UNIT II

COMPANY ACCOUNTS

1. What are Statutory books? (Dec 2017)

Statutory Books are the official records kept by the company relating to all legal
and statutory matters.

A company's statutory books are usually kept at the registered office of the
company. The books should be available to the general public for inspection during
reasonable office hours.

The typical contents of a company's statutory book are:

* The register of shareholders
* The register of company directors and secretaries
* The register of company directors' interests
* The register of charges
* The register of interests in shares if the company is a PLC.

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2. What do you mean by a company?(Dec 2016)

A company means a group of persons associated together for the attainment of a

common end, social or economic. It has “no strictly technical or legal meaning” .It has capital
divisible into parts, known as shares. At the same time, it is an artificial person created by a
process of law .A Company has no body, no soul and no conscience. It is not visible, save to the
eye of the law.
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3. What is preferential allotment?(June 2013) (Dec 2016)

Making a bulk allotment of shares to individuals, companies, venture capitalists or any other
person through a fresh issue of shares is known as preferential allotment. This method is
distinctive from others in the sense that the entire allotment is made to pre-identified people, who
may or may not be existing shareholders of the company, at a pre-determined price.

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4. Define Joint Stock Company? (June 2014) (January 2015)

A joint stock company is a company whose stockholders have the same privileges and
responsibilities as an unlimited partnership.

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 A company or association consisting of individuals organized to conduct a business for gain
and having a joint stock of capital represented by shares owned individually by the members and
transferable without the consent of the group.

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5. What do you mean by employees stock option scheme? (June 2014) (January 2015)
(Dec 2017)

It is option given to the whole time director’s officers &employees of a company, to enjoy
the benefit or right to purchase/subscribe at a future date offered by the company at a pre
determined price.
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6. What is allotment of shares? (Jan 2014)

It means an appropriation of a certain number of shares to an applicant in response to his

application for shares. Allotment means distribution of shares among those who have submitted
written application.

The allotment of shares is the issuing of new shares to the existing shareholders or to third
parties. The Directors of a Company may allot shares in the capital of the Company, if they have
the authority to do so.
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7. What is forfeiture of shares? (Jan 2014)

Forfeiture of shares means cancellation of shares. If a shareholder fails to pay the allotment
or call money .When demanded, the directors have the power of forfeiting shares issued to
shareholders. When shares are forfeited the shareholders name is removed from the register of
members and the amount already paid by him on the shares becomes the property of the
company.

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8. Mention any two methods of alteration of share capital.(June 2013)

(a) increase its share capital by such amount as it thinks expedient by issuing new shares;
(b) Consolidate all or any of its share capital into shares of larger amount than its existing
shares;
(c) Convert all or any of its fully paid-up shares into stock, and reconvert that stock into
fully paid-up shares of any denomination;
(d) Sub-divide its shares, or any of them, into shares of smaller amount than is fixed by
the memorandum,
(e) Cancel shares.

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 9. What is profit and loss account? (Jan 2012)

An official quarterly or annual financial document published by a public company, showing

earnings, expenses, and net profit. Net income is determined from this financial report by
subtracting total expenses from total revenue

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10. What is compound journal entry? (Jan 2012)

A compound journal entry is an accounting entry in which there is more than one debit, more
than one credit, or more than one of both debits and credits. It is essentially a combination of
several simple journal entries; they are combined for either of these reasons:

 It is more efficient from a bookkeeping perspective to aggregate the underlying business

transactions into a single entry. Examples of aggregation that may involve compound
journal entries are:
o Depreciation for multiple classes of fixed assets
o Accruals for multiple supplier deliveries at month-end for which no invoices have
yet been received
o Accruals for the unpaid wages of multiple employees at month-end
 All of the debits and credits relate to a single accounting event. Examples of accounting
events that frequently involve compound journal entries are:
o Record all payments and deductions related to a payroll
o Record the account receivable and sales taxes related to a customer invoice
o Record multiple line items in a supplier invoice that relate to different expenses
o Record all bank deductions related to a bank reconciliation

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11. Define Company.

As per section 3(1)(i) of the Indian Companies Act, 1956 “Company means a company
formed and registered under this Act or an existing company”.

12. Distinction between company and partnership?

FACTOR PARTNERSHIP COMPANY

Formation Through agreement Through registration under
companies Act
Legal status No separate status Separate legal entity
liability Unlimited limited
term Dissolved by death or insolvency of Perpetual existence
partners

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Transfer of shares Not, without partners approval free
Number of Two 2 for private company/ 7 for
members maximum public company
minimum
10 for banking and 20 for other 50 for private company/ no
business limit for public company

Management All partners Board of directors

Audit Not obligatory obligatory
Power& Objects flexible Less flexible
Statutory regulation Relatively free considerable

13. What is a share?

Share as “A share in the share capital of a company, and includes stock except
where a distinction between stock and shares is expressed or implied.

14. List out the various kinds of preference shares issued by the company.

Preference share may be classified in following manner

 Cumulative Preference shares

 Non cumulative Preference shares
 Participating Preference shares
 Non- Participating Preference shares
 Redeemable Preference shares
 Irredeemable Preference shares
 Convertible Preference shares
 Non Convertible Preference shares
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15. Show the comparison between share and stock.
S.No. SHARE STOCK
1 It has a nominal value It has no nominal value
2 It may not be fully paid i.e. it may It is always fully paid up
also be partly paid up
3 It cannot be transferred in small It can be transferred in any fraction.
fraction. It is always transferred as
a whole
4 It can be issued directly to the It cannot be issued directly to the public
public .Only the fully paid shares may be
converted in to stock
5 All shares are of equal The stock may be of unequal amount.
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 denomination
6 All the shares bear distinct numbers The stock discloses the consolidated
value of share capital. Thus, the fraction
of stock do not bear any number

16. What is a deferred share?

It has other name called Founder shares or management shares. It is issued to promoters.
They can share the profit after satisfying the preference and equity dividend. Deferred shares
cannot be issued in following companies.

1. Public limited companies

2. Subsidiaries of public limited companies
3. Private companies deemed to be public limited companies
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17. What is a Sweat equity share?

Shares which are issued to the employee of the company at a discount or for consideration
other than cash for providing know how or making available an intellectual property.

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18. What is Right issue of shares?

The right of the existing equity share holders to receive first such further shares
coupled with the option to renounce their rights to receive such shares to other known as right
issue.
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19. What is a Buy Back share?

It is re purchase by a company of its own shares or other specified securities.

20. Write a short note on Issue of shares at Premium.

A company issues shares at a price greater than its face value. This is called issue of
shares at premium. Premium amount will be collected at the time of allotment or at the time of
shares application. Shares issue at premium is a capital profit for the company. It has to be
credited in separate account called securities premium account. It is a capital gain .It is shown
under the reserve & surplus in balance sheet.

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 21. Explain Capital Reserve.

Capital reserve is the accumulated capital profits e.g., Gain on sale of fixed assets,
gain on forfeited shares, profit on redemption of debentures etc. It is shown in the liabilities side
of Balance Sheet under the heading ‘Reserves and Surplus’. This amount of capital reserve can
be used to write off all the capital losses or for issue of bonus shares etc.

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22. What are the different Methods of ascertaining profit or loss prior to incorporation?
There are three methods to ascertaining profit or loss prior to incorporation:
1. Preparation of trading & profit & Loss account for the period up to the date of
incorporation
2. Preparation of trading & profit & loss account for the whole accounting period and
apportionment of the resulting profit or loss between pre and post incorporation
periods.
3. Preparation of common trading account and the profit and loss account in ‘columnar
form’.
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23. What is Time Ratio?
This is the ratio of months or days before and after incorporation during the
accounting period.
All expenses of a company which can be linked or related to ‘time’ must be divided
between pre and post incorporation periods in time ratio. Examples are salaries, rent,
stationary, postage, depreciation, bank charges, etc.
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24. What is Weighted or Adjusted time ratio?
If any changes were made in the number of employees, or office accommodation,
etc., weightage must be given to the change in arriving at the time Raito. Such a ratio is
called weighted Time ratio. Similarly, when some expenditure is incurred only for a part of
the accounting period, separate ratio has to be computed, based on the actual months or days
in pre and post incorporation periods.
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25. What is Weighted sales ratio?
If sales were not uniform throughout the accounting period, weight age must be given to the
trends observed in the sales. Sales ratio adjusted for the change trend is called weighted sales
ratio.
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26. Explain Allocation of Expense.
Specific expenses which can be identified with either period have to be fully allocated to that
period. All company related expense like debenture interest; director’s remuneration or fees etc.
have no connection with the pre incorporation period. So they must be fully charged to the post

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incorporation period. Similarly, partner’s salaries, interest on purchase price till the date of
incorporation may be allocated to the pre incorporation period.
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27. Explain Profits prior to incorporation.
 Being capital profit in its nature ,it cannot be allowed to be a part of profit and loss
account
 It should not be used for payment of dividend to the shareholders
 It is preferable to credit it to ‘Capital Reserve account ‘which may be used to write off
capital losses and expenses like ‘preliminary expense’ ‘, underwriting commission’, etc.
Unutilized portion of such capital reserve appears in the liabilities side of the balance
sheet under the heading ‘reserves and surpluses’
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28. Explain Profit & loss appropriation account.
In case of joint stock company, there is only one account which is known as Profit & Loss
account. It consists of Trading account, Profit & loss account and Profit and Loss Appropriation
account. By preparing Trading a/c and Profit and loss a/c we can get the gross profit and net
profit for the current year only. But after ascertaining the net profit we have to make some
appropriations such as transfer to reserve, proposed dividend etc. For this purpose, we have to
prepare an account called Profit & Loss appropriation account. This is the third part of Profit
and Loss account.

29. What is Calls in arrears?

It represents the amount not paid by the shareholders on the calls made on them by the
company. This is shown in the balance sheet on the liability side by deducting the amount from
the called up amount. If this item appears in the adjustment then the trial balance shows paid-up
capital (not called-up capital). The amount is first added to paid-up capital to make the paid-up
capital as called-up capital and then deducted again.
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30. What is Provision for taxation?
Since it would take quite some time for the company to get its income assessed, it is usual
to provide some amount for income tax on profits at current rates of taxation. Such provision is
debited to the profit and loss account and credited to provision for taxation account which
appears in the balance sheet under the head ‘current liabilities and provisions’.
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31. What is Managerial remuneration?
The term ‘managerial remuneration’ includes remuneration payable to the (i)
Managing director, (ii) Manager, (iii) Part time directors, and (iv) Whole time directors.
According to the Sec.198 of the companies Act, 1956 the total managerial remuneration payable
by a public company or a private company which is subsidiary of a public company to its
directors and its manager in respect of any financial year shall not exceed 11% of the net profits.
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 PART – B

1. ‘A’ Co. Ltd. Was incorporated on May 1, 2016 to take over the business of ‘X’ and Co.
as a going concern from January 2016. The profit and loss account for the year ending
December 31, 2016 was as follows:

Dr. Cr.
Particulars Rs. Particulars Rs.
To rent and taxes By trading account (Gross 155000
To insurance Profit)
To electricity charges
To salaries
To Directors’ fees
To Auditors’ fees
To commission
To advertisement
To discount
To office expenses
To carriage
To bank charges
To preliminary expenses
To bad debts
To interest on loan
To net profit
155000 155000

The total turnover for the year ending December 31, 2016 was Rs. 500000 divided into
Rs. 150000 for the period up to May1, 2016 and Rs. 350000 for the remaining period.
Prepare the Profit and Loss Account and ascertain the Profit prior to and after incorporation.

Ans: Class work

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2. A Ltd. Was registered with an authorized capital of Rs. 600000 in equity shares of Rs.
10 each. The following is its Trial Balances on 31st march 2016.

Particulars Debit Credit

Goodwill 25000
Cash 750
Bank 39900
Purchases 185000
Preliminary expenses 5000
Share capital 400000
12% Debentures 300000
P&L A/c (Cr.) 26250
Calls in arrears 7500
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 Premises 300000
Plant & Machinery 330000
Interim Dividend 39250
Sales 415000
Stock (1.4.2015) 75000
Furniture & Fixtures 7200
Sundry Debtors 87000
Wages 84865
General Expenses 6835
Freight and carriage 13115
Salaries 14500
Director’s fees 5725
Bad Debts 2110
Debenture Interest Paid 18000
Bills Payable 37000
Sundry Creditors 40000
General Reserve 25000
Provision for bad debts 3500
Total 1246750 1246750
Prepare Statement of Profit and Loss and Balance Sheet in proper form after making the
following adjustments.

i) Depreciate plant and machinery by 15 %.

ii) Write off preliminary expenses.
iii) Provide for 6 months interest on debentures.
iv) Leave bad and doubtful debts provision at 5 % on sundry debtors.
v) Provide for income tax at 50%
vi) Stock on 31.3.2016 was Rs. 95000.
vii) Provide for corporate dividend tax @ 17%.

Ans: Class work

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3. Under what circumstances profit and loss prior to incorporation arises? What is the
accounting treatment for profit or loss prior to incorporation? (Dec2016)

Business is very often taken over by a company from a date earlier than the date of its
incorporation or date of commencement of business. The profit of the company up to the date of
its incorporation/commencement of business, cannot be treated as Trading Profit of the company.
Thus, the profit arising to the company from the date of purchase, up to the date of
incorporation/commencement of business is known as pre-incorporation profit. This pre-
incorporation profit being considered as capital profit is transferred to Capital Reserve or
adjusted with Goodwill. When a business is taken over and working continued, usually same set
of books is used and ultimately, the total profit for the year is divided between pre and post
incorporation periods. At times, this division is made on some estimation.
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 The usual practice is to prepare the profit and loss account only at the end of the year and
then to allocate the profits between the two periods in the following manner :

(a) Gross profit and expenses connected with sales to be apportioned according to the
ratio of sales for the two periods.

(b) Salaries, rent, interest etc. should be apportioned on the basis of ratio of time before
incorporation and after.

(c) Expenses solely incurred for the company on and after its incorporation e.g.
preliminary expenses, directors’ fees, etc. should be charged wholly to the post-
incorporation period.

Method of Computation of Profits/Loss Prior to Incorporation:

In order to ascertain the profit prior to incorporation a Profit and Loss Account is to be
prepared at the date of incorporation. But in practice, the same set of books of accounts is
maintained throughout the accounting year.

A Profit and Loss Account is prepared at the end of the year and thereafter the profits (or
losses) between the two periods are allocated:

(i) From the date of purchase to the date of incorporation or pre-incorporation period;

(ii) From the date of incorporation to the closing of the accounting year or post-
incorporation period.

Method of Accounting of Profit/Loss Prior to Incorporation:

Steps may be suggested for ascertaining profit or loss prior to incorporation:

Step I:

A Trading Account should be prepared at first for the whole period, i.e., between the date
of purchase and the date of final accounts, in order to calculate the amount of gross profit.

Step II:

Calculate the following two ratios:

(i) Sales Ratio:

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 Amount of sales should be calculated for the pre-incorporation and post-incorporation
periods.

(ii) Time Ratio:

It is calculated after considering the time period, i.e., one is required to calculate the
period falling between the date of purchase and the date of incorporation and the period
between the date of incorporation and the date of presenting final accounts.

Step III:

A statement should be prepared for calculating the amount of net profit before and after
incorporation separately on the following principle:

(i) Gross Profit should be allocated for the two periods on the basis of sales ratio which
will present the gross profit for the two separate periods, viz. pre-incorporation and post-
incorporation.

(ii) Fixed Expenses or expenses incurred on the basis of time, viz., Rent, Salary,
Depreciation, Interest, etc. should be allocated for the two periods on the basis of time
ratio.

(iii) Variable Expenses or expenses connected with sales should be allocated for the two
periods on the basis of sales ratio.

(iv) Certain expenses, viz., partners’ salary, directors’ salary, preliminary expenses,
interest on debentures, etc. are not apportioned since they relate to a particular period. For
example, partners’ salary is to be charged against pre-acquisition profit whereas
directors’ remuneration, debenture interest, etc. are to be charged against post-acquisition
profit.

List of Expenses: Allocated on the basis of Sales/Turnover:

(a) Gross Profit

(b) Selling Expenses
(c) Advertisement
(d) Carriage Outwards
(e) Godown Rent
(f) Discount Allowed
(g) Salesmen’s Salaries
(h) Commission to Salesmen
(i) Promotion Expenses for Sales
(j) Distributions Expenses (Variable Portions)
(k) Free Samples given
(l) Expenses incurred for After-Sale Service, etc.
(m) Delivery Van Expenses.
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List of Expenses: Allocated on the basis of Time:
(a) Office and Administration Expenses
(b) Salaries to Office Staff
(c) Rent, Rates and Taxes
(d) Depreciation on Fixed Assets
(e) Printing and Stationery
(f) Insurance
(g) Audit Fees
(h) Miscellaneous Expenses
(i) Distribution Expenses (Fixed Portion)
(j) Travelling Expenses (General)
(k) Interest of Debenture
(l) General Expenses
(m) Expenses Fixed in Nature.
Application/Accounting Treatment of Profit/Loss Prior to Incorporation:
(a) Pre-incorporation Profit:

Since “Profit prior to Incorporation” is a Capital Profit the same should be written off
against:

(i) Preliminary Expenses Account

(ii) Formation Expenses Account
(iii) Liquidation Expenses Account
(iv) Write down the value of Fixed Assets, if any
(v) Goodwill Account
(vi) Balance, if any, transferred to Capital Reserve.
(b) Pre-incorporation Loss:
Since “Pre-incorporation Loss” is a Capital Loss the same is adjusted against
(i) Any Capital Profit
(ii) Debited to Goodwill Account
(iii) Writing-off Fictitious Assets
(iv) Capital Reserve.
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4. P ltd was registered on 1.7.2013 to acquire the running businesses of S & Co with effect
of 1.1. 2013. The following was the profit or loss account of the company on 31.12.2013.

particulars amount Particulars amount

To office expenses 54000 By gross profit b/d 225000
To formation expenses 10000
To stationery expenses 5000
To selling expenses 60000
To director’s fees 20000
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 To net profit 76000
_______ _______
Total 225000 225000

You are required to prepare a statement showing profit earned by the company in
the pre and post incorporation periods. The total sales for the year took place in the ratio of
1:2 before and after incorporation respectively. (Dec 2016)

Ans: refer class work note

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5. What are statutory books? Explain its types. - (8)(Jan2015)
Statutory Books are the official records kept by the company relating to all legal
and statutory matters.
A company's statutory books are usually kept at the registered office of the
company. The books should be available to the general public for inspection during
reasonable office hours.

The typical contents of a company's statutory book are:

* The register of shareholders

* The register of company directors and secretaries
* The register of company directors' interests
* The register of charges
* The register of interests in shares if the company is a PLC.
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6. Illustrate the errors which are disclosed by the Trial Balance with suitable
examples.(Jan 2015)

Errors revealed by the Trial Balance

In subsidiary books:
i. Error in total
Individual entries from subsidiary books are entered individually in personal accounts
in the sales ledger and purchases ledger while the totals are entered in nominal
accounts in the general ledger. In any case, total of entries in personal accounts
should be equal to amount in nominal account. However, when totals in subsidiary
books are wrongly calculated, total of entries in personal accounts will not be equal to
amount in nominal account. Thus, trial balance will not balance.

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 For example, credit sales totaling $5 600 were correctly debited to customers account
but sales account was credited by $5 500 because sales day book was wrongly
totaled.
In ledger:
ii. Omission of one entry
This is a situation where only one entry was made for a transaction. The other entry
was omitted from the ledger. For example, payment for repairs was credited to bank
account but no entry made in repairs account.
iii. Posting to the wrong side of the ledger for one entry
This is a situation where, for a given transaction, one entry was correctly made but
the other entry was made on the wrong side of the ledger, at times in the wrong
account as well. For example, discount allowed was wrongly credited to discount
received account.
iv. Enter in amount for one entry
This is a situation where a transaction was entered on the correct sides of the correct
accounts but with the wrong amount for one account. For example, cash received
from Pinto $250 was correctly debited to cash account but credited to Pinto’s account
as $200.

v. Error in calculation
The trial balance is prepared from account balances. These balances may at times be
wrongly calculated.

Sometimes, the balance calculated may be bigger than the real balance. It is, then,
said that the balance is overstated or overcast.
At other times, the balance calculated may be smaller than the real balance. It is, then,
said that the balance is understated or under cast.

In trial balance:
vi. Error in amount
In this case, the balances are correctly calculated in the ledger but wrongly entered in
the trial balance.
For example, the balance of $1 100 of the furniture account entered as $1 000 in the
trial balance.
vii. Omission of a balance
This is where the balance of a ledger has been omitted from the trial balance.
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7. Define a company and state its essential characteristics. Explain the documents that
have to file with the registrar of companies for getting a company in corporate. (June
2014)

As per section 3(1)(i) of the Indian Companies Act, 1956 “Company means a company formed
and registered under this Act or an existing company”.

Essential characteristics of company

1. Compulsory Incorporation: A company is created by registering or incorporating an

association of persons under Indian companies act, 1956.

2. Voluntary association: No law can compel persons to form a company. It is their

own creation and thinking.

3. Separate legal entity: A company can, purchase or sell properties, hold bank account
in its name and enter in to contract. It can enter without its members .It existence is not
affected by the coming in and going out of its members.

4. Common seal: The common seal with the name engraved on it. It is used as substitute
for its signatures. When it is affixed on any document, it is deemed as signatures. When it
is affixed on any document, it is deemed as signature of the company, beside it has to be
witnessed by two directors.

5. Perpetual Succession: The company survival is not affected by the death or insanity
of the shareholders. According to the company, “Men may come and men may go but I
go on forever” statement is true.

6. Limited Liability: A member’s liability is usually limited to the face value of share he
holds. Once shareholder pays their full value, he will not be called upon to contribute any
further amount whatever be the magnitude of the company’s loss.

7. Transfer of shares: The member can transfer and dispose their shares whenever they
like, without seeking any permission from the company or the other members. Free
transferability &marketability of shares or debentures are considered as distinguishing
features of a company.

Before filing the forms to register a company, the prerequisites (Director Identification
Number, Digital Signature Certificate, Form-1A, Memorandum and Articles of Association)
must be completed.

The forms (form 1, form 18, form 32) and required documents must be submitted to Ministry
of Corporate Affairs and the Registrar of Companies for initiating the incorporation process

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 1. Documents to be filled for registering an India Company

Form 1 This is application or declaration for incorporation of a company. It states that all
the requirements of the Companies Act, 1956 and the rules there under have been
complied with in respect of registration. This form can be filled by the director or any
other specified person (lawyer, CA, advocate etc.) engaged in formation of the company.

Form 18 This is notice of location or change of location of the registered office. It is to be

filed by one of the directors of the company informing the ROC about the registered office
of the proposed company

Form 32 This is a form stating the appointment of the proposed directors on the board of
directors from the date of incorporation of the proposed company and is signed by one of
the proposed directors.

Submit to the Ministry of Corporate Affairs (MCA) Portal, the above mentioned Forms
(eForms 1, 18 and 32) after attaching the digital signature and paying the requisite filing
and registration fees.

Send the physical copy of the following to the Registrar of Companies

1. 3 stamped and signed copies of Memorandum of Association and Articles of

Association to the Registrar of Companies
2. Name availability letter issued by the Registrar of Companies
3. Power of Attorney signed by all the subscribers of MOA authorizing one of
the subscribers or any other person to act on their behalf for the purpose of
incorporation and accepting the certificate of incorporation
4. Any agreement referred to in the Memorandum and Articles of Association
5. Any agreement proposed to be entered into with any individual for
appointment as Managing or whole time Director
6. Once the form has been approved by the concerned official of the Ministry,
you will receive an email regarding the same and the status of the form will
get changed to Approved.

All available forms can be downloaded from the Ministry of Corporate Affairs
website.

Certificate of Incorporation

After approval and verification of forms and documents, a Corporate Identity Number (CIN) is
generated and a Certificate of Incorporation is issued to the company. The Private Company can
start its business immediately after receipt of the certificate.

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 2. Documents Required For Incorporation
After obtaining Registrar’s approval for the company’s name, the promoters should prepare the
following documents, in the prescribed manner and form:
i. Memorandum of Association
ii. Articles of Association
iii. Prospectus /Statement in lieu of prospectus is not requires in case of a private
company
iv. Copy of import agreements.
v. Statutory declaration in Form I
vi. Copy of Letter of Register indicating approval of name.
vii. Power of Attorney.
viii. Notice of situation of registered office (in Form 18) and particulars of
Directors (in Form 32).
These two forms can be field either at the time of incorporation or within 30 days from the date
of incorporation.
 The documents should be duly executed signed and stamped from the date of
approval of name by the Registrar.
 It is to be ensured that subscribers to the Memorandum and Articles of
Association of the proposed company are same as the promoters whose names
are appearing in the application for availability of name. In the case of a
change, the changed subscribers will be asked to make a fresh application for
availability of name. The ROC may allow the same name, if available after six
month from the date when the name was allowed to the original promoter.

8. Explain the different modes alteration of share capital as per the provision of sections
94 to 97 of the companies act. (June 2014)

A company limited by shares can alter the capital clause of its Memorandum in any of the
following ways provided that such alteration is authorised by the articles of association of the
company:-

1. Increase in share capital by such amount as it thinks expedient by issuing new shares.
2. Consolidate and divide all or any of its share capital into shares of larger amount than its
existing shares. e.g., if the company has 100 shares of Rs.10 each (aggregating to Rs.
1000/-) it may consolidate those shares into 10 shares of Rs100 each.
3. Convert all or any of its fully paid shares into stock and re-convert stock into fully paid
shares of any denomination.
4. Subdivide shares or any of shares into smaller amounts fixed by the Memorandum so that
in subdivision the proportion between the amount paid and the amount if any unpaid on

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 each reduced shares shall be same as it was in case of from which the reduced share is
derived.
5. Cancel shares which have been not been taken or agreed to be taken by any person and
diminish the amount of share capital by the amount of the shares so cancelled.

The alteration of the capital of the company in any of the manner specified above can be
done by passing a resolution at the general meeting of the company and does not require any
confirmation by the court.

Reduction of the share capital can be effected only in the manners specified in Section 100-
104 of the Act or by way of buy back under Section 77A and 77B of the Act. Notice of alteration
to share capital is required to be filed with the registrar of the company in Form no 5 within 30
days of the alteration of the capital clause of the MA. The Registrar shall record the notice and
make necessary alteration in Memorandum and Articles of Association of the company. Any
default in giving notice to the registrar renders company and its officers in default liable to
punishment with fine which may extend to the Rs50 for each day of default.

_____________________________________________________________________________
9. Discuss the provisions relating to buy back of securities under the companies act 1956.
(June 2013)

The provisions regulating buy back of shares are contained in Section 77A, 77AA and 77B of
the Companies Act, 1956. These were inserted by the Companies (Amendment) Act, 1999. The
Securities and Exchange Board of India (SEBI) framed the SEBI(Buy Back of Securities)
Regulations,1999 and the Department of Company Affairs framed the Private Limited Company
and Unlisted Public company (Buy Back of Securities) rules,1999 pursuant to Section 77A(2)(f)
and (g) respectively.

Objectives of Buy Back: Shares may be bought back by the company on account of one or more
of the following reasons

i. To increase promoters holding

ii. Increase earnings per share
iii. Rationalise the capital structure by writing off capital not represented by
available assets.
iv. Support share value
v. To thwart takeover bid
vi. To pay surplus cash not required by business

Resources of Buy Back

A Company can purchase its own shares from
(i) free reserves; Where a company purchases its own shares out of free reserves, then a

60
sum equal to the nominal value of the share so purchased shall be transferred to the capital
redemption reserve and details of such transfer shall be disclosed in the balance-sheet or
(ii) securities premium account; or
(iii) proceeds of any shares or other specified securities. A Company cannot buy back its
shares or other specified securities out of the proceeds of an earlier issue of the same kind of
shares or specified securities.

Conditions of Buy Back

(a) The buy-back is authorised by the Articles of association of the Company;

(b) A special resolution has been passed in the general meeting of the company
authorising the buy-back. In the case of a listed company, this approval is required by
means of a postal ballot. Also, the shares for buy back should be free from lock in
period/non transferability. The buyback can be made by a Board resolution if the quantity
of buyback is or less than ten percent of the paid up capital and free reserves;

(c) The buy-back is of less than twenty-five per cent of the total paid-up capital and fee
reserves of the company and that the buy-back of equity shares in any financial year shall
not exceed twenty-five per cent of its total paid-up equity capital in that financial year;

(d) The ratio of the debt owed by the company is not more than twice the capital and its
free reserves after such buy-back;

(e) There has been no default in any of the following

i. in repayment of deposit or interest payable thereon,
ii. Redemption of debentures, or preference shares
iii. Payment of dividend, if declared, to all shareholders within the stipulated time
of 30 days from the date of declaration of dividend or
iv. Repayment of any term loan or interest payable thereon to any financial
institution or bank;

(f) There has been no default in complying with the provisions of filing of Annual
Return, Payment of Dividend, and form and contents of Annual Accounts;

(g) All the shares or other specified securities for buy-back are fully paid-up;

(h) The buy-back of the shares or other specified securities listed on any recognised stock
exchange shall be in accordance with the regulations made by the Securities and
Exchange Board of India in this behalf; and

(i) The buy-back in respect of shares or other specified securities of private and closely
held companies is in accordance with the guidelines as may be prescribed.

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Disclosures in the explanatory statement

The notice of the meeting at which special resolution is proposed to be passed shall be
accompanied by an explanatory statement stating –

(a) a full and complete disclosure of all material facts;

(b) the necessity for the buy-back;
(c) the class of security intended to be purchased under the buy-back;
(d) the amount to be invested under the buy-back; and
(e) the time-limit for completion of buy-back

Sources from where the shares will be purchased

The securities can be bought back from

(a) existing security-holders on a proportionate basis;

Buyback of shares may be made by a tender offer through a letter of offer from the
holders of shares of the company or
(b) the open market through
(i). book building process;
(ii) stock exchanges or
(c) odd lots, that is to say, where the lot of securities of a public company, whose shares
are listed on a recognized stock exchange, is smaller than such marketable lot, as may be
specified by the stock exchange; or
(d) purchasing the securities issued to employees of the company pursuant to a scheme of
stock option or sweat equity.

Filing of Declaration of solvency

After the passing of resolution but before making buy-back, file with the Registrar and
the Securities and Exchange Board of India a declaration of solvency in form 4A. The
declaration must be verified by an affidavit to the effect that the Board has made a full inquiry
into the affairs of the company as a result of which they have formed an opinion that it is capable
of meeting its liabilities and will not be rendered insolvent within a period of one year of the date
of declaration adopted by the Board, and signed by at least two directors of the company, one of
whom shall be the managing director, if any:

No declaration of solvency shall be filed with the Securities and Exchange Board of India
by a company whose shares are not listed on any recognized stock exchange.

Register of securities bought back

After completion of buyback, a company shall maintain a register of the securities/shares

so bought and enter therein the following particulars
62
 a. the consideration paid for the securities bought-back,
b. the date of cancellation of securities,
c. the date of extinguishing and physically destroying of securities and
d. such other particulars as may be prescribed

Where a company buys-back its own securities, it shall extinguish and physically destroy
the securities so bought-back within seven days of the last date of completion of buy-back.

Issue of further shares after Buy back

Every buy-back shall be completed within twelve months from the date of passing the
special resolution or Board resolution as the case may be.

A company which has bought back any security cannot make any issue of the same kind
of securities in any manner whether by way of public issue, rights issue up to six months from
the date of completion of buy back.

Filing of return with the Regulator

A Company shall, after the completion of the buy-back file with the Registrar and the
Securities and Exchange Board of India, a return in form 4 C containing such particulars relating
to the buy-back within thirty days of such completion.

No return shall be filed with the Securities and Exchange Board of India by an unlisted
company.

Prohibition of Buy Back

A company shall not directly or indirectly purchase its own shares or other specified
securities -
(a) through any subsidiary company including its own subsidiary companies; or
(b) through any investment company or group of investment companies;

Procedure for buy back

a. Where a company proposes to buy back its shares, it shall, after passing of the
special/Board resolution make a public announcement at least one English National
Daily, one Hindi National daily and Regional Language Daily at the place where the
registered office of the company is situated.
b. The public announcement shall specify a date, which shall be "specified date" for the
purpose of determining the names of shareholders to whom the letter of offer has to be
sent.
c. A public notice shall be given containing disclosures as specified in Schedule I of the
SEBI regulations.
63
 d. A draft letter of offer shall be filed with SEBI through a merchant Banker. The letter of
offer shall then be dispatched to the members of the company.
e. A copy of the Board resolution authorising the buyback shall be filed with the SEBI
and stock exchanges.
f. The date of opening of the offer shall not be earlier than seven days or later than 30
days after the specified date
g. The buyback offer shall remain open for a period of not less than 15 days and not more
than 30 days.
h. A company opting for buy back through the public offer or tender offer shall open an
escrow Account.

Penalty
If a company makes default in complying with the provisions the company or any officer of
the company who is in default shall be punishable with imprisonment for a term which may
extend to two years, or with fine which may extend to fifty thousand rupees, or with both. The
offences are, of course compoundable under Section 621A of the Companies Act, 1956.

______________________________________________________________________________
10. Given is the Trial Balance of Ms. Malini as on 31.3.2011. You are required to prepare
final accounts:

Trial Balance
Particulars Debit Credit
15 % Loan 2,000.00
Annual Insurance (taken on 1st July) 1,800.00
Bills Receivable 1,200.00
Capital 1, 40,000.00
Carriage Inward 8,700.00
Carriage Outward 2,300.00
Cash at Bank 10,100.00
Cash - In – Hand 100.00
Commission 1,800.00
Creditors & Debtors 20,200.00 12,000.00
Discount 1,200.00
Int. on Loan 200.00
6 % Investment (on 1st May, 2010) 3,600.00
Motor Cycle 34,600.00
Op. Stock 15,500.00
Plant & Machinery 80,700.00
Power & Fuel 1,500.00
Prov. For Bad Debts 200.00
Purchase Return 700.00
64
 Purchases 36,000.00
Rent 12,000.00
Rent & Taxes 1,200.00
Return inward 300.00
Salary 5,000.00
Sales 58,000.00
Wages 2,500.00
2, 26,700.00 2, 26,700.00

Some Important Points:

a) Stock on 31st march, 2011 valued at Rs. 20,000.00.
b) Commission Outstanding worth Rs 200.00
c) Plant and Machinery includes Rs 5,700 worth of old machinery and remaining new
machinery was purchased on 1st Oct, 2010. Depreciate it by 10 % on WDV basis.
d) Loan was taken on 1st April, 2010.
e) Write off Rs 400 as bad debts. Maintain 5 % prov. For doubtful debts and 2 % as Prov.
for Discount.
f) Depreciate Motor Cycle by 5 %.
g) Bill Receivable includes Rs 200 of bill dishonored.

Solution:
Trading and P/L A/c
Particulars Amount Particulars Amount
To Opening stock 15500 By Sales 58000
To Purchase 36000 Less Sales Ret 300 57700
Less Purch. Ret. 700 35300 By Closing Stock 20000
To Wages 2500
To Carriage Inward 8700
To Power & Fuel 1500
To G. P. 14200
77700 77700
To Insurance 1800 By G. P. b/d 14200
Less prepaid By Comm. 1800
for 3 months 450 1350 Add O/s 200 2000
To Carriage outward 2300 By Int. On Investments 198
To Discount 1200 (6% for 11 months o/s)
To Int. On loan 200 By Rent 12000
Add o/s int 100 300
To Rent & Taxes 1200
To Salary 5000
To Depreciation

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Motor Cycle 1730
Plant & Mach old 570
Plant & Mach new 3750 6050
To Bad Debts 400
To Prov. For B. D.
new at 5% 1000
Less old as in TB 200 800
To Prov. For Dis. on Drs. 380
To Net Profit 9418
28398 28398

Balance Sheet
Liabilities Rs Assets Rs
Capital 140000 Plant & Mach.New
Add Profit 9418 149418 (80700-5700) 75000
15% Loan 2000 Less Dep.
O/s int on Loan 100 for 6 months 3750 71250
Creditors 12000 Plant & Mach.Old 5700
Less Dep. 570 5130
Motor Cycle 34600
Less Dep. 1730 32870
6% Investments 3600
Debtors 20200
Add B/R Dishonor 200
20400
Less Bad debts 400
20000
Less Prov. For BD 1000
19000
Less Prov. for Dis. 380 18620
Bills Receivable 1200
Less B/R Dishonor 200 1000
Cash at Bank 10100
Cash in hand 100
Stock 20000
Prepaid Insurance 450
Commission O/s 200
Int. On Investments 198
(6% for 11 months o/s)

163518 163518

66
 11. From the following trial balance of Mr. Lakhani as on 31.3.2010, you are requested to
prepare final accounts.

Trial Balance
Particulars Debit (Rs.) Credit (Rs.)

Bad Debts 5,000.00

Bills Payables 40,000.00
Bills Receivable 20,000.00
Capital 2, 50,000.00
Cash At Bank 40,000.00
Cash In Hand 16,000.00
Drawings 20,000.00
Electricity Exps. 9,000.00
Furniture and Fixtures 15,000.00
Interest 2,000.00
Land and Building 1, 00,000.00
Office Expenses 25,000.00
Plant and Machinery 57,000.00
Purchases 1, 00,000.00
Rates and Taxes 8,000.00
Rent 16,000.00
Repairs 3,000.00
Salaries (For 10 Months) 20,000.00
Sales 1, 70,000.00
Stock 50,000.00
Sundry Creditors 70,000.00
Sundry Debtors 15,000.00
Telephone Exps. 6,000.00
Trading Expenses 5,000.00
Wages 30,000.00
5, 46,000.00 5, 46,000.00

Additional Information:
1. Closing Stock was valued at Rs.1, 00,000.00.
2. Write off Rs.1,000 as bad debts. And make 3 % discount on Debtors. Further make 10% as
provision for doubtful debts.
3. Manager A is entitled for 5% commission on profit before commission while manager B is
entitled for 10% commission on profit after commission.
4. Purchases include a purchase of Computer Rs.12,000 on 1st October, 2009.
5. Sales include Rs.10,000 of goods sent on Approval Basis.
6. Depreciate Furniture by 10%, Computer by 15% and reduce Plant and Machinery to Rs.50000
67
Answer:
Trading and P/L A/c
Particulars Amount Particulars Amount
To Opening stock 50000 By Sales 170000
To Purchase
100000 Lesson approval 10000 160000
Less Purch of Comp
12000 88000 By Closing St 100000
To Wages 30000 Add Sales on approval
To G. P. 102000 10000 110000
270000 270000
To Office Expenses 25000 By G. P. b/d 102000
To Telephone Expenses 6000 By Rent 16000
To Trading Expenses 5000
To Electricity Exp. 9000
To Interest 2000
To Repairs 3000
To Rates & Taxes 8000
To Salary 20000
Add O/s 4000 24000
To Depreciation
Furniture 1500
Plant & Mach 7000
Comp 900 9400
To Bad Debts 5000
Add addl. bad debts 1000 6000
To Prov. For B. D. 400
To Prov. For Dis on drs 108
To Net Profit 20092
118000 118000
To Manager A's Comm
(20092*.05) 1005 By Net Profit 20092
To Manager’s Comm
(20092-1005)*10/110 1735
To Net Profit 17352
20092 20092

68
Balance Sheet
Liabilities Rs. Assets Rs.
Capital 250000 Furniture, Fixtures 15000
less Drawings 20000 Less 10% Dep 1500 13500
230000 Land & Building 100000
Add Profit 17352 247352 Plant & Mach. 57000
O/s Salary 4000 Less Dep 7000 50000
Creditors 70000 Computer 12000
Bills Payable 40000 Less Dep. 900 11100
Managers Commission
A 1005 Debtors 15000
B 1735 2740 Less Addl B. D 1000
14000
Less on approv 10000
4000
Less Prov. For BD 400
3600
Less Prov for Dis. 108 3492
Bills Receivable 20000
Cash at Bank 40000
Cash in hand 16000
Stock 110000
364092 364092

69
12. Following is the Trial Balance of Sanjai Ltd., Hospet as on 31.12.2009.
Trial Balance as on 31.12.2009.

Adjustments:
1. Transfer Rs. 10000 to Reserve Fund.
2. Provide depreciation on building at 5%.
3. Stock on 31.12.2009 was valued at Rs. 12000.
4. Dividend at 15% on share capital is to the provided.
5. Depreciation on Plant and Machinery at 10%.
Prepare Trading, profit and Loss account, Profit and Loss Appropriation, Account and
Balance Sheet in the prescribed form.

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Solution:

71
______________________________________________________________________________

13. Explain in detail profit and loss prior to incorporation

Profit Prior To Incorporation

“The profits earned b/w the date of acquisition and the date of incorporation are called
profits prior to incorporation. These profits are of capital nature and these are not available for
distribution among shareholders and transferred to capital reserve account. If there is any loss
prior to incorporation, it is capital loss and debited to goodwill account.

72
 Under company’s act 1956, pre incorporation profits are capital profits and hence not
available has the declaration of the dividend.
A company comes into existence only when it receives the certificate of incorporation
from the registrar of companies. Sometimes a newly incorporated company acquires a running
business from a date prior to its incorporation. In such a case, the amount of profit earned by the
company from the date of purchase to the date of incorporation is called as “profit prior to
incorporation.”
The profits prior to incorporation can be calculated by following procedure:
1. Prepare trading account. In order to ascertain the amount of gross profit, the trading
a/c, for the whole period should be prepared. The whole period means the period starting
from the date of incorporation to the last date of closing of accounts.

2. Calculation of time ratio. Calculate time ratio by taking into consideration the time
falling from the date of purchase of business to the date of incorporation and the period
b/w the date of incorporation to the last date of preparing final accounts.

3. Calculate sales ratio. It may be calculated as under: - sales ratio = sales of pre
incorporation period: sales of post incorporation period.

4. Prepare profit and loss a/c for pre incorporation and post incorporation periods
immediately.
This is done on the following basis:
(a) Gross profit should be allocated b/w two periods on the basis of sales ratio.

(b) Expenses that are connected with sales should be allocated on the basis of sales ratio.
Examples of such expenses are: selling expenses are; advertisement, discount allowed,
bad debts etc.

(c) Expenses that are incurred on the basis of time should be allocated on the basis of
time ratio. For example : admn expenses, audit fees, salaries, rent and taxes, misc.
Expenses, depreciation, insurance, electricity charges, general expenses, printing and
stationary etc.

(d) Expenses which are incurred after the incorporation of the company like director fees,
preliminary expenses, debenture interest etc. should be charged wholly to the post
incorporation period.
Purpose of profit and loss prior to incorporation
1. How many profits before incorporation or after incorporation of business. The profit
before incorporation is called capital profit and after incorporation profits are called net
profit or revenue profit.

73
 2. A separate profit and loss account is prepared for the pre incorporation period as
distinguished from profit and loss account for post incorporation period which shows
profits separately.

3. In the books of the new company, acquisition entries are passed on the same date after
taking into considerations the assets and liabilities on the date of incorporation, which
thus would include the results up to the date.

4. For calculating net profit and loss of respective period after deducting apportioned
expenses and acquisition entries are passed at the end of the accounting year.

5. For the adjusted loss prior to incorporation of business, these losses would be adjusted
as follows:

(a) Debited to goodwill account.

(b) Debited to capital reserve account arising from acquisition of business.

(c) Debited to a suspense account which can be written off later as a fictitious asset.

From the above points, mainly purpose of company for calculating the profits or loss
from pre and post incorporation of business is that, how much profit is earned from pre
incorporation and post incorporation of business.
These both profits are adjusted in the balance sheet on the liability side.
To know about the profit earned by the company prior to its incorporation, company
prepares its profit and loss account in two columns i.e. one for pre incorporation and other
for post incorporation item.
All the common expenses and incomes are divided in the following appropriate ratio.
1. In sales ratio, expenses related to sales are apportioned in this ratio like, advertisement,
packing expenses, carriage outward, commission to selling agent, discount allowed,
variable expenses etc.

2. In time ratio, expenses such as rent, depreciation salaries, electricity, telephone,

interest, audit fees and other office and admn expenses.

3. In vendor ratio, interest to vendor will be allocated in this ratio.

4. Post of incorporation. Like directors fees, interest to vendors, preliminary expenses (if
written off) are recorded in post to incorporation period.
If there is profit in the first column, such profit is known as profit prior to incorporation.
Company can use profit prior to incorporation for the following purposes.
1. To write off the capital losses and expenditure.

74
 2. To write off goodwill account.
Profit or loss prior to incorporation, can be calculated by adopting the following steps
Step1. Calculation of time ratio. This ratio will be calculated by taking into consideration
the period b/w the date of purchase of the business to the date of incorporation of
business and this period b/w the date of incorporation to the last date of preparing the
final account.
Step2. Calculation of sales ratio. This ratio will be calculated as, sales of pre-
incorporation period: sales of post incorporation period.
Step3. Calculation of vendor ratio. This is another time ratio which is to be calculated by
taking into consideration the period b/w the date of purchase of business to the date of
incorporation and the period b/w the date of incorporation to the date payment of interest
to the vendor.
Step4. Calculation of gross profit. For this purpose we have to prepare trading account for
the whole period i.e. period starting from the date of purchase of business to the last date
of purchase of business to the last date of closing of accounts.
Step5. Preparation of profit and loss account. Profit and loss account will be prepared in
the columnar form i.e. one column for pre incorporation form and other for post
incorporation items.
Common expenses are to be divided b/w pre incorporation and post incorporation as
under:

1. In sales ratio, expenses related to sales and gross profit should be allocated on the basis
of sales ratio e.g. advertisement, packing expenses, carriage outward, commission to
agents, discount allowed, bad debts, entertainment expenses, any variable expenses,
travelling expenses etc.

2. In time ratio, expenses are to be allocated e.g. salary, interest (excluding interest to
vendor and debenture interest), rent, depreciation, fixed expenses, electricity, telephone,
audit fee, other office and administration expenses etc.

3. Vendor ratio. Interest to vendor will be allocated in this ratio.

4. Post to corporation. These expenses are to be recorded in post period column, these are
incurred by the company after incorporation e.g. .director fee, preliminary expenses, or
formation expenses, debentures interest, any provisions created by the company etc.

If there is profit prior to incorporation, then it will be treated as capital profit. If there is
loss prior to incorporation then it will be treated as goodwill.

Profit or loss for the post incorporation period will be treated as revenue profit or loss.

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14. Briefly explain the Alteration of Share Capital of a Company

Sections 94, 95, 96, 97 and 100 of the Companies Act, 1956 lay down the procedure for
alteration of share capital of companies. According to Sub-section (1) of Section 94 of the
Companies Act, a limited company, having a share capital, may, if so authorised by its articles,
alter the conditions of its memorandum so as to change its share capital, as follows, that is to say,
it may—

(a) increase its share capital by such amount as it thinks expedient by issuing new shares;

(b) Consolidate all or any of its share capital into shares of larger amount than its existing
shares;

(c) Convert all or any of its fully paid-up shares into stock, and reconvert that stock into
fully paid-up shares of any denomination;

(d) sub-divide its shares, or any of them, into shares of smaller amount than is fixed by
the memorandum, so, however, that in the sub-division the proportion between the
amount paid and the amount, if any, unpaid on each reduced share shall be the same as it
was in the case of the share from which the reduced share is derived;

(e) cancel shares which, at the date of the passing of the resolution in that behalf, have
not been taken or agreed to be taken by any person, and diminish the amount of its share
capital by the amount of the shares so cancelled. Sub-section (2) of Section 94 lays down
that the powers conferred by this section shall be exercised by the company in general
meeting and shall not be required to be confirmed by the Court.

A cancellation of shares in pursuance of this section shall not be deemed to be a reduction

of share capital within the meaning of the Companies Act. In fact, this is known as diminution of
share capital [Section 94(3)].

Filing of (e-form 5) notice of change in share capital with ROC

Section 95 of the Act makes it obligatory on the part of a limited company having share
capital, which has consolidated, sub-divided, converted, re-converted, redeemed any redeemable
preference shares, or cancelled any shares otherwise than in connection with a reduction of share
capital under Sections 100 to 104, to give notice thereof to the Registrar in the prescribed e-form
5, within thirty days of the passing of the resolution, specifying the shares consolidated,
converted, reconverted, sub-divided, redeemed or cancelled and the Registrar shall record the
same in the memorandum of the company. This e-form is required to be pre-certified by a
professional i.e. Company Secretary/Chartered Accountant/Cost Accountant in whole time
practice.

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The attachments along with e-form 5 are:

1. Proof of receipt of Central Government order

2. Altered memorandum of association
3. Altered articles of association
4. Optional attachment(s) – if any
______________________________________________________________________________
15. What are preferential allotments?
An existing company has three methods available to it for expanding its share capital.
First is through a fresh issue of shares to existing shareholders in proportion to shares held by
them (rights or bonus issues).

Second is by making an open offer, inviting the public in general to subscribe to shares,
which is generally known as initial public offer (IPO).

The third method is by making a bulk allotment to individuals, companies, venture

capitalists or any other person through a fresh issue of shares. This is known as preferential
allotment. This method is distinctive from others in the sense that the entire allotment is made to
pre-identified people, who may or may not be existing shareholders of the company, at a pre-
determined price.

Generally, preferential allotments are made to people who wish to take a strategic stake
in the company. For instance, venture capitalists, existing shareholders like promoters who wish
to enhance their stake in the company, financial institutions, and buyers of the company's
products or its suppliers.

The rationale is to provide a route by which the company can secure the equity
participation of those who it feels can be of value as shareholders, but for whom it may be
inordinately costly and/or impractical to buy large chunks of shares from the market.

How are preferential allotments made?

Preferential allotments are made by means of a special resolution that's passed by existing
shareholders.

This means that three-fourths of the shareholders should agree to the issue of shares on a
preferential basis.

The number of shares to be issued, their pricing, the consideration for issue of shares and
the identity and background of the persons or companies to whom the shares are proposed to be
issued on a preferential basis are taken upfront. Sebi, under its guidelines, has prescribed a
minimum pricing formula, under which the preferential allotment can be made.

77
 Under this, an average of the highs and lows of the 26 weeks proceeding the date on
which the board resolves to make the preferential allotment is arrived at and this is the minimum
price at which the allotments can be made.
______________________________________________________________________________
16. What is ESOP?
Employee Stock Option Plan (ESOP) is a plan through which a company awards Stock
Options to the employees based on their performance. Under an ESOP, the employees have right
to buy the shares of the company on a predetermined date at a predetermined price. The
objective of ESOP is to motivate the employees to perform better and improve shareholders'
value. Apart from giving financial gains to the employees, ESOP also creates a sense of
belonging and ownership amongst the employees.

Different terms used in an ESOP

Grant date - The date on which the company grants an option to its employee.

Option price - The price at which such shares in a scheme are offered. It is also known
as the ‘strike price’ or ‘grant price’. Normally such option price would be below the
market value/ fair value of the shares on the date of grant.

Vesting date - An ESOP would provide for a date on which an option is vested with
employees and time frame over which the stock option would vest with employees
(‘vesting period’).

Exercise period - The employees would be given a time period, called exercise period,
within which they are required to exercise the option. The date on which employees
exercise this option is known as ‘exercise date’.

There are two ways in which a company can set up an ESOP.

(a) Create a Trust (Special Purpose Vehicle) - Depending on the number of options to be
given to the employees, the company will issue shares or options to the trust. The trust would
need funds to buy these shares. For this, the company can either give soft loans from its own
funds or the trust can raise loans through other sources to meet its financial requirement. The
company can act as a guarantee to the lender to the trust. With the funds so raised, the trust then
acquires shares/options required. The trust repays its loans as and when the employees purchase
the options offered and when they exercise their options by paying the exercise price.

(b) Give options directly to employees - The selection of the employees can be based on
performance of the employee, indicated by the annual performance appraisal, minimum period of
service, present and potential contribution of the employees, and such other factors deemed to be
relevant for the success of the company. Number of options per employee can be determined

78
taking into consideration, the grade, level, years of service, salary, etc. These selections would
entirely depend upon the objective of the company for setting up the ESOP.

The real advantage of ESOPs is that, the exercise price remains fixed over the term of the
option. So, the employee would exercise his option when the market price of the shares goes
substantially high and he would gain on the difference between the market price and exercise
price.

Different types of ESOPs

ESOP can be a one-time plan or an ongoing scheme depending upon the objectives that
the company wants to achieve. ESOPs can be in the form of ESOS (Employee Stock Option
Schemes), ESPP (Employee Stock Purchase Plans), Compensation Plans, Incentive Plans,
SAR/Phantom ESOPs etc.

Employee Stock Option Scheme (ESOS) - Under this scheme, the company grants an
option to its employees to acquire shares at a future date at a pre-determined price. Eligible
employees are free to acquire shares on vesting within the exercise period. Employees are free to
dispose of the shares subject to lock-in-period if any. Generally exercise price is lower than the
prevalent market price.

Employee Stock Purchase Plan (ESPP) - This is generally used in listed companies,
wherein the employees are given the right to acquire shares of the company immediately, not at a
future date as in ESOS, at a price lower than the prevailing market price. Shares issued by listed
companies under ESPP will be subject to lock-in-period, as a result, the employee cannot sell the
shares and/or the employee has to continue with the employer for a certain number of years.

Share Appreciation Rights (SAR)/ Phantom Shares - Under this scheme, no shares are
offered or allotted to the employee. The employee is given the appreciation in the value of shares
between two specified dates as an incentive or performance bonus, that is linked to the
performance of the company as a whole, as reflected in its share value.

Rules and Regulations

Companies Act: Issue of stock options requires approval of shareholders by way of a

special resolution as per section 81(1 a). This is not applicable for private companies who can
issue stock options without shareholder approval but approval by the board of directors.
Income Tax Issues
For employees:

Till recently, the difference between the cost of the share to the employees and market
value on the date on which an employee got the share would be taxed as perquisite in addition to
capital gains tax payable by the employee on sale of those shares. However with the recent
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announcement by the Finance Minister the perquisite tax has been removed. Tax is now payable
only at time of sale of shares as capital gains. Since perquisite tax has been removed employers
are not liable for tax deduction at source, thus removing administrative inconvenience.

For the company:

As per SEBI guidelines listed companies have to account for ESOP by treating the same
as an expense. As yet there is no clarity whether this expense will be allowed as deductible
expense by the Income Tax authorities.

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UNIT III

Part - A

1. What is the difference between current ratio and quick ratio? (Dec 2017)
The current ratio and quick ratio are both designed to estimate the ability of a business to
pay for its current liabilities. The difference between the two measurements is that the quick ratio
focuses on the more liquid assets, and so gives a better view of how well a business can pay off
its obligations.
Thus, the difference between the two ratios is the use (or non-use) of inventory.

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2. What is the meaning of Funds from Operation?(Dec 2017)

Funds from operations are the cash flows generated by the operations of a business. The term
is most commonly used in relation to the cash flows from real estate investment trusts (REITs).
This measure is commonly used to judge the operational performance of REITs, especially in
regard to investing in them. Funds from operations do not include any financing-related cash
flows, such as interest income or interest expense. It also does not include any gains or losses
from the disposition of assets, or any depreciation or amortization of fixed assets.

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3. What do you mean by Acid test ratio? (Dec 2016)
The acid test ratio is similar to the current ratio except that Inventory, Supplies, and
Prepaid Expenses, In other words, the acid test ratio compares the total of the cash, temporary
marketable securities, and accounts receivable to the amount of current liabilities.
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4. State the limitations of the ratio analysis?(Jan 2016) (Dec 2016)
 A single ratio in itself does not indicate favorable or unfavorable conditions.
 Ratio analysis gives only quantified relationships, which by themselves cannot give
qualitative aspects.
 Ratios suffer from the inherent weakness of the accounting system itself, which is the
source of data.
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