Accounting for Share CapitalClass 12 Accountancy Part 2 Notes

Features of a Company

A company is a special form of business organization where many people, called shareholders, contribute money to a common fund to be used for a business purpose. Because there are so many owners, it's not practical for everyone to manage the business. Instead, they elect a Board of Directors to run the company on their behalf. All companies in India are governed by the Companies Act, 2013.

Chief Justice Marshal famously described a company as an "artificial person, invisible, intangible and existing only in the eyes of law." This means a company is a legal entity in its own right, separate from its owners.

A company raises money in two main ways:

1. Share Capital: Money from selling ownership stakes (shares).
2. Debt Capital: Money from borrowing (debentures).

This chapter focuses on the accounting for share capital. A company has several distinct features that set it apart from other business types:

• Body Corporate: A company is created and registered according to the law. In India, most companies are formed under the Companies Act, while banking and insurance companies have their own specific laws.
• Separate Legal Entity: A company is legally separate from its members (shareholders). It can own property, sign contracts, and even open a bank account in its own name.
• Limited Liability: A shareholder's financial responsibility is limited. If the company has debts, a shareholder is only liable for the unpaid amount on their shares. Their personal property is safe. For companies limited by guarantee, members are only liable for the amount they guaranteed to pay if the company closes down.
• Perpetual Succession: The company continues to exist even if its members change. The death, insolvency, or insanity of a shareholder does not affect the company's existence. Members can come and go, but the company goes on forever until it is legally terminated.
• Common Seal: Since a company is an artificial person, it cannot sign documents itself. It uses a common seal, which acts as its official signature. A document without the company's common seal is not legally binding on the company.
• Transferability of Shares: The shares of a public limited company can be bought and sold freely without needing permission from the company or other members. The company's Articles of Association can set out the procedure for these transfers.
• May Sue or be Sued: As a legal person, a company can enter into contracts and take legal action against others if those contracts are broken. Similarly, others can sue the company in its own name.

Kinds of Companies

Companies can be classified based on the liability of their members or the number of their members.

On the Basis of Liability

• Companies Limited by Shares: The liability of members is limited to the nominal (face) value of the shares they own. Once a member has paid the full price for their shares, they have no further liability for the company's debts, regardless of how large they are.
• Companies Limited by Guarantee: The liability of members is limited to a specific amount they agree to contribute if the company is wound up (closed down). This liability only arises when the company is closing.
• Unlimited Companies: There is no limit on the liability of the members. If the company cannot pay its debts, the members' private property can be used to settle the claims of creditors. These types of companies are rare in India.

On the Basis of Number of Members

• Public Company: A public company is one that is not a private company and is not a subsidiary of a private company. Its shares are generally offered to the public.
• Private Company: A private company is defined by its articles of association, which:
  • Restricts the right to transfer its shares.
  • Must have at least two members (except for a One Person Company).
  • Limits the number of its members to 200 (not including current or former employees who are members).
• One Person Company (OPC): As defined by the Companies Act, 2013, an OPC is a company with only one person as a member. Key rules include:
  • Only a natural person who is an Indian citizen and resident in India can form an OPC.
  • It cannot engage in non-banking financial investment activities.
  • Its paid-up share capital cannot be more than Rs. 50 Lakhs.
  • Its average annual turnover for the last three years cannot exceed Rs. 2 Crores.

Share Capital of a Company

A company, being an artificial entity, raises its capital by collecting money from many individuals, who become shareholders. The total amount contributed by them is called share capital. Because there are often thousands of shareholders, the company doesn't open a separate capital account for each person. Instead, all contributions are pooled into a single account called the 'Share Capital Account'.

Categories of Share Capital

From an accounting perspective, share capital is classified into several categories:

• Authorised Capital: This is the maximum amount of share capital a company is legally permitted to issue, as stated in its Memorandum of Association. It is also known as Nominal or Registered Capital. The company can increase or decrease this amount by following the legal procedures.
• Issued Capital: This is the portion of the authorised capital that the company actually offers to the public for subscription. The part of the authorised capital not offered is called 'unissued capital'.
• Subscribed Capital: This is the portion of the issued capital that the public has actually applied for and agreed to buy. If the public subscribes to fewer shares than were issued, the subscribed capital will be less than the issued capital. If more shares are applied for (oversubscription), the company can only allot up to the amount it issued.
• Called-up Capital: This is the part of the subscribed capital that the company has asked shareholders to pay. A company may not demand the full face value of the shares at once. [!example] If a share has a face value of Rs. 10 and the company has only asked for Rs. 7 so far, the called-up capital is Rs. 7 per share. The remaining Rs. 3 is uncalled capital.
• Paid-up Capital: This is the portion of the called-up capital that the company has actually received from shareholders. If a shareholder fails to pay an amount that has been called up, this unpaid amount is known as 'calls in arrears'. Therefore, Paid-up Capital = Called-up Capital - Calls in Arrears.
• Uncalled Capital: This is the portion of the subscribed capital that has not yet been requested from shareholders. The company can "call" for this amount whenever it needs more funds.
• Reserve Capital: This is a part of the uncalled capital that a company decides, by a special resolution, to call up only in the event of the company being wound up. This amount is reserved for creditors at the time of liquidation.

Nature and Classes of Shares

A share is one of the equal units into which a company's total share capital is divided. It represents a shareholder's ownership interest in the company. The Articles of Association specify the different classes of shares a company can issue. According to the Companies Act, there are two primary types of shares:

1. Preference Shares
2. Equity Shares (also called ordinary shares)

Preference Shares

A preference share, as per Section 43 of the Companies Act, 2013, has two main preferential rights over other types of shares:

1. Preferential Right to Dividend: They receive a dividend, which is either a fixed amount or calculated at a fixed rate, before any dividend is paid to equity shareholders.
2. Preferential Right to Repayment of Capital: In case the company is wound up, preference shareholders have the right to get their capital repaid before equity shareholders receive anything.

Preference shares can have additional features, such as being participating (sharing in surplus profits) or non-participating, cumulative (unpaid dividends accumulate) or non-cumulative, and redeemable (can be bought back by the company) or irredeemable.

Equity Shares

An equity share is any share that is not a preference share. Equity shareholders are the real owners of the company and bear the ultimate risk. They do not have any preferential rights regarding dividends or repayment of capital.

• They receive dividends only after preference shareholders have been paid.
• The rate of dividend on equity shares is not fixed and depends on the profits available for distribution.
• Equity shares can be issued with standard voting rights or with differential rights as to voting, dividend, or other matters, as specified in the company's Articles of Association.

Issue of Shares

A key feature of company finance is that the payment for shares can be collected in installments over time, matching the company's financial needs. The typical stages of payment are:

1. Application Money: Paid by investors when they apply for shares.
2. Allotment Money: Paid by applicants when the company formally allots (assigns) shares to them.
3. Call Money: Subsequent installments are known as calls (e.g., First Call, Second Call, Final Call).

The process of issuing shares to the public involves three main steps:

• Issue of Prospectus: The company issues a prospectus, which is a formal invitation to the public to subscribe to its shares. It contains detailed information about the company and the share issue.
• Receipt of Applications: Prospective investors apply for shares by submitting an application form along with the application money to a designated bank.
• Allotment of Shares: After receiving a minimum subscription, the company can proceed with allotting shares. A letter of allotment is sent to successful applicants, making them shareholders. A letter of regret is sent to unsuccessful applicants, and their application money is returned.

Minimum Subscription

Minimum subscription is the minimum amount of capital that the directors believe must be raised from the share issue to fund the company's business operations. According to SEBI (Securities and Exchange Board of India) guidelines, a company must receive subscriptions for at least 90% of the issued amount.

Accounting Treatment

When a company issues shares, specific journal entries are recorded at each stage of the process.

On Application

When investors apply for shares, they send application money. This money is initially placed in a temporary account.

• Journal Entry for receiving application money:
  • Bank A/c Dr.
  • To Share Application A/c

On Allotment

Once the company decides to allot shares, the application money for the allotted shares is transferred from the temporary 'Share Application' account to the permanent 'Share Capital' account.

• Key Accounting Implications of Allotment:

  • Application money for allotted shares is transferred to Share Capital.
  • Money for rejected applications is refunded.
  • Excess application money from pro-rata allottees is adjusted against the amount due on allotment.
  • An amount called 'Allotment Money' becomes due from the new shareholders.

• Journal Entries for Allotment:

  1. For transfer of application money on allotted shares:
     • Share Application A/c Dr.
     • To Share Capital A/c
  2. For refunding money on rejected applications:
     • Share Application A/c Dr.
     • To Bank A/c
  3. For amount becoming due on allotment:
     • Share Allotment A/c Dr.
     • To Share Capital A/c
  4. For adjusting excess application money:
     • Share Application A/c Dr.
     • To Share Allotment A/c
  5. For receiving allotment money:
     • Bank A/c Dr.
     • To Share Allotment A/c

Applications Supported by Blocked Amount (ASBA)

ASBA is a process developed by SEBI for applying to public issues. Instead of paying the application money upfront, an applicant authorizes their bank to block the amount in their account. The money is only debited from the account if shares are allotted, and only for the value of the allotted shares. If no shares are allotted, the bank simply unblocks the amount.

On Calls

After allotment, the company may ask shareholders to pay the remaining amount on their shares in one or more installments, known as calls.

• Important Rules for Calls (as per Table A of the Companies Act):

  • The amount of any single call should not exceed 25% of the share's face value.
  • There must be at least a one-month interval between two calls.
  • Shareholders must be given at least 14 days' notice to pay the call amount.

• Journal Entries for Calls:

  1. For call amount becoming due:
     • Share Call A/c (e.g., Share First Call A/c) Dr.
     • To Share Capital A/c
  2. For receiving call money:
     • Bank A/c Dr.
     • To Share Call A/c

Calls in Arrears

When a shareholder fails to pay the amount due on allotment or any call by the due date, the unpaid amount is known as Calls in Arrears.

A company may choose to open a separate 'Calls in Arrears Account' to track these unpaid amounts.

• Journal Entry to record Calls in Arrears:
  • Calls in Arrears A/c Dr.
  • To Share Allotment A/c / To Share Call A/c

The company's Articles of Association may allow it to charge interest on calls in arrears. If the Articles are silent, Table F of the Companies Act applies, which allows for interest at a rate not exceeding 10% per annum.

Calls in Advance

Sometimes, shareholders pay the amount for future calls before the company has officially requested it. This amount is known as Calls in Advance. It is a liability for the company and is credited to a 'Calls in Advance Account'.

• Journal Entry for receiving Calls in Advance:
  • Bank A/c Dr.
  • To Calls in Advance A/c

When the actual call becomes due, the advance amount is adjusted. The company may pay interest on calls in advance, as per its Articles. If the Articles are silent, Table F allows for interest at a rate not exceeding 12% per annum.

Over Subscription

Over subscription occurs when a company receives applications for more shares than it has offered to the public. This is common for well-regarded companies. The directors have three alternatives to handle this situation:

1. Accept some applications in full and reject the rest: The application money for the rejected applications is fully refunded.
2. Make a pro-rata allotment to all applicants: All applicants are allotted shares in a fixed proportion to the number of shares they applied for. The excess application money is usually adjusted against the amount due on allotment. [!example] If a company offers 10,000 shares and receives applications for 15,000, it might allot shares in the ratio of 2:3 (10,000:15,000). An applicant who applied for 30 shares would be allotted 20 shares.
3. A combination of the above two methods: Some applications are rejected, and a pro-rata allotment is made to the remaining applicants. This is the most common approach.

Under Subscription

Under subscription is the opposite situation, where the number of shares applied for is less than the number offered by the company. In this case, the company can only allot the number of shares that have been applied for, provided it has met the minimum subscription requirement of 90%.

Issue of Shares at a Premium

When a company issues shares for a price higher than their nominal (face) value, the excess amount is called a premium.

The premium amount is credited to a separate account called the 'Securities Premium Account'. This account is shown under 'Reserves and Surpluses' in the balance sheet.

1. To issue fully paid bonus shares.
2. To write off preliminary expenses of the company.
3. To write off expenses, commission, or discount on the issue of any securities.
4. To pay the premium on the redemption of preference shares or debentures.
5. To buy back its own shares.

Issue of Shares at a Discount

Issuing shares at a discount means selling them for a price less than their nominal value. As a general rule, a company cannot issue shares at a discount. The only exceptions are for the reissue of forfeited shares and the issue of sweat equity shares.

Issue of Shares for Consideration other than Cash

Sometimes a company buys assets (like machinery or a building) and pays the seller (vendor) by issuing its own fully paid shares instead of cash. The number of shares to be issued is calculated as:

Number of Shares = Amount Payable / Issue Price per Share

The shares can be issued at par or at a premium.

• Journal Entry for purchase of asset:
  • Sundry Assets A/c Dr.
  • To Vendor's A/c
• Journal Entry for issuing shares to the vendor (at par):
  • Vendor's A/c Dr.
  • To Share Capital A/c
• Journal Entry for issuing shares to the vendor (at premium):
  • Vendor's A/c Dr.
  • To Share Capital A/c
  • To Securities Premium Reserve A/c

Forfeiture of Shares

If a shareholder fails to pay allotment money or any call money, the company has the right to forfeit their shares. Forfeiture means cancelling the allotment of shares and keeping the amount already paid by the defaulting shareholder. This action must be done strictly according to the procedure laid down in the company's Articles of Association.

Accounting for Forfeiture of Shares Issued at Par

When shares issued at par are forfeited, the Share Capital account is debited with the amount called-up on those shares. The amount already received is credited to a 'Share Forfeiture Account', and the unpaid amounts are credited to the respective call/allotment accounts.

• Journal Entry for Forfeiture (at Par):
  • Share Capital A/c Dr. (With called-up amount)
  • To Share Forfeiture A/c (With amount already paid)
  • To Share Allotment/Calls A/c (With unpaid amount)

The balance in the Share Forfeiture Account is shown as an addition to the paid-up capital in the balance sheet until the shares are reissued.

Forfeiture of Shares Issued at a Premium

The accounting treatment depends on whether the premium on the forfeited shares has been received or not.

• Case 1: Premium has been received. If the premium amount has already been collected, the Securities Premium Account is not touched during forfeiture. The entry is the same as for shares issued at par.

• Case 2: Premium has not been received. If the premium is due but has not been paid (usually with allotment money), the Securities Premium Reserve Account must also be debited at the time of forfeiture to cancel the premium that was recorded as due but never received.

• Journal Entry for Forfeiture (Premium not received):

  • Share Capital A/c Dr. (With called-up amount, excluding premium)
  • Securities Premium Reserve A/c Dr. (With unpaid premium amount)
  • To Share Forfeiture A/c (With amount received, excluding premium)
  • To Share Allotment/Calls A/c (With total unpaid amount)

Reissue of Forfeited Shares

Forfeited shares can be reissued by the directors at par, at a premium, or at a discount.

When forfeited shares are reissued, the amount received is debited to the Bank Account. If they are reissued at a discount, the discount amount is debited to the Share Forfeiture Account.

• Journal Entry for Reissue:
  • Bank A/c Dr. (With amount received on reissue)
  • Share Forfeiture A/c Dr. (With discount on reissue, if any)
  • To Share Capital A/c (With paid-up value of reissued shares)

After the reissue, any remaining balance in the Share Forfeiture Account related to the reissued shares is a capital profit. This profit must be transferred to the Capital Reserve Account.

• Journal Entry for transferring profit to Capital Reserve:
  • Share Forfeiture A/c Dr.
  • To Capital Reserve A/c