENTURE FOR IMMEDIATE
CANCELLATION

(1) ON PURCHASE AND CANCELLATION OF DEBENTURES

Debentures Account Dr. (With the nominal value)
To Bank Account (With the amount paid)
To Profit on Redemption of Debentures Account (With the profit if any)
(2) ON TRANSFER OF PROFIT ON REDEMPTION
Profit on Redemption of Debentures Account Dr.
To Capital Reserve Account (When no sinking fund exists)
OR
To Sinking Fund Account (When sinking fund exists)

(b) PURCHASE OF OWN DEBENTURES AS INVESTMENT

When a company purchases debentures in the open market not for immediate cancellation, but
for keeping them as investment, then such debentures are popularly called ‘Own Debentures.’ The

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debentures purchased as investment can be reissued when the company requires additional cash in
future or may be canceled in future if the company does not need additional finance.
ACCOUNTING TREATMENT
I. WHEN OWN DEBENTURES ARE PURCHASED AS A PART OF GENERAL INVESTMENTS
When own debentures are purchased as a part of general investments, then following entries will be
passed :
(1) ON PURCHASE OF DEBENTURES AS GENERAL INVESTMENT
Own Debentures Account Dr. With the amount paid for the debenture
To Bank Account
(2) WHEN OWN DEBENTURES ARE SUBSEQUENTLY CANCELLED
Debentures Account Dr. (With the nominal value of debentures
cancelled)
To Own Debentures Account (With book value of own debentures)
To Profit on Redemption of Debentures (With profit if any)
(3) TRANSFER OF PROFIT ON REDEMPTION
Profit on Redemption of Debentures Dr.
To Capital Reserve Account
II WHEN OWN DEBENTURES ARE PURCHASED AS A PART OF SINKING FUND INVESTMENTS
If own debentures are purchased as a part of sinking fund investments, the following entries will be
passed :–
(1) AT THE TIME OF PURCHASE
Sinking Fund Investment (Own Debentures) Account Dr
To Bank Account

(2) AT THE TIME OF SUBSEQUENT CANCELLATION

Debentures Account Dr
To Sinking Fund Investment (Own Debentures) Account
To Sinking Fund Account (Profit on Redemption)

INTEREST ON OWN DEBENTURES

When a company purchases its Debentures as investment, it has to make adjustments of interest
payable on these debentures. As soon as the company purchases it own debentures, it saves the
interest which would have been payable on them. When debentures are purchased as investment, the
total debentures (including own debentures) are deemed to be outstanding. The interest, therefore,
becomes payable on the whole amount of debentures including own debentures but amount of interest
on debentures held by the outsides will be actually paid by the company. The accounting entry is such a
case will be :

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(1) ON PAYMENT OF INTEREST
Debenture Interest Account ............................ Dr. (with total Interest on all
debentures)
To Bank Account (with interest paid to outside)
To Interest On Own Debenture Account (with interest on own
debentures)
(2) TRANSFER OF INTEREST ON OWN DEBENTURES
Interest on Own Debenture Account .....................Dr.
To Sinking Fund Account (when sinking fund exists)
OR
To Profit & Loss Account (when sinking fund does not
exist)
Illustration 4
On 1st April, 2012, Roy Limited made an issue of 10,000 12% Debentures of `100 each at `98 per
debenture. According to the terms of issue, commencing from the year 2013-14 the company should
redeem 500 debentures either by purchasing them from the open market or by drawing lots at par at
the company’s option. Profit, if any, on redemption is to be transferred to capital reserve. The
company’s accounting year ends on 31st March. Interest is payable on 30th September and 31st March.
During 2012-13, and 2013-14, the company wrote off ` 5,000 from debenture discount account.
During 2013-14, the company purchased and canceled the debentures as given below:
(i) ` 20,000 at `97 per debenture on 30th September, 2013.

(ii) ` 30,000 at `96 per debenture on 31st March, 2014.

Give the journal entries for the above said transactions.
Solution.
Journal Dr. Cr.

` `
2012
April 1 Bank Account...............................................................Dr. 9,80,000
Discount on Issue of Debenture Account....................Dr. 20,000
To 12% Debentures Account 10,00,000

(Being Issue of 10,000, 12% Debentures of ` 100 each at a

Discount of `2)
2012
30th Sept. Debenture Interest Account........................................Dr. 60,000

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 To Bank Account 60,000
(Being Payment of half yearly Debenture Interest)
2013
31st Debenture Interest Account........................................Dr. 60,000
March
To Bank Account 60,000
(Being Payment of half yearly Debenture Interest)
31st Profit & Loss Account ..................................................Dr. 1,25,000
March
To Debenture Interest Account 1,20,000
To Discount on Issue Of Debenture Account 5,000
(Being Debenture Interest for the year & Discount on
Debenture Transferred)
2013
30th Sept. Debenture interest Account........................................Dr. 60,000
To Bank Account 60,000
(Being payment of half yearly debenture interest)
2013
30th Sept. 12% Debentures Account............................................Dr. 20,000
To Bank Account 19,400
To Capital Reserve Account 600
(Being Purchase of Debentures in the open market for
cancellation & Profit Transferred to Capital Reserve)
2014
31st Debenture Interest Account........................................Dr. 58,800
March
To Bank Account 58,800
(Being Half Yearly Interest paid on ` 9,80,000 Debentures
@12%)
2014
31st 12% Debentures Account............................................Dr. 30,000
March
To Bank Account 28,800
To Capital Reserve Account 1,200

(Being Purchase for Cancellation `30,000 Debentures at

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 `96 and Profit on Cancellation Transferred to Capital
Reserve)
2014
31st Profit & Loss Account ..................................................Dr. 1,23,800
March
To Debenture Interest Account 1,18,800
To Discount on Issue of Debentures Account 5,000
(Being Debenture Interest for the Year & Discount on
Debentures Transferred)

5.4 SUMMARY
Redemption of debentures means the payment of amount due on debentures to the debenture holders.
Debentures are normally redeemed at the expiry of the period for which they were originally issued. But
the company may also, it so authorized by its Articles of Association, and the terms of issue as stated in
the prospectus, redeem the debentures before the expiry of the fixed period either by installments or
by purchasing them in the open market. Debentures can be redeemed out of profit, or out of capital or
can be redeemed by converting them into shares or new debentures. Companies can also maintain
sinking fund or take an insurance policy to redeem debentures. If authorised by its Articles, a company
can buy its own debentures in the open market for immediate cancellation or keeping them as
investment.

5.5 SUGGESTED READINGS

 R. L. Gupta and Radhaswamy, Advanced Accountancy, Volume II, Sultan Chand and Sons, New
Delhi.
 Maheshwari and Maheshwari, Advanced Accountancy, Volume II, Vikas Publishing House, New
Delhi
 Shukla, Grewal and Gupta, Advanced Accounts, Volume II, S Chand and Company, New Delhi
 Tulsian, P.C., Corporate Accounting, Tata McGraw Hill Education Pvt. Ltd., New Delhi

5.6 ANSWER THE FOLLOWING QUESTIONS

1. What do you mean by ‘Redemption of debentures’? Describe the various methods of
redeeming debentures.
2. Give the accounting treatment of redemption of debentures either through sinking fund
method or insurance policy method.
3. Explain the following:
(i) Redemption of debentures out of capital.
(ii) Redemption of debentures out of profit.
State the impact of latest SEBI guidelines in this regard.

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4. What is sinking fund? Give the accounting treatment of the maintenance of sinking find for
the redemption of debentures by a joint stock company.
5. What do you mean by purchase of debentures in the open market for immediate cancellation
& for investment? Give its accounting treatment.

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 LESSON 6
Underwriting OF SHARES AND DEBENTURES

STRUCTURE

6.0 Objectives

6.1 Meaning and types of underwriting

6.2 Underwriting commission

6.3 Determination of liability of underwriters

6.4 Summary

6.5 Suggested readings

6.6 Model questions

6.0 OBJECTIVES

After reading this lesson, you should be able to:

 Understand the meaning of underwriting and its types
 Determine the liability of underwriters
 Know about the accounting aspect of acquisition of business
 To learn about accounting treatment of profit prior to incorporation=

6.1 MEANING OF UNDERWRITING

Underwriting may be defined as a contract entered into by the company with individuals, firms, or
financial institutions, called underwriters, who guarantee the subscription of shares or debentures offered
to the public. Underwriter undertakes to take up the portion of such of the offered shares or debentures as
may not be subscribed for by the public For this undertaking or guarantee, they receive a consideration
called underwriting commission.

Thus, underwriting is an undertaking or guarantee given by the underwriters to the company that the
shares or debentures offered to the public will be subscribed for in full. In case, the public response is
poor, the underwriters will have to take up the balance of the shares or debentures not subscribed for by
the public and to pay for them. Thus, the underwriters take over the risk of uncertainty of a public issue of
shares or debentures of a company and the company is assured of the success of the issue.

UNDERWRITERS AND BROKERS

The persons or institutions underwriting a public issue of shares or debentures are called ‘Underwriters‘.
The underwriters may be individuals, partnership firms or joint stock companies. Generally, an issue of
shares or debentures of a company is underwritten by two or more firms jointly as it involves more risk
and attaches greater responsibility.

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 Broker is a middleman who merely acts as a connecting link between the company and the subscriber.
He does not take any responsibility of subscribing to the shares or debentures of the company. He simply
procures subscriptions for shares or debentures from the public on behalf of the company and in exchange
of their service rendered to the company, they get remuneration called brokerage.

TYPES OF UNDERWRITING
An underwriting contract may be of any one of the following types:

PURE UNDERWRITING
Pure underwriting refers to a contract whereby the underwriter guarantees the subscription of shares or
debentures upto a specified limit. If the subscription is not received from the public upto that limit, the
underwriter takes up the shares unsubscribed. In case full subscription is received, the liability of the
underwriter is nil. Pure underwriting can be further put into two categories

 Complete underwriting
 Partial underwriting

COMPLETE UNDERWRITING

If whole of the issue of shares or debentures of a company is underwritten, it is said to be complete

underwriting. In such a case, the whole of the issue of shares or debentures may be underwritten by -

(i) one firm or institution, agreeing to take the entire risk;

(ii) a number of firms or institutions, each agreeing to take risk only to a limited extent.
PARTIAL UNDERWRITING

If only a part of the issue of shares or debentures of a company is underwritten, it is said to be partial
underwriting. The part of the issue of shares or debentures may be underwritten by -

(i) one person or institution;

(ii) a number of firms or institutions each agreeing to take risk only to a limited extent.
In case of partial underwriting, the company is treated as underwriter for the remaining part of the issue.

FIRM UNDERWRITING

It refers to a definite commitment by the underwriter or underwriters to take up a specified number of

shares or debentures of a company irrespective of the number of shares or debentures subscribed for by
the public. In such a case, the underwriters are committed to take up the agreed number of shares or
debentures in addition to unsubscribed shares or debentures, if any. Even if the issue is over-subscribed,
the underwriters are liable to take up the agreed number of shares or debentures.

6.2 UNDERWRITING COMMISSION

The consideration payable to the underwriters for underwriting the issue of shares or debentures
of a company is called underwriting commission. Such a commission is paid at a specified rate on the
issue price of whole of the shares or debentures underwritten whether or not the underwriters are called
upon to take up any shares or debentures.

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LEGAL PROVISIONS FOR THE PAYMENT OF UNDERWRITING COMMISSION

According to Section 40 (6) of the Companies Act 2013, a company is permitted to pay
commission to any person in connection with the subscription or procurement of subscription to its
securities. The following conditions which are prescribed under Companies (Prospectus and Allotment of
Securities) Rules, 2014 have to be fulfilled:

(i) the payment of the commission is authorised by the Articles of Association of the company;

(ii) In the case of underwriting commission on issue of shares, maximum amount of commission paid
or agreed to be paid should not exceed 5% of the price at which the shares are issued, or the
amount or rate authorized by the Articles, whichever is less.

(iii) In the case of debentures, underwriting commission which can be paid by the company is 2.5% of
the price at which the debentures are issued or the amount or rate authorised by the Articles,
whichever is less;

(iv) the amount or rate of commission should be disclosed in the prospectus or statement in lieu of
prospectus as the case may be or in a statement filed with the Registrar before the payment of the
commission;

(v) the number of shares or debentures which persons have agreed to subscribe absolutely or
conditionally should be disclosed in the prospectus;

(vi) a copy of the contract relating to the payment of the commission should be delivered to the
Registrar;

(vii) no underwriting commission can be paid if the issue is privately placed, in other words,
underwriting commission is payable only on such shares or debentures as are offered to the general
public.

MARKED AND UNMARKED APPLICATIONS

When the issue of shares or debentures of a company is underwritten by two or more persons, it is
usual that the applications for shares or debentures sent through the underwriters should bear a stamp of
the respective underwriters. Otherwise, it would be very difficult for the company to determine how many
applications have been received through a particular underwriter. Unless this is determined properly, the
company would face a problem in determining the liability of the individual underwriters. Thus, the
applications bearing the stamp of the respective underwriters are called Marked Applications while the
applications received directly by the company which do not bear any stamp of the underwriters are called
―Unmarked Applicationsǁ.

If the entire issue of shares or debentures is underwritten by only one underwriter, the marking of
applications is immaterial since he is to get credit of all the applications whether sent through him or
received directly by the company for determining his liability.

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6.3 DETERMINING THE LIABILITY OF UNDERWRITERS
The liability of the underwriter or underwriters would be determined in the following ways:

COMPLETE UNDERWRITING
IF WHOLE OF THE ISSUE OF SHARES OR DEBENTURES IS UNDERWRITTEN BY ONE
UNDERWRITER ONLY

In such a case, the underwriter will be liable to take up all the shares or debentures that have not
been subscribed for by the public. For determining his liability, it is not material to know how many
applications are sent through him (marked) and how many applications are received directly by the
company (unmarked). Thus, the liability of the underwriter in such a case will be as follows:

Liability of the underwriter = Shares or debentures offered to the public minus shares
subscribed by the public
Note: Students must note that if the shares or debentures are oversubscribed or fully subscribed by the
public, the underwriter is free from his liability and cannot be called upon to take up any shares or
debentures of the company.

But he will be entitled to get his commission on the total issue price of the shares or debentures.

IF THE WHOLE OF THE ISSUE OF SHARES OR DEBENTURES IS UNDERWRITTEN BY A

NUMBER OF UNDERWRITERS IN AN AGREED RATIO:

In such a case, the liability of the respective underwriters can be determined as per the following
steps:

Step I: Determine the gross liability of each underwriter according to the agreed ratio.

Step II: Reduce the gross liability by the marked applications.

Step III: Give credit in respect of unmarked applications in the ratio of their gross liability by way of
deduction from the balance left.

Note: In case any underwriter has some figure in minus, then distribute that surplus to other
underwriters’ account in the ratio of their gross liability.

Last figure so arrived gives the liability of underwriters on account of short fall in the public
subscription.

Illustration 1
ABC Ltd. issued 50,000 equity shares. The whole of the issue was underwritten as follows:

Red 40%; White 30%; Blue 30%

Applications for 40,000 shares were received in all, out of which applications for 10,000 shares had the
stamp of Red; those for 5,000 shares that of White and those for 10,000 shares that of Blue. The
remaining applications for 15,000 shares did not bear any stamp.

Determine the liability of the underwriters.

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Solution:

Statement of liability of underwriters

Particulars Red White Blue

Gross liability (No. of shares underwritten) 20000 15000 15000
Less marked applications 10000 5000 10000
Balance 10000 10000 5000
Less unmarked applications 40000-25000 6000 4500 4500
(divided in the ratio of 40:30:30)

4000 5500 500

Net Liability
Thus, Red will have to buy 4000 shares, White 5500 shares, and Blue 500 shares

PARTIAL UNDERWRITING
If a part of the issue of shares or debentures is underwritten only by one underwriter: In such a case, for
the balance of shares not underwritten, the company itself is said to have underwritten the same. In such a
case, the net liability will be determined as follows:

Net liability = Gross liability – Marked applications.

Students must not that if the marked applications exceed or equal the number of shares or
debentures underwritten; the underwriter is free from his liability and cannot be called upon to
take up any shares or debentures of the company.

Similarly, if all the shares or debentures are subscribed the underwriter is free from his liability in spite of
the fact the marked applications are less than the number of shares or debentures underwritten.

Illustration 2

X Ltd., issued 50,000 equity shares of which only 60% was underwritten by Green. Applications for
45,000 shares were received in all out of which application for 26,000 were marked.

Determine the liability of Green.

Solution:

Gross liability of Green being 60% of 50,000 shares,

i.e., 60% of 50,000 = 30,000 shares

Less: Marked applications = 26,000 shares

Net liability of Green = 4,000 shares

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Notes:

(1) If the marked applications were for 30,000 shares or more, Green would have had no liability at all.
(2) If the applications received by the company were for all the 50,000 shares, Green would have no
liability at all even though the marked applications were for 26,000 shares.

Sometimes, the information as to the marked applications and unmarked applications is not given in the
problem. In such a case, total applications received by the company are divided between the company and
the underwriter in the ratio of shares underwritten.

Illustration 3
ABC Ltd. Issued 50000 shares. 80% of the issue was underwritten by Azad. Applications were received
for 30000 shares. Calculate the liability of Azad.

Statement of liability of underwriter

Particulars Azad Company Total

Gross liability (No. of shares underwritten) 40,000 10,000 50,000
Less shares applied divided in the ratio of 24,000 6,000 30,000
80:20
Net Liability 16,000 4,000 20,000

Azad’s liability is to take up 16000 shares.

FIRM UNDERWRITING
In the case of firm underwriting, the underwriters take up the agreed number of shares or
debentures firm underwritten in addition to unsubscribed shares or debentures, if any. While computing
the individual liability of the underwriters, the firm underwriting can be dealt with in the following
manner:

WHEN FIRM UNDERWRITING SHARES ARE INCLUDED IN MARKED APPLICATIONS

In such a case, the statement of liability of underwriters will be as under:

Gross Liability (agreed ratio) xxxxxxxxx.

Less: Marked applications including firm underwriting xxxxxxxxx.

Balance left

Less: Unmarked application (ratio of gross liability) xxxxxxxxx.

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Net liability

Add: Firm underwriting xxxxxxxxx

Total Liability xxxxxxxxx.

Illustration 4

ABC Ltd. issued 40,000 shares which were underwritten as:

Red: 20,000 shares, White: 12,000 shares, and Blue: 8,000 shares. The underwriters made applications
for firm underwriting as under:

Red: 4000 shares; White: 2000 shares; and Blue: 2,000 shares. The total subscriptions were 36,000
shares. The marked applications (including firm underwriting) were - Red: 14,000 shares; White: 5600
shares; and Blue: 6400 shares. Prepare a statement showing the net liability of underwriters.

Solution:

Statement of liability of underwriters

Particulars Red White Blue

Gross liability (No. of shares underwritten) 20000 12000 8000
Less marked applications 14000 5600 6400
6000 6400 1600
Less unmarked applications 36000-26000 5000 3000 2000
(divided in the ratio of 20:12:8
1000 3400 -400
Surplus of Blue divided in the ratio of 20:12
250 150 +400
between Red and White
750 3250 Nil
4000 2000 2000
Add Firm underwriting
4750 5250 2000
Net Liability

WHEN FIRM UNDERWRITING IS EXCLUDED FROM MARKED APPLICATIONS

In this case firm underwriting shares will also be deducted from gross liability.

ABC Ltd. issued 50,000 shares which were underwritten as:

Red: 30,000 shares, White: 15,000 shares, and Blue: 5,000 shares. Firm underwriting was as under:

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Red: 5000 shares; White: 2000 shares; and Blue: 1,000 shares. The total subscriptions were 37,000
shares. The marked applications (excluding firm underwriting) were - Red: 16,000 shares; White:
10,000 shares; and Blue: 4000 shares. Prepare a statement showing the net liability of underwriters.

Solution:

Statement of liability of underwriters

Particulars Red White Blue

Gross liability (No. of shares underwritten) 30000 15000 5000
Less firm underwriting 5000 2000 1000
Less marked applications 16000 10000 4000
9000 3000 nil
4200 2100 700
Less unmarked applications 37000-30000
(divided in the ratio of 30:15:5)
4800 900 (-)700
Surplus of Blue divided in the ratio of 30:15
+467 +233 + 700
between Red and White
4333 667 Nil
5000 2000 1000
Add Firm underwriting
Net Liability 9333 2667 1000

ACCOUNTING TREATMENT FOR UNDERWRITING OF SHARES OR DEBENTURES

(a) When the shares or debentures are allotted to the underwriters in respect of their liability:

Underwriters A/c Dr. (With the value of the shares or debentures taken up)

To Share Capital A/c

To Debentures A/c

(b) When commission becomes payable to the underwriters:

Underwriting Commission A/c Dr. (With the amount of commission due on the total issue)

To Underwriters A/c

(c) When the net amount due from the underwriters on the shares or debentures taken up by them is
received:

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 Bank Dr. (With the net amount due)

To Underwriters A/c

Note: Underwriting commission is not generally paid in cash. Instead the same is adjusted against the
money due on shares or debentures taken up by the underwriters and only the net amount (i.e., total
amount due on shares or debentures taken up by the underwriters minus the underwriting commission) is
received from the underwriters.

6.4 SUMMARY

Underwriting is a contract entered into by the company with individuals, firms, or financial institutions,
called underwriters, who guarantee the subscription of shares or debentures offered to the public.
Underwriter undertakes to take up the portion of such of the offered shares or debentures as may not be
subscribed for by the public For this undertaking or guarantee, they receive a consideration called
underwriting commission.

An underwriting contract may be ‘pure underwriting’, or ‘firm underwriting’ contract. Pure underwriting
refers to a contract whereby the underwriter guarantees the subscription of shares or debentures upto a
specified limit. If the subscription is not received from the public upto that limit, the underwriter takes up
the shares unsubscribed. In case full subscription is received, the liability of the underwriter is nil. Pure
underwriting can be complete underwriting or partial underwriting. If whole of the issue of shares or
debentures of a company is underwritten, it is said to be complete underwriting. If only a part of the
issue of shares or debentures of a company is underwritten, it is said to be partial underwriting. In case of
Firm underwriting, the underwriters are committed to take up the agreed number of shares or debentures
even if the issue is over-subscribed. The liability of the underwriters is determined on the basis of marked
and unmarked applications.

6.5 SUGGESTED READINGS

 R. L. Gupta and Radhaswamy, Advanced Accountancy, Volume II, Sultan Chand and Sons, New
Delhi.
 Maheshwari and Maheshwari, Advanced Accountancy, Volume II, Vikas Publishing House, New
Delhi
 Shukla, Grewal and Gupta, Advanced Accounts, Volume II, S Chand and Company, New Delhi
 Tulsian, P.C., Corporate Accounting, Tata McGraw Hill Education Pvt. Ltd., New Delhi

6.6 ANSWER THE FOLLOWING QUESTIONS

1. What do you mean by ‘underwriting’? Describe various types of underwriting contract.
2. How the liability of underwriters determined?
3. Explain the following:
(i) Marked and unmarked applications.
(ii) Pure underwriting and firm underwriting.
4. What are the legal provisions relating to the payment of underwriting commission.?.

Page 95 of 167
 LESSON 7
ACQUISITION OF BUSINESS AND PROFITS PRIOR TO

INCORPORATION

STRUCTURE

7.0 Objectives

7.1 Meaning of acquisition of business

7.2 Calculation of purchase consideration

7.3 Accounting aspect of acquisition of business

7.4 Profit prior to incorporation

7.5 Summary

7.6 Suggested readings

7.7 Model questions

7.0 OBJECTIVES
After reading this lesson, you should be able to:
 Understand the meaning of acquisition of business
 Know accounting treatment of acquisition of business
 Understand the meaning and determination of profit prior to incorporation
7.1 MEANING OF ACQUISITION OF BUSINESS
Acquisition of business, generally, refers to the purchase of a non-corporate business like sole-
proprietorship or partnership form of business by a company. This does not necessarily mean that a
limited company cannot acquire the business of a corporate body, i.e., another limited company. But
strictly speaking, the acquisition of business of a limited company by another limited company comes
under the purview of ‘Amalgamation, Absorption and Reconstruction of Companies’.

Such an acquisition of business by a limited company may take any of the following two forms:

a) An existing company may purchase an existing business of a sole-proprietor or a partnership

firm, or

b) A new company may be formed to take over an existing business of a sole proprietor or a
partnership firm, i.e., the existing business unit may be converted into a limited company. If the
object is to retain the control of the sole-proprietor or the partners in the company, a private

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 limited company may be formed. On the other hand, if the object of conversion is to supplement
the resources for carrying out various expansion programmes, a public limited company may be
formed for the purpose.

IMPORTANT POINTS TO BE NOTED IN CONNECTION WITH ACQUISITION OF A

BUSINESS

7.2 PURCHASE CONSIDERATION: Purchase Consideration refers to the price payable by the
company for the business acquired. Generally, an agreement is made between the company and the
vendor containing the terms and conditions of the acquisition of business, the basis for determining the
consideration and the mode of payment of the consideration. Consideration is usually, determined by
taking into consideration the following facts:

a) the present value of the tangible assets acquired acquired by the company;

b) the amount payable, if any, for goodwill of the business acquired; and

c) the liabilities to be taken over by the purchasing company.

METHODS OF CALCULATING PURCHASE CONSIDERATION

The method to be adopted for the calculation of purchase consideration depends upon the
information given in the question, which are explained as below :
1. LUMP-SUM PAYMENT:
The purchase consideration may be stated as a lump sum amount in the question. No calculations are
required in this case. For example, it may be provided that X Ltd. takes over the business for
` 5 lakh. The sum of ` 5 lakh is purchase consideration.

2. NET ASSETS OR NET WORTH METHOD:

Under this method, purchase consideration is calculated by adding the agreed value of only those
assets which have been taken over by the company and deducting there from the agreed value of only
those liabilities which have been taken over by the company. For example, if X Ltd. takes over the
following assets and liabilities of Sham & Sons :–
Assets/Liabilities Book value Agreed value
` `

Fixed assets 6,00,000 6,50,000

Current assets 2,00,000 1,40,000
Current Liabilities 1,00,000 1,00,000
The amount of purchase consideration will be calculated as under:–
Assets taken over : Agreed
Amount
`

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 Fixed assets 6,50,000
Current assets 1,40,000
7,90,000
Less : Liabilities taken over :
Current liabilities 1,00,000 1,00,000
Purchase consideration 6,90,000
Note: If some assets are not taken over by the purchasing company, the same shall not be included
in the calculation of purchase consideration.
The difference between the consideration to be paid and the value of net tangible assets will be the
goodwill. On the other hand, if the value of net tangible assets exceeds the consideration the
difference will be treated as “Capital Reserve”.

MODE OF PAYMENT OF THE CONSIDERATION BY THE COMPANY

After the consideration is determined, the next question that arises is how to satisfy the consideration.
The consideration may be satisfied by the company in any of the following ways:

a) the entire consideration may be paid in cash;

b) the entire consideration may be paid by the issue of shares of the company;

c) the entire consideration may be paid by the issue of debentures of the company; or

d) the consideration may be paid partly in cash and partly by the issue of shares and/or debentures of
the company.

Generally the last method is adopted by a company to satisfy the consideration.

It is important to note here that the shares or debentures may be issued to the vendors either at par
or at a premium or at a discount.

INTEREST PAYABLE TO VENDORS ON THE PURCHASE CONSIDERATION: If the payment

of consideration to the vendors is unnecessarily delayed, the question of payment of interest to vendors
for the period of the delay, naturally, arises. In such a case, the vendors can legitimately claim interest on
the amount due to them for the period of delay, i.e., from the date of purchase to the date of payment.
Hence, the agreement must mention about the payment of interest to vendors specifying the rate of
interest.

REALISATION EXPENSES OF THE VENDOR BORNE BY THE PURCHASING COMPANY

Sometimes, as per the agreement, the purchasing company may agree to bear the cost of realization of
assets of the vendor. Such expenses are to be treated as capital expenditure of the company and should be
debited to Goodwill Account.

COLLECTION OF DEBTORS AND PAYMENT TO CREDITORS OF THE VENDOR

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Sometimes, the debtors and the creditors of the vendor are not taken over by the purchasing company. In
such a case, the purchasing company may agree to collect the debtors of the vendor and to pay the
creditors of the vendor as agent of the vendor in exchange of certain commission at fixed rate.

7.3 ACCOUNTING TREATMENT IN THE BOOKS OF THE PURCHASING COMPANY ON

ACQUISITION OF BUSINESS

1. WHEN THE BUSINESS IS ACQUIRED:

Business Purchase A/c Dr. with the amount of purchase consideration

To Vendors

2. WHEN THE ASSETS AND LIABILITIES TAKEN OVER BY THE COMPANY ARE RECORDED:

Sundry Assets A/c Dr. Revalued figures if given, otherwise, at book value

To Sundry Liabilities A/c with the values at which they are taken over

To Business Purchase A/c with the purchase consideration

Alternatively, instead of passing the above two entries the following entry may also serve the
purpose, when the business is acquired -

Sundry Assets A/c (Individually) Dr. Revalued figures if given, otherwise, at book value

To Sundry Liabilities (Individually) with the values at which they are taken over

To Vendors with the consideration

Notes:

(i) If the credit total is greater than the debit total, the difference should be debited to Goodwill
Account.
(ii) If the debit total is greater than the credit total, the difference has to be treated as capital gain and
as such, Capital Reserve Account should be credited.

Students must note that Goodwill or Capital Reserve should be ascertained only as indicated above
- the amount appearing in the vendor’s balance sheet is not relevant.

3. WHEN THE PAYMENT IS MADE TO VENDORS:

Vendors Dr. With the amount due

To Share Capital A/c With the value of shares allotted, if any

To Debentures A/c with the value of debentures allotted, if any

To Cash or Bank A/c with the amount of cash paid, if any

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Notes:

(i) Shares capital or Debentures should be credited only with their nominal value.
(ii) If the shares or debentures are issued at a premium, Securities Premium Account should be
credited with the amount of the premium.
(iii) Similarly, if the shares or debentures are issued at a discount, Discount on Issue of Shares
Account or Discount on Issue of Debentures Account should be debited with the discount.

4. If interest is payable to vendors on the purchase consideration for delayed payment:

Interest A/C Dr. With the amount of interest payable

To Vendors

Note: This entry would be made before the payment is made to vendors and the amount of interest
would be included in the payment.

5. If the realisation expenses of the vendor are borne by the company and acquisition expenses are
incurred by the company, the same has to be treated as capital loss and the entry for this will be as
follows:

Goodwill A/c Dr. with the amount of expenditure

To Cash/Bank A/c

6. If any item of expenses or losses can be adjusted against Securities Premium Account, the same
should be adjusted to the extent possible and for this the entry will be as follows:

Securities Premium A/c Dr. with the amount of adjustment

Or To Discount on Issue of Shares A/c

Or To Discount on Issue of Debentures A/c

Illustration 1

ABC Ltd., was registered with an authorised capital of 1,00,000 Equity Shares of Rs.10 each and it
acquired the business of Rama BROS. at an agreed price of 2,50,000. The Balance Sheet of Rama BROS.
at the date of acquisition was as follows:

Liabilities Assets

Capital 2,00,000 Freehold Premises 1,00,000

Reserve 20,000 Plant and Machinery 80,000

Sundry Creditors 50,000 Stock 20,000

Bills Payable 30,000 Debtors 27,500

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 Less: Provisions 2,500 25,000

Cash at Bank 75,000

3,00,000 3,00,000

The consideration was to be discharged by the issue of 20,000 equity shares of 10 each as fully paid-up
and the balance in cash. You are asked to journalize the transactions in the books of ABC Ltd.

Solution:

JOURNAL ENTRIES
Date Particulars Credit
Debit
Amount
Amount

` `
Business Purchase Account Dr. 2,50,000
To Rama BROS. 2,50,000
(Being purchase consideration due)
Freehold premises Dr. 1,00,000
Plant & Machinery Account Dr. 80,0000
Stock Account Dr. 20,000
Debtors Account Dr. 27,500
Bank Account Dr. 75.000
Goodwill (Balancing figure) Dr. 30,000
To Creditors Account 50,000
To Bills Payable 30,000
To Reserve for Doubtful Debts Account 2500
To Business Purchases Account 2,50,000
(Being assets & liabilities taken over & differences of
purchase consideration & net assets being profit has
been transferred to Goodwill)
Rama BROS. Dr. 250000
To Equity Share Capital Account 2,00,000
To Bank 50,000
(Being payment in the form of shares and cash)

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7.4 PROFIT OR LOSS PRIOR TO INCORPORATION
A company comes into existence only after its registeration or incorporation. Sometimes, a new
company is formed to take over the business of an existing business unit as a going concern on date prior
to the date of incorporation of the company. For example, a business unit is taken over as on 1st January,
2014 but the company got incorporated on 31st March, 2014. In such case, the profit or loss of the
business, thus acquired, for the period from the date of purchase till the date of incorporation is called
Profit or Loss Prior to Incorporation. Unless the agreement with the vendors provides otherwise, such
a profit or loss belongs to the company. But profit or loss prior to incorporation should not be regarded as
trading profit or loss of the company since the company cannot earn profit or incur loss before it comes
into existence. Thus, profit or loss prior to incorporation is of capital nature and as such it is necessary to
ascertain such profit or loss as accurately as possible.

The profit or loss prior to incorporation should be treated in the books of accounts in the following
manner:

(i) PROFIT PRIOR TO INCORPORATION: Such a profit, being of capital nature, cannot be
credited to the Profit and Loss Account and thus it cannot ordinarily be used for the purpose of payment
of dividend. Hence, such a profit should be credited to Capital Reserve Account which can be utilised in
writing off capital losses like preliminary expenses, discount on issue of shares or debentures or in writing
down the value of fixed assets including goodwill. Until it is fully utilized, Capital Reserve Account has
to be shown in the liabilities side of the Balance Sheet under the heading “Reserves and Surplus’.

(ii) LOSS PRIOR TO INCORPORATION: Such a loss, being of capital nature, should be debited
to either a separate account called ‘Loss Prior to Incorporation Account’ which can be written off against
other capital profits of the company, or it can be debited to ‘Goodwill Account’.

* Students must remember that it is the date of incorporation and not the date of commencement of
business which is considered to calculate profit or loss prior to incorporation.

METHODS TO ASCERTAIN PROFIT OR LOSS PRIOR TO INCORPORATION

Profit or loss prior to incorporation can be ascertained in any of the following methods:

METHOD I : PREPARATION OF TRADING AND PROFIT AND LOSS ACCOUNT FOR THE
PERIOD UP TO THE DATE OF INCORPORATION
Under this method, a trial balance has to be prepared as on the date of incorporation of the company by
balancing off of the books and the value of stock has to be ascertained as on that date. Then, a Trading
and Profit and Loss Account has to be prepared for the period which will disclose the profit or loss prior
to incorporation. Profit or Loss prior to incorporation can be ascertained accurately under this method. All
transactions thereafter would naturally relate exclusively to the post-incorporation period and thus give
post-incorporation profit or loss.

But stock-taking and the balancing off of the books in the intervening period is often very inconvenient as
the same will adversely affect the normal functioning of the business. In view of this difficulty, this
method is not generally adopted in actual practice.

METHOD II: PREPARATION OF PROFIT AND LOSS ACCOUNT BY APPORTIONMENT

INTO PRE-INCORPORATION AND POST-INCORPORATION PERIODS

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Under this method, profit or loss for the pre and post incorporation period is ascertained by apportioning
items of income and expenses between the two periods, i.e., the pre-incorporation and the post-
incorporation periods on some rational basis. Thus under this method, profit or loss for the two periods
cannot be ascertained as accurately as under the first method. This method can only give an estimate of
the profit or loss of the two periods. As the first method involves a lot of inconvenience, there is no other
alternative than to depend on this method.

BASIS OF APPORTIONMENT
The apportionment of profit or loss, in such a case, between the pre-incorporation and post-incorporation
periods can be done on any one of the following basis: Time Basis, or Turnover Basis

TIME BASIS/ TIME RATIO

The profit or loss for the whole accounting period is apportioned between the periods prior to and after
incorporation on the basis of time i.e., in proportion of the time of the respective periods. For example, if
the time of the pre-incorporation and post-incorporation period be 3 months and 9 months respectively,
the profit or loss for the whole period would be apportioned between the two periods in the ratio 3 : 9, i.e.
1 : 3. Thus, 1/4th of the profit would be treated as pre-incorporation profit while 3/4th of the profit would
be treated as post-incorporation profit.

This principle is based on the assumption that profits are earned by the business evenly
throughout the year. But in reality since no business can be expected to earn its profits evenly throughout
the year, apportionment of profit or loss solely on the basis of time is not at all satisfactory.

TURNOVER BASIS/SALES RATIO

The profit or loss for the whole accounting period is apportioned between the periods prior to and after
incorporation on the basis of turnover, i.e., in proportion of the turnover of the respective periods. For
example, if the turnover of the pre-incorporation and post- incorporation periods be 1, 00,000 and 4,
00,000 respectively, the profit or loss for the whole period would be apportioned between the two periods
in ratio of 1 : 4. Thus, 1/5th of the profit would be treated as pre-incorporation profit while 4/5th of the
profit would be treated as post-incorporation profit.

This principle is also based on the assumption that turnover is spread evenly throughout the year.
But in reality, this may not be always true. Besides, all the expenses of business need not necessarily
depend on the turnover. As such, apportionment of profit or loss solely on the basis of turnover is also not
satisfactory.

EQUITABLE BASIS
The manner of apportionment of profit or loss between the pre-incorporation and the post-incorporation
periods actually depends upon the nature of each particular item. The most equitable method is normally
to apportion the gross profit or gross loss of the whole accounting period on the basis of the turnover
and the expenses on their respective nature, those varying with turnover being apportioned on that basis
and those which do not vary with the turnover being apportioned on the basis of time.

What is actually to be done in this case is to prepare a Trading Account for the whole period and to find
out the gross profit or gross loss in the usual way. Then The Profit and Loss Account is split up into the
two periods (i.e., pre-incorporation and post-incorporation periods) and all the items of Profit and Loss

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Account are then apportioned on the basis of their respective nature. For this, following principles are
generally followed:

1. Gross Profit or Gross Loss: On the basis of sales ratio

OR

In the absence of turnover in the respective periods, on the basis of expenses which are
directly related to turnover in the respective periods.

OR

In the absence of any such information, on the basis of time in the respective periods

2. Fixed or standing charges: such as rent, rates, taxes, insurance, general expenses,
salaries, printing and stationery, telephone, postage, and telegrams,
depreciation, audit fees, etc.

On the basis of time ratio

3. Variable expenses directly varying with the turnover: such as commission, discount,
brokerage, salesmen‘s salaries, advertisement carriage outwards, etc.

On the basis of sales ratio.

4. Expenses wholly applicable to the period prior to incorporation: like vendors‘ salary, interest on
vendors‘ capital, interest on purchase consideration upto the date of incorporation, etc.

Exclusively to be shown in the pre-incorporation period.

5. Expenses wholly applicable to the post-incorporation period: like, directors’fees, debenture

interest, discount on issue of debentures, preliminary expenses or formation expenses,
etc.

Exclusively to be shown in the post-incorporation period.

Illustration 2
ABC Ltd. was incorporated on 1st August, 2010 with an authorised capital of 5,00,000 equity shares of
10 each to acquire the business of Raj Kumar with effect from 1st April, 2010. The purchase
consideration was agreed at Rs. 7, 00,000 to be satisfied by the issue of 40,000 equity shares of Rs.10
each as fully paid-up and 3,000, 9% debentures of 100 each as fully paid-up. The entries relating to the

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transfer were not made in the books which were carried on without a break until 31st March, 2011. On
31st March, 2011 the trial balance extracted from the books showed the following:

Sales 10, 43,700

Purchases 7,76,580

Advertising 37,800

Postage and Telegram 8,820

Rent and Rates 18,420

Packing Expenses 16,800

Office Expenses 12,540

Opening Stock as on 1.4.2010 1,05,220

Directors’ fees 20,000

Debenture Interest 18,000

Land and Buildings 3,00,000

Plant and Machinery 1,80,000

Furniture and Fixture 20,000

Sundry Debtors 1,39,500

Cash at Bank 40,000

Cash-in-hand 4,900

Bills Payable 30,000

Sundry Creditors 53,240

Preliminary Expenses 7,360

Capital Account 5, 89,000

Drawings Account 10,000

You are also given the following additional information:

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(i) Stock on 31st March, 2011 amounted to 98,920.

(ii) The average monthly sales for April, May and June were one half of those for the remaining
months of the year and the gross profit margin was constant throughout the year.

You are required to prepare the Trading and Profit and Loss Account for the year ended 31st March,
2011.

Solution:

Trading Account for the year ended 31st March, 2011

Dr. Cr.

Particulars Particulars

-----------------------------------------------------------------------------------------------------------------

To Opening Stock 1,05,220 By Sales 10,43,700

To Purchases 7,76,580 By Closing Stock 98,920

To Gross Profit c/d 2,60,820 ________

11,42,620 11,42,620

Profit and Loss Account for the year ended 31st March, 2011

Particulars Pre-incor- Post- Particulars Pre-incor- Post-

poration incor- Porationpe incor-
period poration riod poration
period, period,

1.4.2010 1.8.2010 1.4.2010 to 1.8.2010

to to 31.7.2010 to
31.7.2010 31.3.2011 31.3.201
1

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To Advertising (5: 16) 9,000 28,800 By Gross Profit b/d 62,100 1,98,720

To Postage and 2,940 5,880 (5 : 16)

Telegram (1 : 2)
6,140 12,280
To Rent and Rates (1 : 2)
4,000 12,800
To Packing Expenses (5 : 16)
4,180 8,360
To Office Expenses (1 : 2)
20,000
To Directors’ fees
18,000
To Debenture Interest
7,360
To Preliminary Expenses
35,840
To Pre-Incorporation Profit
85,240
To Net Profit c/d

Total 62,100 1,98,720 Total 62,100 1,98,720

Working Notes:

1. Ratio of Time between pre-incorporation period and post-incorporation period = 4 months: 8

months = 1: 2

2. Ratio of turnover between pre-incorporation period and post-incorporation period -

Let the turnover for the months of April, May and June be 1, turnover for the remaining months will be
2.

Now, turnover for the pre-incorporation period (i.e. 1.4.2010 to 31.7.2010) = 1+1+1+2 = 5 and turnover
for the post-incorporation period (i.e., 1.8.2010 to 31.3.2010) = 8 x 2 = 16

Ratio of turnover between the two periods = 5 : 16

3. As the amount of preliminary expenses is negligible, it has been assumed that the same has to be
written off against the revenue. .

7.5 SUMMARY
Acquisition of business, generally, refers to the purchase of a non-corporate business like sole-
proprietorship or partnership form of business by a company. Such an acquisition of business by a limited
company may take any of the following two forms: i) An existing company may purchase an existing

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business of a sole-proprietor or a partnership firm, or ii) the existing business unit may be converted into a
limited company.

Sometimes, a new company is formed to take over the business of an existing business unit as a
going concern on date prior to the date of incorporation of the company. In such case, the profit or loss of
the business, thus acquired, for the period from the date of purchase till the date of incorporation is called
Profit or Loss Prior to Incorporation. Thus, profit or loss prior to incorporation is of capital nature and
as such it is necessary to ascertain such profit or loss as accurately as possible. Profit prior to
incorporation should be credited to Capital Reserve Account which can be utilised in writing off capital
losses like preliminary expenses, discount on issue of shares or debentures or in writing down the value of
fixed assets including goodwill.

7.6 SUGGESTED READINGS

 R. L. Gupta and Radhaswamy, Advanced Accountancy, Volume II, Sultan Chand and Sons, New
Delhi.
 Maheshwari and Maheshwari, Advanced Accountancy, Volume II, Vikas Publishing House, New
Delhi
 Shukla, Grewal and Gupta, Advanced Accounts, Volume II, S Chand and Company, New Delhi
 Tulsian, P.C., Corporate Accounting, Tata McGraw Hill Education Pvt. Ltd., New Delhi

7.7 ANSWER THE FOLLOWING QUESTIONS

1. What do you mean by ‘Acquisition of business? Describe accounting treatment for acquiring
the business by a limited company?.
2. What is purchase consideration? How is it calculated?
3. Explain the following:
(i) Time ratio
(ii) Sales ratio
4.What are profits prior to incorporation? How will you calculate profits prior to
incorporation?

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 LESSON 8
VALUATION OF GOODWILL

STRUCTURE

8.0 Objectives

8.1 Meaning and types of goodwill

8.2 Factors determining the value of goodwill

8.3 Need for valuation of goodwill

8.4 Methods of valuation of goodwill

8.5 Suggested readings

8.6 Model questions

8.0 OBJECTIVES
After reading this lesson, you should be able to:
 Understand the meaning and types of goodwill
 Know the factors determining goodwill
 Learn about the need for valuation of goodwill
 Understand the methods of valuation of goodwill

8.1 MEANING OF GOODWILL

Goodwill is the advantage of the good name or reputation of a business. It is those forces which
attracts customers and thereby increase sales and profits. Goodwill is an intangible and invisible asset.
Its value keeps on increasing and decreasing depending upon various factors such as sales, profitability,
tangible assets employed by the business, business connections etc.

Zoological Classification of Goodwill

Types of goodwill can be determined by the type of business and the type of customer which such
a business is likely to attract. In Whiteman Smith Motor Company vs. Chaplin Case, the goodwill is
classified zoologically into cats, dogs, rats & rabbits on the basis of nature of these animals.
(a) CAT GOODWILL: Cat prefers the old home although the person who has kept the home leaves.
Therefore cat goodwill represents the customer who goes to the old shop whosoever keeps it. It
provides the local goodwill and is the most valuable.
(b) DOG GOODWILL: Faithful dog is attached to the person rather than the place. He will follow the
outgoing owner if he does not go too far. Certain customers are attached to the owner of the business

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due to his exceptional skill, personality, honesty etc. This applies specifically to professional persons like
chartered accountants, sweet shop owners, doctors, lawyers etc. Dog goodwill is difficult to be
transferred and is thus less valuable.
(c) RAT GOODWILL: The rat has no attachments and is purely casual. Certain fugitive customers are
neither faithful to the business nor to the owner. They may be here today and gone tomorrow.
Therefore business which has such customers carry little goodwill.
(d) RABBIT GOODWILL: The rabbit is attracted by mere propinquity (nearness in time, place
relationship). Some customers come to a business or shop because they happen to live close by and find
it convenient to to go there. Thus, locational advantage causes goodwill for such type of business.
8.2 FACTORS AFFECTING THE VALUE OF GOODWILL
The value of goodwill depends upon the earning capacity of the business. Therefore, the factors
which affect the profitability of the concern will also affect its goodwill. The important factors are listed
below :
(i) AMOUNT OF CAPITAL EMPLOYED : A business which earns more profits with smaller amount of
capital and with this smaller base of capital enjoys higher goodwill as compared to that business which
has higher amount of capital invested in it, but earning smaller quantum of profits. Hence the amount of
capital will have a bearing on the value of goodwill.
(ii) LOCATION OF BUSINESS: If a business house is located at a place easily approachable by the
customers then it is likely to earn more profits and it will have more goodwill. So locational advantage is
an important determinant of goodwilll.
(iii) NAME OF BUSINESS: Value of goodwill depends upon the name of the business also. For
example names like Tata, Birla, Reliance do signify some amount of good impression in the minds of the
customers. Good name depends upon the past service provided by the business to its customers.
(iv) NATURE OF BUSINESS: A business which involves less risk, has monopolistic advantage etc.
possesses high value of goodwill.
(v) PAST PROFITS: The business earning good profits in the past years will have more goodwill.
Good profits earned by the business in the past help to maintain investors confidence in the business.
Thus, it enhances the value of goodwill of a firm because the indication of the high profits in the past
assures the investors that their money will be put to good use.
(vi) EXPERIENCE OF THE BUSINESS: Old and established business houses have commercial
reputation as compared to new business houses. This helps the old firms to earn higher profits as
compared to new firms although both have same locational advantages.
(vii) EFFICIENCY OF MANAGEMENT: Good management practices eliminate wastage in the
business which result in better business operations. Good planning, decision making and controlling of
the affairs of the firm help to increase productivity of the firm. This results in the improvement of the
overall efficiency of the business. Increased efficiency affects the value of the goodwill of the firm.
(viii) POSSESSION OF PATENTS OR TRADE MARKS: A firm having ownership of valuable patents and
trade marks will enjoy higher amounts of profits, therefore goodwill will be higher.
(ix) PERSONAL SKILLS: Personal skills refer to the abilities of the persons managing the business. A
firm, having professionals like solicitors, management consultants, chartered accountants enjoy higher

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amount of goodwill, because the skills of these experts affect the profitability of the business. Further,
the goodwill of the business, is built up gradually, by the managerial skills of these businessmen.
(x) CONTINUOUS SUPPLIES: A firm with continuous supply of raw materials, even in the times of
shortage enjoys higher amount of goodwill. Thus continuous supply is derived in the form of import
quotas, monopolistic agreements etc.
(xi) EMPLOYER EMPLOYEE RELATIONS: Good and harmonious employer-employee relations in the
past create good impression in the minds of persons dealing with the business, hence such organizations
enjoy high goodwill.
(xii) POLITICAL CONNECTIONS: Political connections of the owners of the business, render security
to the business in case of solution of some of the business problems. Such organisations enjoy more
goodwill as compared to ordinary business houses.
(xiv) RISKS IN BUSINESS : If the risk involved in the business is more, then the goodwill will be less.
On the contrary, less risky ventures enjoy more amount of goodwill.
(xv) ADVANTAGEOUS CONTRACTS: If a business is having some special contracts in hand, which
are giving exceptional profits then goodwill be on the higher side.
8.3 NEED FOR VALUATION OF GOODWILL
Generally, the necessity for valuing the goodwill arises only when the business is to be sold. But in
partnership and company forms of business organisation, the need for valuation of goodwill may arise
during the continuation of the business. In the case of partnership and company, the valuation of
goodwill is needed in following circumstances:
(1) When there is change in the constitution of the concern i.e.
(a) on admission of a new partner
(b) on retirement or death of a partner
(c) on change in profit sharing ratio
(2) On sale of business or conversion of a firm into a company.
(3) In case of amalgamation of two or more firms or companies.
(4) On dissolution of a going concern.
(5) Upon the taking over of the business of a company by another company.
(6) Upon the desire to acquire controlling interest in another company.
(7) Upon the Government taking over the business.
(8) Upon the valuation of the shares of unlisted companies.
(9) Even in case of listed companies, sometimes market value of the shares may not reflect the
true value of the shares.
8.4 METHODS OF VALUATION OF GOODWILL
There are a number of methods of valuation of goodwill. The important methods are :-
1. Arbitrary valuation
2. Average profits method
3. Super profits method

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 4. Capitalization method
5. Annuity method
6. Hidden or implied goodwill
These methods have been explained as follows:-
1. ARBITRARY VALUATION
Value of goodwill, in this case is fixed by mutual agreement between the parties. In some cases, the
value may be fixed by an independent person known as Arbitrator. This method can be used only where
earning capacity of the firm is exactly known.

2. AVERAGE PROFITS METHOD

As the value of goodwill is directly dependent upon its profitability, therefore, average profits
method is the most widely used method of valuation of goodwill. Under this method, goodwill is
calculated on the basis of certain number of year’s purchase of average profits of past few years.
Following steps are involved in this method.
(i) Calculate average maintainable profit of given number of past few years.
Total Adjusted Profit
Average future maintainable profits =
No. of years

(ii) Value of goodwill :

Goodwill = Average adjusted profits  Number of year’s purchase.
LESSON-1 How to calculate Average Future Maintainable Profits
Goodwill is the price paid by the buyer for earning profits from the business in future. For this
purpose, certain adjustments are made in the past profits, discussed below:
(a) Abnormal losses and expenses not likely to occur in the future are added back to the past
profit.
(b) Any item of income earned in the past but not likely to be received in future is deducted from
profits.
(c) Any item of income not earned in the past but likely to be received in future is added to past
profits.
(e) Any loss and expenses likely to occur in the future is deducted from the past profit.
(f) The past average profits should be calculated after deducting tax at current rates.

Illustration 1
X Ltd. decided to purchase business of Y Ltd. The profits disclosed by Y Ltd. were:
2011 ` 2,10,000 (including abnormal gains ` 30,000)

2012 ` 1,80,000 (including abnormal loss ` 22,000)

2013 ` 1,90,000

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 2014 ` 2,70,000 (excluding abnormal loss ` 25,000)

Now, alternate management shall be required for which ` 20,500 p.a. shall have to be spent.

X Ltd. want to insure the property now for which annual insurance premium will be ` 20,000.
Find the value of goodwill on the basis of three year’s purchase of average profits of last four years.
Solution.
Valuation of Goodwill
Adjusted Profits
2011 `
Profit given ` 2,10,000
Less : Abnormal gain 30,000 1,80,000
2012
Profit given ` 1,80,000
Add : Abnormal loss 22,000 2,02,000
2013
Profit given
1,90,000
2014
Profit given 2,70,000
Total Profits 8,42,000
` 8,42,000 ` 2,10,500
Average profits =
4
Less : Managerial remuneration ` 20,500

` 1,90,000
Less : Insurance premium of property ` 20,000
Average Adjusted Profits ` 1,70,000

Value of goodwill = Average Adjusted Profits  No. of years purchase

= ` 1,70,000  3 = ` 5,10,000
WEIGHTED AVERAGE PROFIT METHOD
Average profit method has an important limitation that it gives same weightage to the profits of all
year. In averaging past profits, trend of profits earned must be taken into account. Where the past
profits are widely fluctuating from year to year, an average fails to help future trend. Further, in some

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companies, profits may record a noticeable rising or falling trend from year to year. In such case,
weighted average profit is more appropriate method to calculate goodwill.
The value of goodwill is calculated by using the following formula :
Goodwill = Weighted Average Profit  Number of Year’s purchase.
The following steps are used to calculate the value of goodwill :
(a) Calculate adjusted profit of each year by making past and future adjustments.
(b) Multiply the adjusted profits of different years with their respective weights to get the product
The highest weight should be given to the most recent past year and the smallest weight for the
remotest or earlier year.
Product = Adjusted Profit  Respective Weight
(c) Take the total of product
(d) Calculate the weighted average profit by dividing the product by sum of weights
by using the following formula :
Total of Product
Weighted Average Profit =
Total of Weights
(d) Now multiply weighted average profits by the number of years, purchase.

Illustration 2
A Ltd. proposed to purchase the business carried on by B &Co. Goodwill for this purpose is agreed
to be valued at three year’s purchase of the weighted average profits of the past four years. The
appropriate weights and profits for the last four year are as under :
Year Weight Profit (` )

2010-11 1 1,01,000
2011-12 2 1,24,000
2012-13 3 1,00,000
2013-14 4 1,40,000
On a scrutiny of the accounts the following matters are revealed :
(i) On 1, December, 2012 a major repair was made in respect of the plant incurring ` 30,000 which
was charged to revenue. The said sum is agreed to be capitalised for goodwill calculation
subject to adjustment of depreciation of 10% p.a. on reducing balance method.
(ii) The closing stock for the year 2011-12 was over-valued by ` 12,000.

(iii) To cover management cost, an annual charge of ` 24,000 should be made for the purpose of
valuation of goodwill.

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Solution.
(i) Calculation of Adjusted Profits

`
Profit for 2010-11 1,01,000
Less : Management Expenses 24,000
Adjusted Profits for 2000-01 77,000
Profit for 2011-12 1,24,000
Less : Management Expenses 24,000
1,00,000
Less : Overvaluation of Closing Stock 12,000
Adjusted profit for 2011-12 88,000
Profit for 2012-13 1,00,000
Less : Management Expenses 24,000
76,000
Add : Overvaluation of Opening Stock 12,000
88,000
Add : Major repairs to the plant to be treated as capital expenditure 30,000
1,18,000

Less : Depreciation on plant @ 10% for 4 Months on ` 30,000 1,000

Adjusted Profits for 2012-13 1,17,000

Profits for 2013-14 1,40,000
Less : Management Expenses 24,000
1,16,000

Less : Depreciation for one year on ` 29,000 (` 30,000 – ` 1,000) @ 10% 2,900

Adjusted Profit for 2003-04 1,13,100

(ii) Calculation of Weighted Average Profits

YEAR ADJUSTED PROFITS WEIGHT Product
` `
2011-11 77,000 1 77,000
2011-12 88,000 2 1,76,000
2012-13 1,17,000 3 3,51,000

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 2013-14 1,13,100 4 4,52,400
Total 10 10,56,400
Total of Product ` 10,56,400
Weighted Average Profits = = = ` 1,05,640
Total of Weights 10

Goodwill = Weighted average Profits × No. of Year’s purchases = ` 1,05,640  3 = ` 3,16,920

3. SUPER PROFIT METHOD

A business which is has been earning super profits will obviously expect higher goodwill. Super
profit is the excess of additional earnings over the normal earnings. The excess of average profit over the
normal profit is technically called super profit. Goodwill under super profits method can be calculated by
A) Number of years’ purchase of super profits
B) Capitalization of super profits
A) NUMBER OF YEARS PURCHASE OF SUPER PROFITS
Value of goodwill =Super profits  number of year’s purchase.
Following steps are required for the calculation of goodwill in this method :
(i) Calculate average profits (explained in average profits method)
(ii) Calculate normal profits.
Normal profits = Capital employed  Normal rate of returnt 100
(iii) Calculate super profits :
Super profits = Average profits – normal profit
(iv) Value of goodwill :
Super profits number of year’s purchase.
CAPITAL EMPLOYED
The term “capital employed” has wide variety of meaning. But for the purpose of valuation of
goodwill, it is usually taken to be the value of net tangible assets employed by the business.

Net Tangible assets= Total tangible assets - liabilities

NORMAL RATE OF RETURN
This is the rate of profit or return which the investor would expect on their investment in a particular
type of industry. The normal rate of return is not uniform in all types of industries and therefore differs
from industry to industry.
Normal rate of return= Pure rate of return+ Risk Rate of return
.
Illustration 3
Mr. X has assets worth ` 7, 00,000 and liabilities amounting to ` 3, 50,000. His annual profits are
` 80,000 including a sum of ` 22,000 received as compensation relating to business premises. He can
engage himself in another business from which he expects 8% rate of return. In addition, he could also

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engage himself in part-time employment at an annual salary of ` 16,000. Considering 2% risk involved in
the business, calculate value of goodwill at 5 year’s purchase of super profits.

Solution.
`
Annual Profit 80,000
Less : Compensation received (abnormal gain) 22,000
Alternate salary 16,000 38,000
Average maintainable profits 42,000
Capital employed
Assets 7,00,000
Less : liabilities 3,50,000
Net assets or capital employed 3,50,000
10
Normal Profits = ` 3,50,000  (8%  2%)
100

= ` 35,000

Super Profit = ` 42,000 – ` 35,000 = ` 7,000

(i) Goodwill = Super Profit  No. of Years Purchases
= ` 7,000  5 = ` 35,000

B) CAPITALIZATION OF SUPER PROFITS METHOD

Goodwill can also be calculated by capitalization of super profits. In other words, this method attempts
to determine the amount of capital needed for earning super profit.
100
Goodwill= Super Profit 
Normal Rate of Return

Illustration 4
The net profits of a firm, after providing for taxation for the past five years are ` 4,20,000,
` 4,70,000, ` 4,30,000, ` 4,10,000 and ` 4,70,000. Capital employed in the business is ` 40,00,000 on which
a reasonable rate of return 10% is expected. Calculate the goodwill under Capitalisation of super profits
method.
Solution :

Profits of the year `

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 1st 4,20,000
2nd 4,70,000
3rd 4,30,000
4th 4,10,000
5th 4,70,000
22,00,000
Rs. 22,00,000
Average profits = = ` 4,40,000
5

`
Average profits 4,40,000
 10 
Less : Normal profit  40,00,000   4,00,000
 100 
Super profit 40,000
100
Capitalisation of super profits at 10% = 40,000  = ` 4,00,000
10

Goodwill = Capitalised Value of Super Profit = ` 4,00,000.

4. CAPITALISATION METHOD
Under this method, goodwill is taken to be the excess of capitalised value of business over the net
assets employed in the business.
Under this method, the business unit’s goodwill is valued by the following steps :
(i) Calculate the total value of the firm by capitalising average profits.
100
Capitalised Value of Business = Average Profit 
Normal Rate of Return
(ii) Calculate the value of net tangible assets:
Net Tangible Assets = Total Tangible Assets – All Liabilities
(iii) Value of Goodwill is determined as follows:
Goodwill = Capitalised Value of Average Profit – Value of Net Tangible Assets
Illustration 5.
Average profits of the company for the past five years are ` 22,000 and assets and liabilities are
` 2,75,000 and ` 75,000 respectively. The fair rate of return is 10%. Calculate the value of goodwill by :
(i) Capitalising average profits
(ii) Capitalising super profits
Solution.
(i) Capitalising average profits method
Average profits = ` 22,000

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 ` 22,000  100
Capitalised value of the business =  ` 2,20,000
10
Net tangible assets = Assets – liabilities = 2,75,000 – 75,000
= ` 2,00,000

Value of goodwill = ` 2,20,000 – ` 2,00,000 = ` 20,000

(ii) Average profit = ` 22,000

10
Less : Normal profit = 2,00,000  = ` 20,000
100

Super Profit = ` 2,000

100
Value of goodwill on capitalisation at super profits at 10% = ` 2,000  = ` 20,000
10
5. ANNUITY METHOD
An annuity means a series of equal periodic payments made at equal interval of time. The goodwill
under this method is equal to the present value of future extra profits (super profits) expected to be earned
which is discounted at normal rate of return. Thus, the goodwill is valued at by using the following
formula:
Goodwill = Super Profit  Reference to Annuity Table

Illustration 12.
Average annual profits after tax are ` 1,50,000. Normal rate of return is 12% p.a Present value of
annuity of ` 1 for the five years is 3. 60477. Capital employed in the business is ` 7,50,000. Find out the
value of goodwill by annuity method :
Solution.
Annual profits = ` 1,50,000
12
Normal profits = 7,50,000  = ` 90,000
100

Super profit = ` 1,50,000 – ` 90,000 = ` 60,000

Value of goodwill = ` 60,000  3.60477 = ` 2,16,286 approx.

6. HIDDEN GOODWILL
Sometimes, no particular method of valuation of goodwill or information is provided in the question.
In such a case, goodwill is calculated on the basis of capitals contributed by the partners and their
respective share in the firm. Following steps are required:
(ii) Find out full capital of the firm
Full capital = New partner’s capital  Reverse of new partner’s share

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 (ii) Deduct from the full capital, the combined capital of all the partners and balance is the value
of goodwill.
Illustration 6.
1
A and B are partners with capital ` 2, 00,000 and ` 1,50,000. They admit C for th share who brings
5
` 1,00,000 as capital. Find out the value of goodwill.
Solution.
`
5
Full Capital = ` 1,00,000  = 5,00,000
1
Less : Combined Capital :
A ` 2,00,000

B ` 1,50,000

C ` 1,00,000 4,50,000
Value of hidden goodwill 50,000

8.5 SUGGESTED READINGS

 R. L. Gupta and Radhaswamy, Advanced Accountancy, Volume II, Sultan Chand and Sons, New
Delhi.
 Maheshwari and Maheshwari, Advanced Accountancy, Volume II, Vikas Publishing House, New
Delhi
 Shukla, Grewal and Gupta, Advanced Accounts, Volume II, S Chand and Company, New Delhi
 Tulsian, P.C., Corporate Accounting, Tata McGraw Hill Education Pvt. Ltd., New Delhi

8.6 ANSWER THE FOLLOWING QUESTIONS

1. What do you know about the nature of goodwill? When is it valued?
2. Explain, with suitable examples, the different methods of valuation of goodwill.
3. Explain the factors on which the value of goodwill depends.
4. What is super profit? What are the steps to be followed for calculating super profit for the
valuation of goodwill?
5. How would you determine future maintainable profit?
6. Define Goodwill. What is its zoological classification?

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 LESSON 9

Valuation of Shares

VALUATION OF SHARES
When shares of company change hands, the value of such shares has to be ascertained.
The value of shares of unlisted companies is not available as those shares are not quoted on the stock
exchange. The value of shares of listed companies is available on the stock exchanges. But the market
price quoted in the stock exchange may not reflect the true value of the shares because market value is
a function of many factors. Sometimes it gets unduly affected by the market sentiments. So even when
shares of listed companies are transferred, their value has to be ascertained.
FACTORS AFFECTING VALUATION OF SHARES:
The principal factors which have to be taken into consideration for valuing the shares of a Joint
Stock Company are enumerated below:
1. The present and expected earnings of the company affect the value of shares. The investors are
willing to pay a higher price for the shares of a company which has bright future..
2. The yield or return expected from similar type of companies in the same industry also affects the
value of shares of a company in which the investors are actually interested. The prevailing bank rate and
risks involved have also a bearing on the market yield.
3. The investors take a negative view of a company whose dividend rates fluctuate or which sets
aside either too small or too big a share of divisible profits.
4. A company with in-appropriate financial ratios such as debt-equity ratio, current ratio and
various long term financial position ratios would not be favoured by the investors.
5. Financial position as reflected by the balance sheet of the company also affects the value of
shares.
6. The amount of capital employed in relation to expected profits also affects the valuation of
shares.
7. The shares of reputed companies with efficient and progressive managements command ready
acceptance and good price.
8. The Government may offer special incentives for the growth of a particular type of business e.g.,
tax holidays for companies in backward regions. And if the company in question falls within the
framework of those incentives, the value of its shares would go up due to growth prospects.
9. Political, social and economic conditions inside and outside the country have their impact on the
value of shares in the stock market.

OCCASIONS WHEN SHARES ARE VALUED

Need for valuation of shares arises in following cases:–
(i) For formulation of schemes of amalgamation, absorption etc.
(ii) For assessment of excise duty, wealth tax, gift tax etc.

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 (iii) For acquiring the interest of the dissenting shareholders in case of reconstruction.
(iv) For conversion of one class of shares into another class.
(v) For advancing loans on security of shares.
(vi) For compensation of shareholders in case their shares are acquired by the Government under
some scheme of nationalisation.
(vii) For purchase or sale of block of shares involving acquisition of controlling interest by the
holding company.
METHODS OF VALUATION OF SHARES
Following are the important methods of valuation of shares :
1. Net assets method
2. Yield method or Earnings method
3. Fair Value Method
4. Earning Per Share Method
1. NET ASSETS METHOD
This method is also known as intrinsic value method or break-up value method or assets backing
method. This method attempts to ascertain the amount of assets of the business enterprise against
each share.
This method takes into account the realisable value of assets as reduced by the claims of creditors,
debenture holders and other debts. If preference shares have priority over equity shares, preference
shares are also deducted form the realisable value of assets. The net assets above are divided by the
number of equity shares to give value per share. The procedure has been explained as under :-
(i) CALCULATION OF NET ASSETS
Realisable value of assets :– `
Goodwill XXX
Land XXX
Building XXX
Plant XXX
Furniture XXX
Debtors XXX
Bills Receivable XXX
Closing Stock XXX
Cash and bank balance, etc. XXX
Total Assets XXX

Less : Payment for :–

Debentureholders XXX
Creditors XXX

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 Other debt XXX XXX
XXX
Less : Preference share capital (if have priority over equity XXX
shares)
Balance assets available for equity shareholders XXX
Assets available for Equity Shareholders
(ii) Value per equity share =
Number of Equity `Shares
Notes :
(i) A proper calculation of goodwill must be made.
(ii) Fictitious assets such as preliminary expense, debit balance of profit and loss, discount or
commission on shares or debentures etc. should be excluded from the assets.
(iii) Other assets should be taken at current realisable value.
(iv) Only outside liabilities should be deducted from assets
(v) General reserve/fund, Profit and Loss Account balance, dividend equalisation fund,
contingency reserve, debenture redemption fund etc. should not be deducted.

Alternatively, the value of assets available to equity shareholders can also be calculated as follows :
`
Equity Share Capital XXX
Add : Reserves & Surplus XXX
Profit on Revaluation of Assets (if asset is revised XXX
upward)
XXX
Less:
Loss on Revaluation of Assets XXX XXX
Value of Net Equity XXX
Value of Net Equity
Value per Equity Share =
Number of Equity Shares

Advantage of Net Asset Method

This method enjoys some peculiar advantages as enumerated below :
(a) This method of valuation of shares is very useful when the firm is being liquidated since the
very foundation of this method is to use net realisable value of assets to value shares.
(b) This method takes into consideration both types of assets tangible as well as intangible. Thus,
goodwill, value of patent rights etc. is also included in calculating the value of shares.
(c) This method creates no problem in calculating the value of different types of equity shares.
Limitations of Net Asset Method
This method suffers from the following limitations :

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 (a) It is difficult task to estimate the realisable value of assets. There is a considerable scope for
personal bias.
(b) As the company is treated as going concern and where there is no possibility of its liquidation
in the near future, this method of share valuation is most hypothetical.
Illustration 1
The following is the summarised Balance Sheet of a company as at December 31st, 2014.
Liabilities ` Assets `
Share Capital Fixed Assets 38,00,000
10,000 5% preference shares of `100 Investments 10,25,000
10,00,000 Current Assets
each fully paid
2,00,000 Equity Shares of ` 10 each Stock in Trade 5,72,000
20,00,000 Sundry Debtors less Provisions 12,78,000
fully paid
Reserve and Surplus : Cash and Bank Balances 2,25,000
General Reserve 15,00,000
Profit & Loss Account (Cr.) 12,00,000
Secured Loan
6% Debentures 8,00,000
Current Liabilities
Sundry Creditors 2,75,000
Liabilities for expenses 1,25,000

69,00,000 69,00,000
For purposes of valuation of shares, Fixed assets are to be depreciated by 10 per cent. Investments
are to be taken at ` 10,80,000 and Sundry debtors are to be further reduced by 5 per cent.
Interest on Debentures is accrued due for 9 months and preference dividend for 2014 is also due;
neither of these has been provided for in the Balance Sheet.
Calculate the value of each Equity Share.
Solution.
`
Net Assets :
Fixed Assets (` 38,00,000 – ` 3,80,000) 34,20,000

Investment 10,80,000
Stock 5,72,000
Debtors (` 12,78,000 – 5%) 12,14,100

Cash at Bank 2,25,000

65,11,100

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 Less : Liabilities :–
6% Debentures 8,00,000
Interest on Debenture for 9 months 36,000
Creditors 2,75,000
Outstanding Expenses. 1,25,000 12,36,000
52,75,100
Less : Preference share capital 10,00,00
Preference dividend due 50,000 10,50,000
Assets available for Equity Shareholders 42,25,100
Assets available for Equity Shareholders
Value per share =
Number of Equity Shares
` 42,25,100
= = ` 21.13
2,00,000 Shares

VALUATION OF SHARES HAVING DIFFERENT PAID-UP VALUES

There is no problem if the company has issued one type of equity share-fully paid or partly paid
since the amount of net assets (Assets-Liabilities) has to be divided among them equally. However, if
there are different types of equity shares having different paid-up values then the value of shares can be
worked out by adding the unpaid and uncalled amount of shares (or making the notional call for making
the capital fully paid-up). Such a value when divided by total number of shares (fully paid) would give
up the value of each fully paid share. To get the intrinsic value of such shares the unpaid amount (which
is added earlier) should be further deducted.
Illustration 2
The following particulars relate to a company :
Total assets 18,50,000
External liabilities : 2,50,000
Share Capital :

14% Preference shares of ` 10 each, fully paid 5,00,000

40,000 Equity shares of ` 10 each, fully paid 4,00,000

60,000 Equity shares of ` 10 each , ` 750 paid 4,50,000

Calculate the value of each category of equity shares of the company based on a deemed liquidation.

Solution.
Calculation of Net Assets available to Equity Shareholders
`
Total assets 18,50,000

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 Less : External liabilities 2,50,000
Net assets 16,00,000
Less : Preference shares capital 5,00,000
Net assets for equity shareholder 11,00,000
Add : Notional call on 60,000 equity shares @ ` 2.50 per share 1,50,000

Net Assets available for equity shareholders after notional call 12,50,000
No. of equity shares = 40,000 + 60,000 = 1,00,000
Net Assets available for equity shareholders
Value of fully paid equity share =
Number of Equity shares

= ` 12,50,000/1,00,000 = ` 12.50

Value of partly paid equity share = ` 12.50 – ` 2.50 = ` 10

2. YIELD METHOD OR EARNING METHOD
This method takes prospective earnings of the company as the basis for share valuation. Shares
are valued assuming company as a going concern.
For the valuation of a share under this method, the following two bases are considered:
(a) Valuation based on rate of dividend
(b) Valuation based on rate of earning

(A) VALUATION BASED ON RATE OF DIVIDEND:

This method of valuation of share is based on expected dividend on the shares. This method is
suitable for shareholders having small blocks of shares because these shareholders are usually
interested in dividends.
The value of a share according to this method is ascertained as follows:
Value of Equity Share
Expected Rate of Dividend
=  Paid  up value of a share
Normal Rate of Return
Find the expected rate of dividend as under :–
Profits available for dividend
=  100
Paid up equity share capital
Note : While calculating profits available for dividend, following procedure should be followed :–

Earning before interest and tax (EBIT) 

Less : Interest on debt 
Profit before tax 

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 Less : Income tax 
Profit after tax 
Less : Preference dividend 
Profit after preference dividend 
Less : Transfer to General reserve (if any) 
Profit available as dividend for equity 
shareholders
ADVANTAGES OF EARNING/YIELD METHOD
This method enjoys the following superiority as compared to Net Assets Method :
(a) The investors while making investment decision would be more directly influenced by the
apparent earning power than what he can obtain in the event of company’s liquidation.
(b) The value of share is primarily based on what the investor will earn.
(c) Risk factor plays an important role in any investment decision. Risk factor is suitably taken
into account while calculating the normal rate of return.
LIMITATIONS OF EARNING/YIELD METHOD
This method suffers from following limitations :
(a) It is difficult to predict the future maintainable profit on account of risky and uncertain future.
(b) It is difficult to select a normal rate of return representing the element of risk involved in a
particular business.
(c) In case the company has been incurring losses for number of years then this method is not
suitable for valuation of shares.
Illustration 3
You have been given the following information:
Share Capital of X Ltd. is ` 8,00,000. X Ltd. distributes 60% of its profits as dividend while

Annual profit of X Ltd. is ` 2,00,000. Find out value of shares of X Ltd. Normal rate of return is 10%
p.a. The share of the company is of ` 100 paid-up value.
Solution
Calculation of Expected Rate of Dividend

Annual Profit = ` 2,00,000

Profit available for Dividend = ` 2,00,000  60%

= ` 1,20,000
Profit Available for Dividend
Expected Rate of Dividend =  100
Paid - up Equity Share Capital

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 ` 1,20,000
Expected Rate of Dividend = 100
` 8,00,000
= 15%
Valuation of Share
Expected Rate of Dividend
Value of Share =  Paid - up value of a share
Normal Rate of Return
15
=  ` 100 = ` 150
10
Illustration 4
From the following information, compute the value of equity share :

50,000 equity shares of ` 10 each ` 8 paid up 4,00,000

2,000 9% preference shares of ` 100 each 2,00,000

Estimated profits before tax 2,18,000

Rate of tax 50%
Transfer to reserve fund is required at 20% of profits. Normal rate of earnings 15%

Solution:
Calculation of Expected Rate of Dividend

Annual Profit before tax= ` 2,18,000

Less: Tax = ` 2,18,000  50% = ` 1,09,000

Less: Transfer to reserve fund ` 1,09,000x20% ` 21800

Less: Preference dividend ` 18000

Profit available for dividend 69, 200

Profit Available for Dividend
Expected Rate of Dividend=  100
Paid - up Equity Share Capital

` 69200
Expected Rate of Dividend =  100
` 4,00,000
= 17.3%
Valuation of Share
Expected Rate of Dividend
Value of Share =  Paid - up value of a share
Normal Rate of Return

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 17.3
=  ` 8 = ` 9.23
15
b) VALUATION BASED ON RATE OF EARNING
This method of valuation of shares is particularly suitable in case of big investors because they are
more interested in company’s earnings rather than what the company distributes in the form of
dividends. Value of share in this method is calculated by using the following formula :
Expected Rate of Earning
Value of Equity Share =  Paid-up value of a share
Normal Rate of Earning
Earnings available for equity shareholders
Where, Expected Rate of Earning =  100
Equity Share Capital or Capital Employed

While calculating expected rate of return, students must observe whether earnings show a specific
increasing or decreasing trend or not. In case trend is observed, it is advisable to calculate weighted rate
of return.
Illustration 5
From the following figures, calculate the value of the share of ` 100 on (i) Yield on Capital
employed, and the market expectation being 12%.
Year Capital Profit Dividend
Employed
` ` (%)

2011 5,50,000 88,000 12

2012 8,00,000 1,60,000 15
2013 10,00,000 2,20,000 18
2014 15,00,000 3,75,000 20

Solution.
(i) Valuation of Share on the basis of Yield on Capital Employed
Since the capital employed & profit shows an increasing trend over years, hence weighted average
return on capital employed is calculated as follows :
Year Capital Profit Return On Capital Weight Product
Employed Employed (%)
(`) (`)
5,50,00 88,000
2011 88,000  100 = 16 1 16
0 5,50,000
8,00,00 1,60,000
2012 1,60,000  100 = 20 2 40
0 8,00,000
10,00,0 2,20,000
2013 2,20,000  100 = 22 3 66
00 10,00,000

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 15,00,0 3,75,000
2014 3,75,000  100 = 25 4 100
00 15,00,000
Total 10 222
Weighted Average Rate of
Total of Product
Return On Capital Employed =
Total of Weight
222
= = 222%
10
Weighted Average Rate of
Return on Capital Employed
Value of Share =  Paid-up Value per share
Normal Rate of Return
22  2
=  100 = ` 185
12

3. FAIR VALUE METHOD

From the analysis of two methods i.e., Net Assets Method and Earning /Yield Method, it is clear
that both the methods have different considerations and as a consequence the value of share differs
under the two methods. Many accountants are of the view that neither the net assets method nor the
earning method considered independently is correct method of valuation of shares. They suggested that
valuation of shares should be done by combining the said two methods. Popularly known as fair value
method or dual method of valuation of shares which is a composite of intrinsic value and yield value.
This method provides a better insight about the value of shares as compared to asset backing method
and yield method.
Fair value of a share can be calculated by using the following formula :
Intrinsic Value  Yield Value
Fair value =
2
Illustration 5.
From the following particulars, calculate the fair value of an equity share assuming that out of the
total assets, those amounting to ` 41,00,000 are fictitious :
(i) Share Capital :
5,50,000 10% Preference Shares of ` 100 each fully paid up.

55,00,000 Equity Shares of ` 10 each fully paid up.

(ii) Liability to outsiders : ` 75,00,000.

(iii) Reserves & Surplus: ` 45,00,000.

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 (iv) The average normal profit after taxation earned every year by the company

during last five years ` 85,05,000.

(v) The normal profit earned on the market value of fully paid equity shares of

similar companies is 12%.

Solution:
VALUATION OF SHARES
(a) Intrinsic Value Method
Calculation of Net Assets available to Equity Shareholders

`
Equity Share Capital 5,50,00,000
Reserves & Surplus 45,00,000
5,95,00,000
Less : Fictitious Assets 41,00,000

Net Assets available to Equity shareholders 5,54,00,000

Number of equity shares 55,00,000
5,54,00,000
Intrinsic value of a share
55,00,000

= ` 10.07
(b) Yield Value Method

`
Average Profit after tax (Given) 85,05,000
Less : Preference Dividend (` 5,50,00, 000 × 10%) 55,00,000

Net Profit available to Equity Shareholders 30,05,000

Equity share capital 5,50,00,000
Net Profit Available to Equity Shareholder
Expected Rate of Return =  100
Equity Share Capital
30,05,000
=  100
5,50,00,000
= 5.46%
Expected Rate of Return
Value of an Equity Share = Paid up value of a share 
Normal Rate of Return

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 5.46
= ` 10 ×
12
= ` 4.55
(c) Fair Value of A Share
Intrinsic Value of Share  Yield Value of Share
Fair Value =
2
` 10.07  ` 4.55
=
2

= ` 7.31

4. EARNING PER SHARE METHOD

Earning per share method of valuation of shares has become a very significant & popular method
now a days. In this method, earning per share (EPS) of the company whose shares are to be valued is
calculated. By comparing the earning per share of the company with that of normal earning per share of
similar companies or industry, the value of share of a company is determined. Thus, value of share under
this method is calculated as follows :
EPS of Company
Value of Share =  Paid-up Value per Share
Normal EPS
Profit Available to Equity Shareholde rs
Where, EPS of Company =
Number of Equity Shares
Normal EPS = Paid-up value per share  Normal Rate of Earning
Illustration 28.
From the following balance sheet of Dabur India Ltd., find out the value per share under EPS
method.
Balance Sheet
As on 31st March 2014
Liabilities Amount Assets Amount

` `
Share Capital : Fixed Assets 2,50,000
3,400 Equity Share of ` 100 each 3,40,000

5% Preference Shares of ` 100 50,000 Current Assets 2,20,000

each
Current Liabilities 80,000
4,70,000 4,70,000

Average net profit after tax of the company is ` 1,48,700. Expected normal return is 20% in case of
similar companies.
Solution.

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Calculations of Earning Per Share
`
Net Profit after Tax 1,48,700
Less : Preference Dividend (` 50,000  5%) 2,500

Profit available to equity shareholders 1,46,200

Number of Equity Shares 3,400
Profit available to equity shareholder 1,46,200
Earning Per Share (EPS) = =` = ` 43
Number of Equity Shares 3,400
Normal EPS = Paid-up value per share  Normal rate of return
= ` 100  20% = ` 20
EPS of the company
Value of a Share =  Paid-up Value per Share
Normal EPS
43
=  100 = ` 215
20

SUMMARY
When shares of company change hands, the value of such shares has to be ascertained.The value of
shares of unlisted companies is not available as those shares are not quoted on the stock exchange. The
value of shares of listed companies is available on the stock exchanges. But the market price quoted in
the stock exchange may not reflect the true value of the shares because market value is a function of
many factors. Sometimes it gets unduly affected by the market sentiments. So even when shares of
listed companies are transferred, their value has to be ascertained. The principal factors which have to
be taken into consideration for valuing the shares of a Joint Stock Company are the present and
expected earnings of the company affect the value of shares, the yield or return expected from similar
type of companies in the same industry, financial position as reflected by the balance sheet of the
company etc. Important methods of valuation of shares are i) Net assets method, ii) Yield method or
Earnings method, iii) Fair Value Method.

SUGGESTED READINGS
 R. L. Gupta and Radhaswamy, Advanced Accountancy, Volume II, Sultan Chand and Sons, New
Delhi.
 Maheshwari and Maheshwari, Advanced Accountancy, Volume II, Vikas Publishing House, New
Delhi
 Shukla, Grewal and Gupta, Advanced Accounts, Volume II, S Chand and Company, New Delhi
 Tulsian, P.C., Corporate Accounting, Tata McGraw Hill Education Pvt. Ltd., New Delhi

ANSWER THE FOLLOWING QUESTIONS

1. Explain the steps involved in the valuation of shares under Yield method.

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 2. What do you understand by valuation of shares ? Explain the important methods of valuation of
shares. Illustrate your answer with examples.
3. What factors influence the valuation of shares.
4. What is the need for valuation of shares? State the factors affecting valuation of shares.
5. What is the difference between “Asset Backing Method” & “Yield Valuation Method” for valuing
the shares.
6. What are the circumstances in which there may be a need for valuation of shares of a
joint stock company ? How will you determine the intrinsic value of one equity share of a joint stock
company ? Explain with the help of an illustration.

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 LESSON 10
LESSON-2 FINAL ACCOUNTS OF COMPANIES -I

STRUCTURE

10.0 Objectives

10.1 Meaning and types of financial statements of a company

10.2 Form of Statement of Profit & Loss

10.3 Form of Balance Sheet

10.4 Difference between old format and new format

10.5 Summary

10.6 Suggested readings

10.7 Model questions

10.0 OBJECTIVES

After reading this lesson, you should be able to:

 Understand the meaning and types of financial statements of accompany
 Know about form and contents of Statement of Profit and Loss
 Understand the form and contents of balance sheet

10.1 Financial statements of A company

Financial statements are the basic and formal annual reports through which the corporate
management communicates financial information to its owners and various other external parties such
as stock exchanges, investors, tax authorities, government, employees etc. These normally refer to: (a)
the balance sheet (position statement) as at the end of accounting period, and (b) the statement of
profit and loss of a company. Now-a-days, the cash flow statement is also taken as an integral
component of the financial statements of a company.

Section 129 of Companies Act, 2013 makes it compulsory for a joint stock company to prepare its
Statement of Profit and Loss and Balance Sheet. In case the company has not been carrying on business
for profit, an Income and Expenditure Account shall be laid before the company at its annual general
meeting. The companies are required to prepare their financial statements for the “financial year”.

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Section 2(41) of the Companies Act, 2013 defines “financial year”, in relation to any company as the
period starting on Ist April of and ending on 31st March of the following year.

Legal provisions relating to financial statements of a company

1. Form and Contents of Financial Statements

Section 129(1) of Companies Act, 2013 provides that every financial statement of a company shall
give a true and fair view of the state of affairs of the company, comply with the accounting standards
notified by the Central Government under Section 133 of the said Act, shall be in the form or forms as
may be provided for different class or classes of companies in Schedule III. It shall also include any notes
annexed to or forming part of such financial statements.
2. Exemption from the applicability of Schedule III of the Companies Act, 2013
Schedule III of the Companies Act, 2013 is not applicable to any insurance or banking company or
any company engaged in the generation or supply of electricity, or to any other class of company for
which a form of financial statement has been specified in or under the Act governing such class of
company.
3. Modification of the Format of the financial statements in order to comply with the
requirement of the Accounting Standards
The General Instructions to the Schedule III provide that where requirements of Accounting
Standards as applicable to the companies require any change in treatment or disclosure of any item, or in
the head or sub-head in the financial statements, same shall be made and the requirements of this
Schedule shall stand modified accordingly.
4. Notes to Accounts
Narrative descriptions or details of items presented in financial statements shall be made in Notes
to accounts attached to those statements.

5. Requirement to provide comparable figures for the previous reporting figures

Companies are required to give the corresponding amounts (comparatives) for the immediately
preceding reporting period for all items shown in the Financial Statements.

6. Laying of annual accounts and balance sheet before annual general meeting
Section 129(2) of the Companies Act, 2013 casts an obligation upon the Board of directors of a
company to lay down financial statements before each and every annual general meeting.

7. Compliance with Accounting Standards

Every financial statements of the company shall comply with the accounting standards. Section
129(5) of the Companies Act, 2013 provides that where the financial statements of the company do not
comply with the accounting standards, such companies shall disclose in the financial statement, the
following, namely :-
(a) the deviation from the accounting standards;

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 (b) the reasons for such deviation; and
(c) the financial effect, if any, arising due to such deviation

10.2 Form of Statement of Profit & Loss (COMPANIES ACT, 2013)

Form of Statement of Profit And Loss

(as per schedule-III part-II of companies act, 2013)
STATEMENT OF NAME OF COMPANY……………

Profit and Loss for the year ended………….

Particulars Note Figures as Figures as at
No. at the end the end of
of current previous
reporting
reporting
period
period

` `
I. Revenue from Operations (gross)
Less Excise duty
Revenue from operations (Net)
II. OTHER INCOME

III. Total Revenue (I + II)

IV. Expenses :
Cost of materials consumed
Purchases of stock-in-trade
Changes in inventories of finished
goods, work-in- progress and stock-in-
trade
Employee benefits expense
Finance costs
Depreciation and amortization expense
Other expenses
V. TOTAL EXPENSES

VI. Profit/(Loss) before exceptional and

extraordinary items and tax (III -V)
VII. Exceptional items
VIII. Profit / (Loss) before extraordinary
items and tax (VI+ VII)

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 IX. Extraordinary items
X. Profit / (Loss) before tax (VIII + IX)
XI. Tax expense:
(1) Current tax
(2) Deferred tax
XII. Profit (Loss) from continuing
operations (X – XI)
XII. Profit/(Loss) from discontinuing
operations (before tax)
XIII. Tax expense of discontinuing operations
XIV. Profit (Loss) from discontinuing operations (after
tax) (XII-XIII)
XV. Profit / (Loss) for the period (XII + XIV)

XVI. Earnings per equity share:

(1) Basic
(2) Diluted
.
GENERAL INSTRUCTIONS FOR PREPARATION OF STATEMENT OF PROFIT AND LOSS
1. This form also applies to the income and expenditure account which is prepared by non-
profit organizations.
2. Revenue from operations shall disclose separately in the notes revenue from –
(a) sale of products ;
(b) sale of services ;
(c) other operating revenues ;
Less :
(d) Excise duty.
In respect of a finance company, revenue from operations shall include revenue from
(a) Interest; and
(b) Other financial services
3. Finance Costs: Finance costs shall be classified as:
(a) Interest expense;
(b) Other borrowing costs;
(c) Applicable net gain/loss on foreign currency transactions and translation.
4. Other income: Other income shall be classified as:
(a) Interest Income (in case of a company other than a finance company);
(b) Dividend Income;
(c) Net gain/loss on sale of investments
(d) Other non-operating income (net of expenses directly attributable to such income).

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 5. Additional Information: A Company shall disclose by way of notes additional information
regarding aggregate expenditure and income on the following items:-
(a) Employee Benefits Expense [showing separately (i) salaries and wages, (ii)
contribution to provident and other funds, (iii) expense on Employee Stock Option
Scheme (ESOP) and Employee Stock Purchase Plan (ESPP), (iv) staff welfare
expenses].
(b) Depreciation and amortization expense;
(c) Any item of income or expenditure which exceeds one per cent of the revenue
from operations or Rs.1,00,000, whichever is higher;
(d) Interest Income;
(e) Interest Expense;
(f) Dividend Income;
(g) Net gain/ loss on sale of investments;
(h) Adjustments to the carrying amount of investments;
(i) Net gain or loss on foreign currency transaction and translation (other than
considered as finance cost);
(j) Payments to the auditor as (a) auditor,(b) for taxation matters, (c) for company law
matters, (d) for management services, (e) for other services, and (f) for
reimbursement of expenses;
(k) In case of Companies covered under Section 135, amount of expenditure on
corporate social responsibility activities;
(l) Details of items of exceptional and extraordinary nature;
(m) Prior period items;

(n) Expenditure incurred on each of the following items, separately for each item:-
(a) Consumption of stores and spare parts;
b) Power and fuel;
(c) Rent;
(d) Repairs to buildings;
(e) Repairs to machinery;
(f) Insurance;
(g) Rates and taxes, excluding, taxes on income ;
(h) Miscellaneous expenses,

10.3 Balance Sheet– Forms and Contents

Form of Balance Sheet (AS PER SCHEDULE III - PART-I OF COMPANIES ACT, 2013)
NAME OF THE COMPANY
Balance Sheet as at .................. (Rupees in ...........)

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 Particulars Note
Figures as Figures as
No. at the end at the end
of current of previous
reporting reporting
period period
I EQUITY AND LIABILITIES
(1) Shareholders’ funds
(a) Share capital
(b) Reserves and surplus
(c) Money received against share warrants
(2) Share application money pending
allotment
(3) Non-current liabilities
(a) Long-term borrowings
(b) Deferred tax liabilities (net)
(c) Other long-term liabilities
(d) Long-term provisions
(4) Current liabilities
(a) Short-term borrowings
(b) Trade payables
(c) Other current liabilities
(d) Short-term provisions
TOTAL
ASSETS
II
Non-current assets
(1) (a) Fixed assets
(i) Tangible assets
(ii) Intangible assets
(iii) Capital work-in-progress
(iv) Intangible assets under
development
(b) Non-current investments
(c) Deferred tax assets (net)
(d) Long-term loans and advances
(e) Other non-current assets

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 (2) Current assets
(a) Current investments
(b) Inventories
(c) Trade receivables
(d) Cash and cash equivalents
(e) Short-term loans and advances
(f) Other current assets
Total

NOTES: GENERAL INSTRUCTIONS FOR PREPARATION OF BALANCE SHEET

1. An asset shall be classified as current when it satisfies any of the following criteria:
(a) it is expected to be realised in, or is intended for sale or consumption in, the company’s
normal operating cycle;
(b) it is held primarily for the purpose of being traded;
(c) it is expected to be realised within twelve months after the reporting date; or
(d) it is cash or cash equivalent unless it is restricted from being exchanged or used to
settle a liability for at least twelve months after the reporting date.
All other assets shall be classified as non-current.
2. An operating cycle is the time between the acquisition of assets for processing and their
realisation in cash or cash equivalents. Where the normal operating cycle cannot be
identified, it is assumed to have duration of 12 months.
3. A liability shall be classified as current when it satisfies any of the following criteria:
(a) It is expected to be settled in the company’s normal operating cycle;
(b) It is held primarily for the purpose of being traded;
(c) It is due to be settled within twelve months after the reporting date; or
All other liabilities shall be classified as non-current.
4. A receivable shall be classified as a ‘trade receivable’ if it is in respect of the amount due on
account of goods sold or services rendered in the normal course of business.
5. A payable shall be classified as a ‘trade payable’ if it is in respect of the amount due on
account of goods purchased or services received in the normal course of business.
DISCLOSURES IN NOTES TO ACCOUNTS
A. Share Capital
For each class of share capital (different classes of preference shares to be treated separately):
(a) The number and amount of shares authorized;
(b) The number of shares issued, subscribed and fully paid, and subscribed but not fully paid ;

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 (c) Par value per share;
(d) A reconciliation of the number of shares outstanding at the beginning and at the end of the
reporting period;
(e) The rights, preferences and restrictions attaching to each class of shares including restrictions
on the distribution of dividends and the repayment of capital;
(f) Shares held by holding company in its subsidiaries or associates;
(g) Shares in the company held by each shareholder holding more than 5 per cent shares
specifying the number of shares held
(h) Shares reserved for issue under options and contracts/commitments for the sale of
shares/disinvestment, including the terms and amounts
(i) (A) Aggregate number and class of shares allotted as fully paid up issued for consideration
other than cash.
(B) Aggregate number and class of shares allotted as fully paid up by way of bonus shares.
(C) Aggregate number and class of shares bought back.
Shares issued under (A), (B), and (C) above are to be shown in the balance sheet for the
period
of five years only.
( j) Terms of any securities convertible into equity/preference shares issued.
(k) Calls unpaid (showing aggregate value of calls unpaid by directors and officers)
(l) Forfeited shares (amount originally paid-up).
B. Reserves and Surplus
(i) Reserve and surplus shall be classified as follows
(a) Capital Reserves
(b) Capital Redemption Reserve
(c) Securities Premium Reserve
(d) Debenture Redemption Reserve
(e) Revaluation Reserve
(f ) Share Options Outstanding Account
(g) Other Reserves (specify the nature and purpose of reserve and the amount in respect
thereof)
(h) Surplus i.e. balance in Statement of Profit & Loss disclosing allocations and
appropriations such as dividend, bonus shares and transfer to/from reserves, etc
(Additions and deductions since the last Balance Sheet to be shown under each of the
specified head)
(ii) A reserve specifically represented by earmarked investments shall be termed as a ‘fund’.
(iii) Debit balance of statement of profit and loss shall be shown as a negative figure under the
head ‘Surplus’. Similarly, the balance of ‘Reserves and Surplus’, after adjusting negative
balance of surplus, if any, shall be shown under the head ‘Reserves and Surplus’ even if the
resulting figure is in the negative.
C. Long-term Borrowings
(i) Long-term borrowings shall be classified as:
(a) Bonds/debentures;

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 (b) Term loans;
 from banks;
 from other parties;
(c) Deferred payment liabilities;
(d) Deposits;
(e) Loans and advances from related parties;
(f ) Long term maturities of finance lease obligations;
(g) Other loans and advances (specify nature).
(ii) Borrowings shall further be sub-classified as secured and unsecured. Nature of security
shall be specified separately in each case.
(iii) Where loans have been guaranteed by directors or others, the aggregate amount of
such loans under each head shall be disclosed.
(iv) Bonds/debentures (along with the rate of interest and particulars of redemption or
conversion, as the case may be) shall be stated.
(v) Particulars of any redeemed bonds/ debentures which the company has power to
reissue shall be disclosed.
(vi) Terms of repayment of term loans and other loans shall be stated.
D.Other Long-term Liabilities
Other Long Term Liabilities should be classified into:
(a) Trade payables for long period; and
(b) Others.
E. Long-Term Provisions
This amount should be classified as:
(a) Provision for employee benefits and
(b) Others (specifying the nature).
F. Short-term Borrowings
Short-term borrowings shall be classified as:
(i) (a) Loans repayable on demand
(A) from banks;
(B) from other parties.
(b) Loans and advances from related parties;
(c) Deposits;
(d) Other loans and advances (specify nature).
(ii) Borrowings shall further be sub-classified as secured and unsecured. Nature of security
shall be specified separately in each case.
(iii) Where loans have been guaranteed by directors or others, the aggregate amount of
such loans under each head shall be disclosed.
G. Other Current Liabilities
The amounts shall be classified as:

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 (a) Current maturities of long-term debt;
(b) Current maturities of finance lease obligations;
(c) Interest accrued but not due on borrowings;
(d) Interest accrued and due on borrowings;
(e) Income received in advance;
(f) Unpaid dividends;
(g) Application money received for allotment of securities and due for refund and interest
accrued thereon;
(h) Unpaid matured deposits and interest accrued thereon;
(i) Unpaid matured debentures and interest accrued thereon;
(j) Other payables (specify nature).
H. Short-term Provisions
The amounts shall be classified as:
(a) Provision for employee benefits;
(b) Others (specify nature).
I. Tangible Assets
(i) Classification shall be given as:
(a) Land.
(b) Buildings.
(c) Plant and Equipment.
(d) Furniture and Fixtures.
(e) Vehicles.
(f) Office equipment.
(g) Others (specify nature).
(ii) Assets under lease shall be separately specified under each class of asset.
(iii) Additions, disposals, acquisitions through business combinations and other
adjustments and the related depreciation and impairment losses/reversals shall be
disclosed separately.
J. Intangible Assets
(i) Classification shall be given as:
(a) Goodwill.
(b) Brands /trademarks.
(c) Computer software.
(d) Mastheads and publishing titles.
(e) Mining rights.
(f) Copyrights, and patents and other intellectual property rights, services and
operating rights.
(g) Recipes, formulae, models, designs and prototypes.

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 (h) Licenses and franchise.
(i) Others (specify nature).
(ii) Additions, disposals, acquisitions through business combinations and other
adjustments and the related amortization and impairment losses/reversals shall be
disclosed separately.
K. Non-current Investments
(i) Non-current investments shall be classified as trade investments and other
investments and further classified as:
(a) Investment property;
(b) Investments in Equity Instruments;
(c) Investments in preference shares
(d) Investments in Government or trust securities;
(e) Investments in debentures or bonds;
(f) Investments in Mutual Funds;
(g) Investments in partnership firms
(h) Other non-current investments (specify nature)
(ii) Investments carried at other than at cost should be separately stated specifying
the
basis for valuation thereof.
(iii) The following shall also be disclosed:
(a) Aggregate amount of quoted investments and market value thereof;
(b) Aggregate amount of unquoted investments;
(c) Aggregate provision for diminution in value of investments
L. Long-term Loans and Advances
(i) Long-term loans and advances shall be classified as:
(a) Capital Advances;
(b) Security Deposits;
(c) Loans and advances to related parties (giving details thereof);
(d) Other loans and advances (specify nature).
(ii) The above shall also be separately sub-classified as:
(a) Secured, considered good;
(b) Unsecured, considered good ;
(c) Doubtful.
(iii) Allowance for bad and doubtful loans and advances shall be disclosed under the
relevant heads separately.
(iv) Loans and advances due by directors or other officers of the company or any of them
either severally or jointly with any other persons or amounts due by firms or private
companies respectively in which any director is a partner or a director or a member
should be separately stated.
M. Other Non-current Assets

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 Other non-current assets shall be classified as:
(i) Long Term Trade Receivables
(ii) Others (specify nature)
(iii) Long term Trade Receivables, shall be sub-classified as:
(A) Secured, considered good ;
(B) Unsecured considered good;
(C) Doubtful
(a) Allowance for bad and doubtful debts shall be disclosed under the relevant
heads separately.
(b) Debts due by directors or other officers of the company or any of them either
severally or jointly with any other person or debts due by firms or private
companies respectively in which any director is a partner or a director or a
member should be separately stated.
N. Current Investments
(i) Current investments shall be classified as:
(a) Investments in Equity Instruments;
(b) Investment in Preference Shares
(c) Investments in government or trust securities;
(d) Investments in debentures or bonds;
(e) Investments in Mutual Funds;
(f) Investments in partnership firms
(g) Other investments (specify nature).
(ii) In respect of investments, The following disclosures are also required:
(a) The basis of valuation of individual investments
(b) Aggregate amount of quoted investments and market value thereof;
(c) Aggregate amount of unquoted investments;
(d) Aggregate provision made for diminution in value of investments.
O. Inventories
(i) Inventories shall be classified as:
(a) Raw materials;
(b) Work-in-progress;
(c) Finished goods;
(d) Stock-in-trade (in respect of goods acquired for trading) ;
(e) Stores and spares;
(f) Loose tools;
(g) Others (specify nature).
(ii) Goods-in-transit shall be disclosed under the relevant sub-head of inventories. Mode of
valuation shall be stated.

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P. Trade Receivables
(i) Aggregate amount of Trade Receivables outstanding for a period exceeding six months
from the date they are due for payment should be separately stated.
(ii) Trade receivables shall be sub-classified as:
(a) Secured, considered good;
(b) Unsecured considered good;
(c) Doubtful.
(iii) Allowance for bad and doubtful debts shall be disclosed under the relevant heads
separately.
(iv) Debts due by directors or other officers of the company or any of them either severally
or jointly with any other person or debts due by firms or private companies
respectively in which any director is a partner or a director or a member should be
separately stated.
Q. Cash and Cash Equivalents
(i) Cash and cash equivalents shall be classified as:
(a) Balances with banks;
(b) Cheques, drafts on hand;
(c) Cash on hand;
(d) Others (specify nature).
(ii) Bank deposits with more than 12 months maturity shall be disclosed separately.
R. Short-Term Loans and Advances
(i) Short-term loans and advances shall be classified as:
(a) Loans and advances to related parties (giving details thereof);
(b) Others (specify nature).
(ii) The above shall also be sub-classified as:
(a) Secured, considered good;
(b) Unsecured, considered good;
(c) Doubtful.
(iii) Allowance for bad and doubtful loans and advances shall be disclosed under the
relevant heads separately.
(iv) Loans and advances due by directors or other officers of the company or any of them
either severally or jointly with any other person or amounts due by firms or private
companies respectively in which any director is a partner or a director or a member
shall be separately stated.
S. Other Current Assets (Specify Nature)
This is an all-inclusive heading, which incorporates current assets that do not fit into any
other asset categories.
T. Contingent Liabilities and Commitments (to the extent not provided for)
(i) Contingent liabilities shall be classified as:

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 (a) Claims against the company not acknowledged as debt;
(b) Guarantees;
(c) Other money for which the company is contingently liable
(ii) Commitments shall be classified as:
(a) Estimated amount of contracts remaining to be executed on capital account and not
provided for;
(b) Uncalled liability on shares and other investments partly paid;
(c) Other commitments (specify nature).

10.4 MAIN DIFFERENCES BETWEEN FINANCIAL STATEMENTS AS PER SCHEDULE VI

AND FINANCIAL STATEMENTS AS PER REVISED SCHEDULE III

(a) The revised schedule gives prominence to Accounting Standards (AS) i.e. in case of any
conflict in the treatment of any item or its disclosure between the AS and the Schedule, AS shall
prevail.
(b) The name of ‘Profit and Loss Account’ as contained in the Old Schedule VI, has been changed
to “Statement of Profit and Loss”.
(c) There was no format of Profit and loss in the Old Schedule VI, the Revised Schedule lays
down a format for the presentation of Statement of Profit and Loss.
(d) The format of Statement of Profit and Loss does not mention any appropriation item on its
face. It prescribes appropriations to be presented under “Reserves and Surplus” in the
Balance Sheet.
(e) In Schedule VI, the detailed information in respect of items of profit and loss account and
balance sheet were given in ‘Schedules’. The Schedule III has eliminated the concept of
‘Schedule’ and such information is now to be furnished in the notes to accounts.
(f) The revised schedule has prescribed a vertical format for presentation of financial
statements, therefore, no option to prepare the financial statement in horizontal format.
(g) The revised schedule has classified all assets and liabilities into current and non-current and
presented separately on the face of the Balance Sheet.
(h) Number of shares held by each shareholder holding more than 5% shares now needs to be
disclosed.
(i) Details pertaining to aggregate number and class of shares allotted for consideration other
than cash, bonus shares and shares bought back will need to be disclosed only for a period of
five years immediately preceding the Balance Sheet date.
(j) Any debit balance in the Statement of Profit and Loss will be disclosed under the head
“Reserves and surplus.” Earlier, any debit balance in Profit and Loss Account carried forward
after deduction from uncommitted reserves was required to be shown as the last item on the
asset side of the Balance Sheet.
(k) Specific disclosures are prescribed for Share Application money. The application money not
exceeding the capital offered for issuance and to the extent not refundable will be shown
separately on the face of the Balance Sheet. The amount in excess of subscription or if the

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 requirements of minimum subscription are not met will be shown under “Other current
liabilities.”
(l) The term “sundry debtors” has been replaced with the term “trade receivables.” ‘Trade
receivables’ are defined as dues arising only from goods sold or services rendered in the
normal course of business. Hence, amounts due on account of other contractual obligations
can no longer be included in the trade receivables.
(m) The Old Schedule VI required separate presentation of debtors outstanding for a period
exceeding six months based on date on which the bill/invoice was raised whereas, the
Revised Schedule III requires separate disclosure of “trade receivables outstanding for a
period exceeding six months from the date the bill/invoice is due for payment.”
(n) Tangible assets under lease are required to be separately specified under each class of asset.
(o) In the Old Schedule VI, details of only capital commitments were required to be disclosed.
Under the Revised Schedule III, other commitments also need to be disclosed.

10.5 SUMMARY

Financial statements are the basic and formal annual reports through which the corporate management
communicates financial information to its owners and various other external parties such as stock
exchanges, investors, tax authorities, government, employees etc. These normally refer to: (a) the
balance sheet (position statement) as at the end of accounting period, and (b) the statement of profit
and loss of a company. Now-a-days, the cash flow statement is also taken as an integral component of
the financial statements of a company.

Section 129 of Companies Act, 2013 makes it compulsory for a joint stock company to prepare its
Statement of Profit and Loss as per part II of Schedule III and and Balance Sheet as per Part I of
Schedule III . In case the company has not been carrying on business for profit, an Income and
Expenditure Account shall be laid before the company at its annual general meeting. The companies are
required to prepare their financial statements for the “financial year”. Section 2(41) of the Companies
Act, 2013 defines “financial year”, in relation to any company as the period starting on Ist April of and
ending on 31st March of the following year.

10.6 SUGGESTED READINGS

 R. L. Gupta and Radhaswamy, Advanced Accountancy, Volume II, Sultan Chand and Sons, New
Delhi.
 Maheshwari and Maheshwari, Advanced Accountancy, Volume II, Vikas Publishing House, New
Delhi
 Shukla, Grewal and Gupta, Advanced Accounts, Volume II, S Chand and Company, New Delhi
 Tulsian, P.C., Corporate Accounting, Tata McGraw Hill Education Pvt. Ltd., New Delhi

10.7 ANSWER THE FOLLOWING QUESTIONS

1. DRAW UP A PROFORMA OF BALANCE SHEET AS PER REQUIREMENTS OF
sCHEDULE III OF THE cOMPANIES ACT,
2013.

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2. Give a brief description of statutory contents of assets side of a company’s Balance Sheet?
3. Prepare in a summarised form, the Balance Sheet of a company as per Companies Act, 2013
taking imaginary figures.
4. Draw up the performa of ‘Statement of Profit and Loss’ of accompany as per Schedule III of
Companies Act, 2013.

Page 150 of 167

 LESSON 11
LESSON-3 FINAL ACCOUNTS OF COMPANIES-II

STRUCTURE

11.0 Objectives

11.1 Treatment of special items in final accounts of companies

11.2 Numerical problems to prepare Statement of Profit & Loss as per Schedule III of
Companies Act, 2013

11.3 Numerical problems to prepare Balance Sheet as per Schedule III of Companies Act,
2013

11.4 Summary

11.5 Suggested readings

11.6 Model questions

11.0 OBJECTIVES
After reading this lesson, you should be able to:
 Understand the accounting treatment of special items in financial statements of accompany
 Learn to prepare the Statement of Profit and Loss as per schedule III
 Learn to prepare the Balance Sheet of companies as per Schedule III

11.1 TREATMENT OF SPECIAL ITEMS WHILE PREPARING FINAL ACCOUNTS

Although, the general principles for preparing the final accounts of a company are the same as
partnership firms and the sole proprietorship concerns, some special points relating to the items particular
to a company are worth noting. These special points are :
1. Calls in Arrear: Calls in arrears, which appears in the trial balance, represents the amount not
paid by the shareholders when the call is made on them by the company. This is shown in the
balance sheet on the liability side by deducting the amount from called up capital under the
heading “share capital”.
2. Calls-in-Advance: If Articles of the company permits, a company may accept calls-in-advance.
That is, the shareholders may pay the amount on instalments not yet called by the company.
Calls-in-advance is a debt on the company and hence must be shown on the liability side of
the balance sheet. But the prescribed form of the balance sheet does not contain this item.
In the light of the nature of calls-in-advance, it is suggested that it ought to be treated as a
current liability and hence shown as “Other Current Liabilities” under the heading Current
Liabilities.

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3. Share Forfeited Account: Share forfeited account represents amount forfeited from the
shareholders on their default to pay the calls. This account appears on the credit side of trial
balance and is shown on the liability side of the balance sheet by adding to the paid-up-
capital under the heading “Share Capital”.
4. Securities Premium Account : This account is shown on the liability side of the balance sheet
under the heading “Reserves & surplus”.
5. Interest on Debentures: Interest on debenture account appears on the debit side of trial
balance and is treated as a charge against the profit. Hence this account is shown on
“Statement of Profit & Loss” under the head “Finance Cost”
6. Preference Dividend : Preference dividend is paid to preference shareholders at a fixed rate
in preference to payment of dividend to equity shareholders. If preference dividend account
appears in the trial balance, then it is shown as an appropriation from Profit & Loss Balance
under the heading “Reserves and Surplus” in the Balance Sheet. However, if this account is
given under adjustments then it will be firstly shown as appropriation from Profit and Loss
under the heading “Reserves and Surplus” and secondly shown as “Short Term Provisions”
under the heading “Current Liabilities”.
7. Equity Dividend: Dividend paid to equity shareholders after the payment of preference
dividend is known as equity dividend. Equity dividend is of following two types :
(a) Interim Dividend: Interim dividend represents dividend paid by the company between
two annual general meetings in anticipation of profit. This account always appears in the trial
balance. This is an appropriation of profit and hence is shown as an appropriation from Profit
& Loss Balance under the heading “Reserves and Surplus” in the Balance Sheet”.
(b) Final Dividend: Final dividend is dividend declared by the company after finalisation of
accounts. It will be firstly shown as appropriation from Profit and Loss under the heading
“Reserves and Surplus” and secondly will be shown as “Short Term Provisions” under the
heading “Current Liabilities”.
8. Corporate Dividend Tax : When a domestic company declares, distributes or pays dividends
(interim or final), it also has to pay tax on such dividend which is known as corporate
dividend tax. Rate of corporate dividend tax keeps on varying from year to year. Presently it
is 16.995% of dividends distributed by the company. This rate includes surcharge and
education cess.
The treatment of corporate dividend tax in financial statements of a company is two-
fold. Firstly, it is shown as appropriation from Profit and Loss under the heading “Reserves
and Surplus” and secondly is shown as “Short Term Provisions” under the heading “Current
Liabilities”.
9. Unclaimed Dividend: Unclaimed dividend represents dividend not collected by the
shareholders. This account is shown as “Other Current Liabilities” under the heading
“Current liabilities”.
10. Miscellaneous expenditure : Schedule III is silent on treatment of Miscellaneous Expenditure
like preliminary expenses, discount on issue of shares or debentures, underwriting
commission and brokerage on issue of shares and debentures. It is prudent to write off

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 some amount from these accounts every year. The amount written off is shown on the
“Statement of Profit & Loss” under the heading “other expenses” and the unwritten off
portion appears in the balance sheet under the heading “Other Non Current Assets/Other
Current Assets” depending on whether the amount will be amortized in the next 12 months
or thereafter.
11. Provision for Taxation: According to Income Tax Act, 1961, a company is liable to pay tax on
profits following the year in which such profits are earned. Since, the taxable profits are not
the same as accounting profits, hence it is not possible to determine the actual amount of tax
payable at the time the final accounts are prepared. As such, the liability for tax is estimated
and provided for while preparing the final accounts. It is firstly shown under the heading “Tax
Expense” in Statement of Profit and Loss and secondly shown as “Short Term Provisions”
under the heading “Current Liabilities” in the Balance Sheet.
11.3 Numerical problems to prepare Balance Sheet as per Schedule III of Companies Act, 2013

Illustration 1
How will you treat the following items while preparing Statement of Profit and Loss as per
Revised Schedule III of Companies Act, 2013
(i) Excise Duty
(ii) Staff Welfare Expenses
(iii) Interest on Debentures
(iv) Carriage Inwards
(v) Goodwill Written off
(vi) Stock of Finished Goods and Work in Progress

Solution.
Items Treatment
(i) Excise Duty It will be shown as deduction from sales while calculating
“Revenue from Operations”.
(ii) Staff Welfare It will be shown as an expense under the heading “Employee
Expenses Benefits Expense”.
(iii) Interest on It will be shown as an expense under the heading “Finance
Debentures Cost”.
(iv) Carriage Inwards Added in material cost while calculating “Cost of Materials
Consumed”.
(v) Goodwill Written Off It will be shown as an expense under the heading
“Depreciation and Amortization Expense”.
(vi) Stock of Finished It will be shown under the heading “Changes in Inventories
Goods and Work in of Finished Goods, Work in Progress and Stock in Trade”
Progress as follows.
Balance of Stock at the end:
Work in Progress xxx
Finished Goods xxx
xxxxx
Balance of Stock at the beginning:
Work in Progress xxx
Finished Goods xxx xxx

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 Changes in Inventories xxx

Illustration 2
The following is the Trial Balance of Sat Kartar Ltd. as on 31 st March, 2014. You are required to
prepare a Statement of Profit and Loss for the year ending 31 st March 2014

` `

Land & Buildings 1,25,00 Authorized Capital : 20,000 Equiity

0
Plant and Machinery 30,000 shares of ` 10 each

Goodwill 17,000 (12,000 Equity shares issued and 1,20,000

paid-up)
Stock on 1-4-2013 : General Reserve 25,000
Raw Materials 20,000 8 % Debentures 30,000
Stock in Process 10,000 Sales 1,81,300
Finished Goods 16,000 46,000 Creditors 1,01,490
Purchases of Raw Materials 87,000 Profit & Loss A/c balance on 1-4- 27,630
2013
Discounts 1,000
Manufacturing Wages 42,000
Salaries 8,000
Plant Repairs 2,500
General Charges 1,500
Directors Fees 1,200
Debenture Interest (upto 30-9- 1,200
2013)
Cash at Bank 64,000
Debtors 53,000
Bad Debts 1,020
Interim Dividend paid 5,000

4,85,42 4,85,420

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 0

Additional Information
(i) Depreciate Plant and Machinery by 10%.
1
(ii) Create Reserve for Doubtful Debts @ 2 % .
2

(iii) Closing Stock: Raw materials ` 15,000; Stock in process ` 9,000; Finished Goods ` 14,380.

Solution :

STATEMENT OF PROFIT AND LOSS

FOR THE YEAR ENDED 31 MARCH, 2014
PARTICULARS Note No. Amount
`
INCOME
Revenue from Operations (Gross) 1 1,81,300
Less : Excise Duty NIL
Revenue from Operations (Net) 1,81,300
Other Income ----
Total Revenue 1,81,300
EXPENSES
Cost of Materials Consumed 2 92,000
Change in Inventories of Finished Goods, Work-in Progress and 3 2,620*
Stock-in-trade
Employee Benefits Expenses 4 50,000
Finance Costs 5 2,400
Depreciation and Amortization Expenses 6 3,000
Other Expenses 7 8,545
Total Expenses 1,58,565
Profit of the year 22,735

Notes on Statement of Profit & Loss :

`
1. Revenue from Operations
Sales 1,81,300

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2. Cost of Materials Consumed
Opening Stock of Raw Material 20,000
Add : Purchases of Raw Material 87,000
1,07,000
Less : Closing Stock of Raw Material 15,000
92,000
3. Changes in Inventories of Finished Goods and Work in Progress
Inventories at the close :
Finished Goods 14,380
Stock in Process 9,000
23,380
Inventories at the beginning :
Finished Goods 16,000
Stock in Process 10,000 26,000
2,620
4. Employee Benefits Expenses
Manufacturing Wages 42,000
Salaries 8,000
50,000
5. Finance Costs
Interest on Debentures 1,200
Add : Outstanding for 6 months 1,200
2,400
6. Depreciation and Amortization Expenses
Depreciation on plant and Machinery 3,000
7. Other Expenses
Discount 1,000
Plant Repairs 2,500
General Charges 1,500
Director Fees 1,200
Provision for Bad Debts :
New Provision 1,325
(2.5% of 53,000)
Add : bad Debts 1,020 2,345
8,545

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*Students should note that if closing balance of stock in trade and work in process is higher than
opening balance, then it will appear as negative balance.

Illustration 3
Under which main heading and sub-heading of Equity and Liabilities will you classify the following
items in a Company’s Balance Sheet as per Schedule III :
(i) Debentures, (ii) Public Deposits (iii) Securities Premium Reserve (iv) Capital Reserve (v)
Forfeited Shares Account (vi) Interest Accrued and due on Debentures (vii) Acceptances (Bills Payable),
(viii) Advances Received from Customers (ix) Sundry Creditors, (x) Unclaimed Dividend (xi) Calls in
Arrears (xii) Calls in Advance (xiii) Arrears of Fixed Cummulative Preference Dividends.
Solution.
S No. ITEM Main Heading Sub-heading

(i) Debentures Non-Current Liabilities Long-term Borrowings

(ii) Public Deposits Non-Current Liabilities Long-term Borrowings
(iii) Securities Premium Reserve Shareholders’ Funds Reserves and Surplus
(iv) Capital Reserve Shareholders’ Funds Reserves and Surplus
(v) Forfeited Shares Account Shareholders’ Funds Addition to Subscribed &
Paid-up Capital)
(vi) Interest Accrued and due on Current Liabilities Other Current Liabilities
Debentures
(vii) Acceptances (B/P) Current Liabilities Trade Payables
(viii) Advances Received from Current Liabilities Other Current Liabilities
Customers
(ix) Sundry Creditors Current Liabilities Trade Payables
(x) Unclaimed Dividend Current Liabilities Other Current Liabilities
(xi) Calls-in-Arrear Shareholders Funds Deduction from
Subscribed Capital
(xii) Calls-in-Advances Current Liabilities Other Current Liabilities
(xiii) Arrears of Fixed Cumulative Contingent liability as a 
Preference Dividends footnote by way of a

Illustration 4
How will you treat the following items while preparing balance sheet of a company ?
(i) Advances from Customers
(ii) Proposed Dividend
(iii) Corporate Dividend Tax
(iv) Unclaimed Dividend
(v) Security Deposits
(vi) Creditors for goods and services

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 (vii) Trade Investments
(viii) Loan to Employees
(ix) Fixed Deposits with Banks
(x) Provision for Tax
(xi) Interest due on Debentures
(xii) Advance to Sundry Creditors
(xiii) Interest Receivable on Fixed Deposits with Banks
(xiv) Interest accrued but not due
Solution.
Items Treatment in Balance Sheet
(i) Advances from “Other Current Liabilities” under the heading
Customers “Current Liabilities”.
(ii) Proposed Dividend Shown as appropriation from Profit and Loss under the
heading “Reserves and Surplus” and secondly shown
as “Short Term Provisions” under the heading
“Current Liabilities”.
(iii) Corporate Dividend Tax Shown as appropriation from Profit and Loss under the
heading “Reserves and Surplus” and secondly shown
as “Short Term Provisions” under the heading
“Current Liabilities”.
(iv) Unclaimed Dividend “Other Current Liabilities” under the heading
“Current Liabilities”.
(v) Security Deposits “Long Term Loans and Advances” under the
heading “Non-Current Assets”.
(vi) Creditors for goods and “Trade Payables” under the heading “Current
services Liabilities”.
(vii) Trade Investments “Non Current Investments” under the heading “Non-
Current Assets”.
(viii) Loan to Employees “Long Term Loans and Advances” under the
heading “Non Current Assets”.
(ix) Fixed Deposits with “Cash and Cash Equivalent” under the heading
Banks “Current Assets”.
(x) Provision for Tax “Short Term Provision” under the heading “Current
Liabilities”.
(xi) Interest due on “Other Current Liabilities” under the heading
Debentures “Current Liabilities”.
(xii) Advance to Sundry “Short Term Loans and Advances” under the
Creditors heading “Current Assets”.
(xiii) Interest Receivable on “Other Current Assets” under the heading “Current
Fixed Deposits with Assets”.
Banks
(xiv) Interest accrued but not “Other Current Liabilities” under the heading
due “Current Liabilities”.

Page 158 of 167

Illustration 5
From the following information, prepare the Balance sheet of B Limited in the prescribed form per
Schedule III Part I as on March 31, 2014.

` `
Land 2,00,000 Underwriting commission 15,000
Cost of Building 4,00,000 Brokerage on issue of shares 8,000
Plant and Machinery 3,00,000 Cash-in-hand 15,000
Additions to Plant & Machinery 1,00,000 Cash at Bank 20,000
Investment in Govt. Securities 3,00,000 12% Debentures 4,68,000
Investment in Shares of the 1,50,000 Deposits from the public 3,00,000
Company
Stock in Trade 40,000 Creditors for goods 40,000
Debtors Outstanding for more Creditors for expenses 10,000
than
6 months 20,000 Unpaid Dividend 2,000
Other Debts 60,000 Employees Provident Fund 20,000
Preliminary Expenses 13,000 Arrears of Preference Share 18,000
Dividend
Capital Reserve 10,000
General Reserve 40,000
Profit and Loss (Credit) 50,000
Securities Premium 94,000
Authorized capital 10,000 equity shares of ` 100 each and 1,000, 12% Preference shares of ` 100
each. All the shares were issued. Out of these 4,500 equity shares were subscribed and paid-up except `
1,000 as calls in arrears. Forfeited shares account shows a balance of ` 6,000. All the 1,000 Preference
shares were fully paid up, ` 100 per share.

Additional information-Depreciate building by 5%, Depreciation on Plant and Machinery ` 30,000,

1
provision for bad-debts @ 2 %.
2
Solution:
Balance Sheet of B Ltd.
As at 31st March, 2014
Particulars Note No. Amount
`’000
A Equity and liabilities
1. SHAREHOLDERS’ FUNDS
(A) SHARE CAPITAL 1 555

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 (b) Reserves and Surplus 2 194
2. NON-CURRENT LIABILITIES
(a) Long-term Borrowings 3 768
(b) Long-term Provisions 4 20
3. Current Liabilities
(a) Trade Payables 5 40
(b) Other Current Liabilities 6 12
TOTAL 1,589
B Assets
1. Non-current Assets
(a) Fixed Assets
(i) Tangible Assets 7 950
(b) Non-current Investments 8 450
© Other Non-current Assets 9 36
2. Current Assets
(a) Inventories 10 40
(b) Trade Receivables 11 78
© Cash and Cash Equivalents 12 35
TOTAL 1,589

Contingent Liabilities
Arrears of Preference Dividend 18,000

Notes on Balance Sheet :

`’000
1. Share Capital

10,000 Equity Shares of ` 100 each 1,000

1,000, 12% Preference Shares of ` 100 each 100

1,100
Issued, Subscribed and Paid-up Capital

4,500 Equity Shares of ` 100 each 450

Less : Calls in Arrears 1

449

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 Add : Share Forfeited 6
455

1,000, 12% Preference Shares of ` 100 each 100

555
2. Reserves and Surpluses
Capital Reserve 10
General Reserve 40
Securities Premium 94
Profit and Loss Account 50
194
3. Long Term Borrowings
Secured :
12 % Debentures 468
Unsecured :
Deposits from Public 300
768
4. Long Term Provisions
Provision for Employees Benefits (Provident Fund) 20
5. Trade Payable
Creditors for Goods 40
6. Other Current Liabilities
Creditors for Expenses 10
Unpaid Dividend 2
12
7. Tangible Assets
Land 200
Building 400
Less : Dep. 20 380
Plant and Machinery 300
Add : Additions during the year 100
400
Less : Depreciation 30 370
950

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 8. Non-current Investments
Investment in Govt. Securities 300
Investment in Shares of the company 150
450
9. Other Non-Current Assets
13
Preliminary Expenses
15
Underwriting Commission
8
Brokerage on issue of Shares
36

10.
Inventories
40
Stock in trade
11.
Trade Receivables

Debtors :
20
Outstanding for more than 6 months
60
Other Debts
80

2
Less : Provision for bad debts
78

12.
Cash and Cash Equivalents
15
Cash in hand
20
Cash at bank
35

Illustration 6
The following is the Trial Balance of ABC Limited as on 31-3-2004. Prepare Final Accounts for the
year ended 31-3-2004.
Trial balance

` `

Equity Share Capital 2,80,000

6% Debentures 75,000

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 Leasehold Premises 1,75,000
Salaries 28,350
Carriage Inwards 4,650
Insurance 780
Motor Lorry 16,500
Bad Debts Reserves 2,100
Sales 6,36,850
Bills Payable 23,000
Discount 4,255
Sundry Creditors 30,180
Profit and Loss 1,980
Postage 3,165
Machinery 1,20,000
Rent 2,850
Purchases 2,69,100
Directors Fees 4,695
Office Expenses 5,085
Bad Debts 915
Furniture 4,380
Goodwill 45,000
Opening Stock 2,52,500
Wages 28,450
Interest on Debentures 2,250
Cash at Bank 61,195
Debtors 28,500
10,53,365 10,53,365
Adjustments :
(a) Provide interest on debentures for half year.
(b) Write off further bad debts ` 500 and maintain bad debts reserve @ 5% on debtors.

(c) Unexpired insurance amounted to ` 500.

(d) Depreciate leasehold by 5%, machinery by 10% and motor lorry by 20%.
(e) Out of profits, transfer ` 25,000 to reserve fund and a dividend of 15% to be declared on equity
share capital.

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 (f ) The closing stock is valued at ` 55,905.
Sol.

STATEMENT OF PROFIT AND LOSS

FOR THE YEAR ENDING 31ST MARCH, 2004
Not `
e
No.
(I) Revenue from Operations (Sales) 6,36,850
(II) Other Incomes (Discount) 4,255
(III) Total Revenue (I + II) 6,41,105
(IV) Expenses :
Cost of Materials Consumed 1 4,65,695
Employees Benefit Expenses 2 56,800
Finance Expenses : 3 4,500
Depreciation and Amortisation Expenses 4 24,050
Other Expenses 5 21,440
5,72,485
(V) Profit before tax the year (III-IV) 68,620
Balance Sheet of ABC Ltd.
As on 31st March 2004
Not `
PARTICULARS e
No.
EQUITY AND LIABILITIES
1. Shareholder’s Fund
(a) Share Capital 6 2,80,000
(b) Reserve and Surplus 7 28,600
2. Non-Current Liabilities
(a) Long Term Borrowings 8 75,000
3. Current Liabilities :
Trade Payable 9 53,180
Short Term Provisions 10 42,000
Other Current Liabilities 11 2,250

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 Total 4,81,030
Assets
1. Non-Current Assets
(a) Fixed Assets :
Tangible Assets 12 2,91,830
Intangible Assets 13 45,000
2. Current Assets
(a) Inventories 14 55,905
(b) Trade Receivable 15 26,600
(c) Cash and Cash Equivalents 16 61,195
(d) Short term loans and Advances 17 500
Total 4,81,030

ACCOMPANYING NOTES TO FINAL ACCOUNT

1. Cost of Materials Consumed : `
Opening Stock 2,52,500
Add : Purchases 2,69,100
5,21,600
Less : Closing Stock 55,905
4,65,695
2. Employees Benefit Expenses :
Wages 28,450
Salaries 28,350
56,800
3. Finance Expenses
Interest on Debentures 2,250
Add : Outstanding Interest 2,250
4,500
4. Depreciation and Amortisation Expenses :
Depreciation on Leasehold Premises 8,750
Depreciation on Machinery 12,000
Depreciation on Motor Lorry 3,300
24,050
5. Other Expenses
Director Fees 4,695

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 Carriage Inward 4,650
Insurance 780 780
(–) Prepaid 500 280
Rent 2,850
Office Expenses 5,085
Provision for Bad Debts :
New provision for Bad Debt 1400
Add : Bad debts (915 + 500) 1415
2,815
Less : Existing provision for bad debts 2,100 715
Postage 3,165
21,440
6. Share Capital :
Equity Share Capital 2,28,000
2,28,000
7. Reserves and Surplus
Reserve Fund 25,000
Profit and Loss Account :
Balance as on 1st April 2003 1,980
Add : Profit for the year 68,620
70,600
Less : Transfer to Reserve Fund 25,000
Proposed Dividend 42,000 67,000 3,600
28,600
8. Long Term Borrowings
6% Debentures 75,000
75,000
9. Trade Payables

Bills Payable 23,000

Sundry Creditors 30,180
53,180
10. Short Term Provisions

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 Proposed Dividend 42,000

42,000

11. Other Current Liabilities

Outstanding Interest on Debentures 2,250

2,250

12. Fixed Assets-Tangible Assets

Furniture 4,380
Leasehold Premises (1,75,000 – 8,750) 1,66,250
Motor Lorry (16,500 – 3,300) 13,200
1,08,000
Machinery (1,20,000 – 12,000)
2,91,830
13. Intangible Assets
Goodwill 45,000

14. Inventories
Closing Stock 55,905

15. Trade Receivable

Debtors 28,500
Less : Further Bad Debts 500

28,000
1,400
Less : New Provision for doubtful debts
26,600

16. Cash and Cash equivalents

Cash at Bank 61,195

17. Short Term Loans and Advances

Prepaid Insurance 500

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