CORPORATE ACCOUNTING – I

ISSUE, FORFEITURE AND REISSUE OF SHARES

Share
In the world of finance and investment, we often use the word ‘equity share’. In fact, it is a part of everyday
discussion among investors, stock market analysts, newspapers, business magazines, etc. Share is nothing but
the Ownership of the company divided into small parts and each part is called as Share or Stock. Whether you
term it shares, stocks or ordinary shares, they are all one and the same. A person carrying a share of a company
holds that part of ownership in that company. A person holding maximum shares carry maximum ownership
and designated like director, chairman etc.
Share Market
A Share market is the place where buying and selling of shares takes place. Now days due to internet and
advanced technology there is no need to present physically in exchanges like NSE and BSE but in fact
the buying and selling of shares can be done from anywhere, where there is a computer with internet
connection. One should have a demat and trading account, computer and internet connection and he/she can
start the share trading or investing from anywhere.
What are the different types of shares?
Broadly, there are two—equity shares and preference shares.
Equity Share
Equity shares are also referred as ordinary shares. They are one of the most common kinds of shares. The
holders of these shares are the real owners of the company. Owners of these shares have the right to vote on
various company matters. They have a control over the working of the company. Equity shares are also
transferable and the dividend paid is a proportion of profit. One thing to note, equity shareholders are not
entitled to a fixed dividend. The rate of dividend on these shares depends upon the profits of the company. They
may be paid a higher rate of dividend or they may not get anything. These shareholders take more risk as
compared to preference shareholders.
Equity share capital cannot be redeemed during the life time of the company. Equity shares are the main source
of finance of a firm. It is issued to the general public. Equity shareholders do not enjoy any preferential rights
with regard to repayment of capital and dividend. They are entitled to residual income of the company, but they
enjoy the right to control the affairs of the business and all the shareholders collectively are the owners of the
company.
Features of Equity Shares
The main features of equity shares are:
1. They are permanent in nature.
2. Equity shareholders are the actual owners of the company and they bear the highest risk.
3. Equity shares are transferable, i.e. ownership of equity shares can be transferred with or without
consideration to other person.
4. Dividend payable to equity shareholders is an appropriation of profit.
5. Equity shareholders do not get fixed rate of dividend.
6. Equity shareholders have the right to control the affairs of the company.
7. The liability of equity shareholders is limited to the extent of their investment.
Advantages of Equity Shares
Equity shares are amongst the most important sources of capital and have certain advantages which are
mentioned below:
i. Advantages from the Shareholders’ Point of View
(a) Equity shares are very liquid and can be easily sold in the capital market.
(b) In case of high profit, they get dividend at higher rate.
(c) Equity shareholders have the right to control the management of the company.
(d) The equity shareholders get benefit in two ways, yearly dividend and appreciation in the value of their
investment.
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ii. Advantages from the Company’s Point of View:
(a) They are a permanent source of capital and as such; do not involve any repayment liability.
(b) They do not have any obligation regarding payment of dividend.
(c) Larger equity capital base increases the creditworthiness of the company among the creditors and investors.
Disadvantages of Equity Shares:
Despite their many advantages, equity shares suffer from certain limitations. These are:
i. Disadvantages from the Shareholders’ Point of View:
(a) Equity shareholders get dividend only if there remains any profit after paying debenture interest, tax and
preference dividend. Thus, getting dividend on equity shares is uncertain every year.
(b) Equity shareholders are scattered and unorganized, and hence they are unable to exercise any effective
control over the affairs of the company.
(c) Equity shareholders bear the highest degree of risk of the company.
(d) Market price of equity shares fluctuate very widely which, in most occasions, erode the value of investment.
(e) Issue of fresh shares reduces the earnings of existing shareholders.
ii. Disadvantage from the Company’s Point of View:
(a) Cost of equity is the highest among all the sources of finance.
(b) Payment of dividend on equity shares is not tax deductible expenditure.
(c) As compared to other sources of finance, issue of equity shares involves higher floatation expenses of
brokerage, underwriting commission, etc.
Types of equity share are:
 Blue Chip Shares: This are shares of a well reputed and established companies.
 Penny Stock: This are share which have high risk and are low in price.
 Right Share – Companies give right shares to existing shareholders of the company.
 Sweat Equity Share – Such shares are to directors of the company or employees. They get such
shares for their exceptional services.
 Bonus Shares – Sometimes the company gives shares instead of payable dividend.
Capital
The term capital as used by a layman denotes only the contributions of the owner of a business firm i.e., owned
capital. But the term capital is very wide in its scope. It means and includes owned capital as well as borrowed
capital.
Classification of Share Capital
The capital raised by the company by issuing shares is called share capital. The Companies Act uses the term
capital in several senses. They are the following:
1. Authorized Capital
This is the amount of capital stated in the capital clause of Memorandum of Association. It is also known as
“Nominal Capital” or “Registered Capital”. The company is entitled to raise finance by the issue of
shares only up to the amount of authorized capital. However, the company can increase the amount of
authorized capital by altering the Memorandum suitably. The promoters generally fix the amount of nominal
capital after considering both the long-term and short-term requirements of the proposed company.
2. Issued Capital
It is that part of nominal capital which is issued to the public. Companies generally do not issue all its capital at
once. They issue their capital in installments and so the issued capital is generally less than the nominal capital.
It never exceeds the authorized capital.
3. Subscribed Capital
It is that part of the issued capital which is taken up by the public. Sometimes, the public may not take up all the
shares that are offered to the public, for subscription. In such case, the subscribed capital shall be less than the
issued capital. If the public subscribes all the shares, it shall be equal to the issued capital.
4. Called up Capital

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It is that part of the subscribed capital, which has been called up on shares. For example, if the face value of a
share is Rs.10 and Rs.5 has been called up on each of the 10,000 shares, then the called-up capital shall be
Rs.50,000.
5. Paid-up Capital
It is that part of the subscribed capital which has been actually paid up by the shareholders. The amount not paid
by the shareholders on the calls made is known as calls-in-arrears. The expression “Paid-up Capital” also
includes the amount credited as paid up on the shares.
6. Uncalled Capital
It is that part of the capital, which is not called up on the shares already, issued. The shareholders continue to be
liable to pay as and when the calls are made.
What are Preference Shares?
According to Sec. 85 of the Act, preference shares are those shares on which there is preference right to claim
dividend during the life time of the company, and to claim repayment of capital on the winding up. The
percentage of dividend is fixed in preference shares. The holders of preference shares get the fixed dividend
before any dividend is paid to other classes of shareholders. At the time of winding up of the company, the
preference shareholders can get back their capital before any other classes of shareholders can get back their
money. There are different types of preference shares according to the clause contained in the agreement at the
time of their issue. The following are some important kinds of preference shares.
Types of Preference Shares
There are different classes of preference shares. They are as follows:
1. Cumulative Preference Shares.
2. Non-cumulative Preference Shares.
3. Participating Preference Shares.
4. Non-participating Preference Shares.
5. Convertible Preference Shares.
6. Non-convertible Preference Shares.
7. Redeemable Preference Shares.
8. Non-Redeemable Preference Shares.
1. Cumulative preference shares
Shares which have the right of dividend of a company even in those years in which it makes no profit are called
cumulative preference share. The company must pay the unpaid dividends on preference shares before the
payment of dividends to equity shareholders. If in any gear the company does not earn adequate profit,
dividends on preference shares may not be paid for that year. In case of cumulative preference shares, such
unpaid dividend is treated as arrears. The arrears will accumulate and they will be payable out of the profits of
the subsequent years. Dividend on other classes of shares can be paid only after the payment of such arrears. If
the Articles are silent, all preference shares are assumed to be cumulative preference shares.
2. Non-Cumulative preference shares
Non-cumulative preference shares are in contrast to Cumulative preference shares. Non-cumulative dividends
do not accumulate if they are not paid when due. The dividend on these shares are payable only out of the
profits of the current year. If in any year the company does not earn adequate profit, the holders get no dividend
or partial dividend. In that case, the unpaid dividend will not be carried forward to subsequent years. The holder
cannot claim arrears of dividend.
3. Participating Preference Shares
The holders of Participating preference share receive stipulated rate of dividend and also participate in the
additional earnings of the company along with the equity shareholders. During the lifetime of the company in
addition to the fixed dividend, the shareholders of this kind of shares have a right to participate in the surplus of
profits, which remains after payment to the equity shareholders. At the time of winding up in addition to their
shares, the shareholders have a right to participate in the surplus of assets, which remains after payment to the
equity shareholders. The surplus will be distributed between the participating preference shareholders and
equity shareholders in an agreed ratio.
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4. Non-Participating Preference Shares
In practice, most preference shares are non-participating in nature. It means that preference shareholders receive
only stated dividend and no more. This is based on the fact that the preference shareholders surrender their
claim to extra earnings in lieu of their right to receive the stated dividend. The holders of non-participating
preference shares have no right either to participate in the surplus of profits, which remains after payment to
equity shareholders (during the lifetime) or to participate in the surplus of assets, which remains after payment
to equity shareholders (at the time of winding up). If the Articles are silent, all preference shares are treated as
nonparticipating preference shares.
5. Redeemable preference shares
According to Sec. 80 of the Companies Act, the preference shares, which can be redeemed after a specified
period or at the discretion of the company, are called redeemable preference shares. Non-redeemable preference
share is permanent in nature and its shareholding is continuous till the company goes into liquidation. In this
sense, the preference share resembles the equity share. So, in order to attract the investor, a clause is included in
the agreement for redeeming the preference share after the expiry of a specified period. The redemption of
preference share is advantageous for the company. It acts as a hedge against inflation. When the money rate
declines, the company may redeem the shares and refinance it at a lower dividend rate.
6. Non-redeemable preference shares
Redeemable preference shares are also called, at the option of the company. If this call is exercised by the
company, the investor must find alternative form of investment for investing the sum he gets on the retirement
of the shares. Investment in equity share is more profitable than that of preference share. Preference
shareholders do not participate, in the extra earnings of the company, except in the case of participating
preference shares.
7. Convertible preference shares
Convertible preference shares are those which are converted into equity shares at a specified rate on the expiry
of a stated period. The holders of this kind of shares have a right to convert their shares into equity shares within
a specified period. For example, a 100 Rupee preference share may become convertible into 10 equity shares of
Rs.10 each.
8. Non-Convertible preference shares
Convertible preference share may also have cumulative or participating rights. This kind of preferred stock is
ideal from the view point of the investor. Non-convertible preference shares are not converted into equity stock.
Non-convertible preference shares may also be redeemable.
The holders of this kind of shares have no right to convert their preference shares into equity shares
Difference between Equity & Preference Shares
The following are some of the difference between equity shares and preference shares.
Points of difference Equity Shares Preference Shares
1. Term of financing Used as a method of long-term financing Used for both long term and medium-
term financing.
2. Nature of return Rate of return is fluctuating, depending Dividend at fixed rate may be paid or
upon the earning accumulated.
3. Owners Equity shareholders are the owners. They These shareholders are not owners.
have voting rights. They have no voting rights.
4. Redeemability They are not subject to redemption during It can be redeemed after achieving the
the lifetime of the company. purpose or at the end of a certain
period.
5. Type of Investors Suitable for those investors who are It has appeal for relatively less
adventurous by nature. adventurous investors.

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 Points of difference Equity Shares Preference Shares
6. Right of receiving Residual claimant. Rank next to Entitled for first preference
dividend preference shares.
7. Right of receiving back Entitled for first preference Entitled for first preference
invested capital during
liquidation.
8. Financial burden Payment of equity dividends is optional. It Payment of preference dividend is a
is dependent on the discretion of the fixed financial commitment.
Board of Directors. Therefore, there is no
fixed financial commitment.
9. Voting rights Enjoy voting rights Do not enjoy voting rights
10. Reduction of capital By reorganization By repayment
11. Denomination Generally, of lower denomination. Generally, of higher denomination.
12. Type of investors. Even small investors can invest because of Preferred by medium and large
the lower denomination. investors. Small investors would find
it difficult to invest because of the
higher denomination.
13. Borrowing capacity Strengthens borrowing capacity. Reduces borrowing capacity.
14. Capitalization There are chances for over-capitalizations. Lesser chances for over-capitalization.

Procedure of issue of Shares

When Company has been registered, the following procedure is adopted by the company to collect money from
the public by issuing of shares:
Step-1
Issue of prospectus: When a Public company intends to raise capital by issuing its shares to the public, it
invites the public to make an offer to buy its shares through a document called ‘Prospectus’. According to
Section 60 (1), a copy of prospectus is required to be delivered to the Registrar for registration on or before the
date of publication thereof. It contains the brief information about the company, its past record and of the
project for which company is issuing share. It also includes the opening date and the closing date of the issue,
amount payable with application, at the time of allotment and on calls, name of the bank in which the
application money will be deposited, minimum number of shares for which application will be accepted, etc.
Step-2
To receive application: After reading the prospectus if the public is satisfied then they can apply to the
company for purchase of its shares on a printed prescribed form. Each application form along with application
money must be deposited by the public in a schedule bank and get a receipt for the same. The company cannot
withdraw this money from the bank till the procedure of allotment has been completed (in case of first
allotment, this amount cannot be withdrawn until the certificate to commence business is obtained and the
amount of minimum subscription has been received). The amount payable on application for share shall not be
less than 5% of the nominal amount of share.
Step-3
Allotments of shares: Allotments of shares means acceptance by the company of the offer made by the
applicants to take up the shares applied for. The information of allotment is given to the shareholders by a letter
known as ‘Allotment Letter’, informing the amount to be called at the time of allotment and the date fixed for

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 payment of such money. It is on allotment that share come into existence. Thus, the application money on the
share after allotment becomes a part of share capital. Decision to allot the share is taken by the I Board of
Directors in consultation with the Stock Exchange. After the closure of the subscription list, the bank sends all
applications to the company. On receipt of applications, each application is carefully scrutinized to ascertain
that the application form is properly filled up and signed and the money is deposited with the bank.
Step-4
To make calls on shares: The remaining amount left after application and allotment money due from
shareholders may be demanded in one or more parts which are termed as ‘First Call’ and ‘Second Call’ and so
on. A word ‘Final’ word is added to the last call. The amount of call must not exceed 25% of the nominal value
of the shares and at least 1 month have elapsed since the date which was fixed for the payment of the last
preceding call, for which at least 14 days notice specifying the time and place must be given.
Modes of issue of shares:
A company can issue shares in two ways:
1. For cash.
2. For consideration other than cash.
Issue of shares for cash: When the shares are issued by the company in consideration for cash such issue of
shares is known as issue of share for cash. In such a case shares can be issued at par or at a premium or at a
discount. Such issue price may be payable either in lump sum along with application or in installments at
different stages (e.g. partly on application, partly on allotment, partly on call).
Issue of shares at par: Shares are said to be issued at par when they are issued at a price equal to the face
value. For example, if a share of Rs. 10 is issued at Rs. 10, it is said that the share has been issued at par.
Issue of shares at premium: When shares are issued at an amount more than the face value of share, they are
said to be issued at premium. For example, if a share of Rs. 10 is issued at Rs. 15; such a condition of issue is
known as issue of shares at premium. The difference between the issue price and the face value [i.e. Rs. 5
(Rs.15 – Rs.10)] of the shares is called premium. It is a capital profit for the company and will show credit
balance; hence it will be shown in the liability side of the Balance Sheet under the heading ‘Reserves and
Surplus’ in a separate account called ‘Security Premium Account’. Shares of those companies can be issued at
premium which offer attractive rate of dividend on their existing shares, having a good profit track for last few
years and whose shares are in demand. The amount of premium depends upon the profitability and demand of
shares of such company.
Issue of shares at discount: Shares are said to be issued at a discount when they are issued at a price lower
than the face value. For example if a share of Rs. 10 is issued at Rs. 9, it is said that the share has been issued at
discount. The excess of the face value over the issue price [i.e. Re.1 (Rs. 10 – Rs. 9)] is called as the amount of
discount. Share discount account showing a debit balance denotes a loss to the company which is in the nature
of capital loss. Conditions for issue of shares at discount: For issue of shares a discount the company has to
satisfy the following conditions given in section 79 of the Companies Act 1956:
(i) At least one year must have elapsed since the company became entitled to commence business. It means that
a new company cannot issue shares at a discount at the very beginning.
(ii) The company has already issued such types of shares.
(iii) An ordinary resolution to issue the shares at a discount has been passed by the company in the General
Meeting of shareholders and sanction of the Company Law Tribunal has been obtained.
(iv) The resolution must specify the maximum rate of discount at which the shares are to be issued but the rate
of discount must not exceed 10% of the face value of the shares. For more than this limit, sanction of the
Company Law Tribunal is necessary.
(v) The issue must be made within two months from the date of receiving the sanction of the Company Law
Tribunal or within such extended time as the Company Law Tribunal may allow.
Forfeiture of shares:
When any company allots share to the applicants, it is done on the basis of a legal contract between the
company and the applicant, which makes it binding upon the shareholders to pay the amount of allotment and
calls whenever they are due. Now if any shareholder fails to pay the allotment and or call money due to him, the
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 shareholder violates the contract and the company is entitled to take its share back, which is known as forfeiture
of shares. The company can forfeit such shares if authorized by the Articles of Association. Forfeiture of share
can be done according to the rules laid sown in the Articles and if no rules are given in Articles, the provisions
of Table A, regarding forfeiture will apply. Forfeiture of shares means cancellation of allotment to defaulting
shareholders and to treat the amount already received on such shares is not returnable to him – it is forfeited.
Procedure for forfeited shares:
The usual procedure is that the defaulting shareholder must be given a minimum 14 days notice requiring him to
pay the amount due on his shares along with interest on it stating that if he fails to pay the amount and the
interest on it, the shares will be forfeited. In spite of this notice, the shareholder does not pay the unpaid amount.
The directors after passing a resolution will forfeit the shares and information will be given to the defaulting
shareholder about the forfeiture his shares.
Effect of forfeiture of shares:
1. Termination of membership: The membership of the defaulting will be terminated and they lose all the rights
and interest on those shares i.e. ceases to be the member / shareholder / owner of the company and his name
will be removed from the Register of Members
2. Seizure of money paid: The amount already paid on the forfeited shares by the defaulting shareholders will be
seized by the company and in no case will be refunded back to the shareholder.
3. Nonpayment of dividend: When shares are forfeited the shareholder remains no longer the member of the
company therefore, he loses the right to receive future dividend.
4. Reduction of share capital: Forfeiture of shares result in the reduction of share capital to the extent of amount
called up on such shares.
Surrender of shares:
When a shareholder feels that he cannot pay further calls; he may himself surrender the shares to the company.
These shares are then cancelled. Surrender of shares is a voluntary return of shares for the purposes of
cancellation. The directors can accept the surrender of shares only when the Articles of Association authorise
them to do so. Surrender is lawful only in two cases viz.
(a) Where it is done as a short cut to forfeiture to avoid the formalities for a valid forfeiture and
(b) Where shares are surrendered in exchange for new shares of the same nominal value. A surrender will be
void if it amounts to purchase of the shares by the company or if it is accepted for the purpose of relieving a
member from his liabilities. Entries are passed just like forfeiture of shares.
Thus, surrender of shares is at the instance of shareholder whereas forfeiture of shares at the instance of
company.
Re-issue of Forfeited of shares:
Shares forfeited becomes the property of the company and the directors of a company have an authority to re-
issue the shares once forfeited by them in accordance with the provisions contained in Articles of Association.
Table ‘A’ provides that “A forfeited shares may be sold or otherwise disposed off on such terms and in such
manner as the Board thinks fit”. They can re-issue the forfeited shares at par, at premium or at discount.
However, if the shares are re-issued at discount, the amount of the discount does not exceed the amount paid on
such shares by the original shareholder but in case of shares originally issued at a discount, the maximum
permissible discount will be amount paid on such shares by the original shareholder plus the amount of original
discount.
Minimum subscription
Minimum subscription is the term which is used to represent the amount of the issue which has to be subscribed
or else the shares can't be issued if it is not being subscribed. Company which is offering the shares to the public
then they set a specific amount for the subscription which can be taken by the public in order to issue the shares.
Over subscription of issue:
When the application received from the public are more than the shares issued by the company, this situation is
called as over subscription of issue. The Board of Directors cannot allot shares more than that offered to the
public, in such a condition the Directors of the company make the allotment of shares on the basis of reasonable
criteria. Any allotment to be made by the company in case of over subscription should be according to the
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scheme, which is finalized with the consultation of Security and Exchange Board of India (S.E.B.I.) The journal
entry for application money will be passed for all the shares applied for, but while transferring the application
money to share capital account, only the application money on shares issued will be considered.
Under subscription of issue:
Shares are said to be under-subscribed when the number of shares applied for is less than the number of shares
offered, but at least minimum subscription (According to the guidelines issued by S.E.B.I. minimum
subscription means ‘If the company does not receive a minimum subscription of 90% of the issued amount
within 60 days from the date of closure of the issue, the company shall forthwith refund the entire subscription
amount’) is received. For example, in case has offered 5,000 shares to public but the public applied for 4,500
shares only, it is called a case of under-subscription. Journal entries are passed on the basis of shares applied
for.

CONCEPT OF BOOK BUILDING

Meaning of Book Building:
Every business organization needs funds for its business activities. It can raise funds either externally or through
internal sources. When the companies want to go for the external sources, they use various means for the same.
Two of the most popular means to raise money are Initial Public Offer (IPO) and Follow on Public Offer (FPO).

During the IPO or FPO, the company offers its shares to the public either at fixed price or offers a price range,
so that the investors can decide on the right price. The method of offering shares by providing a price range is
called book building method. This method provides an opportunity to the market to discover price for the
securities which are on offer.

Book Building may be defined as a process used by companies raising capital through Public Offerings-both
Initial Public Offers (IPOs) and Follow-on Public Offers (FPOs) to aid price and demand discovery. It is a
mechanism where, during the period for which the book for the offer is open, the bids are collected from
investors at various prices, which are within the price band specified by the issuer. The process is directed
towards both the institutional investors as well as the retail investors. The issue price is determined after the bid
closure based on the demand generated in the process.

Book Building vs. Fixed Price Method:

The main difference between the book building method and the fixed price method is that in the former, the
issue price to not decided initially. The investors have to bid for the shares within the price range given. The
issue price is fixed on the basis of demand and supply of the shares.

On the other hand, in the fixed price method, the price is decided right at the start. Investors cannot choose the
price. They have to buy the shares at the price decided by the company. In the book building method, the
demand is known every day during the offer period, but in fixed price method, the demand is known only after
the issue closes.

Book Building in India:

The introduction of book-building in India was done in 1995 following the recommendations of an expert
committee appointed by SEBI under Y.H. Malegam. The committee recommended and SEBI accepted in
November 1995 that the book-building route should be open to issuer companies, subject to certain terms and
conditions. In January 2000, SEBI came out with a compendium of guidelines, circulars and instructions to
merchant bankers relating to issue of capital, including those on the book-building mechanism.

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Book Building Process:
The principal intermediaries involved in a book building process are the companies, Book Running Lead
Manager (BRLM) and syndicate members are the intermediaries registered with SEBI and eligible to act as
underwriters. Syndicate members are appointed by the BRLM. The book building process is undertaken
basically to determine investor appetite for a share at a particular price. It is undertaken before making a public
offer and it helps determine the issue price and the number of shares to be issued.

The following are the important points in book building process:

1. The Issuer who is planning an offer nominates lead merchant banker(s) as ‘book runners. The Issuer
specifies the number of securities to be issued and the price band for the bids.
2. The Issuer also appoints syndicate members with whom orders are to be placed by the
investors.
3. The syndicate members put the orders into an ‘electronic book’. This process is called ‘bidding’
and is similar to open auction.
4. The book normally remains open for a period of 5 days.
5. Bids have to be entered within the specified price band.
6. Bids can be revised by the bidders before the book closes.
7. On the close of the book building period, the book runners evaluate the bids on the basis of the
demand at various price levels.
8. The book runners and the Issuer decide the final price at which the securities shall be issued.
9. Generally, the number of shares is fixed; the issue size gets frozen based on the final price per
share.
BUY-BACK OF SHARES
What is Buyback of Shares?
The process by which the Company repurchase its own shares and other securities from the existing
shareholders of the Company at a higher price than market price is referred to as Buyback of Shares. The
number of outstanding shares in the market fall, when a Company Buyback the Shares and other Securities.
Moreover, it can be said that Buyback is the method of cancellation of Share Capital of Company. Whenever
the Company’s management thinks that the shares of Company are undervalued or if the outstanding shares are
falling in the market, the Company goes for Buyback. Buy-Back is a corporate action in which a company buys
back its shares from the existing shareholders usually at a price higher than market price. A share repurchase or
buyback of shares is a way a publicly traded company invests in its own shares from the existing shareholder.
Like dividends, share buyback is an avenue for the company to return cash to its existing shareholders Many
good companies like TCS and Infosys keep rewarding their shareholders through a regular increase in dividend
and share buyback Buy-back helps a company by giving a better use for its funds than reinvesting these funds in
the same business at below average rates or going in for unnecessary diversification or buying growth through
costly acquisitions.
Under Buyback, there is the repurchase of its existing shares by the Company. To increase the overall value of
shareholders, returning cash to shareholders, and restructure its capital structure Company generally Buyback
its existing Shares.
Advantages of Buy Back:
1. To increase EPS
2. To increase promoters holding
3. To support share price in the market
4. To pay surplus cash to share holders
Drawbacks of Buy Back:

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The shares repurchase is criticized for the following reasons:
1. This could enable unscrupulous promoters to use company’s money to raise their personal stakes.
2. It opens up possibilities for share price manipulation.
3. It could divert away the company’s funds from productive investments.

What are the legal provisions governing Buyback of Shares and other Securities?

The legal provisions governing the Buyback of Shares and other Securities are as follows:

Provisions of the Companies Act, 2013 - Section 68

1. The buyback is authorised by its articles
2. Special resolution has been passed in General Body Meeting
3. Resource Test – Buyback must be less than 25% of paid up capital and free reserve
4. Shares outstanding Test – A co. cannot buyback more than 25% of no of share issued or outstanding
5. Debt- Equity Ratio Test – After buyback debt equity ratio cannot be more than 2:1
Companies Act – Three conditions
Maximum no. of shares buyback
Three conditions have to be satisfied
Lowest of the three will be available for buyback
6. All the shares must be fully paid up
7. Free reserve also included in securities premium
8. Buyback can be out of
-Free reserve
- Fresh Issue
Impact of buyback of shares
1. The number of share outstanding goes down due to the buyback of shares.
2. Buyback leads to the increase in earnings per share (EPS). Since it reduces company’s outstanding shares, the
impact is clearly evident in per-share measures of cash flow and profitability.
10
3. It also leads to increase in stock price in the market. Generally, the buyback is looked upon as an increasing
confidence with the promoters.

EMPLOYEE STOCK OPTION PLAN/EMPLOYEE STOCK OPTION SCHEME

In order to retain high caliber employees or to give them a sense of belonging, companies may offer their equity
shares to be purchased at their will. Such scheme is called Employee stock option plan (ESOP). Following are
the characteristics of this scheme:
1. Incentive scheme
2. ESOP implies the right, but not an obligation.
3. The employee has a right to exercise the option of purchase of shares within the vesting period, i.e., the
time period during which the scheme remains in operation.
4. Any share issued under the scheme of ESOP shall be locked-in for a minimum period of one year from
the date of allotment

Employee Stock Option Plan or ESOP is wherein company issues shares to its employees at a price that is lower
than the market price. Employee gets an option to execute the offer with an objective of motivating employees
to perform better and promote a sense of ownership. Employee stock option plan is an option given by the
company to its employees to subscribe to the shares of the company. Now why the company gives option to its
employee: It will create a sense of belongingness among employees. They will feel committed towards the
company. It is a kind of non cash incentive to the employee.

The answer is shares are offered at a price less than the market price of share so in this employee gets a benefit.
Instead of buying shares from market he is getting shares at less than market price. The price offered by
company is called Exercise Price.
The difference between exercise price and market price is treated as an expense by the company.

What kind of employees are actually entitled to ESOPs?

As per Company Rules, only
(i) A permanent employee working in or outside India;
(ii) A whole-time or part-time director of the company; and
(iii)An employee of a subsidiary, holding or an associate company working in or outside India, can claim
benefits under an ESOP scheme
NOTE: A ‘promoter’, or a director holding >10% of the equity shares of the company are not entitled to take
part in this scheme.

Why the Scheme of ESOP?

 Attracting and retaining the best employees.
 Increase performance, trust and sense of ownership among employees.
 Companies on high growth trajectory can introduce this scheme to let key employees continue their stay.
 The companies with shortage of cash can simply adopt ESOP model.

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Tax implications on ESOPs
– When the options are given by the company, there is no tax.
– When the options get vested, there is no tax.
– Tax is payable on the value arrived as the difference between the market value and exercise value. The
difference value is treated as perquisite i.e. salary income and is taxable as per the tax bracket that the employee
falls in.
– When the employee sells the shares, the profit is treated as capital gains. If the shares sold within one year,
15% capital gains tax has to be paid just like in the usual purchase and sale of shares. If the stock is sold after 1
year, there is no tax as it is considered as long-term.
– If the employee has ESOPs of a company that is listed abroad and sells the shares, short-term capital gains is
added to income and one has to pay tax as per the tax slab that he/she falls into.
–10% tax (without indexation) or 20% tax (with indexation benefit) has to be paid if the capital gains are long-
term.

What is the difference between sweat equity shares and ESOP

Employee stock option plan (ESOP) has been issued to the companies employees for purchasing it at a
determined price, which have a low price as compared to the market price. However, in the case of Sweat
Equity shares, they are issued at a discount or without monetary consideration to company employees.

What Is Sweat Equity?

The term sweat equity refers to a person or company's contribution toward a business venture or other project.
Sweat equity is generally not monetary and, in most cases, comes in the form of physical labor, mental effort,
and time. Sweat equity is commonly found in real estate and the construction industry, as well as in the
corporate world—especially for start-ups.

How Sweat Equity Works

Sweat equity originally referred to the value-enhancing improvements generated from the sweat of one's brow.
So when people say they use sweat equity, they mean their physical labor, mental capacity, and time to boost
the value of a specific project or venture.

The term is commonly used in the real estate and construction industries. Sweat equity can be used by
homeowners to lower the cost of homeownership. Real estate investors who flip houses for profit can also use
sweat equity to their advantage by doing repairs and renovations on properties before putting them on the
market. Paying carpenters, painters, and contractors can get extremely pricey, so a do-it-yourself renovation
using sweat equity can be profitable when it comes time to sell.

Sweat equity is also an important part of the corporate world, creating value from the effort and toil contributed
by a company’s owners and employees. In cash-strapped startups, owners and employees typically accept
salaries that are below their market values in return for a stake in the company, which they hope to profit from
when the business is eventually sold.

What is Stock Split?

A stock split is when a company’s board of directors’ issues more shares of stock to its current shareholders
without diluting the value of their stakes. A stock split increases the number of shares outstanding and lowers
12
the individual value of each share. While the number of shares outstanding change, the overall valuation of the
company and the value of each shareholder’s stake remains the same.

Say you have one share of a company’s stock. If the company opts for a 2-for-1 stock split, the company would
grant you an additional share, but each share would be valued at half the amount of the original. After the split,
your two shares would be worth the same as the one share you started with.

UNDERWRITING OF SHARES
Meaning of Underwriting:

‘Underwriting’ refers to the functions of an under-writer. An under-writer may be an individual, firm or a joint
stock company, performing the under-writing function. Under-writing may be defined as a contract entered into
by the company with persons or institutions, called under-writers, who undertake to take up the whole or a
portion of such of the offered shares or debentures as may not be subscribed for by the public. Such agreements
are called ‘Under-writing agreement’.

A newly formed company enters into an agreement with an under-writer to the effect that he will take up shares
or Debentures offered by it to the public but not subscribed for in fully by the public. Such an agreement may
become necessary when a company issues shares or debentures for the first time to the public, or subsequently
when it is in need of working capital.
When the company does not receive 90 per cent of issued amount from public subscription, within 120 days
from the date of opening the issue, the company cannot proceed with allotment. In such a case, the company
must refund the amount of subscription. In the case of a new company, it cannot obtain a certificate to
commence function.

A company is not sure whether the shares or debentures offered for subscription may be taken up by the public.
There arises a risk to ensure the success of issue. Therefore, companies resort to underwriting in order to ensure
that sufficient number of shares or debentures would subscribed for. Thus, risk-bearing or uncertainty bearing is
an important function of an underwriter.

Thus, an underwriter is a person who undertakes to take up the whole or a portion of the shares or debentures
offered by a company to the public for subscription as may not be subscribed for by the public, prior to making
such an offer. The company has to pay a commission to such an underwriter. It is known as underwriting
commission. It is, of course, a type of insurance against under-subscription.
Functions of a Broker in Underwriting:
Broker is a person who helps in subscribing the shares. A broker is one who finds buyers for the shares or
debentures of the company and gets the brokerage on the number of shares or debentures subscribed by the
public through him. Underwriter is different from a broker. An underwriter is a person who agrees to take a
specified number of shares or debentures, in case, not subscribed by the public.

That is, an underwriter is liable to take up shares in case the public fails to subscribe whereas a broker is not
liable. Underwriter gets underwriting commission and a broker gets brokerage. Underwriter gives a guarantee
whereas a broker does the service of placing the shares.

Thus, the function of an underwriter is of great economic significance since he himself assumes the risk of
uncertainty on behalf of the company making public issue of shares or debentures. A broker, on the other hand,
13
does not assume any such risk. Underwriting acts as a sort of insurance or guarantee against the danger of not
receiving minimum subscription.

Sub Underwriting:
An underwriter may himself enter into a sub-agreement with other persons, called sub- underwriters, whereby
he transfers a part of his underwriting risk. Just like re-insurance, sub- underwriting helps in spreading the risk.
An underwriter may appoint several underwriters to work under him. However, the sub-underwriters have no
privacy of contract with the company. They get their commission from the underwriter and are also responsible
to him.

Importance of Underwriting:
1. Underwriting acts as a sort of insurance or guarantee against the danger of not receiving minimum
subscription, in the absence of underwriting agreement, there is always uncertainty regarding subscription of
shares of debentures by the public. The guarantee of the underwriters removes the uncertainty.

2. When shares or debentures are sold through underwriters, there arise more confidence amongst the public.
This is because underwriters undertake shares or debentures of only those companies which are sound concerns
and whose future is bright.

3. Underwriting creates an impression regarding sound status of a company. It increases the goodwill of the
company.

Types of Underwriting:
An agreement to undertake the shares or debentures of a company are of the following types:

(a) Complete Underwriting:

In case, the entire issue of shares or debentures of a company is undertaken, it is said to be full or complete
underwriting. Such an underwriting may be done by one underwriter or by a number of underwriters. If the full
issue is underwritten by one underwriter, then his liability will be equal to the number of shares or debentures
underwritten minus shares applied for.

Even if the issue is fully as subscribed or over-subscribed, the underwriter is eligible to get the agreed
commission on the issue of shares. In case less number of shares or debentures are subscribed by the public, the
underwriter is required to meet the deficiency in whole. In case, the public response is good, the underwriter is
at an advantage to get the underwriting commission, without subscribing even a single share of debenture.

At the same time, if there are more than one underwriter, then allocation of unsubscribed shares or debentures
amongst themselves is made pro-rata, that is, in the ratio in which the number of shares or debentures
underwritten bear to the total number of shares or debentures offered for subscription.

(b) Partial Underwriting:

If a part of the issue of shares or debenture of a company is underwritten, it is said to be partial underwriting.
Such an underwriting may be done by one underwriter or by a number of underwriters. In case of partial
underwriting, the company is treated as ‘underwriter’ for the remaining part of the issue. For instance, a
company issued 1,000 shares and 40% thereof is underwritten by Nikhil. Out of 800 applications received, the
marked applications are 350.

(c) Firm Underwriting:

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It is an underwriting agreement where the underwriter or underwriters agree to buy a certain number of shares
or debentures irrespective of the number of shares or debentures subscribed by the public. Thus, in firm
underwriting, the underwriters agree that a certain number of shares be allotted to them, whether or not the issue
is over subscribed.

An underwriting agreement may be open or firm. An agreement to take up shares or debentures only when the
issue is not subscribed in full is called open underwriting. For instance, if an underwriter guarantees the issue of
1,00,000 shares and the public applied for 70,000 shares, then the underwriter has to purchase the balance of
30,000 shares which are unsubscribed; in case, the public applied for 80,000 shares, then the underwriter has to
purchase the balance of 20,000 unsubscribed shares; in case the public applied for 90,000 shares, then the
underwriter has to purchase the balance i.e., 10,000 shares and in case the public applied for 1,00,000 or more
shares, the underwriter has no liability against the shares. Again, in case of under-subscription, the underwriter
is asked to purchase the deficiency of agreed shares, under open underwriting.

When an underwriter, enters into an agreement with the Company, to purchase certain number of shares or
debentures, irrespective of the public subscription, in addition to the open writing, is known as firm
underwriting. Thus, under firm underwriting, the underwriter agrees to take a specified number of shares or
debentures, in addition to the unsubscribed shares or debentures. An underwriter through such an agreement
with the Company gets priority over the public in relation to the allotment, in case of over-subscription.

Firm applications are generally treated as direct applications from the public and are included therein. If,
however, the agreement specifically provides, personal relief is given for firm applications also along-with the
marked applications. Firm applications are added to the net liability to find out the ultimate liability of an
underwriter.

Marked or Unmarked Applications:

Generally, shares or debentures issued by a Company are usually underwritten by a number of underwriters, in
an agreed ratio of the whole issue. Each of the underwriter tries to sell the shares or debentures at the maximum
in order to reduce the risk of liability. Therefore, a method of marking the application form with the stamp of
the underwriters is adopted.

This facilitates to distinguish the forms of one underwriter from that of others and becomes clear to the
Company to know the exact number of applications received through a particular underwriter. Such applications
with stamp of an underwriter are called marked applications.

In some cases, public get the application form directly from the Company and such forms do not bear the stamp
of underwriters. Such applications, which do not possess the stamp of underwriters, are called unmarked or
direct applications.

REDEMPTION OF PREFERENCE SHARES

Preference shares are those shares which carry certain special or priority rights. Firstly, dividend at a
fixed rate is payable on these shares before any dividend is paid on equity shares. Secondly, at the time of
winding up of the company, capital is repaid to preference shareholders prior to the return of equity capital.
Preference shares do not carry voting rights. However, holders of preference shares may claim voting rights if
the dividends are not paid for two years or more on cumulative preference shares and three years or more on
non-cumulative preference shares.
Types of Preference Shares
1. Cumulative Preference Shares
When unpaid dividends on preference shares are treated as arrears and are carried forward to subsequent years,
then such preference shares are known as cumulative preference shares. It means unpaid dividend on such
15
shares is accumulated till it is paid off in full.
2. Non-cumulative Preference Shares
Non-cumulative preference shares are those type of preference shares, which right to get have fixed
rate of dividend out of the profits of current year only. They do not carry the right to receive arrears of dividend.
If a company fails to pay dividend in a particular year then that need not to be paid out of future profits.
3. Redeemable Preference Shares
Those preference shares, which can be redeemed or repaid after the expiry of a fixed period or after giving the
prescribed notice as desired by the company, are known as redeemable preference shares. Terms of redemption
are announced at the time of issue of such shares.
4. Non-redeemable Preference Shares
Those preference shares, which cannot be redeemed during the life time of the company, are known as non-
redeemable preference shares. The amount of such shares is paid at the time of liquidation of the company.
5. Participating Preference Shares
Those preference shares, which have right to participate in any surplus profit of the company after paying the
equity shareholders, in addition to the fixed rate of their dividend, are called participating preference shares.
6. Non-participating Preference Shares
Preference shares, which have no right to participate on the surplus profit or in any surplus on liquidation of the
company, are called non-participating preference shares.
7. Convertible Preference Shares
Those preference shares, which can be converted into equity shares at the option of the holders after a fixed
period according to the terms and conditions of their issue, are known as convertible preference shares.
8. Non-convertible Preference Shares
Preference shares, which are not convertible into equity shares, are called non-convertible preference shares.
Provisions of the Companies Act
The following are the important provisions of Sec.80 of the Companies Act relating to issue and redemption of
Redeemable Preference Shares.
1. A company limited by shares, may, if authorized by its Articles of Association, issue preference shares
which are liable to be redeemed as per the terms of the issue.
2. Such shares cannot be redeemed unless they are fully paid up.
3. Such shares can be redeemed either out of the profit of the company which would be otherwise be
available for dividend or out of the proceeds of a fresh issue of shares made for the purpose of
redemption.
4. If any premium is payable on redemption of preference shares, such premium has to be provided out of
the profits of the company or out of the securities premium account.
5. When such shares are redeemed out of profits, sum equal to the nominal amount of the shares so
redeemed must be transferred, out of the profits of the company which would otherwise be available for
dividend, to reserve account called Capital Redemption Reserve Account.
6. Capital redemption reserve can be utilized to issue fully paid bonus shares to the equity shareholders.
Unless otherwise sanctioned by the court, it cannot be used for any other purpose.
7. Redemption of preference shares by a company shall not be taken as reduction of its authorized capital.

Model Accounting Entries on Redemption of Preference Shares

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PROFIT PRIOR TO INCORPORATION
Incorporation of a company refers to the legal process that is used to form a corporate entity or a company. An
incorporated company is a separate legal entity on its own, recognised by the law. These corporations can be
identified with terms like ‘Inc’ or ‘Limited’ in their names. It becomes a corporate legal entity completely separate
from its owners.

Sometimes, a company is formed for purchasing certain running or going concern. A company comes into
existence only after its registration i.e., its incorporation. A company can earn profits only after its
incorporation, but not before its incorporation. In many cases, th6 date of acquisition of business may not
coincide with the date of the incorporation.

For instance, a company incorporated on 1st May 2004 may purchase a business from 1st January 2004, the
date on which the financial year starts. Generally, the business of going concern is purchased on the basis of last
Balance Sheet.

It will be more convenient to both—the vendor and the vendee. In case if the business is purchased on a date
other than the date of Balance Sheet, accounts of stocks, assets, liabilities etc. have to be taken and verified. The
processes are tedious jobs. To avoid such a tedious job, the business may be acquired from the date the firm
prepared its last final accounts.

A private company can commence business soon after its incorporation, while a public company can commence
business only after obtaining the certificate of commencement of business. That is, any profit made, in case of
private company, before incorporation and in case of public company any profit made before the
commencement of business, should be taken as a capital profit. However, it should be noted carefully that it is
the date of incorporation and not the date of commencement of business which is taken into consideration for
calculating profit or loss prior to incorporation.

For instance, a company incorporated on 1.4.2004 agrees to take over a running business from 1.1.2004. It
closes its accounts on 31st December. The company is entitled to not only the profit or loss from 1.1.2004 to
31.3.2004 but also the profit or loss from 1.4.2004 to 31.12.2004. The profit earned prior to incorporation i.e.,
1.1.2004 to 31.3.2004 is known as Pre-Incorporation Profit, which cannot be taken as revenue profit, but is
Capital Profit.

Such profit is to be transferred to Capital Reserve or may be used in writing down capital loss. When, there
arises a loss in the pre-incorporation period, the loss should be debited to GOODWILL ACCOUNT. The profit
earned during post period i.e., in the above example, from 1.4.2004 to 31.12.2004, is revenue profit and is
available for dividend.
Allocation of ‘Profit/Loss into Pre-and Post-Incorporation Period:
As the profits earned prior to incorporation are not available for dividend, it is necessary to separate it from
divisible profits. This is possible, when the profit and loss account is prepared separately for the pre-
incorporation period and post-incorporation period. And this is possible only by closing of the books and stock
17
taking for the two periods. These involve tedious work. Therefore, the profit or loss is estimated by
apportioning on some reasonable basis – time, turnover, equitable or actual.
In practice, the same sets of books of accounts are 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 (Pre-incorporation period) and
(ii) From the date of incorporation to the closing of the accounting year (Post-incorporation period).
Method of Accounting:
Steps to find out the profit or loss before and after incorporation are as follows:
1. Prepare one trading account for the whole period. Do not consider the date of incorporation. Thus, one figure
of gross profit for the entire period is arrived at.
2. The gross profit is apportioned between the two periods, prior to incorporation and post- incorporation, on the
basis of sales in the two periods.
3. The various expenses, which are shown in the profit and Loss Account, should be divided between pre and
post incorporation periods on some logical and appropriate basis.
They are given below:

Sales Ratio:
In simple problems, where the sales are evenly spread over the whole period, the sales are apportioned between
pre and post-incorporation periods in the proportion of their time periods. But in many cases, the sales are
fluctuating from time to time. Therefore, the Sales Ratio is found out by considering pre and post-incorporation
periods on the basis of their respective turnover. (Turnover-cum-time basis.)
Treatment of Pre-Incorporation Results:
Profit or loss from the date of purchase of business till the date of incorporation belongs to the company. Such
profit should not be regarded as trading profit. The profit made before incorporation is not available for
distribution as dividends to the shareholders of the purchasing company because it is treated as capital profit.
The treatment of pre-incorporation results is given below:
(A) Profit Prior to Incorporation:
1. The profit is in the nature of capital profit.
2. Capital profit should not be used for payment of dividend.
18
3. It can be used for writing down goodwill or capital losses.
4. The unutilised portion of the profit can be transferred to Capital reserve.
(B) Loss Prior to Incorporation:
1. It can be treated as goodwill and added to goodwill account.
2. It can also be treated as deferred revenue expenditure and written off against profits, over a number of years.
3. It may be debited to a separate account – Loss Prior to Incorporation Accou

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.
Method of Accounting of Profit/Loss Prior to Incorporation:
Step I :Calculate the following two ratios:
(i) Time Ratio: This is the ratio of months or days before and after incorporation during the accounting period.
For example, if business was acquired on 1.1.2006, the company was incorporated on 1.5.2006 and accounts are
closed on 31.12.2006, the time ratio is 4:8 or 1:2. Form 1.1.2006 till 1.5.2006, there are four months before
incorporation. Similarly, there are 8 months after incorporation i.e form 1.5.2006 to 31.12.2006.
(ii) Sales Ratio: This is the ratio of sales or turnover of the company before and after incorporation. For
example, when sales before and after incorporation were `2,00,000 and ` 6,00,000 respectively, the sales ratio is
1:3.
Step II :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, donation given to political parties 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 (k) Free Samples given (l) Expenses incurred for After-Sale Service, etc. (m) Delivery Van
Expenses.
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

ABSORPTION
When one existing company takes over the business of one or more existing company carrying on
similar business, it is called absorption. The purchasing company is called Transferee and the selling company
is called Transferor. The companies whose business is taken over are liquidated. No new company is formed. In
other words, the term absorption has two basic features:
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 1. There is no formation of a company to take over the business of existing company or companies.
2. Only the Transferor Company or companies lose their entities by going into liquidation.
Purchase Consideration:
The price payable by the purchasing company (Transferee) to the selling company (Transferor) for
taking over its business is called purchase consideration. In other words, the purchase consideration is the
amount which is paid by the purchasing company to the selling company.
The purchase consideration has two aspects- the amount of consideration and its forms. Forms of
consideration refers to the amount of cash, shares, debentures etc. receivable from the purchasing company as
part of the purchase price
Purchase consideration is restricted to the total amount payable to the shareholders of the selling
company alone. Any amount agreed to be paid to the creditors of the selling company cannot be included in the
purchase consideration. The amount of purchase consideration can be computed under any of the following four
methods:
1. Lump Sum Method
The purchasing company may agree to pay a lump-sum to the vendor company on account of the purchase of its
business. In fact, this method is not based on any scientific thoughts and techniques. This method is an
unscientific and non-mathematical method of ascertaining purchase consideration.
Example:
A purchasing company agree to take over a business of selling company for ` 5,00,000. In such a case, the
purchase consideration is ` 5,00,000. No calculation is needed.
2. Net payment Method
Under this method the purchase consideration is the total of shares and cash which are to be paid for claims of
equity of the transferor company. PC = Total of all payment made by purchasing company to the selling
company.
3. Net Asset Method or Net Worth Method
According to this method the purchase consideration is calculated by adding up the agreed value of various
assets taken over by the purchasing company and then deducting agreed value of various liabilities taken over
by the purchasing company.
Agreed value of assets taken over – Agreed value of liabilities taken over = Net Assets
4. Intrinsic Value Method or Share Exchange Method
Under this method, the purchase consideration is ascertained on the basis of the ratio in which the shares of the
purchasing company are exchanged with those of the selling company. The exchange ratio is generally
determined on the basis of “Intrinsic Values” of the respective companies’ shares.
Assets available for equity shareholders
Intrinsic Value = Number of equity shares
Important Journal Entries in the books of Buyer
1. Entry for the purchase of business
Business Purchase A/c Dr.
To Liquidator of Transferor Company
2. Entry for the purchase of assets and liabilities
Debit all assets purchased
Credit all liabilities purchased
Credit business purchase
Note:
(a) Always write the agreed value of assets and liabilities
(b) In the above journal entries the debit will not be equals the credit. If debit balance is more than the credit
balance the difference is capital reserve. If the credit is more than the debit the difference is goodwill.
3. Entry for the payment to vendor
Liquidator of Transferor Company A/c Dr
To Equity share capital A/c
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 To Bank A/c
Note:
For shares and debentures separate entries must be recorded for face value and for premiums and discount.
AMALGAMATION
When two or more companies carrying on similar business go into liquidation and a new company is
formed to take over their business, it is called amalgamation. In other words, amalgamation refers to the
formation of a new company to take over the business of two or more existing companies doing similar type of
business.
In amalgamation, two or more companies are liquidated and a new company is formed to take over the
business of liquidating companies. The companies which go into liquidation are called vendor or amalgamating
companies where as the new company which is formed to take over the business of liquidating companies is
called purchasing or amalgamated or transferee company.
The main aim of amalgamation is to minimize the possibility of cut-throat competition and to secure the
advantage of large scale production.
Features of Amalgamation
a) Two or more existing companies are liquidated.
b) A new company is formed to take over the business of liquidating companies.
c) The nature of business of existing companies is similar.
d) Liquidating companies are called vendor companies and the new company is called purchasing
company.
e) Generally, purchase consideration is discharged by the issue of equity shares of purchasing company.
Objectives of amalgamation of companies
Here you should know the reasons for which companies amalgamate with one another. The following are
the main objectives of amalgamation of companies:
(a) To avoid competition: The main purpose of amalgamation of companies is to avoid competition among
themselves. This will give the company an edge over its competitors.
(b) To reduce cost: The amalgamated company can derive the operating cost advantage through lowering the
cost of production. This is possible because of ‘economies of large scale’.
(c) To gain financially: The amalgamated company can derive financial gain which may be in the form of tax
advantage, higher credit worthiness and lower rate of borrowing.
(d) To achieve growth: The amalgamated company can pool its resources to facilitate internal growth and to
prevent the advent of a new competitor.
(e) To diversify the activities: The risk of a company can be lowered by diversifying its activities into two or
more industries. At times, amalgamation may act as hedging the weak operation with a stronger one.
Difference between Amalgamation and Absorption
Following are the main differences between amalgamation and absorption
1. Liquidation: Two or more companies are liquidated in the process of amalgamation. One or more companies
are liquidated in absorption.
2. Formation: In amalgamation, a new company is formed to take over the business of vendor companies. In
absorption, no new company is formed, only purchasing or absorbing company take over the business of
liquidated company.
3. Size: There is no such matter of size of amalgamating companies. Generally, size of purchasing company is
greater than that of Vendor Company in absorption.
Types of Amalgamation
Amalgamation fall into two broad categories namely
(a) Amalgamation in the nature of merger
Amalgamation in the nature of merger is an amalgamation which satisfies all the following conditions.
(i) All the assets and liabilities of the transferor company become, after amalgamation, the assets and
liabilities of the transferee company.

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 (ii) (ii) Shareholders holding not less than 90% of the face value of the equity shares of the transferor
company (other than the equity shares already held therein, immediately before the amalgamation,
by the transferee company or its subsidiaries or their nominees) become equity shareholders of the
transferee company by virtue of the amalgamation.
(iii) The consideration for the amalgamation receivable by those equity shareholders of the transferor
company who agree to become equity shareholders of the transferee company is discharged by the
transferee company wholly by the issue of equity shares in the transferee company, except that cash
may be paid in respect of any fractional shares.
(iv) The business of the transferor company is intended to be carried on, after the amalgamation, by the
transferee company.
(v) No adjustment is intended to be made to the book values of the assets and liabilities of the transferor
company when they are incorporated in the financial statements of the transferee company except to
ensure uniformity of accounting policies.

(b) Amalgamation in the nature of purchase

Amalgamations which do not satisfy one or more conditions specified for amalgamations in the nature of
merger should be treated as amalgamation in the nature of purchase. Thus, in amalgamation in the nature of
purchase,
(i) All the assets and liabilities of the selling company may not be taken over
(ii) Less than 90% of the selling company’s shareholders may become shareholders in the purchasing
company.
(iii) Consideration payable to shareholders of selling company may be in the form of shares or cash or in
any other agreed form.
(iv) Selling company’s business may or may not be carried on in future.
(v) Assets and liabilities taken over by the purchasing company may be shown at values other than book
values at the discretion of the purchasing company.
ALTERATION OF SHARE CAPITAL AND INTERNAL RECONSTRUCTION
There are two types of alteration of share capital of a company.
(i) Alteration which do not require the approval of court of law
(ii) Alteration which require prior approval of a court of law
Alteration of share capital, which does not require court approval
This type of alteration can be done under the provision of Section 94 to 97 of the Companies Act Sec. 94 of the
Companies Act permits a limited company to alter the capital clause of its Memorandum of Association in five
different ways as follows:
(a) Increase the share capital by issue of new shares
(b) Consolidate all or part of its existing shares of smaller denomination into shares of larger amount.
(c) Sub-divide all or part of its existing shares of higher denomination into shares of lesser amount.
(d) Convert all or any part of its fully paid up shares into stock and vice-versa.
(e) Cancel the unissued share capital.
A company can make of the above five alterations (i) If it is authorized by its Articles of Association to carry
out such alteration (ii) An ordinary resolution is passed in the general body meeting. As per Sec.95 of the
Companies Act, any such alteration must be notified to the Registrar of Companies and copy of the resolution
should be filed with him within 30 days of the date of passing of such resolution.
Share Consolidation
Share consolidation is a corporate action conducted by the company with the intention to reduce its number
of shares trading on the stock exchange. It does so by reducing the number of shares held by its existing
shareholders. Share consolidation means, for every 5 shares you own it will be reduced to 1.
Internal Reconstruction or Capital Reduction

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Reconstruction refers to reorganization of the capital structure of a company. It may result in the reduction of
claims of both the shareholders and creditors against the company. Reconstruction may be necessary for those
companies whose financial position is bad. Such reconstruction can be ‘External’ or ‘Internal’. In external
reconstruction, a new company is formed to take over the business of an existing company which will be
liquidated. In internal reconstruction, the capital of a company is reorganized to enable it to make a fresh
beginning, after eliminating accumulated losses. Generally, internal reconstruction is preferred by companies
over external reconstruction due to the following reasons.
(a) Liquidation of the existing company and formation of new company involve a large number of legal
formalities and are also expensive.
(b) Accumulated losses of the liquidating company cannot be set off against the profit of the newly formed
company though the shareholders may be the same. Thus, an important tax advantage is lost.
(c) The time span needed for external reconstruction is generally far more than that of internal
reconstruction.
Reduction of share capital
A company can reduce its share capital as per the provision of Section 100 to 105 of the Companies Act, 1956.
Reduction of capital can take any of the following three forms.
(i) Reducing or completely extinguishing shareholders liability for uncalled capital.
(ii) Refunding surplus paid up capital which is found to be in excess of the needs of the company.
(iii) Cancelling or writing off paid up capital which is lost and not represented by assets.
Procedure for reducing share capital
(1) The Article of Association of the company must permit reduction of share capital. If Articles is silent, it
may be ‘Altered’ though a special resolution to enable the company to reduce its share capital.
(2) In the general body meeting, a special resolution must be passed for reduction of share capital.
(3) Confirmation of the court for capital reduction must be obtained.
(4) A copy of the resolution to reduce capital and the court’s order confirmation should be filed with the
Registrar of Joint Stock Companies.

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