Dcom201 Accounting For Companies I

ACCOUNTING FOR COMPANIES - I
Edited By
Sukhpreet Kaur
Printed by
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Lovely Professional University
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SYLLABUS
Accounting for Companies - I
Objectives: To enable the students to get familiarized with the existing accounting system for companies and to develop
awareness about Corporate Accounting in conformity with the provision of Companies Act.
Sr. No. Topics

1. Shares Capital: Types of share capital, Issue of shares, Under and Over subscription of shares,
forfeiture of shares, Pro-rata allotment.
2. Reissue of forfeited shares.
3. Buy Back of Shares, Rights and Bonus issue of shares, Private placement of shares.
4. Issue and redemption of preference shares.
5. Debentures: concept, types, issue and treatment of discount, Issue for consideration other than cash
and as collateral security, conditions of issue of debentures from redemption point of view.
6. Redemption of Debentures: Methods of redemption, sources of redemption.
7. Underwriting of shares.
8. Profit and loss prior to incorporation.
9. Divisible profits and Managerial Remuneration.
10. Final accounts of companies; meaning, contents, types and limitations of financial statements,
preparation of financial statements as per schedule VI of companies act, 1956.
CONTENT
Unit 1: Share Capital – Issue of Shares 1

Sukhpreet Kaur, Lovely Professional University
Unit 2: Forfeiture of Shares 44

Unit 3: Reissue of Forfeited Shares and Bonus Issue 54

Unit 4: Buy Back of Securities by Private Limited and Unlisted Public Limited 81
Companies
Unit 5: Redemption of Preference Shares 103

Unit 6: Debentures: Concept, Types, Issue 130

Gopika Juneja, Lovely Professional University
Unit 7: Debentures: Conditions of Issue of Debentures from Redemption Point of 152

View
Unit 8; Methods of Redemption-I 170

Unit 9: Methods of Redemption-II 200

Unit 10: Underwriting of Shares 221

Manpreet Kaur, Lovely Professional University
Unit 11: Profit and Loss Prior to Incorporation 255

Unit 12: Divisible Profits and Managerial Remuneration 281

Unit 13: Final Accounts for Companies 307

Unit 14: Preparation of Final Accounts 330

Pooja, Lovely Professional University
Sukhpreet Kaur, Lovely Professional University Unit 1: Share Capital – Issue of Shares
Unit 1: Share Capital – Issue of Shares Notes
CONTENTS
Objectives
Introduction
1.1 Meaning and Categories of Share Capital
1.2 Classes of Shares
1.3 Issue of Shares
1.3.1 Issue of Shares at Premium (Under Section 78)
1.3.2 Issue of Shares at a Discount (Under Section 79)
1.3.3 Issue of Shares at Par
1.3.4 Issue of Shares at Calls-in-Arrear and Calls-in-Advance
1.4 Undersubscription and Oversubscription
1.5 Combined Account for Share Application and Allotment
1.6 Issue of Shares for Consideration Other than Cash
1.7 Summary
1.8 Keywords
1.9 Review Questions
1.10 Further Readings
Objectives
After studying this unit, you should be able to:
 Understand meaning of Share Capital
 Know classes of shares

 Define issue of shares
 Explain under and Over Subscription
 Understand issue of shares for consideration other than cash
Introduction
Share capital refers to the portion of a company's equity that is obtained by trading stock to a
shareholder for cash or an equivalent item of capital value. The term has several meanings. In
classical sense, share capital comprises the nominal values of all shares issued (that is, the sum
of their "par values").
In a wider sense, if the shares have no par value or the allocation price of shares is greater than
their par value, the shares are said to be at a premium (called share premium, additional paid-
in capital or paid-in capital in excess of par); in that case, the share capital can be said to be the
sum of the aforementioned "nominal" share capital and the premium. In the modern law of
shares, the "par value" concept has diminished in importance, and share capital can simply be
defined as the sum of capital (cash or other assets) the company has received from investors for
its shares.
LOVELY PROFESSIONAL UNIVERSITY 1

Accounting for Companies-I
Notes Share capital may also be used to describe the number and types of shares that compose a
company's share structure. The legal aspects of share capital are mostly dealt with in a
jurisdiction's corporate law system. An example of such an issue is that when a company allocates
new shares, it must do so in a way that does not inequitably dilute existing shareholders.
1.1 Meaning and Categories of Share Capital
A share is a single unit into which the entire capital of a company is divided. A share is a
fractional part of the share capital. On the basis of number of shares the ownership of a person
is formed. The persons who contribute the money through shares are called shareholders.
Probably the best description of a share is given in Borland’s Trustees vs. Steel by Farewell, J.
where he defines a share as “the interest of a shareholder in the company, measured as a sum of
money, for the purpose of liability in the first place, and of interest in the second, but also
consisting of a series of mutual covenants entered into by all the shareholders inter se.” Even
though many people contribute varying sums to the company’s share capital, there is no separate
capital account for each shareholder. Therefore, a consolidated capital account called share
capital account is maintained. The share capital of the company is divided into the following
categories:
1. Registered, Nominal or Authorised Capital: The maximum amount of capital with which
the company intends to be registered, is called registered capital. It is stated in the
Memorandum of Association, which is registered with the Registrar of Companies. It is
the maximum amount which the company is authorised to raise by the way of public
subscription. Therefore, it is also called authorised share capital.
2. Issued Capital: The part of Authorised capital which is issued by the company to public
for subscription in cash including shares allotted to vendors or promoters for consideration
other than cash is called issued capital. The remaining part which is not issued, is called
unissued capital. This part can be issued later on.
3. Subscribed Capital: That part of issued capital which is subscribed or applied by the
public, is called subscribed capital. This capital can be more, less or equal to issued capital.
If it is more than issued capital, the excess is returned back to the subscriber. The directors
of the company can allot only upto the extent of issued capital. If the whole issued capital
is not subscribed, the balance of the issued capital is called unsubscribed capital.
4. Called-up Capital: Generally, the full amount of share is not called at one time but for the
convenience of shareholder and according to the requirement of the company, the amount
is called in different instalments. The amount of share which is actually demanded by the
company is known as called-up capital.
5. Paid up Capital: The part of called-up capital that is actually paid by the subscribers to the
company is known as paid up capital. The paid up capital can be more, less or equal to
called-up capital. If paid up capital is less than called-up capital, this difference is known as
call-in-arrear or unpaid calls. However, some shareholders may also pay the amount for
those calls which are not made. Such amount is known as calls-in-advance.
6. Reserve Capital: It is that part of the uncalled capital which, by passing a special resolution,
can be called up only in the event of winding up of a company. This capital cannot be
converted except with the leave of the court; it cannot be changed by directors. Therefore,
this capital is left for the protection of the company’s creditors.
1.2 Classes of Shares
Those companies which are formed after the commencement of the Companies Act 1956, are
permitted to issue only preference shares and equity shares, not deferred shares.
2 LOVELY PROFESSIONAL UNIVERSITY

Unit 1: Share Capital – Issue of Shares
1. Preference Shares: According to Section 85, preference shares are those shares which enjoy Notes
the following two rights:
(a) Right to receive dividend at a fixed rate before any dividend is paid to equity
shareholders.
(b) Right to receive repayment of capital in the event of winding up, before the capital
of equity shareholders is returned.
!
Caution In any condition, a preference shareholder cannot compel the company to pay his
dividend. He can only prevent the company from paying dividend to equity shareholders
without his dividend being paid first. In addition to these two preferential rights, a
preferential shareholder may carry some other rights. On the basis of additional rights,
preference shares can be classified as under:
(i) Cumulative vs. Non-Cumulative Preference Share: There is however, no obligation to

pay until dividend is declared. The arrears of dividend are therefore, shown at the
footnote of balance sheet as contingent liabilities only. Non-cumulative preference
shareholders are entitled to take a fixed dividend only out of the profit each year. If in
any year, due to shortage of profit, dividend is not paid to them, there will be no
accumulation for unpaid dividend. The unpaid balance of dividend will automatically
lapse.
(ii) Redeemable vs Irredeemable Preference Share: Redeemable Preference Share is that

share whose amount is returned by the company to the shareholder within the lifetime
of the company as per the provisions of Section 80 and Section 80A of the Companies
Act 1956. The amount of irredeemable preference share can be returned only when
the company is wound up. After the commencement of the Companies (Amendment)
Act 1988, no company limited by shares can issue any preference share which is
irredeemable. The Act also provides for the redemption of such shares issued prior to
the amendment of the Act in 1988.
(iii) Participating vs Non-participating Preference Share: Participating preference shares

are those shares that carry the right of sharing profit left after paying equity and
preference dividend at a stipulated rates. The preference shareholders may also be
extended to participate in the surplus assets available at the time of liquidation after
paying off all equity shareholders. Non-participating preference shares are those
shares which do not carry the right of sharing in the surplus profit after paying a
certain rate of dividend to equity shareholders. These are entitled to receive only the
fixed rate of dividend. Preference shares are assumed to be non-participating.
(iv) Convertible vs Non-convertible Preference Shares: Convertible preference shares are

those which have the right to get them converted into equity shares. When such a
right does not exist, those are called non-convertible prudential shares.
Did u know? Cumulative preference shareholders are entitled to a dividend at a stipulated

rate. If the current year’s profit are not sufficient, such dividend will be accumulated and
will be payable out of future profit. All the arrears of dividend on these shares must be
paid before the equity shareholders can participate in the profit.

Notes Convertible Cumulative Preference Shares
Companies limited by shares are permitted by the Controller of Capital Issue (CCI) to issue
cumulative convertible preference shares (CCP) for which guidelines are framed by the Central
Government. For the objective of setting up new projects, expansion or diversification of existing
projects, normal capital expenditure for modernisation and the requirement of working capital
CCP shares can be issued. As per the guidelines of CCI, the entire issue of CCP shares would be
convertible into equity shares between the end of 3 years and 5 years, as may be decided by the
company and approved by the CCI. The rate of preference dividend on CCP shares would be
10%. The face value of these shares will ordinarily be ` 100 each.
Notes The conversion of Cumulative Preference Shares into equity shares would be
compulsory at the end of five years and these preference shares would not be redeemable
at any stage.
Equity Shares
Those shares which are not preference shares are called equity or ordinary shares. Equity
shareholders do not have any priority as to dividend or refund of capital. The balance of profit
after paying the preference dividend can be distributed among the equity shareholders as
dividend. There is no fixed rate of dividend for these shareholders. Right to claim dividend on
equity shares will arise only when the dividend is declared by the company in the general
meeting. In the case of the liquidation of a company, the equity shareholders would be paid only
if any surplus is left after the return of preference share capital.
1.3 Issue of Shares
The process of collecting the capital by issue of shares for a newly formed company, or an
established company requiring more capital for its expanding operations, is the same. Only a
public company can issue its shares to the public by issuing a prospectus. This invites the public
to submit their applications to take up the shares of the company. The Prospectus gives detailed
information about the company, the details of the issue, issue highlights, terms of present issue,
risk factors, history of the company, main objectives and present business, details of the projects
for which capital is being raised, prospects and profitability, market price of the share, previous
issues, companies under the same management, minimum subscriptions and any other details
as stated in the Companies Act. Details regarding the procedure to apply for the shares are also
given in application form. The prospectus gives details of the number and class of shares offered
and manner in which the amount of shares is to be paid by the public. Generally, the total
amount of shares is paid in a number of instalments. These instalments are termed as:
First Instalment : Application Money
Second Instalment : Allotment Money
Third Instalment : First Call Money
Fourth Instalment : Second Call Money
Last Instalment : Final Call Money

Notes
Notes A printed application form is attached with the prospectus. After reading the
prospectus, the public fills up the application form for shares and submits it with application
money mentioned in the prospectus. As per Section 63 Less or Profit (3) the application
money must not be less than 5% of the nominal value of the share. An application for
shares without application money is not a valid offer and therefore, shares cannot be
allotted to such an applicant. The company is permitted to ask the applicant to pay the full
value on application or partly on application and the balance on allotment, or it may also
collect the amount by providing the calls after allotment to suit the convenience of the
applicant.
Procedure for Receipt of Application Money
The names of bankers to the issue are given in the application form. The investor applying for
shares must fill the application form and remit the application money by cheque, draft or stock
invest to the banker to the issue. The banker of the company presents the cheques and drafts
immediately and amount is kept in a separate account. In the case of stock invests which are
recently issued by the bankers against customers accounts after noting the lien, the company
encashes the stock invests of only those applicants to whom the allotment is made. The balance
of applicant’s account is not reduced until allotment and the applicant continues to earn interest.
In case of unsuccessful applicants the stock invests maybe returned to the investors. In the case
of partial allotment, the stock invest is encashed only to the extent of the application money and
allotment money in respect of the shares allotted.
Allotment of Shares
After receiving the applications, the boards of directors proceed to allot the shares in consultation
with the stock exchange in the case of over-subscription. Prospectus is an invitation to offer,
application for shares offer made by the applicant and hence the directors are free to accept or
reject any application. Similarly, if the applicant wants to withdraw his offer before its acceptance,
he can do so. For a valid allotment, it is compulsory that at least minimum subscription which
is stated in prospectus should be received from public. If the minimum subscription is not
received by the company within 120 days from the date of opening of the issue, the company has
to refund the subscription without interest. If these moneys are not refunded within 130 days
from the date of opening of issue, company is liable to pay interest @ 6% p.a. for such a delay.
Minimum subscription refers to the minimum amount which, in the consideration of directors,
must be raised by the issue of shares to meet the following requirements:
(i) the purchase price of any property purchased or to be purchased, which is to be met out of
the proceeds of the issue,
(ii) any preliminary expenses payable by the company and any commission payable in
connection with the issue of shares,
(iii) the repayment of any money borrowed by the company in respect of any of the above two
matters,
(iv) working capital, and
(v) any other expenditure stating the nature and purpose thereof and the estimated amount in
each case.

Notes Allotment is the acceptance of offer made by the applicant to purchase the shares. If there is
oversubscription, the board of directors is free to allot the shares. Directors may allot the full
number of shares applied for, or none at all, or a number less than applied for. A letter of regret
along with refund of application money is dispatched to those applicants whose applications are
rejected. Letters of Allotment are dispatched to other applicants whose applications are accepted
and in this letter they are requested to remit any money due on allotment. Some applicants may
be accepted partially or on a pro-rata basis. The surplus application money on such an application
can be retained for allotment money; the balance of surplus application money will be refunded
unless the applicant has agreed to get it treated as calls in advance. Such retention of over
subscription is normally permitted up to 15% of the amount sanctioned. If the company wants
such retention of application money, it should so state in the original application to the CCI and
obtain the approval. It should inform the CCI and the Stock Exchange immediately after the
issue about the outcome of the issue and the retention of oversubscription upto the permitted
amount. In any case, the directors of a company cannot allot more than the number of shares
offered to the public in the prospectus even if it has received applications for a large number.
Calls on Shares
5% of the face value of share is paid on application, some money is paid on allotment and the
balance of the face value of share is paid on calls. This balance may be called in one call or in
different calls. Call notices are sent to the shareholders who will make the payment. Generally,
calls are due by the board of directors on particular dates fixed by its Articles. If the Articles are
silent in this respect, provisions laid down in Table A shall apply. These are:
(i) a period of one month must elapse before another call is made
(ii) the amount of each call should not exceed 25% of the face value of the share, and
(iii) a notice of 14 days is given to the shareholders to pay the amount; a call must be made on
a uniform basis on all shares within the same class.
Books of Account of a Public Company
As per Section 209 of the Companies Act 1956 a company is required to maintain such books as
will give a true and fair picture in respect of :
(a) all sums of money received and extended by the company and the matters in respect of
which receipts and expenditure take place.
(b) all sales and purchases of goods of company.
(c) all assets and liabilities of the company.
(d) and such particulars regarding utilisation of materials or labour or other items of cost as
may be prescribed by the Central Government, in case the company belongs to a class of
companies engaged in manufacturing, processing and mining.
Sub-section (3) makes it clear that these accounts should be maintained to show the true and fair
picture of the state of affairs of the company. These books must be prepared on accrual basis and
according to the double entry system of accounting. These must be preserved for a minimum
period of eight years. Books of account should be kept at the registered office of the company
and these should be open for the inspection of directors, the registrar and the officers authorized
by the Central Government during business hours. If the directors decide to place these books of
accounts of the company at a place other than registered office (but in India) the company shall
within seven days of this decision, file with the registrar a notice in writing, giving the full
address of that other place.

Accounting Treatment Regarding Issue of Shares Notes
1. On receipt of application money:
Bank Account Dr. (with the total application money)
To Share Application Account
(Being the receipt of application money on ——shares @————per share)
The nature of share application account is a personal account which represents the total of
all those people who have applied for shares. This application money is treated as deposit
money of the applicants. These applicants are treated as creditors of the company until
they are allotted some shares. If no share is allotted to them, their application money has
to be returned. Upon the acceptance of application for shares, the boards of directors
proceed to allot the shares. As soon as the shares are allotted, the creditors (applicants)
become the shareholders of the company and their deposits are transferred into share
capital account.
2. On the acceptance of applications for share:
Share Application Account Dr. (with application money due on shares allotted)
To Share Capital Account
(Being the transfer of application money to share capital account.)
When a company issues different types of shares, a separate share capital account will be
opened for each type of shares. In order to distinguish one type of share from the other
one, the name of the share must be prefixed with the word share i.e., Preference share
capital, Equity share capital and Equity share application account.
3. On making the allotment money due:
Share Allotment Account Dr. (With allotment money due)
(Being share allotment money due on _______ shares @_______per share.)
Here, the nature of share allotment account is a personal account which represents all the
applicants. (now shareholders/debtors of the company).
4. On receipt of allotment money:
Bank Account Dr. (with actual allotment money received)
To Share Allotment Account
(Being the receipt of allotment money)
If any shareholder does not pay the allotment money, this unpaid amount is known as
calls-in-arrear and shown in the liabilities side of Balance Sheet of the company.
5. On making the first call due:
Share First Call Account Dr. (with first call money due)
(Being first call money due ________shares @_______per share)

Notes 6. On receipt of first call money:
Bank Account Dr. (with actual first call money received)
To Share First Call Account
(Being receipt of first call money)
The above No. 5 & 6 entries would be similar for subsequent calls. These subsequent calls
are distinguished from each other by their serial numbers i.e., second call, third call and so
on. In the case of last call the word “Final” is also added to that call as second and final call.
If there is requirement to prepare cash book too, above all, cash and bank transaction will
be entered in the cash book and other transactions will appear in ‘ Journal Proper.’
Task If no contra information is given, preference shares are deemed to be:
(a) Cumulative, Convertible and Participating.
(b) Non-cumulative, Convertible and Participating.
(c) Non-cumulative, Non-Convertible and Participating
(d) Cumulative, Non-Convertible and Non-Participating.
Self Assessment
True or False:
1. Preference share is that share which alone enjoys a preferential right regarding payment
of dividend.
2. At least 10% amount of the face value should be payable with application.
3. A maximum discount of 10% can be allowed on shares.
When Equity or Ordinary Shares are Issued at Par and Shares are Fully Subscribed
Example 1: X Ltd. was registered on January 1, 2006 with an authorised capital of

10,00,000 divided into 10,000 equity shares of 100 each. It offered 9,000 equity shares at par,
payable as under:
On Application 10
On Allotment 50
On First Call 20
On Second and Final Call 20
All the shares were subscribed and amount duly received. Pass the necessary journal entries and
prepare the Balance Sheet of the company.

Solution: Notes
Journal Entries in the Books of X Ltd.
Date Particulars Debit (`) Credit (`)

2006 Jan. 1 Bank A/c Dr. 90,000
To Equity Share Application A/c 90,000
(Being application money received on 9,000
equity shares @ ` 10 per share)
Equity Share Application A/c Dr. 90,000
To Equity Share Capital A/c 90,000
(Being application money transferred to
share capital A/c)
Equity Share Allotment Account Dr. 4,50,000
To Equity Share Capital Account 4,50,000
(Being allotment money due on 9,000
shares @ ` 50 per share)
In the place of above two entries one combined
can be made as:
Equity Share application A/c Dr. 90,000
Equity Share Allotment A/c Dr. 4,50,000
To Equity Share Capital A/c 5,40,000
(Being the transfer of application and allotment money
to share capital A/c on 9,000 shares @ ` 60 per share)
Bank Account Dr. 4,50,000
To Equity Share Allotment Account 4,50,000
(Being allotment money received on 9,000 shares
@ ` 50 per share)
Equity Share First Call Account Dr. 1,80,000
(Being 1st call money due on 9,000 shares @ ` 20 per share)
To Equity Share First Call Account 1,80,000
(Being 1st call money received on 9,000 shares @ ` 20
per share)
Equity Share Second & Final Call Account Dr. 1,80,000
(Being 2nd and final call money due on 9,000 shares @ ` 20
per share)
To Equity Share Second & Final Call Account 1,80,000
(Being 2nd and final call money received on 9000 shares &
` 20 per share)
Balance Sheet of X Ltd. as on………..
Liabilities ` Assets `
Share Capital : Current Assets :
Cash at bank 9,00,000
Authorised Capital (10,000 equity shares of ` 100 each) 10,00,000
Issued, Subscribed, Called up and Paid up capital
(9,000 equity shares of ` 100 each) 9,00,000
9,00,000 9,00,000

Notes Issue of Two Classes of Shares
Example 2: Surjeet Ltd. was incorporated on January 1, 2006. The authorised capital of
the company was 2,50,00,000 divided into 15,00,000 equity shares of 10 each and 1,00,000, 10%
preference shares of 100 each. The company issued 6,00,000 equity shares and 50,000 preferences
shares payable as follows:
 Equity shares: 3 on application, 3 on allotment, 2 on first call and 2 on second and final
call.
 Preference shares: 30 on allotment, 30 on allotment, 20 on first call and 20 on second

and final call.
All these shares were subscribed. Prepare cash book and journal assuming that all money was
duly received:
Solution:
Journal of Surjeet Ltd.
Date Particulars L.F. (Debit ) (Credit )

Equity Share Application Account Dr. 18,00,000
(Being transfer of application money to share capital account)
Preference Share Application Account Dr. 15,00,000
To Preference Share Capital Account 15,00,000
(Being transfer of application money to preference share capital account)
(Being allotment money due on 6,00,000 equity shares @ 3 per share)
Preference Share Allotment Account Dr. 15,00,000
(Being allotment money due on 50,000 Preference share @ 30 per share)
(Being first call money due on 6,00,000 equity shares @ 2 per share)
Preference Share First Call Account Dr. 10,00,000
(Being first call money due on 50,000 preference share @ 20 per share)
Equity Shares Second & Final Call Account Dr. 12,00,000
(Being second and final call money due on 6,00,000 equity share @ 2 per share)
Preference Share Second & Final Call Account Dr. 10,00,000
(Being second and final call money due on 50,000 preference shares @ 20 per share)
Cash Book (Bank Column Only)
Date Particulars Date Particulars

To Equity Share
Application account 18,00,000 By Balance c/d 1,10,000
To Preference Share
Application Account 15,00,000
To Equity Share
Allotment Account 18,00,000
To Preference Share Contd...
To Equity Share
First Call Account 12,00,000
10 ToLOVELY
Preferences Share
PROFESSIONAL UNIVERSITY
nd
To Equity Share 2
and Final Call Account 12,00,000
nd
To Pref. Share 2
To Equity Share
Application account 18,00,000 By Balance c/d 1,10,000
To Preference Share Unit 1: Share Capital – Issue of Shares
To Equity Share
To Preference Share Notes
To Equity Share
To Preferences Share
nd
To Equity Share 2
nd
To Pref. Share 2
1,10,00,000 1,10,00,000
Self Assessment
Fill in the blanks:

4. A Public Company Limited by shares must have at least .......................... members.
5. A Private Company should have at least .......................... members.
6. Shareholders are the ......................... of the company.
1.3.1 Issue of Shares at Premium (Under Section 78)
When a share is issued at a price higher than the face value, par value or nominal value then it
is said that it has been issued at premium. For instance, if a share of 100 is issued by a company
for 110, 10 are the premium on share. Premium on issue of shares is the capital profit for the
company and the amount so earned has to be credited to a separate account known as share
premium account.
!
Caution No restriction is imposed on the issue of shares at premium and the power to issue
shares at premium need not be taken in the Articles of Association. But there are some
restrictions on the use of the amount of share premium.
Under Section 78 of the Companies Act 1956, the amount of share premium may be used wholly
or partly in the following ways:
(a) It may be utilized in paying up unissued shares of a company, to be issued to members of

the company as fully paid bonus shares, or
(b) It may be utilized in writing off the preliminary expenses of the company, or
(c) It may be utilized in writing off the expenses of, or the commission paid or discount
allowed on any of shares or debentures of the company, or
(d) It may be utilized in providing for the premium payable on redemption of any redeemable
preference shares or debentures.
Premium on shares maybe collected by a company in a lump sum or in instalments. According

to the terms of issue the amount of share premium may be included in either application money
or allotment money or one of call money. Usually, the amount of share premium is to be paid
along with application or allotment money. If nothing is mentioned in the problem, it should be
assumed that the entire amount of the share premium is to be paid along with allotment money.

Notes Accounting Treatment: When the amount of premium is to be paid along with application
money by a shareholder, entry will be:
Bank Account Dr. (with amount of application and premium)
To Share Application Account
When share are allotted, entry will be:
Share Application Account Dr.
To Share Premium Account
When the entire amount of share premium is collected by the company on allotment or a call,
the company may adopt any one of the following two alternatives:
(A) (i) When allotment money is due with share premium –
Share Allotment account Dr.
(ii) When allotment money is received along with share premium
Bank account Dr.
In this method, share premium is being credited even before the premium is received in cash. If
any shareholder fails to pay the allotment money, the share premium will have to be debited at
the time when shares are forfeited. Therefore, it is disliked by some accountants. They adopt the
second alternative.
(B) In this method, the amount of share premium will be ignored at the time of passing the
entry for allotment money due. Share premium is recorded only at the time of actual
receipt of cash.
(i) When allotment money is due (without premium)
Share Allotment Account Dr. (only allotment money)
(ii) When allotment money is received with premium
Bank account Dr.
Considering the restrictions imposed by the Companies Act, there are some persons who doubt
the propriety of debiting share premium account for non-receipt of cash at the time of forfeiture.
Therefore, the second method is better in which share premium will be credited only when the
amount of share premium has actually been received in cash.
Example 3: Mars Co. Ltd. issued 1,00,000 shares of 10 each at a premium 2 per share,
the terms of payment per share were as follows:
3 on application
4 on allotment

5 on first and final call Notes

The subscription list totalled 1,16,000 shares. Applications for 16,000 shares were rejected, all
other applications were accepted in full. Call was duly made. All moneys were received in time.
Pass the necessary journal entries for all the transactions in each one of the following cases:
Case I: Share premium is included in the application money
Case II: Share premium is included in the allotment money
Case III: Share premium is included in the call money.
Solution:
Mars Co. Ltd. Journal
Case I
Date Particulars L.F. Debit Credit

1. Bank Account Dr. 3,48,000
To Share Application Account 3,48,000
(Being application money received on 1,16,000
shares @ 3 per share including 2 per share as
premium)
2. Share Application Account Dr. 3,00,000
To Share Capital Account 1,00,000
To Share Premium Account 2,00,000
(Being application money transferred to share
capital and share premium account on 1,00,000
shares)
3. Share Allotment Account Dr. 4,00,000
(Being due of allotment money on 1,00,000
share @ 4 per share)
4. Share Application Account Dr. 48,000
To Bank Account 48,000
(Being return of excess application money on
16,000 shares)
To Share Allotment Account 4,00,000
(Being receipt of allotment money on 1,00,000
shares)
6. Share First and Final Call Account Dr. 5,00,000
(Being first and final call money due on 1,00,000
To Share First and Final all Account 5,00,000
(Being receipt of first and final call money on
1,00,000 shares)

Notes Case II
Date Particulars L.F. Debit Credit

(Being receipt of application money on 1,16,000
shares @ 3 per share)

(Being transfer of application money to share
capital on 1,00,000 shares & refund on 16,000
shares)
(Being allotment money due on 1,00,000 shares
@ 4 per share with premium @ 2 per share)
(Being receipt of allotment money
with premium) Alternate treatment of 3 & 4
entries may be as:
(Being allotment money due on 1,00,000 share
@ 2 per share)
(Being receipt of allotment money with
premium on 1,00,000 share)
(Being first and final call money due on 1,00,000
To Share First and Final Call Account 5,00,000
(Being receipt of first and find call money)

Case III Notes
Journal
Date Particulars L.F.

(Being receipt of application money on
1,16,000 shares @ 3 per share)
To Share Capital Account 48,000
To Bank Account
(Being transfer of application money to
share capital and refund of application
money to unsuccessful applicants)
(Being allotment money due on 1,00,000
(Being allotment money received)

(Being first and final call due on 1,00,000
shares @ 3 per share with share premium
@ 2 per share)
To Share First and Final Call 5,00,000
Account
(Being receipt of first and final call money
with premium)

(Being first and final call due on 1,00,000
To Share First and Final Call 3,00,000
Account
2,00,000
(Being receipt of first and final call money
on 1,00,000 shares @ 3 per share along with
share premium @ 2 per share)
1. Amount of share premium can be utilised in writing off the preliminary expenses of the
company.
2. When the shares originally issued at discount are forfeited, discount account in respect of
them is always credited.
3. Calls-in-advance is a part of share capital.

Notes 1.3.2 Issue of Shares at a Discount (Under Section 79)
When a share is issued at a price lower than the face value, par value or nominal value then it is
said it has been issued at discount. For instance, if a share of 100 is issued by a company for
90, it is said that company has issued the share at discount of 10%. To issue the shares at discount
a company has to fulfil the following conditions laid down in Section 79 of the Companies Act.
These conditions are:
(i) The issue of shares at a discount is authorized by a resolution passed by the company in
general meeting and sanctioned by the Company Law Board.
(ii) The resolution must specify the maximum rate of discount at which shares are to be
issued, but the rate of discount must not exceed 10%. The rate may exceed 10% only if the
Company Law Board is of the opinion that a higher percentage of discount may be allowed
in the special circumstances of the case.
(iii) The share of a class that has already been issued.
(iv) At least one year has elapsed since the company was entitled to commerce the business.
(v) The shares are issued within two months from the date of receiving sanction from the
Company Law Board, or within such extended time as the Company Law Board may allow.
Accounting Treatment
Did u know? Discount on issue of shares is a loss of money for a company, therefore, it
must be debited to a separate account called “Discount on Issue of shares.”
It is a loss of capital nature so we should show it in the assets side of Balance Sheet Show under
the heading ‘Miscellaneous Expenditure.’ It is written off over three or four years.
In the absence of any instruction, generally, discount on issue of shares is allowed at the time of
allotment of shares. At this time the journal entry will be:
Share Allotment Account Dr. (with amount due)

Discount on Issue of Shares Account Dr. (with amount of discount)
To Share Capital Account (Total amount)
One more journal entry is passed at the time of writing off the discount on issue of share. This
writing off can be from Profit and Loss Account or Share Premium Account:
Profit and Loss Account Dr. or
Share Premium Account Dr.
To Discount on Issue of Share Account.
Example 4: Final Ltd. issued 1,00,000 shares of 100 each at a discount of 10%. If was
payable as follows:
On Application 20 per share
On Allotment 30 per share
On First Call 15 per share
On the final call the balance amount.

Applications were received for 1,50,000 shares. The board of directors made pro-rata allotment Notes
to the applicants for 1,20,000 shares. A shareholder Akash could not pay the allotment money on
200 shares, while another shareholder Mukesh did not pay the final call on 120 shares. Pass
necessary journal entries to record the above transactions.
Solution:
Fine Limited Journal

150,000 shares @ 20 per share)
capital account on 1,00,000 shares and that
for 20,000 shares utilized for allotment
money)
To Bank Account 6,00,000
(Application money for 30,000 shares
refunded)
Discount on Issue of Shares Account Dr. 10,00,000
(Being allotment money due @ 20 each and
discount at 10 each)
(Allotment money received on 99,200 shares)
6. Share First Call Account Dr. 15,00,000
(Being first call money due on 1,00,000 shares
@ 15 each)
To Share First Call Account 14,97,000
(Being receipt of first call money on 99,800
shares)
8. Share Second and Final Call Account Dr. 35,00,000
(Being second and final call money due on
1,00,000 shares @ 35 per shares)

To Share Second & Final Call Account 34,88,800
(Being receipt of second and final call on
99,680 shares)

Notes Working Note:
(i) In this problem allotment is on pro-rata basis. Therefore, Mr. Akash who was allotted 200
shares must have applied for:
Money received on 240 shares @ 20 each 48,00

App. money transferred to capital 200 × 20 4,000
Amount available for adjustment in allotment 800
Amount due on allotment on 200 shares 200 × 20 = 4,000
Amount already received with application 800
Amount not received on allotment 3200
(ii) Total amount receivable on allotment 1,00,000 × 20 = 20,00,000

Received with application 20,000 × 20 = 4,00,000
16,00,000
Not paid by Akash 3,200
15,96,800
Example 5: Following are the excerpts from the balance sheet of Sushil Ltd. As on 31st
Dec. 2005
Liabilities:
Authorized Share Capital 90,00,000
Issued and subscribed:
400,000 Equity shares of 10 each fully paid up 40,00,000
2,00,000 10% Preference shares of 10 each fully paid up 20,00,000
Reserve and surplus:
Share premium 1,50,000
In January, 2006 the company issued to public 3,00,000 equity shares of 10 each at a discount of
5%. The amount per share was payable as follows:
With application 2.5
On allotment 4.5
On first and final call 2.5
The public applied for 2,70,000 shares only.
These were allotted in February 2006. The call was made in March 2006. All the money ware
received. Record the transactions relating to the issue in the books of company and draw the
balance sheet as it would appear after the collection of money.
Solution:
Sushil Limited Journal

Jan. Equity Share Application Account Dr. 6,75,000
capital account)
Feb. Equity Share Allotment Account Dr. 12,15,000 Contd...
18 (Being
LOVELYallotment money due onUNIVERSITY
PROFESSIONAL 2,70,000
shares @ 4.5 each at a discount of 5%)
March Equity Share First and Final Call Account Dr. 6,75,000
To equity Share Capital Account 6,75,000
(Being first and final call money due on
2,70,000 shares @ 2.5 per share)
Jan. Equity Share Application Account Dr. 6,75,000 6,75,000
To Equity Share Capital Account
capital account)
Feb. Equity Share Allotment Account Dr. 12,15,000 Notes
shares @ 4.5 each at a discount of 5%)
March Equity Share First and Final Call Account Dr. 6,75,000
To equity Share Capital Account 6,75,000
Share Premium Account Dr. 1,35,000
To Discount on Issue of Shares Account 1,35,000
(Being utilised share premium to write off the
discount on issue of shares)

Dr. Cr.
To Equity Share Application Account 6,75,000 By Balance c/d 25,65,000

To Equity Share First and Final Call Account 6,75,000
25,65,000 25,65,000
Equity Share Capital Account
To Balance c/d 67,00,000 By Balance b/d 40,00,000

By Equity Share Application Account 6,75,000
By Equity Share Allotment Account 12,15,000
By Discount on Issue of Share Account 1,35,000
By Equity Share First and Final Call Account 6,75,000
67,00,000 67,00,000
Equity Share Application Account
To Equity Share Capital Account 6,75,000 By Bank Account 6,75,000

6,75,000 6,75,000
Equity Share Allotment Account

12,15,000 12,15,000
Equity Share First and Final Call Account

6,75,000 1,35,000

Notes Discount on Issue of Shares Account
To Equity Share Capital Account 1,35,000 By Share Premium 1,35,000

1,35,000 Account 1,35,000
Share Premium Account
To Discount on Issue of shares account 1,35,000 By Balance b/d 1,50,000

To Balance c/d 15,000
1,50,000 1,50,000
Balance Sheet of Sushil Limited as on __________
Liabilities Amount Assets Amount
Share Capital: Sundry 61,50,000

Assets
Authorised 90,00,000 Current
Assets:
Issued: Bank Balance 25,65,000
7,00,000 Equity Shares of 10 each 70,00,000
2,00,000, 10% Pref. Shares of 10 each 20,00,000 90,00,000
Subscribed:
6,70,000 equity shares of 10 each fully paid up 67,00,000
2,00,000, 10% Preference shares of 10 each
fully paid up
20,00,000
Reserve and surplus 15,000
87,15,000 87,15,000
1.3.3 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 10 is issued at 10, it is said that the share has been issued at par.
1.3.4 Issue of Shares at Calls-in-Arrear and Calls-in-Advance
If any amount has been called by the company in respect of shares allotment or call money and
the shareholder has not paid that amount before or on the date fixed for payment thereof that
amount which is not paid is known as Calls-in-Arrear.
Notes The company directors can charge interest on calls-in-arrear at a rate specified in
the Articles from the last date fixed for payment to the date of actual payment. But if the
Articles are silent, Table A (16) shall be applicable, which empowers the Board of Directors
of the company to charge interest on the unpaid amount from the date fixed for payment
thereof to the date of actual payment at a rate not exceeding 5% p.a.
The Board of Directors shall be at liberty to waive the payment of interest on unpaid amount.

Accounting Treatment Notes
Though there is no requirement to open calls-in-arrear account separately and generally

call-in-arrear account is not opened– yet some companies open this account and pass the following
journal entry:
Call-in-arrear account Dr. (for unpaid amount)
To Relevant Call Account
And when the amount of calls in arrear is received.
Bank Account Dr.
To Call-in-Arrear Account
If there is any balance for calls-in-arrear account, it is shown by the way of deduction from the
called up capital in the balance sheet.
Calls-In-Advance
When any applicant pays more amount than the amount due from him, this excess amount is
known as call-in-advance. A company may, if so authorised by its Articles of Association, accept
calls-in-advance from its shareholders. If there is a provision in the Articles of Association of a
company, the Board of Directors must pay interest on call-in-advance at a rate specified in the
articles of association from the date of its receipt to the date when the call became due. But if the
Articles are silent at this point, Table A(18) shall be applicable, which provides the option to
board of directors to pay interest on calls-in-advance at a rate not exceeding 6% per annum.
Calls-in-advance is shown in the liability side of the balance sheet separately from paid up
capital. Calls-in-advance are not entitled for any dividend declared by the company. The
accounting journal entries relating to calls-in-advance are as follows:
When amount of calls in advance is received:
Bank Account Dr.
To Call-in-advance account
When the relevant call is received:
Calls-in-advance account Dr.
To relevant call account
Example 6: The authorised capital of Bhatia Limited is 200,000 shares of 10 each. On

April 20, 2006. 1,00,000 shares are issued for subscription at a premium of 20%. The share money
is payable as follows:
5 including premium with application
3 on allotment
2 on first call
2 on second and final call.

Notes The subscription list closes on May 11, 2006 and directors proceed to allot on May 18, 2006. The
shares are fully subscribed and the application money (including premium) is received in full.
The allotment money is received by June 30, 2006, except as regards 1,000 shares. It is expected
that the allotment money on these 1,000 shares will not be received. The first call and second call
money is received by September 30, 2006 and December 30, 2006 respectively, barring the
second call money on 400 shares, which is not received and which is not likely to be received.
Pass the necessary journal entries in the books of Bhatia Limited.
Solution:
Bhatia Limited Journal
2006
May 11 Bank Account Dr. 5,00,000
(Being receipt of application money on 1,00,000 shares
@ 5 each)
May 18 Share Application Account Dr. 5,00,000
(Being transfer of application money to capital and share
premium account)
Share Allotment Account Dr. 3,00,000
(Being allotment money due on 100,000 shares @ 3 per
share)
Either:
June 30 Bank Account Dr. 2,97,000
(Being receipt of allotment money on 99000 shares)
OR
Call-in-Arrear Account Dr. 3,000
(Being receipt of allotment money on 99,000 shares and
unpaid amount on 1000 shares transferred to calls-in-
arrear)
Sep. 30 Share First Call Account Dr. 2,00,000
(Being first call money due on 1,00,000 shares @ 2 each)
Either:
(Being receipt of first call money on 99000 shares)
OR
Calls-in-Arrear Account Dr. 2,000
(Being receipt of first call money on 99000 shares and
unpaid amount on 1,000 shares transferred to calls-in-
arrear)
Dec. 31 Share Second & Final Call Account Dr. 2,00,000
Contd...
(Being second & final call money due on 1,00,000 shares @
2 each)
Either:
22 LOVELY To Share Second & FinalUNIVERSITY
PROFESSIONAL Call Account 1,97,200
(Being receipt of second & final call on 98,600 shares)
OR
Calls-in-arrear A/c Dr. 2,800
To Second & Final Call Account 2,00,000
(Being receipt of first call money on 99000 shares)
OR
Calls-in-Arrear Account Dr. 2,000
To Share First Call Account Unit 1: Share Capital – Issue of Shares
2,00,000
(Being receipt of first call money on 99000 shares and
unpaid amount on 1,000 shares transferred to calls-in-
arrear)
Dec. 31 Share Second & Final Call Account Dr. 2,00,000 Notes
(Being second & final call money due on 1,00,000 shares @
2 each)
Either:
To Share Second & Final Call Account 1,97,200
(Being receipt of second & final call on 98,600 shares)
OR
Calls-in-arrear A/c Dr. 2,800
To Second & Final Call Account 2,00,000
(Being receipt of second & final call and unpaid transferred
to calls-in-arrear account)
Example 7: On 1st January, 2006, XYZ Limited issued 5,000 equity shares of 100 each.
Payment on shares is to be made in following manner. Application fees of 2 were received on
1st Feb. 2006, while allotment fees of 3 were received on 1st March, 2006. First and final call of
6 were received on 1st July, 2006. Applications were received for 6,500 shares and directors
made allotment in full to the applicants demanding five or more shares and returned the money
to the applicants for 1,500 shares. One shareholder who was allotted 20 shares paid the first and
final call money with allotment money. Another shareholder did not pay allotment money on
his 30 shares but paid the same with first and final call. The directors have decided to charge and
allow interest, as the case may be, on calls-in-arrear and calls-in-advance, respectively according
to the provisions of Table A.
Journalise the transactions–
Solution:
XYZ Limited Journal
2006
Feb. 1 Bank Account Dr. 13,000
To Equity Share Application Account 13,000
(Being receipt of application money on 6,500 shares @
2 Per share)
Equity Share Application Account Dr. 13,000
To bank account 3,000
To Equity Share Capital Account 10,000
(Being application money transferred to share capital
and refund to 1500 unsuccessful applicants)
March 1 Equity Share Allotment Account Dr. 15,000
To Equity Share Premium Account 5,000
(Being allotment money due on 5000 share @ 3 each
including premium of Re 1 per share)
Bank Account Dr. 15,030
To Equity Share Allotment Account 14,910
To Calls-in-Advance Account 120
(Being receipt of allotment money on 4,970 shares and Contd...
calls-in-advance on 20 shares)
July 1 Equity Share First & Final Call Account Dr. 30,000
To equity share capital account 30,000
LOVELY
(Being first and final call money PROFESSIONAL
due on 5,000 shares @ UNIVERSITY 23
6)
Calls-in-Advance Account Dr. 120
To Equity Share First & Final Call Account 30,000
March 1 Equity Share Allotment Account Dr. 15,000
To Equity Share Premium Account 5,000
(Being allotment money due on 5000 share @ 3 each
including premium of Re 1 per share)
To Calls-in-Advance Account 120
Notes (Being receipt of allotment money on 4,970 shares and
calls-in-advance on 20 shares)
July 1 Equity Share First & Final Call Account Dr. 30,000
To equity share capital account 30,000
(Being first and final call money due on 5,000 shares @
6)
Calls-in-Advance Account Dr. 120
To Equity Share First & Final Call Account 30,000
To Equity Share Allotment Account 90
(Being receipt of first and final call money on 4,980
shares and allotment money on 30 share.)
Interest on Calls in Advance Account Dr. 2.4 2.4
To Bank Account
(Being payment of interest on calls-in-advance)
Bank Account Dr. 1.5
To Interest on Calls-in-Arrear Account 1.5
(Being interest on calls in arrear received)
Working Note:
(i) Calls-in-arrear on allotment = 30 3 = 90
Interest on calls-in-arrear for 4 months (March, April, May and June) @ 5% per annum
4
= 90 ´ ´ = 1.50
12
(ii) Calls-in-advance on 20 shares for first and final call at the time of allotment = 20 6=
120
Interest on calls-in-advance for four months (March, April, May and June) @ 6% p.a.
´ 4
´ = 2.4
12
Interest on Calls in Advance Account Dr. 2.4
To Bank Account 2.4
(Being payment of interest on calls-in-advance)
Bank Account Dr. 1.5
To Interest on Calls-in-Arrear Account 1.5
(Being interest on calls in arrear received)
1.4 Undersubscription and Oversubscription
The issue of a company is called under-subscribed, if the number of shares applied for is less
than the number of shares issued by the company. In this case the accounting entries are made on
the basis of the number of shares applied for, but minimum subscription has been received by
the company.

The issue is said to be over-subscribed if the number of shares applied is more than the number Notes
of shares offered to issue. As explained earlier, in any condition the board of directors cannot
allot more shares than the shares offered for issue in the prospectus. Therefore, the board of
directors have to adopt any one of the following methods in such a situation:
(a) Total excess applications of shares over the shares issued may be rejected and their
application money refunded with the letter of regret. For this purpose, journal entry
will be:
Share Application Account Dr. (with actual refund)
To Bank Account
(Being the refund of excess application money on ______ shares @ _______ per shares)
(b) Allotment is made on pro-rata basis to the all applicants. In the pro-rata allotment, shares
are partially allotted to all applicants. No application for shares is refused and also no
applicant is allotted the shares in full. In pro-rata allotment all applicants get shares in the
same proportion. This proportion is: Total shares issued : Total shares applied for. For
instance, if one has applied for 200 shares and he is allotted 100 shares only. This would be
pro-rata allotment. Here, the basis of allotment would be one share allotted for every two
shares applied for. In this case, excess application money is not refunded to the applicant
but is adjusted towards the money due on allotment and the deficit of allotment money
will be payable by the applicant at the time of allotment money due. For this purpose
entry will be:
Share Application Account Dr. (with the excess application money)
(Being the excess application money transferred to share allotment account)
(c) In the form of third alternative the directors may adopt the following criteria:
(i) Some applicant may be totally rejected.
(ii) Some applicants may be accepted in full.
(iii) The remaining applicants will be allotted on the basis of pro-rata.
Where pro-rata system is adopted to allot shares, the excess application money will be transferred
from the share application account to the share allotment account. To the extent of allotment
money on shares allotted, the balance of excess of application money is refunded. If the directors
are authorised by the Articles, this balance of excess of application money will be transferred to
calls-in-advance account. If the application money received from any applicant exceeds the total
amount payable on shares allotted to him, such an excess will have to be refunded. Thus, the
combined journal entry for the disposal of excess application money will be:
Share Application Account Dr.
To Share Calls-in-Advance Account
To Bank Account.
In brief, if the entire surplus application amount is not refunded and is equal to the allotment
money due on shares allotted, these shareholders will not pay any amount on allotment. If it is
less than the allotment money due, the applicants have to pay the deficit amount on allotment
and if it is more that allotment money due, first it will be utilised for allotment money in full
and balance can be returned or transferred to the calls-in-advance account.

Notes Under-subscription
Example 8: Raja Ram Ltd. issued a prospectus for 20,000 shares of 25 each at par,
payable as under:
On Application 6
On Allotment 6
On First Call 7
On Second Call 6
The applications were received for 19,000 shares and all these were accepted and all the money
due received. Show the cash book and journal and prepare the balance sheet of the company.
Solution:
Raja Ram Ltd. Journal Entries
Date Particulars Debit ( ) Credit ( )

Share Application Account Dr. 1,14,000
To share capital account 1,14,000
capital account on 19,000 shares @ 6 per share)
(Being allotment money due on 19,000 shares @ 6 per share)
Share First Call Account Dr. 1,33,000
(Being first call money due on 19,000 shares @ 7 per share)
Share Second & Final Call Account Dr. 1,14,000
(Being second & final call money due on 19,000 shares @ 6 per share)
Balance Sheet As On …………….
Liabilities Assets
Authorised & Issued Capital
(20,000 shares of 25 each) 5,00,000 Cash at Bank 4,75,000
Subscribed, Called up and Paid up capital
(19,000 shares of 25 each) 4,75,000
4,75,000 4,75,000
Over-subscription
Example 9: Waye Ltd. invited applications for 50,000 equity shares of 100 each on the
following terms:
On applications 10 per share, on allotment 40 per share and on final payment 50 per share.
Over-payments on application were to be applied towards sums due on allotment. Where no
allotment was made, application money was to be returned in full. The issue was over-subscribed
to the extent of 15,000 shares. It was decided to :
(i) refuse allotment to the applicants for 10,000 shares and send them letters of regret.
(ii) allot 10,000 shares to Mr. X who has applied for 15,000 shares.

(iii) allot in full to other applicants Notes
(iv) utilise excess application money in part payment of allotment.
All the moneys due on allotment and final calls were duly received. Make necessary journal
entries in the books of company.
Solution:
Waye Ltd.Journal Entries
Date Particulars Debit ( ) Credit ( )

To Equity Share Application Account 6,50,000
(Being receipt of application money on 65,000 shares @ 10 per share)
(Being application money on 50,000 shares transferred to share capital
and that for 5,000 shares utilised for allotment money)
(Being application money for 10,000 share refunded)
(Being allotment money due on 50,000 shares @ Rs 40 per share)
(Being allotment money received)
Equity Share First and Final Call Account Dr. 25,00,000
(Being first and final call money due on 50,000 share @ 50 per share)
(Being the receipt of first and final call on 50,000 shares)
Task The main difference between subscribed capital and called up capital will be:
(a) Calls-in-Arrear
(b) Calls-in-Advance
(c) Uncalled Capital
(d) Paid up Capital
Example 10: (Adjustment of Excess Application Money in Various Ways)

X and Y Ltd. made an issue of 60,000 equity shares of 100 each payable as under:
On Application 25
On Allotment 50
On Call 25

Notes Total application were received for 100,000 shares and allotment was made as:
Applicants for 10,000 shares (in respect of applications for 2,000 or more) received 5,000 shares.
Applicants for 40,000 shares (in respect of applications for 1,000 or more) received 8,000 shares.
Applicants for 50,000 shares (in respect of applications for less than 500 shares) received 47,000
shares.
Excess application money was utilised for the payment of allotment and call and balance was
returned. All money due on allotment and call was received. Make the necessary journal entries
and show the relevant ledger accounts.
Solution:
Working Note:
Analytical Table for Adjustment of Excess Application Money
X Y Ltd. Journal Entries
1. Bank Account Dr. 25, 00,000

(Being receipt of application money on 1,00,000 shares
@ 25 per share)
2. Equity Share Application Account Dr. 2,00,000
(Being the refund of application money for 8000 shares
@ 25 per share)
(Being share application money transferred to share
capital a/c)
To Calls-in-Advance Account 2,00,000
(Being utilisation of excess application money in
allotment and calls-in-advance)
5. Equity Share Allotment Account Dr. 30,00,000
Contd...
share)
28 6. Bank AccountPROFESSIONAL UNIVERSITY
LOVELY Dr. 24,00,000
(Being the receipt of balance of allotment money)
7. Equity Share First and Final Call Account Dr. 15,00,000
(Being share application money transferred to share
capital a/c)
(Being utilisation of excess application money in
allotment and calls-in-advance)
5. Equity Share Allotment Account Dr. 30,00,000 Notes
share)
(Being the receipt of balance of allotment money)
7. Equity Share First and Final Call Account Dr. 15,00,000
(Being first and final call due on 60,000 shares @ 25
per share)
Call-in-Advance Account Dr. 2,00,000
To Equity Share First and Final Call A/c 15,00,000
(Being calls-in advance adjusted and balance of call
money received)
Ledger Accounts Bank Account
Particulars Particulars
To Equity Share Application Account 25,00,000 By Equity Share Application
(Application money on 1,00,000 Account (Application
shares @ 25 per share) money refunded on 8,000
To Equity Share Allotment Account shares @ 25 per share)
24,00,000 2,00,000
(balance of allotment money received) By balance c/d
60,00,000
To Equity Share First and Final Call
13,00,000
Account
(Balance of first and final call money)
62,00,000 62,00,000
Equity Share Application Account
To Bank Account 2,00,000 By Bank Account 25,00,000
To Call-in-Advance Account 2,00,000
25,00,000 25,00,000
Equity Share Allotment Account
30,00,000 By Equity Share 6,00,000

To Equity Share Capital Account Application A/c 24,00,000
By Bank Account
30,00,000 30,00,000
2,00,000 By Equity Share 15,00,000

To Call-in-Advance Account
13,00,000 Capital Account
To Bank Account
15,00,000 15,00,000

Notes Equity Share Capital Account
` `
60,00,000 By Equity Share 15,00,000
To balance c/d By Equity Share Allotment Account 15,00,000
By Equity Share First & final call account
60,00,000 60,00,000
1.5 Combined Account for Share Application and Allotment
Some accountants prefer to prepare a combined account for share application and share allotment,
which is called the share application and allotment account. By preparing this account, they save
their time and energy. Only one journal entry is made for transferring the application money to
share capital account and allotment money due. Along with it, they need not make an entry for
transferring the excess application money to allotment account too.
Example 11: X Y Company was registered with an authorised capital of ` 10,00,000

which was divided into 6,000 equity shares of ` 100 each and 4,000, 8% preference shares of ` 100
each. The company issued a prospectus to issue these shares on the condition that full amount of
the shares would be paid in lump sum. All these shares were taken up and paid by the public.
Pass the necessary journal entries in the books of the company.
Solution:
Journal Entries
Date Particulars Dr. ` Cr. `

To Equity Share Application & Allotment Account 15,70,000
(Being receipt of application money on 157,000 shares
@ ` 10 per shares)
Equity Share Application & Allotment Account Dr. 12,50,000
(Being application money @ ` 10 and allotment money
` 15 per share credited on 50,000 equity share)
Equity Share Application and Allotment Account Dr. 4,70,000
To Bank Account to Calls-in-advance account 20,000
(Being refund of excess application money after adjusting
allotment money and adjusting in calls in advance) 4,50,000
To Equity Share Application and Allotment Account 1,50,000
(Being receipt of balance of allotment money due after
adjustment of excess application money)
To equity share capital account Dr. 7,50,000
(Being first and final call money due on 5000 shares 7,50,000
@ ` 25 per share)
Calls-in-advance Account Dr. 4,50,000
(Being receipt of balance first and final call money on 50,000
shares after adjusting calls in advance)

Self Assessment Notes
True or False:
7. Share application account is a nominal account.
8. Right shares are those which are issued to the existing shareholder.
Fill in the blanks:
9. Rate of dividend for equity shares is .................... fixed.
10. The .................. of the company defines the objectives of the company.
11. Minimum subscription has been determined at ................... of the total issue.
12. The nature of share application account is .........................
1.6 Issue of Shares for Consideration Other than Cash
Sometimes, a company may issue fully paid shares to any person or firm from whom it purchases
any assets such as land, plant and machinery, building etc. This type of issue is called issue of
shares for consideration other than cash because this issue does not involve the receipt of cash.
If such shares are issued, it must be clearly stated in the balance sheet and must be distinguished
from the issue made for cash. Such an issue can be as follows:
1. Issue of Shares to Vendors: For the payment of purchase price of assets, the company may
issue fully paid shares to vendors of assets. Such an issue can be at par, discount or premium.
In such a case the following entries will be purchased:
(a) When assets are purchased:
Assets Account Dr. (with the purchase price of assets)
To Vendors’ Account
(Being assets purchased)
(b) When shares are issued for payment –
(i) if this issue of shares is at par –
Vendors account Dr. (with the nominal value of shares allotted)
(ii) if this issue of shares is at discount –
Vendors’ Account Dr. (with purchase price)
Discount on shares Account Dr. (with the amount of discount)
To Share Capital Account (with the nominal value of shares allotted)
(c) If the issue of shares is at premium –
Vendors’ Account Dr. (with the purchase price)
To Share Capital Account (with the nominal value of shares allotted)
To Share Premium Account (with the amount of premium)
2. Issue of shares to promoters: A company may issue its fully paid shares to its promoters in
recognition of their services to the company. Similarly a company may also issue shares

Notes to other persons who might render technical information, engineering services, plant
layout etc. Being are capital expenditure, these are therefore debited to the goodwill
account. Its accounting record can be understood with the help of following journal entry.
Goodwill Account Dr. (with the nominal value of shares allotted)
3. Issue of shares to under-writers: A company may issue its fully-paid shares to underwriters
for the payment of underwriting commission.
(a) When commission is due–
Underwriting Commission Account Dr. (with the amount of commission)
To underwriter’s account
(b) When commission is paid by shares –
Underwriters Account Dr. (with the nominal value of shares issued)
To share capital account
Example 12: Sikander Ltd. acquired the business of Subhash and Brothers for 5,40,000.
The payment was made by the issue of fully paid shares of 100 each. What entries will be made
in the books of Sikander Ltd. if such issue is (i) at par, (ii) at a premium of 20% and (iii) at a
discount of 10%.
Solution:
Sikander Ltd.Journal
Date Particualars L.F.

(i) Sundry Assets A/c Dr. 5,40,000
To Subhash & Brothers 5,40,000
(Being Business purchased)
(ii) When issue is at par:
Subhash & Brothers Dr. 5,40,000
(Being issue of 5400 shares of 100 each to
Vendor)
(iii) When issue is at premium:
To Share Premium Account 90,000
(Being issue of 4500 shares of Rs 100 each at
a premium of 20% to vendor)
(iv) When issue is at discount:
Discount on Issue of Shares A/c Dr. 60,000
(Being issue of 6,000 shares to vendor at a
discount of 10%)
Working Note: In order to find out the number of shares allotted to vendor, first of all discounted
price or price with premium, of one share which is issued to vendor, is calculated. Here it is 120
in the case of premium and 90 in the case of discount. The following formula is used:
Purchase Price
(i) No of shares issued at premium of 20% =
Issue price of one share

Notes
= = 4, 500 shares
Amount of share capital = 4500 ´ 100 = 450,000
Amount of share premium – 4,5000 ´ 20 = 90,000
Purchase Price
(ii) No of shares issued at a discount of 10% =
Issue price of one share
= = 6,000 shares
Amount of share capital = 6000 ´ 100 = 6,00,000
Amount of discount on shares = 6000 ´ 10 = 60,000
Example 13: Agfa & Co. Ltd. has an authorised share capital of 5,00,000 divided into
50,000 shares of 10 each. Out of these, 8,000 shares were issued to the vendors as fully paid,
16,000 shares were subscribed for by the public and the first year 2 per share were paid on
application, 2 per share on allotment and 6 per share were called up. 4,000 shares were issued
as fully paid to promoters.
Of the 16,000 shares subscribed for by the public, these have been paid at the end of the first year.
On 12,000 shares the full amount was called up. On 2,500 shares 4 per share were called up and
on 1,500 shares 2 per share were called up.
You are required to prepare the journal and cash book entries and the balance sheet of the
company.
Solution:
Agfa & Co. Ltd. Journal Entries

Sundry Assets Account Dr. 80,000
To Vendors’ Account 80,000
(Being sundry assets purchased)
Vendors’ Account Dr. 80,000
(Being the issue of 8,000 shares of 10 each to vendor for the
consideration of purchase of assets.)
Goodwill Account Dr. 40,000
(Being issue of 4,000 shares of 10 each to promoters for
their services)
Share Application Account Dr. 32,000
To share Capital Account 32,000
(Being application money transferred to share capital A/c)
Share Allotment Account Dr. 32,000
(Being share allotment money due on 16,000 shares)
Share First & Final Call A/c Dr. 96,000
(Being first and final call money due on 16,000 shares @ 6
per share)

Notes Cash Book (Bank Column Only)
To Share Application Account 32,000 By balance c/d 1,33,000
To Share Allotment Account 29,000
To Share First and Final Call Account 72,000
1,33,000 1,33,000
Balance Sheet of Agfa Co. Ltd. for the year ending...................
Liabilities Assets
Authorised capital: 5,00,000 Sundry Assets 80,000
50,000 shares of 10 each Goodwill 40,000
Bank Balance 1,33,000
Paid up Capital 8,000 shares of Rs 10 each 80,000
issued to vendor for the purchase of assets 40,000
4,000 shares of 10 each issued to promoters 1,33,000
16,000 shares of 10 each issued used
for cash 1,60,000
Less : Call-in-Arrear 27,000
2,53,000 2,53,000
Self Assessment
Fill in the blanks:
13. A public limited company must have at least ................................. directors.
14. The director of a public limited company must be a .................................
Choose the correct answer:
15. Right shares means such shares which are
(a) issued by a newly formed company
(b) issued to the directors of the company
(c) first offered to the existing shareholders
(d) issued to any person.
16. Preference shares of a company means:
(a) Creditors
(b) Owners
(c) Customers
(d) Partners

Notes

Case Study Share Capital and Issue of Shares
Dabur Over the Years: The Dabur Story
A classic case of a family owned business being handed over to professionals, a company
making timely strategic interventions to adapt to the business environment and
maintaining its brand equity over the years.
Dabur India Limited (DIL) is the third largest FMCG Company operating in India with a
turnover of more than 2,233 crores. It operates under three business categories namely
Consumer Care Division (CCD), Consumer Healthcare Division (CHD) and Dabur foods
Limited (in July 2007, Dabur announced the de-merger of DFL with DIL).
Background
Dr. S.K Burman started Dabur in 1884 as a small pharmacy. Initially, he prepared Ayurvedic
medicines to treat diseases like malaria, plague and cholera that had no cure during that
period. It was his dedication, commitment and empathy that made Dabur a renowned
name among the masses. And today, after more than 120 years, Dabur is known for its
trustworthiness more than anything else.
During this passage of time, Dabur went through several structural and strategic changes
to maintain its market strength. The real mass production started in 1896. Early 1900’s saw
Dabur emerge as the first company to provide health care through scientifically tested
methods. It achieved significant improvements after setting up Research and Development
centers and manufacturing automation. The launch of Dabur’s Amla hair oil and
Chyawanprash was a boon to the expanding business. To keep up with the times, Dabur
computerized its operations in 1957. Its Dant Manjan and digestive tablets were widely
accepted as well.
However with a large product portfolio in the market, Dabur had to maintain operational
efficiency. To make sure it adjusted to the business environment it became a public limited
company in 1986 followed by diversification in Spain in 1992. A major change came when
Dabur came up with its IPO in 1994. Because of its position, Dabur’s issue was 21 times
oversubscribed. Dabur further divided its business into three separate groups:
 Health Care Products Division
 Family Products Division
 Dabur Ayurvedic Specialties Limited
In 1998, for the first time in the history of Dabur, a non-family member took charge. Dabur
handed over the operations to professionals. Successful implementation of procedures,
timely changes and maintaining its essence, Dabur achieved its highest-ever sales figure
of 1166.5 crore in 2000-01.
As FMCG sector was struggling with the slow growth in the Indian economy, Dabur
decided to take numerous strategic initiatives, reorganize operations and improvise on
its brand architecture beginning 2002. It decided to concentrate its marketing efforts on
Dabur, Vatika, Anmol, Real and Hajmola to strengthen their brand equity, create
differentiation and emerge as a pure FMCG player recognized as a herbal brand. This was
Contd...

Notes chosen after a study with Accenture, which revealed that Dabur was mainly perceived as
a Herbal brand and connected more with the age group above 35.
Also, larger retailers were making their foray into the FMCG market. Apart from HLL,
P&G, Marico and Himalaya, ITC was also posing a challenge. The supply chain of Dabur
was becoming complex because of the large array of products. Southern markets share in
the sales figure was negligible. These factors posed a threat to Dabur and hence small
changes were not enough.
Given below is the product portfolio of Dabur (Consumer Care Division 2006):
Product Category Products

Hair oil Vatika, Amla, Sarso
(Anmol coconut)
Shampoo Vatika heena conditioning, root-
strengthening
Anmol-natural shine, silky
Baby & Skin Care Vatika fairness, Gulabari, Vatika fairness
face pack
Janmaghutti, Olive oil, Gripe water,
Dabur lal tel
Digestive Hajmola range, Hingoli, Pudin hara
Health Supplements Chyawanprash, chyawanshakti, Dabur
Honey, Glucose
Oral Care Babool (rural market), Meswak (unani
method), promise, Lal paste, Binaca,
Promise
Home Care Odomos, Odonil, Odopic, Sanifresh
Given Below is a Segment Wise Competitor list:
Category Dabur’s Share Main Competitors

Fruit Juice 58% Real and Active Tropicana
Fruit Drinks (coolers) 1% Coolers Frooti and Maaza
Hair oil Coconut base 6.4% Vatika HLL
Shampoo Vatika 7.1% HLL and P&G
Hair care (overall) 27% HLL, P&G and Himalaya
Chyawanprash 64% Himani, Zhandu and
Himalaya
Honey 40% Himani, Hamdard and
local Players
Digestives 37% Paras and local players
Recent Initiatives
Following its plans, Dabur made significant changes in the time period 2002-2007.
Contd...

Brand Rejuvenation Notes
With youth forming a major population of India, Dabur decided to revamp its brand
identity. Dabur associated itself with Amitabh Bachchan, Vivek Oberoi, Rani Mukherjee
and Virender Sehwag for endorsements. New packaging and advertising campaign saw
the sales of Chyawanprash grow by 8.5 per cent in 2003-04.
The year 2004-05 saw a whole new brand identity of Dabur. The old Banyan tree was
replaced with a new, fresh Banyan tree.
The logo was changed to a tree with a younger look. The leaves suggesting growth,
energy and rejuvenation, twin colors reflecting perfect combination of stability and
freshness, the trunk represented three people raising their hands in joy, the broad trunk
symbolized stability, multiple branches were chosen to convey growth, and warmth and
energy were displayed through the soft orange color. ‘Celebrating Life’ was chosen as a
new tag that completely summarized the whole essence.
The Chairman in his annual report message said, “If I were to summarize your Company’s
performance during the year under review (2004-2005), it would be ‘Pursuit of Profitable
Growth’”.
HR Initiatives
The culture at Dabur gives full autonomy to its employees. Various training and
development programs like Young Manager Development Program, Prayas, Leading and
Facilitating Performance, Campus to Corpora and a Balanced scorecard approach to
performance evaluation, helps employees realize their potential.
Recently, Dabur has adopted an innovative HR program of offering ESOPs to new

engineering and management trainees at the time of joining. Also in 2005, Dabur gave
Bonus to its employees after 12 years. This boosted the employee morale further.
Dabur was listed as a “Great Place to Work”, in a survey conducted by Grow Talent &
Company and Great Place to Work Institute, USA. Dabur was listed as the 10th “Great
Place to Work”. The results were published in Business World dated February 2006.
IT initiatives
Dabur installed centralized SAP ERP system from 1st April 2006 for all business units. It
also implemented a country wide new WAN Infrastructure for running centralized ERP
system. Further it set up new Data Center at KCO Head Office.
Supply chain Initiatives
Dabur has undertaken e-procurement in a big way. In 2003-04 Dabur India procured 210
crore of raw materials through e-sourcing — or almost 50 per cent of total raw material
expenditure — and, in the process, considerably controlled raw material costs which were
on a rise.
For better production and operation management, Dabur included automation,

debottlenecking, Kaizen and wastage control. It set up production units in locations
providing tax holidays to reduce cost and improve efficiency.
Contd...

Notes Other important changes
Dabur made its largest acquisition by taking over Balsara hygiene and home products
business. Dabur bought the entire promoters’ stake of three Balsara companies through an
all-cash deal of 140 crore. This was done to ensure Dabur’s presence in all price segments
in the herbal oral care market. Moreover, it allowed Dabur’s entry in the household care
segment, where Balsara has well-established brands.
Dabur also de-merged its pharmaceutical business to come out as a pure FMCG player.
Dabur estimated that the southern region was contributing as low as 7% to its overall
growth. For this purpose, the south team adopted a three-phase approach. First, it focused
on point of sale promotions and stocking practices. Second phase included better marketing
efforts in terms of advertising and packaging. Finally, it envisioned customized product
launches for the Southern states. The completion of first two phases by 2005-06 resulted in
increasing contribution to 10%.
Vision 2010
After the successful implementation of the 4-year business plan from 2002 to 2006, Dabur
has launched another plan for 2010. The main objectives are:
 Doubling of the sales figure from 2006
 The new plan will focus on expansion, acquisition and innovation. Although Dabur’s
international business has done well — growing by almost 29 per cent to 292 crore
in 2006-07, plans are to increase it by leaps and bounds.
 Growth will be achieved through international business, homecare, healthcare and

foods.
 Southern markets will remain as a focus area to increase its revenue share to 15 per
cent.
With smoothly sailing through its previous plans, this vision seems possible. Time and
again, Dabur has made decisions that have led to its present position. However, if Dabur
could be more aggressive in its approach, it can rise to unprecedented levels. To conclude,
this is a 10 year performance table from Dabur’s website.
Contd...

Notes
* Stock split from 10/share to 1/share

** Consolidated results from FY02 onwards
*** Dabur Pharma got de-merged.
# Bonus issue of 1:1 was issued during the year
^ Bonus Issue of 1:2 was issued during the year
1.7 Summary
 Share capital comprises the nominal values of all shares issued (that is, the sum of their
“par values”).
 In a wider sense, if the shares have no par value or the allocation price of shares is greater
than their par value, the shares are said to be at a premium (called share premium, additional
paid-in capital or paid-in capital in excess of par); in that case, the share capital can be said
to be the sum of the aforementioned “nominal” share capital and the premium.
 In the modern law of shares, the “par value” concept has diminished in importance, and
share capital can simply be defined as the sum of capital (cash or other assets) the company
has received from investors for its shares.
1.8 Keywords
Nominal Capital: Authorised capital of a company.
Convertible Shares: Share that can be easily converted.
Stipulated Rate: Formal agreement on your permanent disability rating.
1. ABC Limited was registered with an authorised capital of 1,00,000 shares of 100 each.
80,000 shares were issued to the public. The public subscribed for 60,000 shares. The company
called up 8 per share. All the money called up was duly received with exception of a call
of 2 per share on 500 shares. Show the amounts of various types of capital in the balance
sheet.
2. Authorised capital of Samraat Ltd. is 50,00,000 divided into 50,000 equity shares of 100
each. Out of these shares only 40,000 shares were issued to the public payable as follows:
With application 20
On allotment 25
On first call 30
On second and final call 25

Notes All the shares were subscribed by the public. The board of directors accepted all the
applications. Both the calls were made. All the moneys were duly received. You are
required to:
(i) pass journal entries for all the transactions including cash transactions,
(ii) prepare cash book,
(iii) show ledger accounts, and
(iv) draw balance sheet after the receipt of final call money.
3. Subhash Limited was formed on 1st Jan, 2006 with an authorised capital of 3,00,000
divided into 10,000 equity shares of 100 each and 2,000; 9% preference shares of 100
each. The share capital was to be collected as under:
Equity shares 9% Preference shares
With application 15 20
On allotment 20 30
On first call 30 20
On second and final call 35 30
All the shares were subscribed. The first and second and final calls on 160 equity shares
and 240; 9% preference shares were not received. Enter the transactions in the journal of
the company. Ledger accounts are not required.
4. Cheema Limited was floated with a capital of 50,00,000 divided into 50,000 shares of
100 each. It offered 25,000 shares on the following terms: 2 per share on application, 3
on allotment, 3 on first call and 2 on final call. Applications were received for 40,000
shares. Applicants for 15,000 shares were sent letters of regret and application money was
refunded. All the money due on shares was duly received. Pass the necessary journal
entries and the balance sheet.
5. A company with an authorised capital of 15,00,000 invited applications for 1,00,000
shares of 10 each. The shares are payable as follows:
On application 3, on allotment 3 and on first and final call 4.
There was over-subscription and applications were received for 2,13,000 shares. The
allotment of shares was made as under:
To applicants of 20,000 shares 20,000 shares
To applicants of 23,000 shares Nil
To applicants of 1,70,000 shares 80,000 shares
Excess application money paid on applications was adjusted against sums due on allotment
and first call. All money due were received.
Pass journal entries, ledger and balance sheet.
6. Anand Co. Limited invited the applications for 1,50,000 shares of 10 each payable as
follows:
With applications 2 on 1st March 2005.
On allotment 3 on 1st April 2005.
On first call 2 on 1st September 2005.

On second call 3 on 1st January, 2006. Mr Ramesh had 1,500 shares paid the amount of Notes
second call with first call. According to the Articles of Association, 6% interest is payable
on call-in-advance. All amounts were duly received. Mr. Dinesh who had 500 shares, paid
the amount of the first and second call with allotment. Interest was paid to both of these
shareholders on 1st January, 2006. Mr. Umesh who is the holder of 400 shares failed to pay
allotment money on its due date, but later on paid this amount with interest @ 5% p.a. with
first call. Pass the necessary journal entries to give the effect of above mentioned
transactions.
7. Issue of Shares for Consideration other than Cash:
(a) Suri Limited purchased the assets of Karim Limited for 25,00,000 payable 20% in
cash and balance in fully paid up shares of 100 each. Give the necessary journal
entries in the following cases:
(i) if these shares are issued at par
(ii) if these shares are issued at a premium of 25%
(iii) if these shares are issued at a discount of 20%
(b) Mehrotra Company Limited acquired the assets of Sudhir Limited for 50,00,000
payable as to 30,00,000 in equity shares 15,00,000 in 8% Preference shares and
balance in cash. The assets were as:
Plant & Machinery 20,00,000
Stock of Materials 1,00,000
Land & Building 25,00,000
Furniture 2,00,000
(c) Damodar Limited is floated to acquire the assets of Sonu Limited for a consideration
of 2,00,000 payable in 15,000 shares of 10 each and balance in cash. The assets
taken over include:
Land & Building 70,000
Furniture 80,000
Patents 70,000
Pass the necessary journal entries to give the effect of above mentioned transactions:
8. Expert Engineers Ltd. with an authorised capital of 10,00,000 divided into 1,00,000 equity
shares of 10 each, issued 80,000 shares payable 3 on application, 5 on allotment
(including 2 premium) and 2 each on two calls. Holders of 4,000 shares failed to pay
allotment money and further on 2,000 shares there were arrears to the first call. All these
shares were forfeited.
Then the final call was made. There was arrear on 800 shares. All the shares on which only
application money was paid and half of the shares on which there was default of first call
money were reissued at 8 as fully paid shares.
Pass journal entries and show how these will appear in the balance sheet.

Notes 9. Brij Lal & Co. Limited having a nominal capital of 10,00,000 in shares of 100 each,
invited applications for 5,000 shares, payable as follows:
With application 20
On allotment 25
On first call 35
The company received application for 4,500 shares. All the applications were accepted. All
money due on stated above were received with the exception of the second and final call
on 100 shares; these shares were forfeited and reissued as fully paid @ 90 per share.
Record the entries relating to above mentioned transactions in the journal and balance
sheet of the company.
10. (a) Explain fully the procedure to be adopted for forfeiture of shares for non-payment
of allotment and for calls.
(b) ‘X’ Ltd. had an authorised capital of 10,00,000 divided into 10,000 shares of 100
each, out of which 7,500 shares were issued to the public for subscription. The terms
of issue were that 20 was payable on application, 20 per share on allotment, 30
per share on first call and the balance of 30 on second call. All the amounts were
duly received except the following:
From A - Holding 15 shares on which the allotment money and money due on the
first and second call was in arrear.
From B – Holding of 10 shares, on which the first and second call money was in
arrear.
From C – Holding 5 shares on which the second call money was in arrear.
The directors forfeited the shares and reissue the same to D on the following terms:
A’s shares were issued at 90 per share
B’s shares were issued at 70 per share.
C’s share were issued at 50 per share.
Pass journal entries necessary to record the above-mentioned transactions assuming that
D had paid whole amount due from him.
11. New comes Limited issued 4,00,000 equity shares of 10 each, payable as 3 on application,
4 on allotment and 3 on first call. Applications were received for 6,40,000 shares out of
which letters of regret were issued for 1,20,000 shares. Full allotment was made to the
applicants for 1,60,000 shares and pro-rata allotment was made on the balance. A shareholder
holding 400 shares to whom the full allotment was made failed to pay the allotment
money. Another shareholder holding 800 shares to whom pro-rata allotment was made
also failed to pay the allotment money. On call there was a further default on 1200 shares.
All these shares were forfeited the first lot of 1,200 (400 + 800) shares was reissued at 8 per
share. Pass journal entries in the books of the company to record the above transactions.
Answers: Self-assessment
1. False 2. False
3. True 4. Seven

5. Two 6. Owners Notes
7. False 8. True
9. Not 10. Memorandum of Association,
11. 90%, 12. Personal Account,
13. Three 14. Shareholder
15. (c) 16. (a)
Books Corporate Accounting - Dr. K.K. Verma
Online links http://moneyterms.co.uk/rights-issue/

http://investmentarticle.com/why-do-companies-conduct-rights-issue.html

Accounting for Companies-I Sukhpreet Kaur, Lovely Professional University
Notes Unit 2: Forfeiture of Shares
CONTENTS
Objectives
Introduction
2.1 Meaning and Procedure
2.2 Accounting Treatment
2.3 Forfeiture of Shares Issued at Premium and at Discount
2.4 Summary
2.5 Keywords
Objectives
 Understand the procedure of forfeiture of shares
 Know accounting treatment
 Explain forfeiture of shares issued at discount and premium
Introduction
Sometimes some shareholders fail to pay the called up amount in full i.e., they do not pay in one
or more instalments after the allotment of the shares to them. In such a case either the company
can go to the court and file a suit against the defaulting shareholders for recovery of the due
amount or can cancel the membership of the defaulting shareholders. In case the membership is
cancelled, the amount paid by the defaulting members towards share capital stands forfeited, is
called ‘Forfeiture of Shares.’ In this lesson you will learn about different situations in which
shares can be forfeited and accounting treatment thereof.
2.1 Meaning and Procedure
If a shareholder fails to pay the due amount of allotment or any call on shares issued by the
company, the Board of directors may decide to cancel his/her membership of the company.
With the cancellation, the defaulting shareholder also loses the amount paid by him/her on
such shares.
When a shareholder is deprived of his/her membership due to nonpayment of calls, it is known

as forfeiture of shares.
!
Caution The result of forfeiture of shares is: Cancellation of membership of the shareholder.
Reduction of issued share Capital of the company.

Unit 2: Forfeiture of Shares
Let us take an example to make it clearer. S.K. Ltd. issued 100000 shares of 10 each payable as Notes
2 on application, 2 on allotment, 3 on first call and 3 on second and final call. Mr. Harish,
the allottee of 100 shares, fails to pay the second and final call money made by the company. In
this case if the Board of Directors decide to forfeit his shares, his membership will be cancelled
and the amount of 700 paid by him (on 100 shares 2 on application, 2 on allotment and 3
on first call per share) will be forfeited. Now Mr. Harish will no longer be the member of the
company and the issued capital of the company will be reduced by 1000.
Procedure of Forfeiture of Shares
The authority to forfeit shares is given to the Board of Directors in Articles of Association of the
company. The Board of Directors has to give at least fourteen days notice to the defaulting
members calling upon them to pay outstanding amount with or without interest as the case may
be before the specified date. The notice must also state that if the shareholders fail to remit the
amount mentioned therein within the stipulated period, their shares will be forfeited. If they
still fail to pay the amount within the specified period of time, the Board of Directors of the
company may decide to forfeit such shares by passing a resolution. The decision regarding the
forfeiture of shares should be communicated to the concerned allottees and should be asked to
return the allotment letters and share certificates of the forfeited shares to the company.
Self Assessment
Fill in the blanks:

1. If a shareholder fails to pay the due amount on shares, the board of directors may decide
to ...................................... shares.
2. The authority to forfeit shares is given by company’s ......................................
3. The Board of Directors has to give at least ...................................... days notice
to the defaulting members.
You have learnt that shares can be issued at par, at discount and at premium. Accounting treatment
for forfeiture of shares in these three situations can be explained as under:
Forfeiture of shares issued at Par
When shares issued at par are forfeited the accounting treatment will be as follows:
(i) Debit Share Capital Account with amount called up (whether received or not) per share up
to the time of forfeiture.
(ii) Credit Share Forfeited A/c. with the amount received up to the time of forfeiture.
(iii) Credit ‘Unpaid Calls A/c’ with the amount due on forfeited shares. This cancels the effect
of debit to such calls which take place when the amount is made due.
The journal entry is:
Share capital A/c Dr
(Amount called up)
To share forfeited A/c
(Amount paid)

Notes To unpaid calls A/c
(Amount called but not paid)
Notes (i) Amount called up = No. of shares called up per share
(ii) Amount paid = No. of shares Amount paid per share
(iii) Amount called but not paid = No. of shares Amount called but not paid per share
Illustration 1:
X, a shareholder, holding 100 shares of 10 each has paid application money of 2 per share and
allotment money of 3 per share, but has failed to pay the first call of 2 per share and second
call of 3 per share. His shares were forfeited. Make the journal entry to record the forfeiture of
shares.
Solution:
Journal Entry
Date Particulars L.F Amount Amount
Share Capital A/c (100 10) Dr 1000

To Share forfeited A/c (100 5) 500
To Share First Call A/c (100 2) 200
To Share Second and Final Call A/c 300
(100 3) (forfeiture of 100 shares)
Illustration 2:
Alpha Ltd. issued 10000 shares of 100 each payable as: 25 on application.
25 on allotment
20 on First call and
30 on second and final call.
9000 shares were applied for and allotted. All the payments were received with the exception of
allotment money, first call and second and final call money on 300 shares allotted to Ganesh. The
Board of Directors decided to forfeit these shares. Make journal entry to record transaction
relating to forfeiture of shares.
Solution:
Journal Entry
Particulars Amount Amount

Share Capital A/c (300 100) Dr 30000
To Share forfeited A/c (300 25) 7500
To Share allotment A/c (300 25) 7500
To Share first call A/c (300 20) 6000
To Share second call A/c (300 30) 9000
(300 shares of 100 each forfeited due to non payment

of allotment money and calls money)

Forfeiture of Shares allotted on Pro-rata Basis Notes
In case the shares being over subscribed one of the scheme of allotment of shares to applicants
is to allot in the ratio of shares for which applications are entertained by the company for
allotment and the number of shares company has offered for subscription. This is called allotment
of shares on pro-rata basis. In case of pro-rata allotment the excess money received on applications
is transferred to Share Allotment A/c from Share Application A/c. In case a shareholder fails to
make payment on allotment and call money of shares held by him/her, the unpaid amount will
be calculated as under:
(i) Number of shares applied for allotment
Total No. of shares applied ´ shares allotted to defaulter

=
Total shares allotted
(ii) Number of shares applied for (as per step) – number of shares allotted = Excess applications
received.
(iii) Excess application money received = Excess number of applied shares × money called per
share on application.
(iv) Amount unpaid on allotment = Amount due on allotment – excess application money
adjusted towards allotment
Illustration 3:
A company has offered for subscription to the public 10000 shares of 10 each. It has received
applications for 15000 shares. Company has decided to allot shares on pro-rata basis. Gunakshi
holding 200 shares failed to pay allotment money and first call money. Her shares were forfeited:
Amount payable was as under:
2 per share on application.
3 per share on allotment.
5 per share on call.
Make journal entries and prepare relevant account in the books of the company.
Solution:
Working notes:
Total No. of shares applied ´ shares alloted to Gunakshi

Number of shares applied =
Total No. of shares allotted
15000
= 300
10000 ´ 200
Excess applications received = 300 – 200 = 100
Excess applications amount received = 100 2 = 200 Amount Due on allotment = 200 3 = 600
Excess application money adjusted = 200
Net unpaid amount on allotment = 600 – 200 = 400

Notes Journal Entries

Bank A/c Dr. 30000 30000
To Share Application A/c
(Share application money received for 15000 shares
@ 2 per share)
Share Application A/c Dr 20000
To Share capital A/c 10000
To Share Allotment A/c. 30000
(Share application money for 10000 shares
transferred to share capital A/c on their allotment 30000
and application money for 500 shares transferred to
share allotment A/c.)
Share Allotment A/c Dr 30000
To Share Capital A/c
(Allotment money due on 10000 Shares @ 3 per 19600
share)
Bank A/c Dr 19600
To Share Allotment A/c
(Allotment money received on 9800 shares)
Share First & Final call A/c Dr 50000 50000
To Share Capital A/c.
(Call money made due on 10000 Shares @ 5 per
share)
Bank A/c Dr 49000 49000
To Share First & Final Call A/c
(Call Money received on 9800 shares @ 5 per share)
Share capital A/c Dr 2000 600
To Share forfeited A/c 400
To Share Allotment A/c 1000
To Share First & Final call A/c
(200 shares forfeited for non payment of allotment &
call money)
Ledger Bank A/c

Dr Cr
Date Particulars JF Amount Date Particulars JF Amount
Share Applicaton A/c 30000 Balance cld 98600

Share Allotment A/c 19600
Share First and Final 49000
all A/c
Balance b/d
98600 98600
98600

Share Applicaiton A/c Notes
Dr Cr
Share Capital A/c 20000 Bank A/c 30000

Share Allotment A/c 10000
30000 30000
Share Capital A/c

Dr Cr
Share forfeited 600 Share 20000

A/c Application
Share 400 A/c
Allotment A/c
Share First and 1000 Share 30000
Final call A/c Allotment A/c
Balance cld 98000 Share First and 50000
100000 Final call A/c 100000
Balance b/d 98000
Share Allotment A/c

Dr Cr

Share Application 10000
A/c 400
Share Capital A/c
30000 30000
Share First and Final Call A/c

Dr Cr

Share Capital A/c 1000
50000 50000
Share Forfeited A/c

Dr Cr
Balance cld 600 Share Capital A/c 600
600 Balance b/d 600

Notes Balance Sheet of..........................................Co. Ltd.

As on..........................................
Liabilities Amount ( ) Assets Amount ( )

Authorised Capital
Shares of 10 each Cash at Bank 98600
Issued Capital
10000 shares of 10 each 100000
Less Capital of 200 shares 2000 98000
forfeited
Share forfeited A/c 600
2.3 Forfeiture of Shares Issued at Premium and at Discount
Forfeiture of Shares Issued at Premium
In case shares are issued at premium and thereafter forfeited there can be two situations:
 Premium on shares has been received prior to the forfeiture.
 Amount of premium on shares has not been received and it still stands credited to the
Securities Premium A/c.
Premium Money has been Received Prior to the Forfeiture
If the amount of premium on shares forfeited has been received by the company prior to the
forfeiture, securities Premium A/c will not get affected. In this case the journal entry of forfeiture
of shares will be similar to the entry made as if the shares had been issued at par.
The journal entry will be:
Share Capital A/c ...Dr
To Share forfeited A/c

To Unpaid Calls A/c./Calls in arrears A/c (forfeiture of share issued at premium)
Illustration 4:
M.B. Software Ltd. issued 500000 capital divided into equity shares of 10 each. The shares
were issued at a premium of 4 per share and were payable as: 3 per share on application, 7
(including premium) per share on allotment and the balance on call.
All the shares applied for and were duly allotted. All the money was duly received except on 500
shares on which the call money was not received. Company decided to forfeit these shares.
Make journal entry to record the forfeiture of 500 shares.
Solution:
Journal Entry
Share Capital A/c Dr. 5000
To Share Forfeited A/c 3000
To Share First & Final Call A/c 2000
(Forfeiture of 500 shares of 10 each due to on non payment of call money of 4 per share)

Premium on shares has not been received and stands credited to Securities Premium A/c Notes
as due but not paid
When a share is forfeited on which the amount of premium has been made due but has not been
received, either wholly or partially, the Securities Premium A/c will be cancelled. At the time of
making due, Securities Premium A/c will be credited. The journal entry will be as follows:
Share Capital A/c Dr
Securities Premium A/c Dr
To Share Forfeited A/c
To Unpaid call A/c.
(Forfeiture of shares originally issued at premium due to non payment of dues).
Forfeiture of shares issued at discount
Discount on issue of shares is a loss to the company. When shares issued at a discount are
forfeited for non payment of dues, the discount allowed on such shares is written back. At the
time of issue of shares, Discount on issue of Shares A/c is debited and when forfeited, this
account is credited to cancel the discount allowed on such shares. In this case the following
journal entry is made:
Share Capital A/c Dr.
To Share Forfeited A/c
To Discount on Issue of Shares A/c
To Unpaid call A/c
(Forfeiture of shares originally issued at discount for non payment of dues).
Illustration 5:
The Evergrowing Ltd. invited applications for 20000 shares of 50 each at a discount of 10%
payable as follows:
On application 10 per share
On allotment 20 per share
On call 15 per share
Whole of the issue was subscribed and paid for except the calls money on 200 shares which were
forfeited by the company.
Make journal entry for forfeiture of shares.
Solution:
Share Capital A/c (200 50) Dr. 10000
To Shares forfeited A/c (200 30) 6000
To Discount on Issue of Shares A/c (200 5) 1000
To Share First and Final call A/c (200 15) 3000
(Forfeiture of 200 shares of 50 each issued at discount of 10% on nonpayment of call money)

Notes Self Assessment
In the following cases write whether the account given is to be debited or credited and the
amount by which it is debited or credited.
4. Forfeiture of 100 shares of ` 10 each fully paid issued at par on which final call of ` 3 per
share is not received.
Shares forfeited A/c.
5. 250 shares of ` 10 each issued at a premium of ` 4 per share forfeited for non payment of
call money. ` 2 per share premium as called with allotment is paid.
Shares forfeited A/c
6. 100 shares of ` 10 each issued as fully paid at a premium of ` 2 per share forfeited on which
only application money @ ` 2 per share is received.
Securities Premium A/c
7. 200 shares of ` 20 each issued at a discount of ` 2, ` 15 called are forfeited for non payment
of final call of ` 5 per share.
Discount on issue of shares A/c
2.4 Summary
Forfeiture of shares means cancellation of membership of a shareholder due to non-payment of

calls made by the company. Forfeiture of shares amount to cancellation of the membership of
the defaulting shareholder and reduction of share capital of the company. Power to forfeit
shares is given in the Articles of Association of the company. The Board of Directors have to give
a fourteen days notice to the defaulting shareholder There are three situations when shares can
be forfeited: (i) Shares issued at par (ii) Shares issued at premium. Premium received in full
Premium due but not yet received (iii) Shares issued at discount In all cases share capital is
debited by the called up amount on forfeited shares. Shares forfeited A/c is credited by the
amount received (excluding the amount of premium) on forfeited shares. Securities premium
A/c will not get affected if premium on forfeited shares has been received but it will be debited
if it is due but not received Shares issued at a discount when forfeited discount on issue of shares
will always be credited by the amount of discount allowed on forfeited shares.
2.5 Keywords
Actual Payment – Real payment and not the assumed one.
Allotment of Shares – Allocation of shares in a company.
Par Value – Nominal or reasonable value.
Premium – A sum added to an ordinary price.
1. State the meaning of forfeiture of shares. When can shares be forfeited?
2. What accounting treatment is given to Securities Premium A/c on forfeiture of shares

when:
(i) Amount of premium has been received

(ii) Amount of premium has not been received on such forfeited shares. Notes
3. X Ltd. forfeited 500 shares of 100 each on which final call of 30 per share has not been
received. Other calls have been duly received. Make journal entry to record the forfeiture
of shares.
4. All Time Entertainment Ltd. issued 50000 shares of 10 each at a premium of 4 per share
payable as 3 per share on application 7 (including premium) on allotment and the
balance on call. Akbar who was allotted 300 shares failed to pay the allotment amount and
on his subsequent failure to pay the call money his shares were forfeited. Make the journal
entry for the forfeiture of 300 shares.
5. Exe Ltd issued 10000 shares of 50 per share issued at a discount of 5 per share payable
as 10 per share on application, 20 per share on allotment and the balance on call. All
money was duly received except of 400 shares on which allotment and call money was not
received. These shares were forfeited. Make journal entries in the books of the company
and prepare ledger accounts also.
Answers: Self Assessment
1. Forfeit 2. Articles of Association
3. Fourteen 4. Credited by 700
5. Credited by 2000 6. Debited by 200
7. Credited by 400
2.7 Further Reading

Accounting for Companies-I Sukhpreet Kaur, Lovely Professional University
Notes Unit 3: Reissue of Forfeited Shares and Bonus Issue
CONTENTS
Objectives
Introduction
3.1 Reissue of Forfeited Shares
3.2 Forfeiture and Reissue of Shares in the Case of Over-Subscription and
Pro-rata Allotment
3.3 Right Issue (Under Section 81)
3.4 Right Issue
3.5 Bonus Issue of Shares
3.6 Summary
3.7 Keywords
Objectives
 Understand reissue of forfeited shares
 Explain forfeitures reissue of shown in over-subscription and pro-rata allotment
 Define right issue
 Explain Bonus shares
Introduction
Forfeiture is withdrawal of shares due to non-payment of any call by the shareholder or for any
other ground as may be provided in the Articles. On forfeiture of shares the member loses the
amount paid thereon and his interest in the ownership of the shares.
Reissue of forfeited shares is a sale of shares and it does not amount to an allotment. The
company should duly record the particulars of the members who acquire those shares as if it
were a transfer of shares. The directors would fix a price for the forfeited share that should not
be lower than the amount of the call(s) due and unpaid on the share at the time of forfeiture.
In the case of a company whose shares are listed in a recognized stock exchange, re-issue of
forfeited shares shall be as per Guidelines for Preferential Issue of the Securities and Exchange
Board of India and the listing agreement.
3.1 Reissue of Forfeited Shares

As per the Articles of Association, directors are empowered to reissue the forfeited shares
when they find it suitable for sale and convenient to them. If there is no provision to reissue
the forfeited shares in the Articles of Association, Table A of Companies Act confers the power
upon them to do so.

Unit 3: Reissue of Forfeited Shares and Bonus Issue
Notes
!
Caution The directors can reissue the forfeited shares at any price which they like. But in
any condition, the reissue price of forfeited share plus the amount already received on
these forfeited shares from defaulters cannot be less than the amount credited as paid up
on reissue of shares.
In other words, maximum discount on reissue of forfeited shares is permissible to the amount
credited to forfeited shares account (when the shares were originally issued at discount, amount
of original discount also included to this amount). This reissue price can be understood well by
an illustration: if a share of 100 on which 15 are paid is forfeited and reissued (a) fully paid
up, then a sum of 85 must be collected, or (b) as partly paid up 75 paid then a sum of 60
must be collected by the reissue of share. In the case of reissue of forfeited shares the following
points are worth noting:
1. If the forfeited shares are reissued at discount, the amount of discount cannot be more than
the amount earlier received in respect of these shares from defaulters. The journal entry
for reissue will be:
Bank Account Dr. (Amount actually received on reissue)
Forfeited Shares Account Dr. (Discount given on reissue)
To Share Capital Account (Paid up value of share)
2. If the discount allowed on the reissue of forfeited shares is less than the amount earlier
received from defaulters, there will be some balance in the forfeited shares account.
This balance is treated as net capital profit and is transferred to capital reserve account.
The journal entry will be:
Forfeited Shares Account Dr. (any balance in forfeited shares a/c after reissue)
To Capital Reserve Account
3. If the whole of the forfeited shares are not reissued, only a proportionate profit on the
reissue of these shares will be transferred to Capital Reserve Account. This profit will be
calculated as under:
æ Total amount Forfeited ö

Profit = ç ´ No. of shares reissued÷ – Amount with which forfeited
è No. of shares forfeited ø
shares A/C was debited at the time of reissue of these shares.
4. If all the forfeited shares are reissued at par, entire amount of forfeited shares account will
be treated as capital profit and will be transferred to Capital Reserve Account.
5. If all the forfeited shares are reissued at a premium, the amount of premium will be
transferred to Share Premium Account. And in this case too, the entire amount will be
treated as capital profit and will be transferred to Capital Reserve Account. The entry will
be:
(i) On Reissue:
Bank Account Dr.
(ii) On transfer of forfeited shares account:
Forfeited Shares Account Dr.
To Capital Reserve Account.

Notes 6. If the forfeited shares, which were previously issued at discount, are reissued at discount
“Discount on Issue of Shares Account” will be re-recorded with the proportionate amount
the shares reissued.
If the discount on reissue of forfeited shares is more than the original discount, this loss
due to excess of discount will be debited to forfeited shares account. The journal entry
will be:
Bank Account Dr.
Discount on Issue of Shares A/c Dr. (with original discount)
Forfeited Shares Account Dr. (excess over original discount)
If the forfeited shares previously issued at discount, are reissued at par or premium,
discount on issue of shares account will not be rerecorded.
7. If the forfeited shares were previously issued at premium and premium has been received
fully, share premium will not be recorded again on the reissue of shares.
If the premium has not been collected earlier, share premium will be recorded on reissue
to the extent it is available. This availability depends on the amount collected earlier and
reissue price.
Example 1: Forfeiture & Reissue

Sanjay Mills Limited issued 1,50,000 shares of 10 each at par payable as under:
On first and final call 3 per share.
Only 1,20,000 shares were subscribed and allotted call money on 2,000 shares was not received.
These shares were forfeited. Out of forfeited shares 1,200 shares were reissued to Mr. X @ 8 per
share. Later, 200 shares were reissued to Mr. Y at their paid up value and still later the remaining
600 shares were reissued to Mr. Z @ 11 per share.
Pass journal entries for the above mentioned transactions in the books of Sanjay Mills
Limited.
Solution:
Sanjay Mills Limited

(Application money received on 1,20,000 shares @ 2
each)
(Being transfer of application money to share capital
account)
(Allotment money due on 1,20,000 shares @ 5 per share)
(Allotment money received on 1,20,000 shares)
Share First Final Call Account Dr. 3,60,000
(First and final call money due on 1,20,000 shares @ 3 Contd...
per share)
To Share First & Final Call Account 3,54,000
56 LOVELY
(Being receiptPROFESSIONAL
of first and final callUNIVERSITY
money on 1,18,000
shares)
Share Capital Account Dr. 20,000
To Forfeited Shares Account 14,000
To Shares First and Final Call Account 6,000
(Being forfeiture of 2,000 shares for non-payment of first
(First and final call money due on 1,20,000 shares @ 3
per share)
To Share First & Final Call Account 3,54,000
(Being receipt of first and final call money on 1,18,000
shares) Unit 3: Reissue of Forfeited Shares and Bonus Issue
To Shares First and Final Call Account 6,000
(Being forfeiture of 2,000 shares for non-payment of first Notes
& final call of 3 per share)
Forfeited Shares Account Dr. 2,400
(Being reissue of 1200 shares @ 8 per shares and loss of
2 per share transferred to forfeited shares account)
To Capital Reserve Account 6,000
(Profit on the reissue of 1200 shares transferred from
forfeited shares account to capital reserve account)
Bank Account Dr. 2,000 2,000
(Being reissue of 200 shares at par)
Forfeited Shares Account Dr. 1,400 1,400
(Profit on reissue of 200 shares transferred to capital
reserve)
To Share Premium Account 600
(Reissue of 600 shares to Mr. Z @ 11 per share)
(Profit on reissue of the remaining shares transferred to
capital reserve)
Working Note:
(i) Amount forfeited on 1,200 shares 12007 = 8,400
Less: Loss on reissue of 1200
Forfeited shares 12002 2,400
Profit on reissue of 1,200 shares 6,000
(ii) Since 200 forfeited shares are reissued at par, entire forfeited amount on these shares will
be treated as capital profit i.e., 200 × 7 = 1,400.
(iii) In this case also the entire forfeited amount on 600 shares will be treated as capital profit
because these shares are reissued at premium.
Example 2: Reissue of Forfeited Shares Originally Issued at Discount

Anuj Cloth Mills Limited invited applications for 50,000 shares of 100 each at a discount of 5%
payable as follows:
On first and final call 45 per share
The applications received were for 45,000 shares. All of these were accepted. All moneys due
were received except the first and final call on 500 shares, which were forfeited. 250 shares were
reissued @ 90 as fully paid. Pass necessary journal entries in the books of the company.

Notes Solution
Anuj Cloth Mills Limited Journal
Date Particulars L.F. Dr. ( ) Cr. ( )

(Application money received on 45,000 share @
30 each)
(Application money transferred to share capital
account)
(Allotment money due on 45,000 shares @ 20
each and discount allowed at 5 each)

(Allotment money received on 45,000 shares)
Share First and Final Call Account Dr. 20,25,000

(Being first and final call money due on 45,000
shares @ 45 each)
To Share First and Final Call Account 20,02,500
(Being first and final call money received on
44,500 shares)
To First and Final Call Account 22,500
To Discount on Issue of Shares Account 2,500
(Being forfeiture of 500 shares for non-payment
of first and final call money)
Discount on Issue of Shares Account Dr. 1,250
To Shares Capital Account 25,000
(Being 250 forfeited shares reissued at 90 each
as fully paid)

(Profit on reissue of 250 shares transferred to
capital reserve)
Working Note:
Total amount forfeited on 250 shares = 25050 = 12,500

Basis loss on reissue of share = 2505 = 1,250 Notes
Profit on reissue of shares 11,250
Example 3: (Reissue of forfeited shares previously issued at premium)

Dynamic Ltd. makes an issue of 5,000 equity shares of 100 each at a premium of 12.50 per
share payable as follows:
1. 12.50 on application,
2. 25.00 on allotment (including premium),
3. 50.00 on first call,
4. 15 on second all,
5. 10 on final call.
The application and allotment money are duly received and in addition, holders of 2,500 shares
pay in full on allotment. Holders of 100 shares fail to pay first call and after due notice their
shares are forfeited. The amounts payable on second call (made after forfeiture) are paid in full,
except that a holder of 50 shares fails to pay. 75 of the 100 shares forfeited are reissued, credited
with 90 paid for 65 per share. The new shareholder pays these shares in full. The balance of
10 per share is being treated as calls-in-advance. The final call is met in full including the arrears
of the second call.
Show the necessary journal entries including cash in the books of Dynamic Ltd.
Solution:
Dynamic Limited Journal
Dr. Dr.
To Equity Shares Application Account 62,500
(Being application money received on 5,000 shares @
12.5 per share)
Equity Share Application Account Dr. 62,500
(Being transfer of application money to shares capital
account)
Equity Share Allotment Account Dr. 62,500
(Being allotment money due on 5,000 shares @ 12.5
each)
To Calls-in-Advance Account (2500×75) 1,87,500
(Being allotment money received along-with premium
@ 12.5 each and advance call Pr.-money on 2,500
shares @ 75 each)
(Being first call money due on 5,000 shares @ 50 per
Contd...
share)
Calls-in-Advance Account (2500 × 50) Dr. 1,25,000
(Being receipt of first call money on LOVELY
4900 shares.)
PROFESSIONAL UNIVERSITY 59
Equity Share Capital Account Dr. 7,500

To Equity Share First Call Account 5,000
To Forfeited Share Account 2,500
(Being forfeiture of 100 shares for non-payment of first

Notes (Being first call money due on 5,000 shares @ 50 per
share)
Calls-in-Advance Account (2500 × 50) Dr. 1,25,000
(Being receipt of first call money on 4900 shares.)
Equity Share Capital Account Dr. 7,500

To Equity Share First Call Account 5,000
(Being forfeiture of 100 shares for non-payment of first
call)
Equity Share Second Call Account Dr. 73,500 73,500
(Being second call money due on 4,900 shares @ 15
per share)
Call-in-Advance Account (2500 × 15) Dr. 37,500
To Equity Share Second Call Account
(Being second call money received on 2,350 shares)
Bank Account (75 × 65) Dr. 4,875 6,750
Forfeited Shares Account (75 × 25) Dr. 1,875
To Equity Share Capital Account (75 × 90)
(Being reissue of 75 shares at 65 each 90 paid up at
a discount of 25 each)
Bank Account Dr. 750
To calls in Advance Account 750
(Being receipt of calls-in-advance from new share-
holders on 75 shares @ 10 each)
Equity Share Third & Final Call Account Dr. 49,750 49,750
(Being third and final call money due on 4,975 (4,900 +
75) shares @ 10 each)
Calls-in-Advance Account (2500 + 75) × 10 Dr. 25,750
To Equity Share Third & Final Call Account 49,750
To Equity Share Second Call Account (50 × 15) 750
(Being receipt of third and final call money with arrear
of second call)
Example 4: Pass journal entries in the following cases for forfeiture and reissue of shares:
(a) The directors of Sanjay Ltd. forfeited 100 shares of 50 each fully called up for non-
payment of allotment money of 15 per share and final call of 20 per share. These shares
were reissued to Mr. X for 40 per share.
(b) Wazid Ltd. forfeited 300 shares of 100 each. 70 was called up on which, Mr. Suresh has
paid only 50 for application and allotment money and first call of 20 has been unpaid.
The company forfeited these shares and reissued to Mr. Y crediting 70 per share paid for
a payment of 50 each.
(c) Vijay Limited’s directors forfeited 500 shares of 50 each ( 30 were called up) issued at a
discount of 10% on which Mr. X paid on 15 for application money only. Out of these 500
shares, 300 shares were reissued to Mr. Sohan as 40 called up for 30 per share.

(d) Laxam Limited forfeited 80 shares of 50 each 40 were called up issued at 5% discount on Notes
which 2,400 has been paid. These shares were reissued to Mr. Ram for a payment of
2,800 credited as fully paid.
(e) Alfa Limited forfeited 250 shares of 50 each fully called up for non-payment of final call
of 25 per share. Subsequently, 200 shares were reissued at 65 per share as fully paid.
(f) Thomson Limited forfeited 250 shares of 50 each, 45 were called up issued at 8%
premium to Mr. Axe on which he failed to pay allotment (including premium) of 15 and
first call of 10. Out of these forfeited shares, 150 shares were reissued to Mr. Waye as fully
called up for 40 per share and 50 shares to Mr. Zed as fully paid up for 60 and 50 shares
to Mr. Dawlo as fully paid up for 25. These all were issued on different dates.
Solution:
Journal Entries

Share Capital Account (100 × 50) Dr. 5,000
To Share Allotment Account (100 × 15) 1,500
To Share Find Call Account (100 × 20) 2,000
To Forfeited Shares Account (100 × 15) 1,500
(Being 100 shares forfeited for non-payment of allotment
and final call money)
Bank Account (100 × 40) Dr. 4,000
To Share Capital Account (100 × 50) 5,000
(Being reissue of forfeited share @ 40 per share)
Forfeited Share Account Dr. 500
To Capital Reserve Account 500
(Profit on reissue of forfeited shares transferred to capital
reserve i.e., 1500 – 1000)
To Share First Call Account (300 × 20) 6,000
(Being forfeiture of 300 shares for non-payment of first call
of 20 each share)
Bank Account (300 × 50) Dr. 15,000
(Being reissue of 300 shares @ 50 per share at a discount
of 20 per share)
Forfeited Share Account Dr. 9,000
(Profit on reissue of forfeited shares transferred to capital
reserve i.e., 15,000 – 6,000)
To Calls-in-Arrear Account (500 × 10) 5,000
To Discount on Issue of Shares Account (500 × 5) 2,500
(Being forfeiture of 500 shares for non-payment of call
money)
Bank Account (300 × 30) Dr. 9,000 Contd...
Discount on Issue of Shares Account (300 × 5) Dr. 1,500
(Being reissue of 300 shares for 30 per share as paid up
40 each) LOVELY PROFESSIONAL UNIVERSITY 61
(Being profit on reissue of 300 forfeited shares transferred
8 7 , 500
to capital reserve i.e. 8
ö
8 300ö – 1,500)
8 500 ö
To Forfeited Shares Account (500 × 15)
money)
Notes Bank Account (300 × 30) Dr. 9,000
Discount on Issue of Shares Account (300 × 5) Dr. 1,500
(Being reissue of 300 shares for 30 per share as paid up
40 each)
(Being profit on reissue of 300 forfeited shares transferred
æ 7, 500 ö
to capital reserve, i.e. çè ´ 300÷ – 1,500)
500 ø
To Call-in-Arrear Account (80 × 2.50) 600
To Discount on Issue of Shares Account (80 × 2.50)
money)
Discount on Issue of Share Account (80 × 2.5) Dr. 200
(Being reissue of 80 forfeited shares for a payment of
2,800)
Forfeited Shares Account Dr. 1,400 1,400
(Profit on reissue of 80 shares transferred to capital reserve
account i.e., 2400 – 1000)
To Share Final Call Account (250 × 25) 6,250
(Being forfeiture of 250 shares for non-payment of final
call of 25 per share)
To Share Premium Account (200 × 15) 3,000
(Being reissue of 200 shares for 65 per share at premium)
6250
(Profit on reissue of 200 shares transferred, i.e. × 200)
250
Share Premium Account (250 × 4) Dr. 1,000
To Share Allotment Account (250 × 15) 3,750
To Share First Call Account (250 × 10) 2,500
To Forfeited Share Account (250 × 24) 6,000
(Being forfeiture of 250 shares for non-payment of
allotment and first call money)
Contd...

Bank Account (150 × 40) Dr. 6,000 Notes

To Share Premium Account (150 × 4) 600
(Being reissue of 150 share @ 40 per share)
(Being profit on reissue of 150 shares transferred to capital
6, 000
reserve i.e. ´ 150  2,100)
250
Bank Account (50 × 60) Dr. 3,000
To Share Premium Account (50 × 10) 500
(Being reissue of 50 shares for 60 per share)
(Profit on reissue of 50 forfeited shares transferred to
6, 000
capital reserve a/c i.e., ´ 50)
250
Bank Account (50 × 25) Dr. 1,250
(Being reissue of 50 shares for 25 each.)
Self Assessment
Fill in the blanks:
1. As per the .............................., directors are empowered to reissue the forfeited shares when
they find it suitable.
2. The directors can reissue the ....................... shares at any price which they like.
3. ........................... will not be recorded again on the reissue of shares if already recorded.
True or False:
4. The reissue price of forfeited share plus the amount already received on these forfeited
shares from defaulters cannot be less than the amount credited as paid up on reissue of
shares.
5. If the forfeited shares, which were previously issued at discount, are reissued at discount
"Discount on Issue of Shares Account" will not be re-recorded with the proportionate
amount the shares reissued.
3.2 Forfeiture and Reissue of Shares in the Case of

Over-Subscription and Pro-rata Allotment
If a company has a reputation in the market, there is a possibility that shares applied for would
be more than what the company proposes to issue. In such a condition it is not possible for a
company to allot shares to the all applicants, therefore, the company rejects some applications
altogether, allots in full to some applicants and makes a pro-rata allotment to the remaining
applicants.

Notes
Notes In solving the examination problem, students generally face a difficulty in calculating
the amount of arrears on allotment and forfeited amount, in the case on shares are allotted
the basis of pro-rata.
In such a case the following procedure may be adopted to calculate these correct amounts and to
avoid difficulties:
1. Calculate the total number of shares applied for by the defaulters (if not given) as under.
2. Calculate the total amount of application money received by the company from the
defaulters, by multiplying the number of shares applied for by defaulters and application
money per share. This is the forfeited amount which would be transferred to the forfeited
shares account.
3. Calculate application money due on shares allotted to defaulters by multiplying the

shares allotted to defaulters and application money per share and deduct it from total
application money received. The result would be the excess application money to adjust in
allotment money.
4. Calculate the allotment money due to defaulters by multiplying the number of shares
allotted to defaulters and allotment money per share and deduct it from excess application
money received from defaulters (calculated above in No. 3). This will be the net amount of
arrears on allotment, which will be credited to share allotment account at the time of
forfeiture.
Example 5: Bharat Limited invited applications for 20,000 shares of 10 each at a discount
of 5% (allowed at the time of allotment). The amount was payable as under:
On application 2.5, on allotment 5, and balance on call.
The public applied for 18,000 shares and these were allotted. All money due was received with
the exception of allotment and call money on 300 shares. These shares were forfeited after-
words. 200 of these forfeited shares were reissued as fully paid for a payment of 7.50 per share.
Journalise the transaction in the books of the company.
Solution:
Bharat Limited Journal

To Share application Account
(Being receipt of application money on 18000 shares
@ 2.50 per share)
Share Application Account Dr. 45,000 45,000
account)
(Being allotment money due on 18,000 shares @ 5 Contd...
per share at a discount of 5%)
64 (Being
LOVELYallotment money receivedUNIVERSITY
PROFESSIONAL on 1700 shares)
Share Final Call Account Dr. 45,000
(Being final call money due on 18,000 shares 2.5 per
share)
(Being receipt of application money on 18000 shares
@ 2.50 per share)
Share Application Account Dr. 45,000 45,000
account) Unit 3: Reissue of Forfeited Shares and Bonus Issue
(Being allotment money due on 18,000 shares @ 5 Notes
per share at a discount of 5%)
(Being allotment money received on 1700 shares)
Share Final Call Account Dr. 45,000
(Being final call money due on 18,000 shares 2.5 per
share)
To Share Final Call Account
(Being final call money received on 17,700 shares)
To Share Allotment Account. 1,350
To Share Final Call Account 750
To Discount on Issue of Shares Account 150
To Forfeited Shares Account 750
(Being forfeiture of 300 shares for non-payment of
allotment and final call money)
Discount on Issue of Shares Account Dr. 100
Forfeited Shares Account Dr. 400
(Being reissue of 200 forfeited shares @ 7.5 per
shares as fully paid).
Forfeited Shares Account Dr. 100
(Profit on reissue of 200 forfeited shares transferred.)
Working Note:
Profit on reissue of 200 forfeited shares
750
Forfeited amount on 200 shares ´ 200 500
300
Less: loss on reissue of 200 share 400
Profit on reissue of 200 forfeited Shares transferable to Capital Reserve. 100
Example 6: Seema Limited offered to public 1,00,000 shares of 100 each at a premium of
10 each. The payment was to be made as follows:
On application 20
On allotment 40 including premium
On first and final call 50
Applications were received for 1,82,500 shares. Applications for 20,000 were accepted in full,
those for 2,500 were rejected and on the remaining applications 80,000 shares were allotted, on
pro-rata basis. Varun who had applied for 200 shares and to whom 100 shares had been allotted
failed to pay the balance of allotment money due from him. His shares were forfeited and then
reissued to Ankur as 60 (including premium of 10) per share paid up @ 40 per share. Gitesh
another shareholder failed to pay call money on 50 shares held by him. His shares were also

Notes forfeited. Later, these shares were reissued as fully paid up, to Vikram @ 120 per share.
Expenses regarding the issue of shares were 30,000. Prepare journal, cash book and balance
sheet in the books of company.
Solution:
Dr. Cr.
To Equity Share 36,50,000 By Equity Share 50,000
Application Account 23,98,000 Application Account
To Equity Share Allotment 4,000 By Expenses on Issue of 30,000
Account 49,97,500 Share Account
To Equity Share Capital By Balance c/d
5,000 1,09,75,500
Account
1,000
(100 × 40)
To Equity Share First and
Final Call Account
(99,950 × 50)
To Equity Share Capital
Account
(50 × 100)
To Share Premium
Account (50 × 20)
1,10,55,500 1,10,55,500
Journal

(Being transfer of application money to
share capital and excess application money
to allotment account).
To Equity Share Premium Account 10,00,000
shares @ 40 per share including premium)
Equity Share Capital Account (100 × 50) Dr. 5,000
Share Premium Account (100 × 10) Dr. 1,000
(Being forfeiture of 100 shares for
non-payment of allotment money)
(Being reissue of 100 forfeited shares @ 60
each as paid up 40 each)
If cash transaction is not recorded in
cashbook directly, entry will be: Dr. 4,000
Bank Account (100 × 40) Dr. 2,000
Forfeited Shares Account (100 × 20) Contd...
(100 × 50)
1,000
To Share Premium Account (100 × 10)
66 Forfeited
LOVELY Shares Account
PROFESSIONAL Dr.
UNIVERSITY 2,000
(Profit on reissue of 100 forfeited shares
transferred to capital reserve a/c i.e.,
4000 – 2000)
non-payment of allotment money)
(Being reissue of 100 forfeited shares @ 60
each as paid up 40 each) Unit 3: Reissue of Forfeited Shares and Bonus Issue
If cash transaction is not recorded in
cashbook directly, entry will be: Dr. 4,000
Bank Account (100 × 40) Dr. 2,000
Forfeited Shares Account (100 × 20) Notes
(100 × 50)
1,000
To Share Premium Account (100 × 10)
(Profit on reissue of 100 forfeited shares
transferred to capital reserve a/c i.e.,
4000 – 2000)
1,00,000 shares @ 50 per share)
Equity Share Capital Account (50 × 100) Dr. 5,000
To Equity Share First and Final Call 2,500
Accounts (50 × 50) 2,500
To Forfeited Shares Account
(Being forfeiture of 50 shares for non-
payment of first & final call money)
(Profit i.e., entire forfeited amount on reissue
transferred to capital reserve a/c)
Working Note:
1. Analytical Table for Adjustment of Excess Application Money
No. of No. of Application Application Excess Allotment Excess Balance Refund

shares shares money money due application money Transfer due on ( )
applied allotted received on allotted money due to allotment
for ( ) shares ( ) ( ) allotment ( )
( ) money
( )
20,000 20,000 4,00,000 4,00,000 Nil 8,00,000 — 8,00,000 —
2,500 Nil 50,000 — — — — — 50,000
1,59,800 79,900 31,96,000 15,98,000 15,98,000 31,96,000 15,98,000 15,98,000 —
200 100 4,000 2,000 2,000 4,000 2,000 2,000 —
1,82,500 1,00,000 36,50,000 20,00,000 16,00,000 40,00,000 16,00,000 24,00,000 50,000
2. Amount Received on allotment
Total amount due on allotment (1,00,000 40) 40,00,000
–Excess application money adjusted in allotment (as per above table) 16,00,000
Balance receivable on allotment 24,00,000
– Amount not paid by Varun on allotment 2,000
23,98,000
3. Share Premium Account
To equity share allotment a/c 1,000 By E share allotment account 10,00,000

To balance c/d 10,01,000 By forfeited shares account 1,000
By bank account 1,000
10,02,000 10,02,000

Notes 4. Balance Sheet of Seema Limited as on.................
Liabilities Amount Assets Amount

Share Capital: Fixed assets:
Issued & subscribed: 1,00,00,000 Current Assets: 1,09,75,500
(1,00,000 equity shares of 100 each 10,01,000 Bank Balance 30,000
fully paid up). 4,500 Miscellaneous
Reserve & Surplus: Expenditure:

Share premium Expenses on issue of shares
Capital reserved (2,000 + 2,500)
1,10,05,500 1,10,05,500
Task Over-confident Co. Ltd. issued a prospectus offering 2,00,000 shares of 10 each on
the following terms:
On application Re. 1 per share.
On allotment 3 per share (including premium of 2)
On first call (three months after allotment) 4 per share.
On second call (three months after first call) 4 per share.
Subscriptions were received for 3,17,000 shares on 23rd April and allotment was made on
30th April as under:
Shares allotted
(i) Allotment in full (two applicants paid in full on allotment in respect of 4,000
shares each.) 38,000
(ii) Allotment of two-third of shares applied for 1,60,000
(iii) Allotment of one-fourth of shares applied for 2,000
Cash amounting to 31,000 (being application money received with applications for
31,000 shares upon which no allotments were made) was returned to the applicants on 5th
May. The amounts due were received on the due dates with the exception of final call on
100 shares. These shares were forfeited on 15th November and reissued to Varun on the
16th November for payment of 9 per share. The company paid the interest due on calls-
in-advance on 31st October in cash. Show the journal and cash book entries and draw a
balance sheet of the company giving effect to the above transactions.
Self Assessment
True or False:
6. If a company has a reputation in the market, there is a possibility that shares applied for
would be more than what the company proposes to issue.
7. In case of difficulty, calculating the amount of arrears on allotment and forfeited amount,
on shares are not allotted the basis of pro-rata.

Fill in the Blanks: Notes
8. In solving the examination problem, students generally face a difficulty in calculating the
amount of arrears on allotment and forfeited amount, in the case on shares are allotted the
basis of ................................
9. If a company has a ................................ the market, there is a possibility that shares applied
for would be more than what the company proposes to issue.
3.3 Right Issue (Under Section 81)
If a company proposes to increase its subscribed capital by allotment of further shares at any
time after the expiry of two years from the formation of the company, or at any time after the
expiry of one year from the allotment of shares whichever is earlier, then:
(a) Such further shares must be offered to the persons, who at the time of offer, are holders of
the equity shares of the company, in preparation, as nearly as circumstances admit, to the
capital paid up on those shares at that time.
(b) The above offer is made by giving a notice mentioning the number of shares. This notice
should also fix a time which should not be less than fifteen days from the date of offer
within which the offer must be accepted.
(c) On the receipt of the notice the existing shareholder may exercise his right to take new
shares himself or may transfer his right in favour of any other person.
(d) After the expiry of the time specified in the notice or on the receipt of earlier intimation
from the shareholder to whom the notice is served, that he declines to accept the shares,
the board of directors may dispose off these shares in such a manner as the board thinks
most beneficial to the company.
On the basis of above conditions if the further share capital is issued to existing shareholders
who are entitled to take these shares, such shares are known as Right Share.
“The objective of Section 81 obviously is that there should be an equitable distribution of shares
and the holding of shares by each shareholder should not be affected by the issue of new share.”
This further issue of shares can be offered to any person other than existing shareholder in any
manner whatsoever:
(i) If a special resolution has been passed by the company to allot the new shares in a different
manner than that provided in the Section 81 in the general meeting.
(ii) If an ordinary resolution has been passed by the company to that effect and the Central
government is satisfied on an application made by the board of directors that the proposed
offer of shares to the other persons is most beneficial to the company.
The provisions of Section 81 do not apply in the following cases:
1. Where the object of the issue is to allot qualification shares to one or more persons to
enable them to become the directors of the company.
2. Where the issuing company is a private limited company.
3. Where the increase in subscribed capital is due to the conversion of debentures or loans
into shares in the company.
4. Where, by the order of government, debentures issued to government or loan obtained

from government by the company, are converted into shares.

Notes Method of Calculating the Value of Right
Sometimes in the examination, the students are asked to calculate the value of right. The
following procedure is adopted to calculate the value of right:
1. First of all, find out the basis or rate of right issue and then calculate the market value of
shares held by the shareholder. For example, if a company makes a right issue of one share
for every four shares held, a shareholder who wants to take a right share, must hold four
shares. And if the market value of one share of this company is 150, the total market
value of shares will be 4 150 = 600
2. The amount paid to acquire the right share should be added to the total market value of
the shares calculated in (1) for example if the company is issuing one right share for 140,
total value of 5 shares will be = (4150) + (1140) = 740.
3. Calculate the average price of the shares including right share. In the given example:
= 148 per share
4. Deduct the average price of a share from the market value of a share in order to calculate
the value of right in the given example:
Value of right = market value – average price
150 – 148 = 2
3.4 Right Issue
1.(a) ABX Corp. decides to issue the stock via a general cash offer. The board believes it can
raise the $18 million the company requires by issuing shares at $36. The company has 5
million shares outstanding and the current stock price is $40. Ignoring the underwriter’s
spread, calculate the following:
(a) The number of new shares that ABX will have to offer.
(b) The expected price of the shares after the issue.
(c) The loss per share to existing holders.
(d) The percentage reduction in value of an existing stockholder’s investment in the

company
(e) The net present value of purchasing 100 shares via the general cash offer.
(b) ABX is considering the alternative of a privileged subscription stock issue to raise $18
million. The terms of the issue are 1 for 10 at $36, and the corporation’s current stock price
is $40. Calculate the following:
(a) The market value of the corporation’s equity prior to the issue.
(b) The percentage increase in market value due to the issue.
(c) The expected price of one right.
(d) The expected price of the stock ex-rights.
Solution:
1.(a) (a) Number of new shares = $18,000,000/$36 = 500,000 shares
(b) Value of company after issue = $200,000,000 + $18,000,000 = $218,000,000

Share price after issue $218,000,000/5,500,000 = $39.64 Notes
(c) Loss per share to existing holders = $40 - $39.64 = $0.36
(d) Percentage reduction in value = ($0.36/$40) 100 percent = 0.90 percent
(e) NPV purchasing shares via offer = $39.64 – $36 = $3.64
(b) (a) Value of equity before issue = 5,000,000 $40 = $200,000,000
(b) Increase in value = $18 m/$200 m 100 percent = 9%
(c) Value of right = (rights-on price - issue price)/(N+ 1) = ($40 – $36)/11 = $0.36
(d) Ex-rights price = (rights-on price - value of right) = $40 – $0.36 = $39.64
2. Jackrabbits Corporation is making a right issue to raise $6 million. Just before the issue,
Jackrabbits’ stock price was $20, and the terms of the issue are 1 for 4 at a subscription price
of $15.
Calculate (a) the expected price of the stock ex-rights and (b) The value of one right.
(c) Baby Rabbit owns 20,000 shares. How many rights will he have to sell to maintain the
same ($400,000) investment in the company? (d) Show that in general, the value of a right
is given by the formula (rights-on price - issue price)/ (N + I) when the terms of the issue
are 1 for N.
Solution:
(a) After the issue is completed, all shares will be ex-rights. For every 4 shares worth $20
before the issue, there will be 5 shares worth $20 x 4 + $15 (= $95) after the issue. Each share
will, therefore, be worth $95/5, so the ex-rights price is $19.
(b) The value of one right is the difference between the rights-on price (the share price before
the issue) and the ex-rights price. This is $1.
(c) Baby Rabbit will get 5,000 rights and if he were to keep all his rights, he would end up with
25,000 shares valued at a total of 25,000 $19 = $475,000. In order to retain his original
investment, he should have $400,000/$19 = 21,053 shares. Therefore, he needs to keep only
1,053 rights and sell the remaining 3,947 rights. This will give him $3,947.
(d) N shares at the rights-on price gets an additional share subscribed to at the offer price. This
gives the basic equation:
N (rights-on price) + issue price = (N + 1)(ex-rights price)
Alternatively, this can be written as:
[(N + 1) rights-on price] – (rights-on price - issue price) = (N + 1) ex-rights price
Value of a right = right-on price – ex-rights prices = rights-on price – issue price/(N + 1)
3.5 Bonus Issue of Shares
Introduction
“Capitalisation of profits refers to the process of converting profits or reserves into paid up
capital.” A company may capitalise its profits or reserves which otherwise are available for
distribution as dividends among the members by: (a) paying up amount unpaid on existing
partly paid shares so as to make them fully paid shares, or (b) issuing fully paid bonus shares to
the members. The Companies Act does not contain any specific provision regarding capitalisation
of profits and consequently issue of bonus shares. However, the Companies Act permits that the

Notes share premium amount (collected in cash only) can be used by the company in paying up
unissued shares of the company to be issued to its members as fully paid bonus shares. Also the
company can utilise the amount of the capital redemption reserve in paying up unissued shares
of the company to be issued to its members as fully paid bonus shares. The SEBI (Disclosure and
Investor Protection) Guidelines, 2000 which came into force w.e.f. 27th day of January, 2000
require that the company while issuing bonus shares shall ensure the following : (a) No company
shall, pending conversion of FCDs/PCDs/ issue any by way of bonus unless similar benefit is
extended to the holders of such FCDs/ through reservation of shares in proportion to such
convertible part of FCDs or PCDs (b) The shares so reserved may be issued at the time of
conversion(s) debentures on the same terms on which the bonus issues were made.
Definition
Bonus Share: A bonus share is a free share of stock given to current shareholders in a company,
based upon the number of shares that the shareholder already owns. While the issue of bonus
shares increases the total number of shares issued and owned, it does not increase the net worth
of the company. Although the total number of issued shares increases, the ratio of number of
shares held by each shareholder remains constant. An issue of bonus shares is referred to as a
bonus issue. Depending upon the constitutional documents of the company, only certain classes
of shares may be entitled to bonus issues, or may be entitled to bonus issues in preference to
other classes.
Bonus Issue: A bonus issue (or scrip issue) is a stock split in which a company issues new shares
without charge in order to bring its issued capital in line with its employed capital (the increased
capital available to the company after profits). This usually happens after a company has made
profits, thus increasing its employed capital. Therefore, a bonus issue can be seen as an alternative
to dividends. No new funds are raised with a bonus issue.
Issue of Bonus Shares: Bonus shares are issued by cashing in on the free reserves of the company.
The assets of a company also consist of cash reserves. A company builds up its reserves by
retaining part of its profit over the years (the part that is not paid out as dividend). After a while,
these free reserves increase, and the company wanting to issue bonus shares converts part of the
reserves into capital.
Conditions for Bonus issue: Bonus shares are issued by converting the reserves of the company
into share capital. It is nothing but capitalization of the reserves of the company. There are some
conditions which need to be satisfied before issuing Bonus shares:
(a) The bonus issue is not made unless the partly-paid shares, if any, are made fully paid-up.
(b) The company has not defaulted in payment of interest or principal in respect of fixed
deposits and interest on existing debentures or principal on redemption.
(c) The Company has sufficient reason to believe that it has not defaulted in respect of
payment of statutory dues of the employees such as contribution to provident fund,
gratuity, bonus etc.
(d) A company which announces its bonus issue after the approval of the Board of directors
must implement the proposal within a period of six months from the date of such approval
and shall not have the option of changing the decision.
(i) The articles of association of the company shall contain a provision for capitalisation
of reserves, etc.
(ii) If there is no such provision in the articles the company shall pass a resolution at its
general body meeting making provisions in the articles of association for
capitalisation.

Resolution for Increased Authorised Capital: Consequent to the issue of bonus shares, if the Notes
subscribed and paid up capital exceed the authorised share capital, a resolution shall be passed
by the company at its general body meeting for increasing the authorised capital.
Return of Bonus Issue: A return of bonus issue along with a copy of resolution authorising the
issue of bonus shares is to be filed with the Registrar within 30 days of the allotment of such
shares.
Issue of Bonus Shares by Public Sector Undertakings: It has come to the notice of the Government
that a number of Central Government Public Sector Undertakings are carrying substantial
reserves in their balance sheets against a relatively small paid up capital base. The question of
the need for these enterprises to capitalize a portion of their reserves by issuing Bonus Shares to
the existing shareholders has been under consideration of the Government. The issue of Bonus
Shares helps in bringing about a proper balance between paid up capital and accumulated
reserves, elicit good public response to equity issues of the public enterprises and helps in
improving the market image of the company. Therefore, the Government has decided that the
public enterprises, which are carrying substantial reserves in comparison to their paid up capital
issue Bonus Shares to capitalize the reserves for which the certain norms/conditions and criteria
may be followed and fulfilled. There are some SEBI guidelines for Bonus issue which are contained
in Chapter XV of SEBI (Disclosure & Investor Protection) Guidelines, 2000 which should be
followed in deciding the correct proportion of reserves to be capitalized by issuing Bonus
Shares.
The amount of profit that is distributed to the shareholders in addition to dividend is called
bonus. This bonus can be declared in the following conditions:
(a) In the condition of Excess Profit: If more profits are earned by a company in a year,
directors of that company do not distribute the entire profit to the shareholders. If the
entire profit is distributed to the shareholders, the current rate of dividend will increase.
And if this profit is not earned in future and current rate to dividend is not maintained, the
company’s goodwill will go down. Therefore, in the case of excess profit, some profit is
distributed in the form of dividend and some in the form of bonus.
(b) In the condition of Excess Reserves: If a company has accumulated more profits or reserves
and directors deem it fit, excess profit or reserves can be distributed among shareholders
in the form of bonus.
This bonus can be distributed in the form of cash, portly paid up shares or fully paid up shares
to the shareholders. Bonus is generally not paid in cash. If it is paid in cash, the working capital
of the company will be adversely affected. Mostly companies use this amount to make up the
existing partly paid up shares as fully paid. This is called Bonus Issue or Bonus Shares. Generally,
bonus shares are issued in the following cases:
(i) When cash is not sufficient to pay off bonus.
(ii) When there is under-capitalisation.
(iii) When there are more general reserves than necessity.
From where the bonus shares can be issued: Bonus shares can be issued from the following
accounts:
(i) From the profits of the company
(ii) From general reserves
(iii) Any reserve which is made from profit
(iv) From capital reserves (in some special cases)

Notes (v) Sinking fund account
(vi) Capital redemption reserves
(vii) Share premium
The following general entries are recorded regarding the issue of bonus shares:
(i) When bonus is declared from accumulated profits:
Profit and Loss Account Dr.
General Reserve Account Dr. As the case may be
Capital Redemption Reserve A/c Dr.
To bonus to shareholders account
(ii) When bonus shares are issued
Bonus to Shareholders Account Dr.
(iii) If bonus shares are issued at premium:
Bonus to Shareholders Account Dr.
(iv) If the bonus shares are issued to make up the existing partly paid up shares as fully paid:
(a) On due
Share Call Account Dr.
(b) When bonus is adjusted in call
Bonus to Shareholder Account Dr.
To Share Call Account
Note:
Bonus shares cannot be issued unless the partly paid up share are made fully paid up.
Bonus shares are issued to the existing shareholders on a pro-rata basis.
Bonus shares are distributed free of charge.
Example 7: (Issue of Bonus Shares Out of Capital Redemption Reserve, Premium and
General Reserve)
On 31st March 2006 the balance sheet of Kavita Limited stood as follows:

Liabilities ` Assets ` Notes
Share Capital: Fixed Assets:

Authorised 60,00,000 Land and Buildings 25,00,000
Issued and subscribed 30,00,000 Plant and Machinery 20,00,000
3,00,000 equity shares
of ` 10 each fully paid
13500; 8% redeemable 13,50,000 Furniture and 11,70,000
preference shares of fittings
` 100 each fully paid.
Reserve and surplus: Investments:
Capital reserve 37,500 Bonds of ICICI 4,35,000
Share premium 60,000 Current assets, loans 15,00,000
and advances stock
General Reserve 24,91,500 Debtors 16,59,000
Profit and loss account 11,61,000 Cash in hand 53,000
Current Liabilities: Bank balance 2,80,000
Sundry creditors 10,00,000 Unexposed 3,000
Insurance
Provision:
Provision for taxation 5,00,000
96,00,000 96,00,000
On 1st April, 2006, in order to redeem all of its preference shares at a premium of 5%, the
company issued 60,000 equity shares of ` 10 each at a premium of 10% and sold all of its bonds
in ICICI for ` 4,80,000.
After the redemption of preference shares, the company issued one fully paid equity share of `
10 as bonus for every three shares held by its shareholders.
Show the journal entries for above transactions and prepare the balance sheet of the company
immediately after the issue of bonus shares.
Solution:
Kavita Limited Journal
Date Particulars L.F. ` `
August 1 8% Redeemable Preference Shares Dr. 13,50,000
Capital Account
Premium on Redemption Account Dr. 67,500
To Preference Shareholders 14,17,500
Account
(Being amount due to preference
shareholders on redemption)
(Being receipt of amount from the
issue of new shares)
Share Premium Account Dr. 67,500
Contd...
To Premium on Redemption 67,500
Account
(Being utilisation of share premium
in writing off the premium on
redemption of preference LOVELY
shares) PROFESSIONAL UNIVERSITY 75
General Reserve Account Dr. 7,50,000
To Capital Redemption Reserve 7,50,000
Account
(Being utilisation of general reserve
for the redemption of preference
To Preference Shareholders 14,17,500
Account
(Being amount due to preference
Accounting for Companies-I To Equity Share Capital Account 6,00,000
(Being receipt of amount from the
issue of new shares)
Notes Share Premium Account Dr. 67,500
To Premium on Redemption 67,500
Account
(Being utilisation of share premium
in writing off the premium on
redemption of preference shares)
To Capital Redemption Reserve 7,50,000
Account
(Being utilisation of general reserve
for the redemption of preference
shares)
To Bonds of ICICI Account 4,35,000
To Profit and Loss Account 45,000
(Being the proceeds of sale of
investments and profit transferred to
P & L Account.)
Preference Shareholders Account Dr. 14,17,500
(Being payment made to
shareholders on redemption of
preference shares)
Capital Redemption Reserve Dr. 7,50,000
Account
To Bonus to Shareholders 12,00,000
Account
(Being utilisation of Capital
Redemption Reserve Share Premium
and General Reserve for declaration
of bonus)
Bonus to Shareholders Account Dr. 12,00,000
(Being issue of one bonus share to
every three of shares)
Balance Sheet of Kavita Limited as on 1st April, 2006
Authorised 60,00,000 Land and Buildings 25,00,000
Issued and Subscribed: Plant and Machinery 20,00,000
4,80,000 equity shares of ` 10 each fully Furniture and Fittings 11,70,000
paid up (of the above 60,000 equity 48,00,000
shares are issues as fully paid up bonus
shares)
Reserve & Surplus: Current Assets:
Loans and Advances:
Capital Reserve 37,500 Stock 15,00,000
Contd...
General Reserve 13,44,000 Debtors 16,59,000
Profit and Loss Account (11,61,000 + 12,06,000 Cash in hand 53,000
45,000)
76 LOVELY PROFESSIONAL
Current Liabilities and Provisions: UNIVERSITY Cash at bank 2,500
Sundry Creditors 10,00,000 Unexpired
Provision for Taxation 5,00,000 Insurance 3,000
88,87,500 88,87,500
Issued and Subscribed: Plant and Machinery 20,00,000
4,80,000 equity shares of ` 10 each fully Furniture and Fittings 11,70,000
paid up (of the above 60,000 equity 48,00,000
shares are issues as fully paid up bonus
shares)
Loans and Advances:
Capital Reserve 37,500 Stock 15,00,000
General Reserve 13,44,000 Debtors 16,59,000 Notes
Profit and Loss Account (11,61,000 + 12,06,000 Cash in hand 53,000
45,000)
Current Liabilities and Provisions: Cash at bank 2,500
Sundry Creditors 10,00,000 Unexpired
Provision for Taxation 5,00,000 Insurance 3,000
88,87,500 88,87,500
Working Note:
1. Bank Balance = ` 2,80,000 + 6,60,000 + 480,000 – 1,41,7500 = ` 2,500
2. No. of Equity shares = ` 3,00,000 + 60,000 + 1,20,000 = ` 4,80,000

3. Balance in General Reserve = ` 24,91,500 – 3,97,500 – 7,50,000 = ` 13,44,000
Example 8: (Adjustment of Bonus into Final Call)

Abhijeet Co. Limited whose issued share capital on 31st March, 2006, consisted of 30,000; 7%
redeemable preference shares of ` 100 each fully paid up and 1,00,000 equity shares of ` 100 each,
` 80 paid up, decided to redeem the preference shares at a premium of 5%. The balance sheet of
the company as on 31st March, 2006 showed a general reserve of ` 45,00,000 and a capital reserve
of ` 5,10,000. The redemption was effected partly out of profits and partly out of the proceeds of
a fresh issue of 15,000 equity shares of ` 100 each at a premium of ` 30 per share.
On 1st May, 2006, the company at its general meeting resolved that all capital reserve will be
applied towards the declaration of bonus at the rate of ` 20 per share on equity shares, for the
purpose of making the said equity shares fully paid.
Pass the necessary journal entries to record the above mentioned transactions in the books of the
company.
Solution:
Abhijeet Co. Limited

Journal
Date Particulars ` `
7% Redeemable Preference Share Capital Dr. 30,00,000
Account
Premium on Redemption Account Dr. 1,50,000
To Preference Shareholders Account 31,50,000
(Being amount due to preference shareholder
on redemption)
(Being 15,000 equity shares issued of ` 100
each at premium)
Share Premium Account Dr. 1,50,000
To Premium on Redemption Account 1,50,000
(Being utilisation of share premium in
writing off the premium on redemption)
General Reserve Account Dr. 15,00,000 Contd...
To Capital Redemption Reserve Account 15,00,000
(Being utilisation of general reserve for
redemption of capital)
(Being payment made to preference
Equity Shares Find Call Account Dr. 20,00,000
(Being 15,000 equity shares issued of 100
each at premium)
Accounting for Companies-I Share Premium Account Dr. 1,50,000

To Premium on Redemption Account 1,50,000
(Being utilisation of share premium in
writing off the premium on redemption)
Notes General Reserve Account Dr. 15,00,000
(Being utilisation of general reserve for
redemption of capital)
(Being payment made to preference
Equity Shares Find Call Account Dr. 20,00,000
(Being final call of 20 each due on 1,00,000
equity shares)
Capital Reserve Account Dr. 5,10,000
Capital Redemption Reserve Account Dr. 14,90,000
To Bonus to Shareholders Account 20,00,000
(Being bonus declared to make fully paid up
shares)
Bonus to Share-holders Account Dr. 20,00,000
To Equity Shares Final Call Account 20,00,000
(Being adjustment of bonus in final call of
equity shares)
Self Assessment
Fill in the blanks:
10. The objective of .............................. is that there should be an equitable distribution of
shares and the holding of shares by each shareholder should not be affected by the issue of
new share.
11. The amount paid to acquire the .............................. should be added to the total market
value of the shares.
12. After the expiry of the .............................. in the notice from the shareholder to whom the
notice is served, the board of directors may dispose off the shares.
13. Calculating application money due on shares allotted to defaulters by multiplying the
shares allotted to defaulters the result is the excess ............... to adjust in allotment money.
State True or False:
14. Forfeited amount is transferred to the forfeited share account.
15. By virtue of this lien, the company has a prior right to the shares over any creditor to
whom they are given as a security for a loan.
3.6 Summary
 If a company has a reputation in the market, there is a possibility that shares applied for
would be more than what the company proposes to issue.
 In such a condition it is not possible for a company to allot shares to all the applicants;
therefore, the company rejects some applications altogether and allots in full to some
applicants
 If there is no provision to reissue the forfeited shares in the Articles of Association, Table
A of Companies Act confers the power upon them to do so.

3.7 Keywords Notes
Discount at Issues: The discount from par value at the time that a bond is issued.
Forfeiture of Shares: A share in a company that the owner loses (forfeits) by failing to meet the
purchase requirements.
Share Capital Account - Funds raised by issuing shares in return for cash or other considerations.

1. Explain in short reissue of shares?
2. What do you mean by Right Issue of Shares.
3. What is the meaning of forfeiture of shares? How are the shares forfeited? Can forfeited
shares be reissued at discount? If so, to what extent?
4. State the relevant provisions of the Companies Act regarding right issue in case of a public
company. How is the value of right computed?
5. What do you mean by forfeiture of shares? How are shares forfeited? Pass journal entries
regarding forfeiture and reissue of shares.
6. A Limited has a share capital of 10,00,000 divided into 10,000 equity shares of 100 each.
5,000 new shares of 100 each are issued to the existing shareholders at 140 per share in
such a way that the shareholder of every two old shares will get one share in this new
issue. The market value of one old share, on the commencement of the issue of right share,
becomes 200 cum-right. Find out the value of right included in market price.
7. X Co. Limited issued a prospectus for 20,000 shares of 10 each at a premium of 2 per
share payable as follows:
On application 2
On first call 3
Applications were received for 30,000 shares and allotment made pro-rata to the applicants
of 24,000 shares and remaining were rejected. Money overpaid on application was
employed on account of sums due on allotment.
Mr. Y, to whom 400 shares were allotted, failed to pay allotment money and on his
subsequent failure to pay the first call, his shares were forfeited. Mr. Z, the holder of 600
shares failed to pay two calls and his shares were forfeited after the second call.
Of the shares forfeited, 800 shares were sold to Mr. A credited as fully paid for 11 per
share the whole of Mr. Y’s share being included.
Show the journal, cash book and balance sheet.
8. A company was registered with a nominal capital of 1,60,00,000 in equity shares of 100
each. 50,000 of these shares were issued to the public at a premium of 20 per share
payable as to 20 on application, 45 on allotment including premium, 25 on first call
and the balance on final call.
Applications were received for 65,000 shares and allotment was made on the basis of pro-
rata to the applicants of 60,000 shares. Money over paid on application was utilised on
account of sums due on allotment.

Notes Prakash holding 1,000 shares paid the whole of the amount due on first call along with the
allotment but failed to pay the final call. Mr. Yeshpal holding 1,500 shares failed to pay the
two calls and Mr. Rane holding 2,000 shares failed to pay only the final call. All these
shares were forfeited after the final call.
Of the shares forfeited, 1,000 shares belonging to Mr. Yeshpal and 1,000 shares belonging
to Mr. Rane were sold to Mr. Rajheet Singh as fully paid for 90 per share.
Show the journal entries in the banks of company.
1. Articles of Association 2. forfeited

3. Share premium 4. True
5. False 6. True
7. False 8. Pro-rata
9. Reputation 10. Section 81
11. right share 12. Time specified
13. Application money


Sukhpreet Kaur, LPU Unit 4: Buy Back of Securities by Private Limited and Unlisted Public Limited Companies
Unit 4: Buy Back of Securities by Private Limited and Notes
Unlisted Public Limited Companies
CONTENTS
Objectives
Introduction
4.1 Meaning of Buy Back
4.2 Funds for Financing Buy Back
4.3 Circumstances where Buy Back is not Allowed
4.4 Escrow Account
4.5 Summary
4.6 Keywords
Objectives
 Explain the meaning of buy back
 Understand funds for financing buy back
 Define escrow Account
 Describe the issue of bonus shares
Introduction
Share capital is a very essential part of a company, listed or unlisted. Share capital can be of two
types i.e. equity share capital or preferential share capital. The share capital of a company has to
be subscribed by one or more persons. After the share of a company has been allotted to the
subscribing members, the subscribers have no right over the money gone as proceeds of the
shares subscribed. All that the shareholder has is the right to vote at the general meetings of the
company or the right to receive dividends or right to such other benefits which may have been
prescribed. The only option left with the shareholder in order to realise the price of the share is
to transfer the share to some other person.
But there are certain provisions in the companies act which allow the shareholders to sell their
shares directly to the company and such provisions are termed as buy back of shares. Buy back
of shares can be understood as the process by which a company buys its share back from its
shareholder or a resort a shareholder can take in order to sell the share back to the company.
4.1 Meaning of Buy Back
Buy back of securities simply implies purchase of its own shares by the Company. Till the issue
of these Rules, buy back of shares was prohibited under the law and by introducing section 77A
by Companies (Amendment) Act, 1999, effective from 31.10. 1998.

Notes The Company generally resorts to it for the following reasons:
1. to enhance the true or intrinsic value of its shares.
2. to return surplus cash to its shareholders.
3. to achieve desired capital structure.
!
Caution The buy-back of the shares or other specified securities, if listed on a stock exchange,
shall be carried out in accordance with the Regulations framed by the SEBI.
However, in the case of securities of unlisted companies, the buy-back shall be done as per the
guidelines framed by the Central Government.
Securities include:
1. shares, scrips, stocks, bonds, debentures, debentures stock or other marketable hybrid
securities of a like nature in or of any incorporated company or other body corporate;
2. derivative;
3. units or any other instruments issued by any collective investment scheme to the investors
in such schemes;
4. Government securities;
5. Such other instruments as may be declared by the Central Government to be securities:

(not so far) and
6. Rights or interest in such securities.

“Hybrid means any security which has the character of more than one type of securities,
including their derivatives”.
4.2 Funds for Financing Buy Back
A Company may buy back its own shares by utilising the money only out of the following
heads:
1. Free reserves;
2. The proceeds of any issue of shares or specified securities other than proceeds of an earlier
issue of the same kind of shares or same kind of specified securities which are proposed to
be bought back;
3. Cash reserves of the Company. However, the money borrowed from Banks/Financial
Institutions can not be utilised for the same.
Notes Free reserves mean those reserves which as per the latest audited Balance Sheet are
free for distribution of dividend and shall include the amount to the credit of securities
premium account and balance kept in the Profit and Loss Account. The share application
amount and revaluation reserve will not form part of free reserve.

Unit 4: Buy Back of Securities by Private Limited and Unlisted Public Limited Companies
Conditions to be fulfilled before buy back Notes
Section 77A(2) provides that no Company shall purchase its own shares unless the following
conditions are met:
(a) There must be a specific provision in the Articles of Association authorising the Company
to buy back its own shares, otherwise the Articles must be amended by a special resolution
to incorporate a suitable provision. Special resolution must also be passed in the General
Meeting authorising Board of Directors to buy-back the shares of the Company or other
specified securities. However no special resolution in General Meeting is required in case
the buy-back is of or less than 10% of the total paid up equity capital and free reserves of
the Company and the same is authorised by way of a resolution passed at a duly convened
Board Meeting.
(b) The quantum of buy back could be upto 25% of paid up capital and free reserves provided
the buy back of the equity shares in any financial year shall not exceed 25% of its total paid
up equity capital in that financial year.
(c) The company shall after the buy-back ensure that the debt of the Company viz., the
amount of secured and unsecured debts shall not be more than twice the paid up capital
and free reserves. It is open, however, for the Central Government to prescribe a higher
ratio of debt for any class or classes of Companies.
(d) All the shares or other specified securities involved in buy-back must be fully paid-up.
(e) The explanatory statement sent to members along with the notice for passing the special
resolution referred to in clause (a) above shall, inter-alia, set out the following particulars:
(i) A full and complete disclosure of all material facts ;
(ii) The necessity for the buy-back ;
(iii) The class of security proposed to be bought back ;
(iv) The amount involved in the buy-back ;
(v) An indication of time limit for completion of buy-back. In any case, the buy-back
should be completed within 12 months from the date of passing the special resolution.
(f) The Company shall make no offer of buy-back within a period of 365 days reckoned from
the date of the preceding offer of buy-back, if any. Further the Company cannot come out
with a fresh issue of shares of the same class within a period of 6 months except by way of
bonus issue or in the discharge of subsisting obligations such as conversion of warrants,
Stock options schemes, sweat equity or conversion of preference shares or debentures into
equity shares.
Manner of making buy-back
The buy-back may be made as follows:
(a) From the existing shareholder holders on a proportionate basis through private offers.
(b) By purchasing the securities issued to employees of the Company pursuant to a scheme of
stock option or sweat equity.
The buy-back under sub-section (1) may be:
(a) from the existing security-holders on a proportionate basis;
(b) from the open market

Notes (c) from odd lots, that is to say, where the lot of securities of a public company, whose shares
are listed on a recognised stock exchange, is smaller than such marketable lot, as may be
specified by the stock exchange
(d) by purchasing the securities issued to employees of the company pursuant to scheme of
Self Assessment
Fill in the blanks:
1. ........................ of securities simply implies purchase of its own shares by the Company.
2. ........................ means any security which has the character of more than one type of securities,
including their derivatives.
3. The buy-back of the shares or other specified securities, if listed on a stock exchange, shall
be carried out in accordance with the Regulations framed by the .................................
True or False:
4. The quantum of buy back could be upto 25% of paid up capital.
5. The Company shall make no offer of buy-back within a period of 365 days reckoned from
the date of the preceding offer of buy-back.
4.3 Circumstances where Buy Back is not allowed
No Company shall directly or indirectly purchase its own shares:
(Section 77 B)
 Through any subsidiary Company or its own subsidiaries if any;
 Through any investment Company or companies;
 If the Company commits a default in the repayment of deposit or payment of interest,

redemption of debentures or preference shares or payment of dividend to any shareholder
or repayment of term loans or payment of interest to any financial institution which is
subsisting;
The idea seems to be to stop accumulation of its shares by indirect means.
 Where a Company has not complied with the provisions of sections:
 159 regarding Annual Return
 207 regarding failure to pay dividend within 30 days of declaration; and
 211 regarding disclosure of true and fair view in the Balance Sheet. Section 211(3A)
requires that every company’s profit & Loss account and balance sheet shall comply
with the accounting standards.
There should be no subsisting default by the Company in payment of:
1. any deposit or interest due thereon
2. redemption of debentures or preference shares
3. payment of dividend
4. any term loan or interest thereon to any financial institution or bank.

Securities not purchasable Notes
(a) partly-paid securities
(b) securities which are subject to lock-in period or otherwise non-transferable.
(c) Securities held by promoters or persons in control of the company, if the buy-back is
through stock exchange.
Procedural formalities
The process of Buy-back, inter-alia, includes the following steps to be taken up by the Company:
1. A Board resolution should be passed at a duly convened Board meeting authorising buy-
back and approving the draft notice for convening Extraordinary General Meeting to pass
the necessary resolution(s) and amending Articles of Association, if required.
2. Notice convening EGM should be sent to each and every shareholder entitled to receive
and attend the general meeting along with an explanatory statement containing prescribed
particulars.
3. Necessary resolution(s) should be passed at the Extraordinary General Meeting of the

members of the Company authorising the Company to buy-back its own shares/securities
and amending Articles of Association, if required.
4. As soon as the Company has passed the special resolution for buy-back and before making
the buy-back, the Company shall file with the Registrar of Companies the following
forms/documents:
(i) Form No. 23 pursuant to Section 192 of the Act.
(ii) Declaration of Solvency in Form No. 4A signed by two directors including the
Managing Director, if any of the Company and duly verified by way of an affidavit.
(iii) A draft letter of Offer containing prescribed particulars. On filing of the same the
offer becomes irrevocable on the part of the Company.
5. Letter of offer, shall be sent to the shareholders of the Company, within 21 days of filing
of draft letter of offer with the ROC.
6. The letter of offer should contain inter alia the following:
(i) true factual and material information;
(ii) no misleading information;
(iii) a statement that the directors of the company accept the responsibility for the
information contained in it.
7. No shares including bonus shares shall be issued till the date of the closure of the offer of
buy-back of shares.
8. Confirm in the letter of offer the opening of a separate bank account testifying the
availability of funds earmarked for it and also about payment of consideration only by
way of cash or Bank Draft/pay order.
9. Once the draft letter of offer has been filed with the Registrar of Companies, it shall not be
withdrawn.
10. Any money borrowed from Banks/Financial Institutions shall not be used for the purpose
of buying back the company’s shares.
11. The offer should remain open for a period not less than 15 days and not exceeding 30 days
from the date of despatch of letter of offer.

Notes 12. The Company shall complete the verification of the offers received from the shareholders
within 15 days from the date of closure of offer and the shares lodged shall be deemed to
be accepted unless shareholders are communicated otherwise within 21 days from the
closure of the offer.
13. In case of the number of shares offered by the shareholders is more than the total number
of shares to be brought back by the company, see that the acceptance per shareholder is
made on proportionate basis.
14. The Company should make arrangement to ensure that payment is made to the
shareholders within 7 days of the time specified in clause 12, supra, by opening a special
bank account, immediately after the closure of offer.
15. The share certificates should be extinguished and physically destroyed by the Company
within 7 days of acceptance of shares. And a certificate to this effect shall be filed with ROC
duly verified by two whole time directors including Managing Director, if any and a
Company Secretary in whole time Practice within 7 days of the extinguishment and
destruction of share certificates.
16. As soon as the buy-back is complete the Company shall file with the Registrar of Companies
within 30 days of such completion a return containing prescribed particulars called return
of buy-back.
17. The Company should maintain a Register of Shares Bought Back by the Company in the
prescribed form.
Self Assessment
Fill in the blanks:
6. The money borrowed from ............................... cannot be utilized for the buy back.
7. There must be a specific provision in the ............................... authorizing the Company to

buy back its own shares.
4.4 Escrow Account

Deposit in an escrow account, on or before the opening of the offer the following sum by way
of security for performances of obligations by the company under the Regulations:
(a) if the consideration payable does not exceed 100 crores; 25% of the consideration payable;
(b) if the consideration payable exceeds 100 crores; 25% on 100 crores and 10% thereafter.
Mode of Payment to Escrow Account
The escrow account can consist of either cash deposited with a scheduled commercial bank or
bank guarantee in favour of a merchant banker or deposit of acceptable securities with appropriate
margin with the merchant banker or a combination of the above.
Did u know? If the company has deposited the specified sum in an escrow account with a
scheduled commercial bank then while opening the account, empower the Merchant
banker to instruct the Bank to issue a Banker’s cheque or Demand Draft for the amount
lying to the credit of the escrow account.

If the escrow account consist of a bank guarantee, the said bank guarantee shall be in favour of Notes
the merchant banker which will be valid until thirty days after the closure of the offer. If the
escrow account consist of securities, then empower the merchant banker to realize the value of
such escrow account by sale or otherwise.
Opening Special Account
A special account has to be opened with the bankers , immediately after the date of closure of the
offer and deposit therein such sum due as would together with the amount lying in the escrow
account make up the entire sum due and payable as consideration for buy-back in terms of
Regulations and for this purpose the company may transfer the funds from the escrow account.
Make payment of consideration in cash, within 21 days from the closure of the offer, to those
shareholders whose offer has been accepted.
Extinguishment of Share Certificates bought back
The certificates of shares bought back by the company must be extinguished and physically
destroyed in the presence of a Company secretary or the Statutory Auditor of the company
within seven days from the date of acceptance of the shares.
In case the shares offered for buy-back by the company have already been dematerialized then
extinguish and destroy them in the manner specified under Securities and Exchange Board of
India (Depositories and Participants) Regulations, 1996 and the bye-laws framed therein.
The company has to furnish to the stock exchanges where shares of the company are listed, the
particulars of shares certificates extinguished and destroyed within seven days of such
extinguishment and destruction of the certificates.
Transfer to capital redemption reserve account
Where a company purchases it own shares out of free reserves, then a sum equal to the nominal
value of the shares purchased shall be transferred to the Capital Redemption Reserve (referred
to in section 80(1) clause (d) & proviso) Account and details of such transfer will be shown in the
balance sheet. (Sec.77 AA)
Effect of buy-back on Earning per share
Whenever a Company resorts to buy-back, the basic idea underlying is that its own shares
represent the best investment opportunity available. Thus those who continue to hold the
shares of the Company find that their percentage of holding goes up because as a result of buy-
back the total number of outstanding shares, reduced. Further the Earning per share also goes up
because the cake is now divided among fewer people. Thus the value of shareholders holding
goes up without making any additional investment.
Section 2(22) of Income Tax Act, 1961 ( as amended ) defines as “Dividend” includes inter alia:
(a) any distribution by a company of accumulated profits, whether capitalised or not, if such
distribution entails to release by the company to its shareholders of all or any part of the
assets of the company.
(b) any distribution to its shareholders by a company of debentures etc., whether with or
without interest.

Notes (c) Any distribution made to shareholders of a company on its liquidation, to the extent to
which it is attributable to the accumulated profits of the company.
(d) Any distribution to its shareholders on the reduction of its capital. to the extent to which
the Company possess accumulated profits whether capitalised or not.
But “dividend” does not include:
As per section 22 (iv) of the Act (as amended), any payment made by a company on purchase of
its own shares from a shareholder in accordance with the provisions of section 77A of the
Companies Act, 1956. Thus buy back of shares and securities does not tantamount to distribution
of dividend to shareholders.
Tax on distributed profits of domestic companies
Section 115-O of the Act says that, in addition to the income-tax chargeable in respect of the total
income of a domestic company for any assessment year, any amount declared, distributed or
paid by such company by way of dividends on or after the 1st April, 2003, whether out of current
or accumulated profits shall be charged to additional income-tax at the rate of twelve and one-
half per cent.
The Principle officer of the company shall be liable to pay the tax on distributed profits to the
credit of the Central Government within fourteen days from the date of:
(a) declaration of any dividend
(b) distribution of any dividend
(c) payment of any dividend
whichever is earliest
As regards expenses incurred in the buy back process, judicial pronouncements are not clear
with some holding that expenses are of revenue nature whereas others have advocated as capital
nature. In fact, it is for the Company to present its stand about the usefulness of the buy back and
claim the expenses as they deem best in their interest.
Once the buy back process is complete, the shares are cancelled. Buy back does not result into a
transfer and hence, no stamp duty if payable. It is neither a transfer nor a release as per Indian
Stamp Act.
The accounting entry is
(i) In case investment are sold for buying back of own shares:
Bank Dr
To Investment Account
(The difference if any will be credited to Profit on sale of Investment Account or debited to
Loss on sale of Investment Account, which in turn will be transferred to profit & loss
account)
(ii) In case the proceeds of fresh issues are used for buy-back purpose, then on fresh issue.
Bank Dr
To Debentures/other Investments Account
To Securities Premium Account (if any)

(iii) For buying back of shares: Notes
Equity Shareholder’s Account Dr
To Bank
(iv) For cancellation of shares bought back:
Equity Share Capital Account Dr (with the nominal value of shares bought Back)
Free Reserves/Securities Premium Account Dr (with the excess amount/premium Paid

over nominal value)
To Equity Shareholder’s Account (with the amount paid)
(v) In case the shares are bought back at a discount:
Equity Share Capital Account Dr (with the nominal vale)
To Equity Shareholders’ Account (with the amount paid)
To Capital Reserve Account (with the amount of discount on buy-back
For transfer of nominal value of shares purchased out of free reserves/securities premium
to Capital Redemption Reserve Account:
Free Reserves Account Dr (with the amount transferred)
Securities premium Account Dr (with the amount transferred)
To Capital Redemption Reserve Account (with the nominal value of shares bought back)
(vi) For expenses incurred in buy-back of shares:
Buy-back Expenses Dr (with the amount)
To Bank
(vii) For transfer of buy-back expenses:
Profit & Loss Account Dr
To Buy-back Expenses
The expenses incurred on the buy back formalities, e.g. Fees of advisers, filing fees, merchant
bankers, cost of paper announcements etc. If these expenses are set off against the current Profit
& Loss Account of the Company, it would help in claiming these expenses as revenue items for
tax deduction purpose. Another alternative is to amortise over a period of 5 years this expenses
and carry forward the expenditure in the Balance Sheet as a deferred revenue expenditure till it
is fully written off.
Thus buy-back is a procedure, which enables the Company to go back to its shareholders and
offer to purchase from them the shares that they hold. The decision to buy-back reflects
management’s view that the Company’s future prospects are good and hence investing in its
own shares is the best option. It also signals undervaluation of the Company’s shares in relation
to its intrinsic value. It appears that only financially sound companies should be able to resort to
buy-back. Companies should follow the principles of model corporate governance and there
should be transparency in buy-back deals.
The best example of such a buyback in the Indian context was the buyback of shares undertaken
by the Great Eastern Shipping Company (GESCO) to protect itself from a hostile takeover bid
led by the A H Dalmia group. In October 2000, the A H Dalmia group of Delhi made a hostile bid

Notes for a 45 per cent stake in the Great Eastern Shipping Company (GESCO) at 27 a share. The price
offered was less than half the book value of the company. The offer and counter offers made by
the A H Dalmia group and the promoters of GESCO pushed up the bidding cost. The A H Dalmia
group ultimately sold its 10.5% stake (around 3 million shares) at 54 per share for a consideration
of 163 million before the year end. The A H Dalmia group had acquired the 10.5% stake in
Gesco at an average cost of 24 per share for a consideration of 72 million. Hence, the A H
Dalmia group was able to make a profit of 91 million through green mail transaction in less
than 6 months.
Companies can also use the book building process to buy back shares. The book building
process is a mechanism of price discovery which helps determine market price of securities. If
the book building option is used, a draft prospectus has to be filed with SEBI. The prospectus
should contain all the details of the offer, except the price at which the securities will be offered
(a price band is specified). The copy of the draft prospectus is filed with SEBI and is circulated
among institutional buyers by a leading merchant banker acting as the book runner. Institutional
investors specify the price as well as the volume of shares they intend to buy. The book runner,
on receiving the above information, determines the price at which the offer is to be made to the
public.
Self Assessment
Fill in the blanks:
8. The .......................... can consist of either cash deposited with a scheduled commercial bank.
9. Where a company purchases it own shares out of free reserves, then a sum equal to the
nominal value of the shares purchased shall be transferred to the ................................
State True or False:
10. Notice convening EGM should be sent to each and every shareholder entitled to receive
and attend the general meeting along with an explanatory statement.
11. If the escrow account consists of a bank guarantee, the said bank guarantee shall be in
favour of the merchant banker.
12. There must be a specific provision in the Articles of Association authorising the Company
to buy back its own shares.
Problem 1: K Ltd. furnishes you with the following Balance Sheet as at 31st March, 2009:
( in crores)
Sources of Funds
Share capital:
Authorised 100
Issued:
12% redeemable preference shares of 100 each fully paid 75
Equity shares of 10 each fully paid 25 100
Reserves and surplus
Capital Reserve 15
Securities Premium 25
Revenue Reserves 260 300
400
Funds employed in : Contd...
Fixed assets : cost 100

Less: Provision for depreciation 100 nil
Investments at cost (Market value 400 cr.) 100
Current assets 340
Less : Current liabilities 40 300
400
12% redeemable preference shares of ` 100 each fully paid 75
Equity shares of ` 10 each fully paid 25 100
Capital Reserve 15
Securities Premium Unit 4: Buy Back of Securities by Private Limited
25 and Unlisted Public Limited Companies
Revenue Reserves 260 300
400
Funds employed in : Notes
Fixed assets : cost 100
Less: Provision for depreciation 100 nil
Investments at cost (Market value ` 400 cr.) 100
Current assets 340
Less : Current liabilities 40 300
400
The company redeemed preference shares on 1 st April 2009. It also bought back 50 lakh equity
shares of ` 10 each at ` 50 share. The payments for the above were made out of the huge bank
balances, which appeared as a part of Current assets.
You are asked to:
i. Pass journal entries to record the above
ii. Prepare Balance Sheet
iii. Value equity share on net asset basis.
Solution:
Part-I: Journal entries in the books of K Ltd.

(` in crore)
Particulars Debit Credit
a. Redemption of Preference Shares on 1st April 2009
(i) Due Entry
12% Preference Share capital A/c Dr. 75
To Preference Share Hodlers A/c 75
(ii) Payment Entry
Preference Shareholders A/c Dr. 75
To Bank A/c 75
b. Shares bought back
(i) On buy back
Shares bought back A/c Dr. 25
To Bank A/c 25
(50 lakhs shares ` 50 per share)
(ii) On Cancellation
Equity Share capital A/c (50 Lakhs ` 10) Dr. 5
Securities premium A/c (50 Lakhs ` 40) Dr. 20
To Shares bought back A/c 25
(iii) Transfer to Capital Redemption Reserve
Revenue reserve A/c Dr. 80
To Capital Redemption Reserve A/c 80
(Being creation of capital redemption reserve to the
extent of the face value of preference shares redeemed
and equity shares bought back)

Notes Part-II: Balance Sheet of K Ltd after reconstruction:
Balance Sheet of K Ltd as at 1.4.2009
Liabilities Assets
Share capital Fixed assets
Authorised Cost:
Issued, subscribed and paid up Less : Provision for 100
equity shares of 200 lakhs of 10 20 Depreciation (100) Nil
each
Investment at Cost
12% Redeemable preference shares (Market Value of 100
were redeemed at par. Investments =
400 crores)
Capital Redemption Reserve 80 redemption and buy (100) 240
back
340 340
Part-III: Net Asset Value of Equity Shares
( in crores)
a. (i) Fixed assets
(ii) Investments (at market value) Nil 400
(iii) Current assets 240 640
b. Less : Current liabilities (40)
Net assets available for equity share holders 600
c. No. of equity shares outstanding (in lakhs) 2
d. Value per equity share of 10 each = (600÷2) 300
Problem 2: The following was the balance sheet of Diamond Ltd. as at 31st March, 2009.
Liabilities in lakhs
10% Redeemable Preference Shares of 10 each, fully paid up 2,500
Equity Shares of 10 each fully paid up 8,000
Capital Redemption Reserve 1,000
Securities Premium 800
General Reserve 6,000
Profit and Loss Account 300
9% Debentures 5,000
Sundry creditors 2,300
Sundry Provisions 1,000
26,900
Assets in lakhs
Fixed assets 14,000
Investments 3,000
Cash at Bank 1,650
Other Current assets 8,250
26,900

On 1st April, 2009 the company redeemed all of its preference shares at a premium of 10% and Notes
bought back 25% of its equity shares @ 20 per share. In order to make cash available, the
company sold all the investments for 3, 150 lakh and raised a bank loan amounting to 2,000
lakhs on the security of the company’s plant.
Pass journal entries for all the above mentioned transactions including cash transactions and
prepare the company’s balance sheet immediately thereafter. The amount of securities premium
has been utilized to the maximum extent allowed by law.
Solution:
Journal Entries
Particulars Debit Credit

Bank A/c Dr. 3,150
To Investment A/c
To Profit and Loss A/c 3,000
(Being sale of investments and profit thereon) 150
Bank A/c Dr. 2,000
To Bank Loan A/c 2,000
(Being loan taken from bank)
10% Redeemable preference Share Capital A/c Dr. 2,500
Premium on redemption of preference shareholder Dr. 200
A/c 2,750
To Preference shareholder A/c
(Being redemption of preference shares)
Preference shareholders A/c Dr. 2,750
To Bank A/c 2,750
(Being payment of amount due to preference
shareholders)
Securities premium A/c Dr. 250
To Premium on redemption of preference Dr.
share A/c 250
(Being use of securities premium to provide premium
on redemption of preference shares)
Equity Share capital A/c Dr. 2,000
Securities premium A/c [800 - 250] Dr. 550
General reserves A/c Dr. 1,450
[(200x20) - 2000 - 550] 4,000
To Equity shareholders A/c
(being buy back of equity shares)
Note: Balance of General Reserve
[6000 - 1450] = 4550.
General Reserves A/ c Dr. 4,500
To Capital Redemption Reserve A/c (2000 + 4,500
2500)
extent of the face value of preference share redeemed
and equity shares bought back).
Note: Balance in General reserve as on 01.04.09 Contd...
(4550 - 4500) = 50.
Equity shareholders A/c Dr. 4,000
To Bank A/c 4,000
(Being payment of amount due to equity
shareholders).
Note: Cash at Bank
[1650+3150+2000-2750-4000] = 50
(being buy back of equity shares)
Note: Balance of General Reserve
[6000 - 1450] = 4550.
General Reserves A/ c Dr. 4,500
To Capital Redemption Reserve A/c (2000 + 4,500
Accounting for Companies-I 2500)
extent of the face value of preference share redeemed
and equity shares bought back).
Notes Note: Balance in General reserve as on 01.04.09
(4550 - 4500) = 50.
Equity shareholders A/c Dr. 4,000
To Bank A/c 4,000
(Being payment of amount due to equity
shareholders).
Note: Cash at Bank
[1650+3150+2000-2750-4000] = 50
Balance Sheet of Diamond Ltd. as on 01.04.09
Liabilities Assets
Issued, subscribed and paid up 6,000 Current asset, Loans and 14,000
equity shares of 10 each Advances
Capital Redemption Reserve 5,500 Cash at Bank 50
(1000 + 4500) Other Current assets 8,250
General Reserves 50
Profit and Loss A/c (300+ 150) 450
Secured Loans
9% Debentures 5,000
Bank Loan 2,000
Current liabilities and Provisions
Sundry creditors 2,300
Provisions 1,000
Total 22,300 Total 22,300
Problem 3: XYZ Ltd. has the following capital structure as on 31st March 2009.
Particulars in crores
Equity Share capital (Shares of 10 each) 300
Reserves :
General Reserve 270
Security Premium 100
Profit and Loss A/c 50
Export Reserve (Statutory reserve) 80
Loan Funds 800
The shareholders have on recommendation of Board of Directors approved vide special resolution
at their meeting on 10th April 2009 a proposal to buy back maximum permissible equity shares
considering the huge cash surplus following A/c of one of its divisions.
The market price was hovering in the range of 25 and in order to induce existing shareholders
to offer their shares for buy back, it was decided to offer a price of 20% above market.
Advice the company on maximum number of shares that can be bought back and record journal
entries for the same assuming the buy back has been completed in full within the next 3 months.
If borrowed funds were 1200 lakhs, and 1500 lakhs respectively would your answer change?
Maximum shares that can be bought back:

Situation I Situation II Situation III Notes
Shares outstanding test (WN # 1) 7.5 7.5 7.5

Resources test (WN # 2) 6 6 6
Debt Equity ratio test (WN # 3) 10.67 4
Maximum number of shares for 6 4
buy back - LEAST of the above
Situation I Situation II
Particulars
Debit Credit Debit Credit
Shares bought back A/c Dr. 180 120 120
To Bank A/c 180
[Being purchase of shares from
public]
Share capital A/c Dr. 60 40
Securities premium A/c Dr. 100 80
Dr.
General reserve A/c (balancing 20
figure) 180
To Shares bought back A/c 120
[Being cancellation of shares bought
on buy back]
General Reserves A/c To Capital
Redemption Reserve A/c
[Being transfer of reserves to capital
redemption reserve to the extent
capital is redeemed]
Notes Under situation III, the company does not qualify the debt equity ratio test. Therefore
the company cannot perform the buy back of shares (Under section 77A of the Companies
Act, 1956)
Working Notes:
WN # 1: Shares outstanding test
Particulars Amount
No. of shares outstanding 30 crores
25% of shares outstanding 7.5 crores
WN # 2: Resources test
Particulars ( in Crores) Amount

Paid up capital 300
Free reserves 420
Shareholders fund (a + b) 720
25% of shareholders fund 180
Buyback price per share 30
Number of shares that can be bought back 6 Crore

Notes WN # 3: Debt Equity ratio test:
( in crores)
Particulars Situation I Situation II Situation III
Borrowed Funds 800 1,200 1,500
Minimum equity to be 400 600 750
maintained after buy back in the
ratio 2 : 1
Present equity 720 720 –720
Maximum possible dilution in 320 120 –
equity
Maximum shares that can be 10.67 4 –
bought back @ 30/- per share
Self Assessment
Fill in the blanks:

13. The amount of profit that is distributed to the shareholders in addition to dividend is
called .........................
14. This bonus can be distributed in the form of cash, portly paid up shares or fully paid up
shares to the .........................
15. Bonus is generally not paid in .........................

Case Study Minority Share Buyback
T
his case study is based on the experience of a business owner who owned 70 percent
of his business. The balance was owned by two individuals, one of whom owned 20
percent and was causing much difficulty. The controlling shareholder wished to
reacquire the shares of the troublesome stockholder, whose interest was valued at $200,000.
But after working through the numbers, the business owner decided that the cost to the
company would be too great. He decided to simply live with the troublesome minority
shareholder.
Corporate stock redemptions are considered by company owners principally for the
following reasons:
1. Peace: To silence a troublesome minority stockholder.
2. Obligation: For example, one of your executives is leaving the company and he or

she has the legal right to require the company to buy the stock he or she purchased
previously under a stock option plan.
3. Mandated Buyout: When a court of law orders the company to buy out a minority
owner’s shares.
4. Investment: Management might cause the company to buy the stock from willing
sellers because they think it will provide a fair return on investment and raise the
value of the shares that remain.
Contd...

5. Stay below the 500-shareholder threshold. Private firms that have 500 or more Notes
shareholders can be required to make public filings similar to public companies.
As principal owner of your business, you have to be concerned with any corporate stock
redemption, for the following reasons:
 Many states restrict or prohibit the purchase of stock by the company from its
stockholders, principally depending on the availability of cash and capital surplus
within the company to effect the stock repurchase. Basically, you cannot “impair”
the capital account and solvency of the business by repurchasing “equity” securities.
 Other stockholders may complain because of the effect on the corporation,

particularly its balance sheet. The operating agreement of the company may also
require that such a transaction be approved by some percentage of the shareholders.
 You may be accused of unfair dealing if you don’t offer all owners the right to sell
their stock back to the company at the same time, price and terms.
 Your creditors may object since the stockholders’ equity account drops after a
redemption. For this reason, most loan agreements prohibit or restrict a company’s
repurchase of equity shares or interest.
 You may be sued by the selling stockholder if you know of certain facts that affect
the value of the stock and these facts are unknown to the seller (material insider
information) at the time of the stock repurchase.
Effect on the Company
Below is a description of the subject business owner’s analysis, with explanatory remarks.
Note that this approach can be applied to companies with other forms of ownership,
including S-corporations, partnerships and limited liability corporations (LLCs). Let’s
start with the stockholders’ equity account, in which there are 100,000 shares of common
stock outstanding.
Stockholders’ Equity Account
Common Stock – $1 par:
100,000 Shares Outstanding $100,000
Capital Surplus $120,000
Retained Earnings $280,000
Total Stockholders’ Equity $500,000
Book Value per Share $5.00
Net Income $75,000
Earnings per Share $0.75
Let’s also assume that total company debt is $1 million and that of the 100,000 shares
outstanding, 20,000 shares are being acquired by the company (20 percent of the outstanding
common stock). The agreed-on purchase price is $10 per share (two times the company’s
$5 book value per share), which represents a $200,000 total purchase price. Based on these
facts, here’s the result:
 Corporate cash declines by $200,000 (20,000 shares times $10).

Contd...

Notes  Stockholders’ equity decreases from $500,000 to $300,000 — a reduction of 40 percent.
 Leverage increases from 200 percent ($1 million total debt divided by $500,000
equity) to 333 percent ($1 million debt divided by $300,000 equity). This assumes
that no additional capital was borrowed to finance the stock repurchase. If that were
necessary, the debt-to-equity ratio would have risen even higher.
Effect on Remaining Owners
The remaining stockholders increase their ownership percentages. Since 20,000 shares are
in treasury, a stockholder owning 10,000 of the remaining 80,000 shares will now own 12.5
percent of the corporation (10,000 shares divided by 80,000). Before the purchase, this
stockholder owned 10 percent (10,000 shares divided by 100,000). The percentage ownership
position of all stockholders will increase by 25 percent.
Book value per share declines from $5 to $3.75–$300,000 pro forma (after repurchase)
stockholders’ equity position divided by 80,000 shares. The proforma decline in book
value occurs because the buy-back price of $10 per share was double the previous book
value per share of $5 ($500,000 stockholders’ equity divided by 100,000 shares). That’s why
other minority stockholders may not be in favor of the transaction – unless they also are
given the right to sell shares back to the company on the same terms.
Based on last year’s net income of $75,000, earnings per share would increase from $0.75 to
$0.94 ($75,000 net income divided by 80,000 shares). But note that if debt is used to finance
the stock purchase, pretax income (and net income) should be adjusted downward to
reflect the resulting interest expense. Company cash is being used for nonproductive
purposes. This may significantly impact the company’s future growth and its profitability
and, as explained below, can negatively impact the company’s borrowing ability.
Finally, the tax basis of each share of stock owned by the remaining shareholders remains
unchanged despite the fact that the value of each share has risen due to the lower number
of shares outstanding. When the remaining shareholders sell their shares, as if the entire
company were sold, the taxable gain will be greater than it would have been had the
buyout of the 20 percent owner been effected by a direct purchase from the shareholders.
Such a purchase would have required the shareholders to use personal funds to effect the
purchase, but a step-up in the basis of the stock would have occurred and the tax owed in
a subsequent sale would be less.
Effect on Company’s Value
Since $200,000 is purchasing 20 percent of this company, the value placed on the business
is $1 million ($200,000 divided by .20). In terms of fundamental valuation methods, this $1
million value represents:
 A price-earnings multiple (P/E) of 13.3 times last year’s net income of $75,000.
 2.0 times stockholders’ equity of $500,000 before the stock repurchase.
 3.3 times stockholders’ equity of $300,000 after the stock repurchase.
This value analysis is presented to give you additional information to help you in deciding
whether or not to effect the buyout. You also will have to determine the value of the
company going forward. For example, if this company were projecting net income of
$150,000 next year, the $1 million value would represent a P/E multiple of only 6.7. This
alone could justify the stock repurchase, particularly if the company’s growth continues
on course.
Contd...

Access to Capital Notes
The company redemption/purchase of common stock also has dramatic effects on the
company’s creditors, who now have a lower stockholders’ equity account under their debt
position, and a debt-to-equity ratio of 3.3 to 1 ($1 million debt divided by $300,000
stockholders’ equity). In addition, the company’s future borrowing capacity is substantially
lower. Thus, if you are going to redeem any stock, be sure your overall cash position (today
and projected) is more than adequate to finance growth and contractual debt repayments.
What If You, the Owner, Are the Seller?
If you are the owner and your common stock is being purchased by the company,
read ”Owner Stock Repurchase Tax Traps”. Proceeds of your sale could be taxed to you at
ordinary income rates rather than capital gain rates unless you completely sever your
relationship with the company. Also, for liability reasons, make sure that the:
 Stock redemption price is at fair market value as established by an independent

appraiser.
 Shares are purchased by the company on an arm’s-length basis.
 Acquisition price and terms don’t discriminate against other stockholders.
 Tax impact of the sale/purchase on both you and the company has been reviewed by
your accountant.
4.5 Summary
 Buy back can be made From the existing shareholder holders on a proportionate basis
through private offers.
 By purchasing the securities issued to employees of the Company pursuant to a scheme of
 Bonus can be distributed in the form of cash, portly paid up shares or fully paid up shares to
the shareholders. Bonus is generally not paid in cash. If it is paid in cash, the working capital
of the company will be adversely affected. Mostly companies use this amount to make up
the existing partly paid up shares as fully paid. This is called Bonus Issue or Bonus Shares
4.6 Keywords
Buy-Back: To buy that is previously sold.

Free Reserves: Difference between borrowed reserves and excess reserves.
Subsidiary Company: Company that is completely controlled by another company.
1. Write a note on funds for financing buy back.

2. Explain the circumstances where buy back is not allowed.
3. Write a note on manner of making buy back.
4. Mohan Limited has an authorised capital of 40,000 in equity shares of 10 each. The
issued capital of the company is 24,000 divided into shares of 10 each, with 8 per share
called and paid. A sum of 12,300 was capitalised out of reserve fund and out of amount so

Notes capitalised, the directors were so authorised to: (a) declare a bonus dividend to make the
shares fully paid; (b) to issue 600 new equity shares of 10 each at a premium of 2.50 per
share on the basis of one equity share for every four equity shares held. Assuming that
Mohan Ltd. has passed the resolution for this purpose, pass the necessary journal entries in
its books.
5. The share capital of ABC Ltd. consists 40,000 shares of 100 each, 75 called up and paid.
It has 20,00,000 in general reserve. The directors recommended the following with a
view to capitalise the reserve:
(a) The existing shares to made fully paid without the shareholders having to pay
anything.
(b) Each shareholder to be given (proportionate to his holdings) bonus to the remaining
amount, the shares to be valued at 125. Assuming that the recommendation is
accepted and all legal formalities are completed. Pass journal entries and state in
what proportion bonus shares will be distributed among the shareholders.
A company having sufficient balance to the credit of Profit and Loss Account decided as
under:
(a) To redeem 6%, 16,000 redeemable preference shares of 10 each, fully paid at a
premium of 1 share.
(b) To apply the resultant reserve fund in paying the unissued shares of the company
distributed as fully paid equity shares of 10 each by way of bonus to its members.
Show the journal entries required to record the redemption and the bonus issue.
6. Ajanta Trading Co. Limited has an authorised capital of 8,00,000 divided into:
10,000; 6% redeemable preference shares of 10 each.
20,000; 7% preference shares of 100 each and 50,000 equity shares of 100 each.
On January 1, 2006 the whole of the two classes of preference shares and 15,000 of equity
shares stood in the books as fully paid. The share premium account as on that date showed
a balance of 20,000. The balance of profit was 32,000.
On July 1, 2006 it was decided to redeem the whole of 6% preference shares at a premium
of 1 per share and for this specific purpose the company issued for cash 8,000 equity
shares of 10 each at a premium of 2 per share, payable in full on allotment. All the
above shares were taken up. The cost of issue of shares amounted to 3,000.
On October 1, 2006 the company issued to the existing shareholders one bonus share of
10 each fully paid for each five held. It is the intension of the directors that minimum
reduction should be in revenue reserve account which starts at 125,000.
Give necessary journal entries.
7. On January 1, 1975 Shibpur Motors Ltd. issued 3,000, 7% redeemable preference shares of
10 each, all of which were taken on and fully paid. The shares were issued on condition
that the same at any time after March 31, 1981 could be redeemed at a premium of 4 per
share.
On June 30, 1982, the company decided to redeem the shares. For this purpose it issued
1,800, 6% preference shares of 10 each at a premium of 1 per share on July 15, 1982. The
shares were subscribed and paid for by July 31, 1982. The 7% redeemable preference shares
were redeemed at the same date.

The company had a balance of 28,000 in its Profit and Loss Account on 1st September, Notes
1982 the company decided to issue 5,000 fully paid bonus shares of 10 each for allotment
to equity share-holders in the ratio of one equity share for every four shares hold. It has
also a reserve of 1,10,000.
Record the necessary journal entries in the books of the company.
8. The balance sheet of P.Q. Limited on 31st December 2006 was as under:
Liabilities Assets
8% Redeemable Preference Shares of
9,00,000 Fixed Assets 20,00,000
100 each fully paid.
Current Assets 3,80,000
Investment 2,70,000
Bank 2,00,000
Equity Shares of 10 each fully paid 9,00,000
General Reserve 3,60,000
Share Premium 27,000
Profit and Loss Account 5,40,000
Creditors 1,23,000
28,50,000 28,50,000
The preferential shares were to be redeemed at 10% premium along with dividend due for
2006. The company issued 45,000 equity shares of 10 each at a premium of 5 per share.
All shares were subscribed and cash fully received. The investments were sold for
3,00,000. The payment was made to the preference shareholders and therefore the directors
decided to issue bonus shares in the ratio one share for every four shares held. For this
purpose free reserve were utilised to the minimum extent necessary. Give journal entries
with narrations and balance sheet after redemption.
9. The following is the balance sheet of Zed Ltd. as on 31st March, 2006.
Liabilities Assets
50,000 Equity Shares of 10 4,00,000 Fixed Assets 6,00,000
each, 8 per share called up 5,00,000 Investments 2,00,000
and paid up.
98,000 Stock 2,00,000
5000, 13% Redeemable 90,000 Sundry Debtors 2,00,000
Preference shares
1,12,000 Cash at Bank 3,00,000
Share Premium
3,00,000
General Reserve
Profit and Loss Account
Sundry Creditors
15,00,000 15,00,000
The Company resolved:
(a) To convert the partly paid up equity shares into fully paid up on 1st April, 2006
without requiring the shareholders to pay for the same.
(b) To redeem the preference shares on 30th April, 2006 at a premium of 7.5% and for
this purpose to issue 3,000; 12% preference shares of 100 each at a premium of 10%
payable in full on application.
The resolutions were carried into effect. For the purpose of the above redemption,
on 29th April, 2006, the company sold its fixed assets costing 3,00,000 for 3,82,500

Notes and all the investments for 2,60,000. On 31st May 2006, all payments were made on
redemption, except to the holders of 200 shares who could not be traced.
On 30th June, 2006, the directors issued fully paid bonus shares to the then
shareholders at the rate 3 for 5 held at a premium of 5%.
You are required to give necessary journal entries in the books of the company to
record the above transactions.
1. Buy back 2. Hybrid
3. Capital Redemption Reserve 4. True
5. True 6. Banks/Financial Institutions
7. Articles of Association 8. SEBI.
9. escrow account 10. True
11. False 12. True
13. Bonus 14. Shareholders
15. cash


Sukhpreet Kaur, Lovely Professional University Unit 5: Redemption of Preference Shares
Unit 5: Redemption of Preference Shares Notes
CONTENTS
Objectives
Introduction
5.1 Purpose of Legal Restrictions
5.2 Sources of Redemption
5.2.1 Explanation of Proceeds of Fresh Issue
5.2.2 Capital Redemption Reserve Account
5.3 Summary
5.4 Keywords
Objectives
After studying this unit, you will be able to:
 Describe the Redemption of shares
 Explain Fresh issue
 Understand Redemption of capital account
Introduction
Generally, a company limited by shares is not permitted to return the share money to its
shareholders except in the case of its winding up. If a company wants to return the share money
to the shareholders, it must be empowered by the Articles of Association and it must secure the
permission of the court as per Section 100 of Companies Act. But the court’s permission is not
necessary if the share money is being returned to the preference shareholders. Under Section 80
of Companies Act, a company limited by shares may, if so empowered by its Articles of
Association, issue redeemable preference shares which will be redeemable at the discretion of
the company, or after the expiry of a stipulated time. Along with it, section 80(5A) states that
“Notwithstanding contained in this Act, no company limited by shares shall, after the
commencement of the Companies (Amendment) Act 1988, issue any preference share which is
irredeemable or is redeemable after the expiry of a period of ten years from the date of its issue.”
If a company is issuing redeemable preference shares, redemption will be according to the
terms of issue but the following legal restrictions as per Section 80 relating to redemption of
preference shares must be fulfilled:
(i) No share can be redeemed unless they are fully paid.
(ii) Such share can be redeemed either (a) cut off the profits which would otherwise be available
for dividend or (b) out of the proceeds of the fresh issue of shares made for the purpose of
redemption. Both of the sources can be used simultaneously.
(iii) Where redemption is made out of profits otherwise available for dividend, a sum equal to
nominal amount of the shares so redeemed must be transferred to a reserve fund account
to be called ‘Capital Redemption Reserve Account.’

Notes (iv) Capital Redemption Reserve Account can be utilised for declaring fully paid bonus shares
to the shareholders of the company. Otherwise it must be maintained intact unless otherwise
sanctioned by the court.
(v) If any share premium is payable on the redemption of preference, shares, such a premium
must be provided out of the profits of the company, or out of the share premium account
of the company.
(vi) Redemption of preference shares shall not be treated as reduction of authorised share
capital. To the extent a company has redeemed or is about to redeem any preference
shares, it has the power to issue upto the nominal amount of the shares redeemed or to be
redeemed, as if those shares had never been issued.
(vii) If the new shares are issued for the purpose of redemption of preference shares, capital
shall not be deemed to have been increased.
5.1 Purpose of Legal Restrictions
A careful analysis of the conditions of Section 80 of Companies Act regarding the redemption of
preference shares reveals that the basic objective of these conditions is to protect the interest of
creditors of the company. According to Section 80 of the Companies Act, redemption of preference
shares can be either from out of the profits or from out of the proceeds of the fresh issue of
shares. If these conditions are not followed and redemption is carried out any other manner, as
from out of borrowings or by the sale of assets that will affect adversely to the interest of
creditors.
If the redemption of preference shares is carried out of profits available for dividend, amount of
preference share capital redemption will take place Capital Redemption Reserve Account which
will be used only for one purpose namely the issue of fully paid bonus shares. Thus the interest
of creditors will not be affected.
If the redemption of preference shares is carried out of fresh issue of shares, amount of fresh
issue of share capital will take place the amount of preference share redeemed. This will also not
affect the interest of creditors of the company. Thus, on redemption of preference shares, the
amount of redemption of preference shares will be any one of the following:
1. Amount of redemption of preference shares = Amount of capital redemption reserve.
2. Amount of redemption of preference shares = proceeds of fresh issue of shares.
3. Amount of redemption of preference shares = Amount of capital redemption reserve

proceeds of fresh issue of shares.
Self Assessment
True or False:
1. A company can redeem only its preference share during its lifetime.
2. There cannot be redemption of partly paid up preference shares.
Fill in the blanks:
3. Dividend on preference shares is always …………… .
4. The …………… preference shares cannot be issued by a limited company.

Unit 5: Redemption of Preference Shares
Choose the answer: Notes
5. The redemption of preference shares can be from:
(a) Capital reserve
(b) Proceeds of issue of debentures
(c) Development rebate reserve
(d) General reserve
5.2 Sources of Redemption
Redeemable Preference shares are those shares, the capital of which is refunded by the company
after a specified duration. The redemption of such shares is made in accordance with the provisions
of section 80 of the Companies Act.
In case preference shares can be redeemed when they are fully paid up. In case a company has
partly paid preference shares, it must see that they are made fully paid up before they are
redeemed.
Sources of Redemption of Preference Shares
1. Fresh Issue
2. Capital Redemption Reserve
5.2.1 Explanation of Proceeds of Fresh Issue
There is a lot of controversy and confusion over the term proceeds of a fresh issue of shares. It is
therefore, compulsory to understand this term properly. A closer examination of the provisions
and intentions of Company Law implies the meaning of the word ‘proceeds’ as the amount
received excluding the premium on the fresh issue and net amount received in the case of
discount or at par. In other words, if the fresh shares are issued at par, ‘proceeds’ means the actual
amount realised. If the fresh shares are issued at discount, proceeds means the net amount
realised from the issue of fresh shares i.e., nominal value of shares minus discount allowed. This
is done because nominal value of shares does not represent the wholly tangible assets capable of
providing the real protection to the creditors (third party). This can be understood properly
with the help of the following example. If a company has to redeem preference shares of
2,00,000 and decides to issue the equity shares at a discount of 10%, it will get only 1,80,000
(2,00,000 – 20,000) in cash from the cash issue. But the company will needs 2,00,000 in cash for
the redemption of preference shares. On the liability side of the balance sheet, the nominal value
of fresh shares will replace properly the redeemable preference shares by an equivalent sum i.e.,
2,00,000. But on the assets side, there will appear two items (i) cash of 1,80,000 (ii) discount on
issue of shares (loss) 20,000. Further, suppose this company goes into liquidation immediately
after the redemption of preference shares and due to a bad financial position it is unable to
satisfy the claims of the third party in full. Here, it would mean the repayment of capital in
priority over creditors to the extent of 20,000, which is discount. This is a clear violation of
Section 80.
Notes If the fresh shares are issued at premium for the redemption of redeemable
preference shares, meaning of ‘proceeds’ will be the amount realised from the issue of
fresh shares excluding the amount of premium.

Notes Only the nominal value of shares should be taken into consideration. The reason for not including
the premium in proceeds is clear that it does not provide any protection to the third party
(creditors). Section 78 of Company Act clearly depicts the four uses of share premium discussed
in the preceding chapter. And if premium is utilised for other than these four uses, it will be
treated as reduction of capital. If the amount of premium is included in the total proceeds for
redemption purpose, the amount of redeemable preference share will be replaced partly by
share capital and partly by share premium. Here, the security available for third party (creditors)
may be reduced at any time by the amount of premium as premium is open for four uses under
Section 78.
To put in a nutshell, the proceeds of fresh issue of shares means:
(i) When shares are issued at par, the nominal value of fresh shares.
(ii) When shares are issued at discount the amount realised from the fresh issue.
(iii) When shares are issued at premium, the nominal value of shares. The amount of premium
is not used for redemption of preference shares.
Profits which would otherwise be available for dividend
One of the sources of redemption of preference shares is the profit that would otherwise be
available for dividend. It means general profits can be utilised for redemption. Profit should not
be of capital nature. The list of such profit from which redemption can be made or can be
transferred to capital redemption reserve is as follows:
(i) General Reserve Fund
(ii) Credit balance of Profit and Loss Account
(iii) Reserve Fund
(iv) Dividend Equalisation Fund
(v) Workmen’s Compensation Fund
(vi) Workmen’s Accident Compensation Fund
(vii) Insurance Fund
(viii) Debenture Redemption Fund/Sinking fund
(ix) Contingency Reserve
(x) Reserve for doubtful debts or taxation.
Profits which will not be available for dividend:
The following profits are of capital nature, therefore cannot be utilised for redemption of
preferences shares or cannot be transferred to capital redemption reserve:
(i) Forfeited Shares Account
(ii) Share Premium Account
(iii) Profit Prior to Incorporation
(iv) Development Rebate Reserve
(v) Investment Allowable Reserve
(vi) Capital Reserve
(vii) Profit from Sale of Fixed Assets.

5.2.2 Capital Redemption Reserve Account Notes
!
Caution Capital redemption reserve account is created under Section 80 which states that
it should be treated as paid up capital. When redeemable preference shares are redeemed
from out of those profits which are otherwise available for dividend (mentioned above),
these profits are transferred to capital redemption reserve account.
Capital Redemption Reserve Account is utilised by the company in paying up unissued shares
of the company to be issued to existing members of the company as fully paid bonus shares. In
other words, this reserve is non-distributable and only fully paid bonus shares can be issued
from this reserve. If this reserve is distributed among shareholders as profit, it will entail a
reduction of capital which will adversely affect the interest of third party (creditors).
No redemption of partly paid up preference shares until they are fully paid
As per Section 80(a) (mentioned above) there will be no redemption of such a redeemable
preference shares which are not fully paid. The purpose of this Section is only to protect the
interest of third party (creditors). Whenever a third party gives loans and advances to the
company they look for security. This security is not only in existing assets but also in prospective
amount of assets to be received in future. Thus, when preference shares are partly paid up, the
uncalled amount of capital on partly paid up shares can always be called up by the company and
by the liquidator at the time of its liquidation under conditions of the contract. If Section 80 of
Companies Act allows the redemption of partly paid redeemable preference shares, it would
mean the replacement of equivalent amount either by the proceeds of fresh issue of shares, or by
the capital redemption reserve account. This will deceive the creditors whose calculations are
based on the nominal value of shares at the time of advancing the loans or extending the credit
facilities. Thus, in order to protect the interest of creditors, it was felt necessary that it is not paid
up amount of redeemable preference shares, but the nominal value of shares that requires
replacement. Thus, in order to protect the interest of creditors, Section 80 of the Companies Act
makes it compulsory that no partly paid up preference share will be redeemed unless they are
fully paid up. This will automatically replaces that amount (fully paid up) on which creditors’
calculation are based.
Remedy for redemption of preference shares at the time of failure of the company
If a public company fails or is unable to redeem its redeemable preference shares by a certain
date fixed for redemption, the following remedies will be available to the shareholders:
(i) If redeemable shares are issued and redeemable at the option of the company, shareholders
can have no grievance.
(ii) If the shares are redeemable after the expiry of a particular period, possibly an order for
liquidation may be obtained against the company on the just and equitable ground.
Preference shareholders are not the creditors of the company and therefore, they cannot
sue for the money due on the shares undertaken to be redeemed and cannot, as a right,
claim a return of their share money except in liquidation.
Premium on Redemption of Preference Shares
If the redeemable preference shares are redeemable at a premium, the amount payable on the
redemption of preference share can be provided either out of the share premium received from
the fresh issue of shares, or from the profits of the company whether it is a capital profit or
revenue profit.

Notes Procedure for Solving Examination Problems
In order to solve the examination problem relating to the redemption of preference shares, the
following procedure should be adopted:
Step I: First, we should see whether the redeemable preference shares are fully paid or partly
paid up. If these are partly paid up, with the help of following journal entry, make them eligible
for redemption, because only fully paid up shares can be redeemed.
(i) When final call money is due:
Preference Share Final Call Account Dr.
To Preference Share Capital Account
(ii) When amount of final call is received:
Bank Account Dr.
To Preference Shares Final Call Account
Step II: Now we have to determine how much money is required to pay off the preference
shareholders whose shares are to be redeemed. This total amount payable will consist of face
value of preference shares which are to be redeemed and, if any, share premium payable on
redemption. The entry will be:
(i) When preference shares are redeemable at par:
Redeemable Preference Share Capital Account Dr.
To Preference Shareholders Account
(ii) When preference shares are redeemable at premium:
Redeemable Preference Share Capital Account Dr.
Premium on Redemption of Preference Shares Account Dr.
To Preference Shareholder Account
Premium on redemption of preference shares is a loss is therefore being debited.
Step III: In this step, we have to decide the sources from where redemption is to be made. To find
out the source we have to examine the liability side of the balance sheet:
(i) How much profits which will otherwise be available for dividend, are available to need
the redemption of nominal value of redeemable preferences shares.
(ii) How much other profits (capital profits) and balance in share premium account are available
in order to provide for premium, if any, payable on redemption.
It will then be decided whether the new issue of shares is required for the purpose of
redemption or not.
The journal entries will be:
(i) If the redemption is made by using the profits which will otherwise be available for
dividends, that amount of profits which is being utilised for redemption of preference
shares will be transferred to capital reserve account:

General Reserve Account Dr. As the case may be
Dividend Equalisation Fund a/c Dr.

To Capital Redemption Reserve Account Notes
(ii) When premium on redemption of preference shares is transferred to either profit and loss
account or any reserve or share premium account.
Share Premium account Dr. with that amount which is being paid on
Profit and Loss account Dr. redemption
To Premium on Redemption of Preference Shares Account
(iii) If the profits that will otherwise be available for dividend, are not sufficient to meet the
redemption of nominal value of redeemable preference shares, for shortage, there will be
new issue of fresh shares. This new issue of fresh shares can be at par, at discount or at
premium. There will be the following journal entries:
(a) When fresh shares are issued at par
Bank Account Dr.
(b) When fresh shares are issued at premium
Bank Account Dr.
(c) When fresh shares are issued at discount
Bank Account Dr.
Discount on Issue of Shares Account Dr.
The amount required from the issue of fresh shares can be computed with the help of following
equation:
Amount of Redeemable Capital Redemption Amount received from
= +
Preference Shares Reserve Account the issue of fresh shares
Step IV: In this step, we have to look for sums available from cash in hand and at bank in the
assets side of balance sheet of the company. If the total sums available from cash in hand and at
bank are not enough to meet the redemption of preference shareholders, shortage of cash will
be raised by one or more of the following methods:
(i) from taking bank loan
(ii) from the sale of investment or current assets.
(iii) from the issue of new shares
For these transactions the journal entries will be as follows:
(a) when bank loan is raised
Bank account Dr.
To Bank Loan Account
(b) When current assets or investments are sold (if there is any profit or loss on the sale
of assets, that will be transferred to Profit and Loss Account)

Notes Bank Account Dr.
To Investment Account or
To other current assets (which are being sold)
(c) When new shares are issued
Bank Account Dr.
Step V: If money available in bank is sufficient, the company will pay off the preferences
shareholders for redemption by cash.
Preference Shareholders Account Dr.
To bank account
Sometimes, the redemption of preference shares is made by the conversion of some new shares;
the following entry will be passed:
Preference Shareholders Account Dr.
To New Share Capital Account.
In this case no amount is required to transfer to Capital Redemption Reserve Account.
Self Assessment
Fill in the blanks:
6. In the condition of excess profits or reserves …………… shares can be issued.
7. When bonus shares are issued at premium, …………… account is credited.
8. If money available in bank is sufficient, the company will pay off the preference
shareholders for redemption by …………… .
True or False:
9. Redemption of preference shares cannot be made from out of the proceeds of fresh issue of
preference shares.
10. Capital redemption reserve is utilised in writing off the preliminary expenses.
11. Premium payable on redemption of preference shares must be debited to Profit and Loss
Account only.
Example 1: Determination of Minimum Amount of Fresh Issue

Find out how much minimum fresh issue is necessary in order to comply with the provisions of
Section 80 of Companies Act in the following cases:
(a) (i) Redeemable preference shares of 1,00,000 are to be redeemed at par and credit
balance of P.L. Account and share premium are 20,000 and 5,000 respectively.
(ii) 7% Redeemable Preference Shares of 1,50,000 are to be redeemed at a premium of

5% and credit balance of Profit and Loss Account and balance of share premium
account are 40,000 and 7,000 respectively in the balance sheet.

(iii) 10% Redeemable Preference Shares of 2,00,000 are to be redeemed at a premium of Notes
10%. General Reserve, Share Premium and Dividend Equalisation Funds are of
20,000, 4,000 and 40,000 respectively in the balance sheet.
(b) (i) A company has to redeem its Redeemable Preference Shares of 1,00,000 at 10%
premium. In its balance sheet shows profits available for dividend are 15,000,
Share premium of 2,000 and new shares are to be issued at 5% premium.
(ii) The Redeemable Preference Shares of a company are of 5,00,000 which are to be
redeemed at 10% premium. In its balance sheet there is credit balance of Profit and
Loss account of 1,12,500, balance in Share Premium Account is 10,000. The company
has to issue the new shares at 5% discount.
Solution:
The following amount from fresh issue of shares is required for redemption:
(a) (i) 80,000, because profit available of 20,000 can be utilised for redemption of
preference shares and will be transferred to Capital Redemption Reserve Account.
As per Section 80 the amount of premium cannot be utilised for redemption of
preference shares.
(ii) 1,10,500, because after writing off the premium on redemption of preference shares,
the profit available will only 39,500 which will be utilised for redemption of
preference shares and will be transferred to Capital Redemption Reserve Account.
(iii) 1,56,000, because after writing off the premium on redemption of preference shares
from share premium account and other profit, the profit available will only be
44,000 which will be utilised for redemption of preference shares and will be
transferred to Capital Redemption Reserve Account.
(b) (i) ( )
Profits available for dividend 15,000
—Premium on redemption to be paid out of profit (10,000 – 2,000) 8,000
Profits available for redemption 7,000
Amount of preference shares to be redeemed 1,00,000
Proceeds of fresh issue should be equal to 1,00,000 – 7,000 = 93,000
As the new shares are issued at 5% premium, nominal value of fresh

share capital will be:
100
93,000 × = 88, 571.4
105
(ii) ( )
Credit balance of P/L A/c 1,12,500
Premium on redemption to be paid out of profit (50,000 – 10,000) 40,000

Profit available for redemption 72,500
Amount of preference shares to be redeemed is 5,00,000
Proceeds of fresh issue should be equal to 5,00,000 – 72,500 = 4,27,500

Notes As the new shares are being issued at 5% discount, nominal value of fresh
share capital will be:
100
4, 27, 500 × = 4, 50,000
95
Example 2: Redemption of Preference Shares out of Profits

The balance sheet of Sonex Limited as on 31 March 2006 was as under:
Liabilities ( ) Assets ( )
Share Capital: Sundry Assets 21,25,000
5,000, 8% Preference Bank Balance 3,75,000
Shares of 100 each fully paid 5,00,000
1,00,000 Equity shares of 10 each 10,00,000
15,00,000
Profit & Loss Account 3,00,000
General Reserves 2,50,000
Creditors 4,50,000
25,00,000 25,00,000
The preference shares are redeemable on April 1, 2006 at a premium of 10%. The redemption was
duly carried out on the due date, assuming that the company raised the necessary loan from
bank. Show the necessary journal entries in the books of Sonex Limited.
Solution:
Sonex Limited Journal
Date Particulars L.F. ( ) ( )

April 1 8% Redeemable Preference Share Capital Account Dr. 5,00,000
Premium on Redemption of Preference Share A/c Dr. 50,000
To 8% Preference Shareholders Account 5,50,000
(Being amount on redemption due to shareholders with premium)
Profit & Loss account Dr. 3,00,000
General Reserve Account Dr. 200,000
(Being utilisation of profit and general reserve for redemption)
General Reserve Account Dr. 50,000
To Premium on Redemption of Preferences Shares account 50,000
(Being utilisation of general reserve for writing off the premium on
To Bank Loan Account 1,75,000
(Being raised of bank loan to pay off preference share holders)
8% Preference Shareholders Account Dr. 5,50,000
(Being payment made to preference shareholders on redemption)
Note: 8% Preference Share Capital will be replaced by capital redemption reserve account in the liability
side of balance sheet.

Notes
Example 3: Redemption of Preference Shares Out of Profit & Balance Sheet
The following is the summarised balance sheet of Ding Dong Limited as on 31st March 2006:
Authorised Share Capital: Plant and Machinery 10,00,000
10% Redeemable Preference Shares of 100 each. 3,20,000 Current Assets 6,00,000
Equity Shares of 10 each 10,20,000
13,40,000
Issued and paid up capital:
10% Redeemable Preference
Shares of 100 each fully paid 2,80,000
Equity shares of 10 each fully paid up 8,40,000
Creditors 1,40,000
16,00,000 16,00,000
The preference shares were redeemed on 1st April, 2006 at a premium of 10%. No trace could be
found of the holder of 15 preference shares.
You are required to give the journal entries in the books of the company and give its balance
sheet also.
Solution:
Ding Dong Limited
Journal

April 1 10% Redeemable Preferences Share Capital Account Dr. 2,80,000
Premium on redemption of preference shares account Dr. 28,000
To 10% Preference Shareholders Account 3,08,000
(Being amount on redemption due to shareholders with premium)
Profit and Loss Account Dr. 2,80,000
(Being utilisation of profit for the redemption of preference shares)
To Premium on Redemption of Preferences Shares Account 28,000
(Being utilisation of premium in writing off the premium on
10% Preferences Shareholders Account Dr. 3,06,350
(Being payment made to 2,785 Preference shareholders on
redemption)

Notes Balance Sheet of Ding Dong Limited

as on 1st April, 2006
Authorised Shares capital: Fixed Assets:
3200, More 10% Preferences Shares of 100 each 3,20,000 Plant & Machinery 10,00,000
1,02,000 Equity Shares of 10 each. 10,20,000 Current Assets 2,93,650
( 6,00,000 – 3,06,350)
13,40,000
Issued, Subscribed, Called up and Paid up capital:
84,000 Equity Shares of 10 each fully paid up 8,40,000
Capital Redemption Reserve Account 2,80,000
Share Premium Account (35,000- 28,000) 7,000
Profit and Loss A/c (3,05,000 – 2,80,000) 25,000
10% Preference Shareholders (15 holders could not 1,650
be traced)
Creditors 1,40,000
12,93,650 12,93,650
Notes:
1. Amount belonging to 15 preference shareholders who could not be traced out, will be treated as current
liabilities (15 × 100 + 10%) = 1,650.
2. Inspite of being redemption of 10% preference shares, authorized share capital will not be changed
because redemption of preference shares is not treated as reduction of capital as per Companies Act.
Example 4: Redemption of Preference Shares out of the Proceeds of Fresh Issue of

Shares
The following extract of Asha Limited’s balance sheet, is given below:
Liabilities ( )
Authorised share capital: 70,00,000
Issued and subscribed:
3,00,000 Equity Shares of 100 each, fully paid up 30,00,000
10,000; 10% Redeemable Preference Shares of 100 each
90 called up and paid up 9,00,000
Capital Reserve 1,50,000
Profit on sale of fixed assets 3,20,000
Profit and Loss Account (credit) 1,00,000
The company decides to redeem all the preferences shares at a premium of 2%. For the specific
purpose of the redemption it issued 20,000, 12% preference shares of 50 each at a premium of
5%. The entire amount is being payable along with application. The whole issue is taken by
public. The redemption of 10% Redeemable Preference Shares is duly completed.
Journalise the above mentioned transactions in the books of Asha Limited.

Solution: Notes
Asha Limited
Journal

10% Redeemable Preference Share Final Call Account Dr. 1,00,000
To 10% Preference Share Capital Account 1,00,000
(Being the final call money due on preference shares for the purpose
of its redemption).
To 10% Redeemable Preference Share Final Call A/c 1,00,000
(Being the receipt of final call money an 10,000 preference shares)
(Being issue of 12% preference shares at a premium of 5% for
10% Redeemable Preference Share Capital Account Dr. 10,00,000
Premium on Redemption of Preference Shares Account Dr. 20,000
(Being amount due to preference shareholders on redemption)
To Premium on Redemption of Preference Share Account 20,000
(Being share premium utilised for writing off premium on
(Being payment made to preference shareholders on the redemption
of preference shares)
Note: Under Section 80 preference shares cannot be redeemed until they are fully paid up. Therefore, final
call of 10 is being made.
Example 5: Redemption of Preference Shares Partly Out of Profits and Partly from the
Proceeds of Fresh issue of Shares
The following is the balance sheet of Abhimanyu Limited as on 31 December, 2005.
Share capital: Fixed assets 12,00,000
2,500, 11% Redeemable Stock 2,50,000
Preference Shares of 100 each 2,50,000 Debtors 25,000
5,000 Equity Shares of 100 each 5,00,000 Cash 25,000
Capital Reserve 50,000
General Reserve 1,00,000
Share Premium Account 50,000
Profit and Loss Account 50,000
Creditors 5,00,000
15,00,000 15,00,000

Notes The preference shares are to be redeemed on 1st January 2006 at 10% premium.
On 1st January 2006, a fresh issue of equity shares was made to the extent it is required under the
Companies Act for the purpose of redemption of preference shares.
The shortfall in cash resources for the purpose of redemption after utilising the proceeds of fresh
issue was met by raising a bank loan, the cash balance 25,000 being the minimum the company
requires for its trading operations.
Draft journal entries in the books of the company to record these transactions and prepare the
balance sheet in the form prescribed by the Companies Act 1956, immediately after the
redemption.
[Adapted from B. Com. (Hons.) Delhi 1987]
Solution:
Abhimanyu Limited
Journal
2006 Particulars L.F. ( ) ( )

Jan. 1 11% Redeemable Preference Share Capital Account Dr. 2,50,00
(Being amount due to preference shareholders on redemption with
premium)
Profit and Loss Account Dr. 50,000
(Being utilisation of general reserve and profits for redemption of
preference shares)
To Premium on Redemption Account 25,000
(Being utilisation of share premium for writing off the premium on
(Being receipt the proceeds from the issue of fresh shares)
To Bank Loan Account 1,75,000
(Being raised of bank loan for the redemption of preference shares)
Preferences Shareholders Account Dr. 2,75,000
(Being the payment made to preference shareholder on redemption of
preference shares)
Balance Sheet of Abhimanyu Limited

as on 1st January 2006
Share Capital: Fixed Assets: 12,00,000
6,000 Equity Shares of 100 Current Assets:
each fully paid up 6,00,000 Cash Balance 25,000
Reserve & Surplus: Stock 2,50,000
Contd...
Capital Redemption Reserve 1,50,000 Loans and Advances:
Capital Reserve 50,000 Debtors 25,000
Secured Loans:
Bank Loan 1,75,000
Creditors 5,00,000
15,00,000 15,00,000
Share Capital: Fixed Assets: 12,00,000
6,000 Equity Shares of 100 Current Assets:
each fully paid up 6,00,000 Cash Balance 25,000
Reserve & Surplus: Stock 2,50,000 Notes
Capital Redemption Reserve 1,50,000 Loans and Advances:
Capital Reserve 50,000 Debtors 25,000
Secured Loans:
Bank Loan 1,75,000
Creditors 5,00,000
15,00,000 15,00,000
Working Note:
( )
Total amount required for redemption
Face value of shares 2,50,000
+ Premium to pay on redemption 25,000

Total amount required 2,75,000
- Amount received from fresh issue of shares 1,00,000

Amount required which will be 1,75,000
Taken by raising bank loan
Example 6: On 1st August 2006, the following balances were extracted from the balance
sheet of Seema Limited:
(i) 12% Redeemable Preference Share Capital: ( )
12,500 shares of 100 each fully called up 12,50,000
(ii) Calls unpaid
Final call on 500 shares @ 20 each 10,000
(iii) Shares Premium 1,25,000
(iv) General Reserve 4,00,000
(v) Profit & Loss Account 2,96,365
(vi) Declared Preference Dividend, not yet paid 1,44,800
The company redeemed all its preference shares at a premium of 6% and for the purpose,
Company issued equity shares of 10 each at a discount of 10% for such an amount as was
necessary for the purpose after utilising the available profits to the maximum possible extent. It
also paid the declared preference dividend. Show the journal entries.
Solution:
Journal

To Call-in-Arrear Amount 10,000
(Being the receipt of calls-in-arrear)
12% Redeemable Preference Share Capital Account Dr. 12,50,000 Contd...
To Preference Shares-holders Account 13,25,000
(Being amount due to preferences shareholders on redemption of
preference share on premium) LOVELY PROFESSIONAL UNIVERSITY 117
Profit & Loss Account Dr. 2,96,365
To Capital Redemption Reserve A/c 6,96,365
(Being profit and general reserve utilised for redemption of
To Call-in-Arrear Amount 10,000
(Being the receipt of calls-in-arrear)
Notes 12% Redeemable Preference Share Capital Account Dr. 12,50,000
To Preference Sharesholders Account 13,25,000
(Being amount due to preferences shareholders on redemption of
preference share on premium)
(Being profit and general reserve utilised for redemption of
preference shares)
(Being the utilisation of share premium for writing off the premium
on redemption.)
Discount on Issue of Share Account Dr. 61,520
To Equity Shares Capital Account 6,15,200
(Being the receipt of the proceeds from the issue of 6,152 shares of
100 each at 10% discount.)
Preference Shares’ Dividend Account Dr. 1,44,800
(Being payment made of declared preference dividend)
Preference Shareholders’ Account Dr. 13,25,000
Working Note:
1. It is assumed that calls-in-arrear of 10,000 on 100 shares have been received.
2. Total amount required for redemption ( )
Face value of preference shares 12,50,000
Less: Divisible profits available (4,00,000 + 2,96,365) = 6,96,365
Minimum amount of new shares
Which will be issued at discount 5,53,635
5, 53,635 × 100
Face value of new shares = = 6,15,150
90
No friction of shares is allowed therefore total
No. of shares issued will be 6,152 of 100 each.
3. It is assumed that company has sufficient cash to pay the preference dividend and to
redeem the preference shares.
Example 7: Redemption of Preference Shares with Unpaid Calls Out of Fresh Issue at
Discount

The Balance Sheet of Sanjeev Limited as on 31st December 2005 was as follows: Notes
Share Capital: Fixed Assets 3,25,000
25,000 Equity Shares of 10 each 2500, 10% Redeemable 2,50,000 Investments 75,000
Stock 50,000
Preference Shares of , 100 each 2,50,000 Debtors 1,25,000
Less Calls-in-Arrear 20 per share 5,000 2,45,000 Bank Balance 1,01,500
Share Premium 30,000 Misc. Exps. 20,000
Reserve Funds 74,000
Current Liabilities 52,500
6,96,500 6,96,500
On 1st January 2006, investments costing 50,000 were sold for 45,000.
On the same date, it was decided to redeem the preference shares at a premium of 20% by issuing
sufficient number of equity shares at a discount of 10% subject to leaving a balance of 25,000 in
reserve fund. All payments were made in full, except to a holder 125 shares only due to his
leaving India for good.
You are required to show the journal entries and the balance sheet of the company after
redemption.
Solution:
Sanjeev Limited
Journal

Jan., 1 10% Redeemable Preference Share Capital Account Dr. 2,25,000
To Preference Shareholder Account 2,70,000
(Being amount due to preference share-holders on redemption of
preference shares with 20% premium)
(Being utilisation of share premium and profit in writing off the
premium on redemption of preference shares)
Reserve Fund Account Dr. 49,000
To Capital Redemption Reserve Account 74,000
(Profits and reserve funds utilised for the redemption of preference
shares)
(Being fresh shares issued at 10% discount for the redemption of
preference shares)
Bank Account Dr. 45,000 Contd...
To investments account 50,000
(Being sale of investment and loss transferred to P/L A/c)
(Being the payment of 2,125 preference shareholders)
To Capital Redemption Reserve Account 74,000
(Profits and reserve funds utilised for the redemption of preference
shares)
Accounting for Companies-I Discount on Issue of Shares Account Dr. 16,778

(Being fresh shares issued at 10% discount for the redemption of
preference shares)
Notes Bank Account Dr. 45,000
To investments account 50,000
(Being sale of investment and loss transferred to P/L A/c)
(Being the payment of 2,125 preference shareholders)
Balance Sheet of Sanjeev Limited

as on 1st January 2006
Share Capital: Fixed assets 3,25,000
Issued and Subscribed Investment 25,000
41,778 shares of 10 each fully paid 4,17,780 Stock 50,000
250; 10% Preference shares of 100 each 25,000 Debtors 1,25,000
Calls in arrear 20 per share 5000 20,000 Misc. Exps. 20,000
Reserve Fund 25,000 Bank Balance 42,502
Capital Fund Redemption Reserve Account 74,000 Discount on issue of shares 16,778
Current liabilities 52,500
Preference shareholders 15,000
6,04,280 6,04,280
Working Note:
1. Total amount required for redemption: ( )
Face value of preference shares 2,25,000
+ 20% premium on redemption 45,000

2,75,000
2. Sources available to write off premium on redemption:
Share premium account 30,000
Out of profits 15,000

45,000
3. Sources available for redemption of preference share capital
Profit available:
Balance of P & L Account 45,000
—Loss on sale of investment 5,000

40,000
—Amount utilised for premium on redemption 15,000
25,000
Reserve fund for redemption (74,000 – 25,000) 49,000

74,000

Amount of fresh issue of shares = 2,25,000 – 74,000 Notes
= 1,51,000
1, 51,000
No. of shares to be issued = = 1,677.7 or 16,778
9
4. Bank balance = 1,01,500 + 1,51,002 + 45,000 – 2,55,000 = 42,502
Example 8: Sale of Investments at Profit for Redemption of Shares

The following is the summarised balance sheet of Jumbo Limited as on 31st March, 2006:
Balance Sheet of Jumbo Limited
as on 31st March, 2006
5,000 Equity Shares of 100 each 5,00,000 Investment 2,00,000
3,000; 8% redeemable preference shares of 100 each 80 per 2,40,000 Current Assets:
share Called up and Paid up
4,000; 9% redeemable preference shares of 100 each 4,00,000 Stock 1,00,000
Reserve and surplus: Sundry Debtors 2,00,000
Capital reserve 1,00,000 Cash at Bank 3,00,000
General reserve 1,00,000
Share premium 60,000
Current Liabilities:
Sundry creditors 1,00,000
17,00,000 17,00,000
On 1st April, 2006, the company redeemed the preference shares at a premium of 10%. In order
to pay off the preference shareholders, the company sold the investments realising 210,000 and
also issued 2,000; 7% preference shares of 100 each which were fully subscribed in cash on the
same date company issued fully paid. Bonus shares in the ratio of one for every two shares held.
Show the journal entries and also prepare the balance sheet of the company after the completion
of the transactions which took place on 1st April, 2006.
[ICWA, Inter, June 1986]
Solution:
Jumbo Limited
Journal
Date Particulars L.F. (`) (`)

Contd...
(Being utilisation of share premium in writing off the premium on
redemption)
To Capital Redemption Reserve A/c
LOVELY PROFESSIONAL UNIVERSITY 2,00,000 121
(Being the utilisation of general reserve and profits for redemption
To Investment Account 2,00,000
Notes To Premium on Redemption Account 40,000
(Being utilisation of share premium in writing off the premium on
redemption)
(Being the utilisation of general reserve and profits for redemption
To Investment Account 2,00,000
(Investments sold and profit transferred to P. & L. A/c)
(Being receipt of amount on issue of 2,000 shares)
(Being amount paid off to preference shareholders on redemption)
Capital Redemption Reserve Account Dr. 2,00,000
To Bonus to Shareholders Account 2,50,000
(2,500 bonus shares declared to 5,000 existing equity shareholders)
Bonus to Shareholders Account Dr. 2,50,000
(Being bonus shares issued)
Balance Sheet of Jumbo Limited

as on 31st March, 2006
Issued and Subscribed: Investments Nil
7,500 equity shares of 100 each fully paid up (2,500 equity 7,50,000 Current Assets:
shares were issued as bonus shares out of Capital Redemption
Reserve and Profit and Loss A/c)
Stock 1,00,000
3,000; 8% Redeemable Preference shares of 100 each, 80 2,40,000 Sundry Debtors 2,00,000
paid up
2,000; 7% Preference Shares of 100 each 2,00,000 Bank Balance 2,70,000
Reserve and Surplus:
Capital Reserve 1,00,000
Profit and Loss Account (2,00,000 + 10,000 – 50,000 – 1,00,000) 60,000
Current liabilities:
Creditors 1,00,000
14,70,000 14,70,000

Working Note: Notes

1. Bank Balance = 3,00,000 + 2,00,000 + 2,10,000 – 4,40,000
= ` 2,70,000
2. Bonus shares can be issued by using the full amount of premium account.
Example 9: Redemption of Preference Shares by Fresh Issue of Equity Shares or by

Profits or by Both
Pass the necessary journal entries in the books of the company in connection with redeemable
preference shares in the following cases:
(i) A company issued 57,500 equity shares of ` 10 each, fully called up, for the redemption of
10,000; 8% Redeemable Preference Shares of ` 50 each at a premium of 15%.
(ii) For the redemption of 250, 10% preference shares of ` 200 each at a premium of 5%, a
company issued 5,000 equity shares of ` 10 each at 5% premium all payments on these
shares were duly received.
(iii) A company has to redeem 10% Redeemable Preference Shares of ` 5 lakhs using its profits
available for dividend.
(iv) For the payment of 5,000; 9% Redeemable Preference Shares of ` 100 each at a premium of
10%, a company issued 4,000 equity shares of ` 100 each at a premium of 10% and the
balance of the amount was paid out of profit. The full amount was received on this new
issue.
(v) For the redemption of 5,000; 7% Redeemable Preference Shares of ` 500 each, a company
issued 25,000 equity shares of ` 100 each at 10% discount and balance was payable from
profits.
(vi) For the redemption of 4,00; 7% Redeemable Preference Shares of ` 500 each at a premium
of 10%. The company utilised its profit.
Solution:
Journal
Particulars (`) (`)

(i) 8% Redeemable Preference Share Capital Account Dr. 5,00,000
To Preference Share Holders Account 5,75,000
(Being issue of 57,500 shares of ` 10 each for the redemption of
preference shares)
(ii) 10% Redeemable Preference Share Capital Account Dr. 50,000
Premium on Redemption Account Dr. 250
To preference shareholders account 50,250
(Being amount due to share holders on redemption with premium)
Share Premium Account Dr. 250 Contd...
To Premium on Redemption Account 250
(Being share premium utilised in writing off the premium on
redemption)
(Being receipt of amount from the issue of shares for redemption)
Preferences Shareholders Account Dr. 50,250
Notes Share Premium Account Dr. 250

To Premium on Redemption Account 250
(Being share premium utilised in writing off the premium on
redemption)
(Being receipt of amount from the issue of shares for redemption)
Preference Shareholders Account Dr. 50,250
(Being payment made to shareholders on redemption)
(iii) 10% Redeemable Preference Share Capital Account Dr. 5,00,000
(Being amount due to shareholders on redemption of preference
shares)
(Being payment made to shareholders on redemption of preference
shares)
(iv) 9% Redeemable Preference Share Capital Account Dr. 5,00,000
shares)
(Being receipt of amount from the issue of shares at premium)
Profit & Loss Account Dr. 10,000
(Being the utilisation of share premium and profit in writing off
premium on redemption)
(Being utilisation of profit for redemption of preference shares)
(Being payment made to share holders on redemption of preference
shares)
(v) 7% Redeemable Preference Share Capital Account Dr. 25,00,000
(Being amount payable to preference shareholder on redemption)
Contd...
(Being receipt of amount from issue of shares at discount)
Bank Account Dr. 22,50,000 Notes

(Being receipt of amount from issue of shares at discount)
(Being payment made to shareholders on redemption of preference
shares)
(vi) 7% Redeemable Preference Shares Capital Account Dr. 2,00,000
shares)
(Being utilisation of profit for redemption of Pref. Capital and
premium thereon)
(Being payment made to shareholders on redemption of Pref. Shares)
Self Assessment
Fill in the blanks:
12. There is a lot of controversy and confusion over the term proceeds of a …………… .
Choose the answer:
13. Capital Redemption reserve account is created:
(a) Voluntarily
(b) To meet the legal requirements
(c) Out of Capital reserve
(d) Out of share premium
14. Bonus shares can be issued from:
(a) Capital redemption reserve
(b) Profit on sale of fixed assets
(c) Development reserve
(d) Employees' deposit

Notes 15. If a company has to redeem its 7% redeemable preference shares of 40,000 and issue 3,000
equity shares of 10 each at a premium of 10%, how much amount should be transferred
to capital redemption reserve account:
(a) 40,000
(b) 7000
(c) 10,000
(d) 33,000

Case Study OCBC Preference Shares
T
his preference share is currently trading in SGX under the symbol, OCBC Bk NCPS
5.1% 100. The trading symbol itself can reveal a lot of details. OCBC Bk simply
stands for OCBC Bank while NCPS stands fornon-cumulative and non-convertible
preference shares. Non-cumulative means the dividends that were not declared and not
paid in the previous financial year will not be accumulated to the next financial year while
non-convertible means there is no option for the preference shareholders to convert their
preference shares to ordinary shares. The 100 at the end of the trading symbol means that
the lot size is 100 shares i.e. 1 lot is equal to 100 shares as compared to the usual lot size of
1 lot is equal to 1000 shares.
The following are some of the issues that you should consider.
1. Perpetuity: One of the main issue for preference shares is that it will never mature
unless the issuer which in this case, OCBC Bank decides to redeem it back. Notice
that it is stated very clearly that OCBC Bank may, at its option, redeem in whole but
not in part the preference shares on 29 July 2013 or on each dividend date after 29
July 2013. As compared to bonds, the issuer has the obligation to redeem it back. So
what happens if you wish to cash your preference shares out after holding it for
quite a long time ? Either you can wait for OCBC Bank to redeem it back or try to sell
it on SGX but that brings me to my second issue.
2. Liquidity: Due to the small quantity of preference shares that are issued generally,
preference shares usually have poor liquidity and that pose a problem. Firstly, there
may not be buyers who wish to buy your preference shares if you need to sell it and
even if there are buyers, their buying price may not be that favorable i.e. the spread
which is the difference between the buying and selling price can be rather far apart.
That will definitely put you at a disadvantage.
3. Dividends: Do take a closer look on how much dividends they are issuing and
whether it will remain the same. For the OCBC Bk NCPS 5.1% 100, it is clearly stated
that the dividend is 5.1%. However, another preference share that was also issued by
OCBC Bank in August 2008 i.e. OCBC Cap 5.1% NCPS 100 has a different dividend
policy. The dividend policy is such that on or before 20 September 2018, the dividend
is 5.1%. However, after this date, the dividend is pegged to the 3-Month Singapore
Swap Offer Rate plus 2.5% and that to me is a big difference. That would mean that
the amount of dividends will fluctuate subsequently.

5.3 Summary Notes
 The preference shareholders contribute capital to the company. According to section 85 of

the Companies Act, 1956, persons holding preference shares, called preference shareholders.
 They are assured of a preferential dividend at a fixed rate during the life of the company.
 This type share holders carry preferential right over other shareholders to be paid first in
case of liquidation of the company. Companies use this mode of financing as it is cheaper
than raising debt.
 A company may issue redeemable type of shares on the condition that the company will
repay the amount of share capital to the holders of this category of shares after the fixed
period or even earlier at the discretion of the company. Section 80 of the Companies Act,
1956 deals with the redemption of preference shares.
5.4 Keywords
Fully Paid Shares: Shares in which whole amount is paid and no money is required.
Legal Restrictions: Legal limitations on activities.
Redemption: The action of saving or being saved.
Reserve Account: Funds taken out of earnings to provide for anticipated future payments.
1. What do you mean by preference share? Explain.

2. Distinguish between equity shares and preference shares.
3. Name the shares from where the preference shares can be redeemed.
4. What are the legal restrictions on the redemption of preference shares?
5. Explain in details the requirements for the redemption of preference shares as laid down
in Section 80 of the Companies Act, 1956.
6. What is capital redemption reserve account? How is it created? How is it utilised?
7. Explain the different kinds of preference shares.
8 Explain the following terms:
(i) Profit which would otherwise be available for dividend.
(ii) Proceeds from the issue of fresh shares.
(iii) Capital redemption reserve account.
9. A company has 20,000 redeemable preference shares of 100 each, fully paid. The company
decides the redeem to shares on 31st March, 2006 at a premium of 8%. The company has
sufficient profits but in order to augment liquid funds the following issue was made:
12,500 equity shares of 100 each at 111.
The issue was fully subscribed and all the amounts were received. The redemption was
duly arrived out. Pass journal entries.

Notes 10. The following balances were extracted from the books of Raman Limited as on 31st Dec.,
2005 3,000, 8% redeemable preference shares of 100 each fully called up 3,00,000
Less: Calls in Arrear at 20 per share on 450 shares 9,000
2,91,000
General Reserve 75,000
Capital Reserve 15,000
The preference shares were redeemed on 1st January, 2006 at a premium of 10%. The
company issued such further equity shares of 10 each as were necessary for the purpose
of redeeming the preference shares, which were fully subscribed and duly allotted. You
are required to show the journal entries showing the transactions relating to the redemption
of shares and the relevant extracts on the liabilities side of the balance sheet after such
redemption. (Adapted from B. Com. Mysore)
11. The summarised balance sheet of Sahitya Company Limited on 30th June 2006.
Share Capital: Sundry Assets 80,00,000
Authorised, Issued and Paid up: Cash Balance 32,00,000
2,00,000; 8% Redeemable Preference Shares of 10 each 20,00,000
5,00,000 Equity Shares of 10 each 50,00,000
Current Liabilities 30,00,000
Profit & Loss A/c 12,00,000
1,12,00,000 1,12,00,000
The condition of issue of redeemable Preference Shares provided to their being redeemed
on 1st July, 2006 at a premium of 5%. The profits available being not sufficient to redeem
the whole issue, the company issued 10,000, 10% preference shares of 100 each at par on
1st July, 2006 which were duly taken up and paid for. The redeemable preference shares
were redeemed on the due date.
Show the journal entries to record the above mentioned transactions.
12. On 31st March, 2006 the summarised balance sheet of Arti Limited stood as follows:
Share capital: Fixed capital 15,00,000
Authorised, Issued and Subscribed Cash at Bank 5,00,000
12,500 equity shares of 100 each fully paid up 12,50,000 Other Current Assets 7,50,000
6,250, 10% Redeemable Preference shares of 100 6,25,000
each, fully paid up
Reserve & Surplus:
Share premium 25,000
Dividend equalization Reserve 2,55,000
Profit and Loss A/c 95,000
Current Liabilities 5,00,000
27,50,000 27,50,000
The company redeemed all its preference shares at a premium of 10 per cent by issuing the
fresh equity shares of 100 each at a premium of 5% for minimum amount necessary, after
using all its divisible profits for purpose of redemption.

First, ascertain the amount for which first equity shares were issued. Show journal entries Notes
for all transactions concerning the redemption of preference shares and prepare the balance
sheet as it would appear immediately after redemption.
13. Spotlight Limited has issued share capital of 60,000, 14% Redeemable Preference Shares of
20 each and 4,00,000 Equity Shares of 10 each. The preference shares are redeemable at
premium of 5 per cent on 1st April, 2006.
As at 31 March, 2006 the company's balance sheet showed the following position:
Issued Share Capital 60,000, 14% Redeemable 12,00,000 Plant and Machinery 25,00,000
Preference shares of 20 each fully paid Furniture 9,00,000
Investments 3,50,000
4,00,000 equity shares of 10 each fully paid 40,00,000 Stock 15,00,000
Profit and Loss Account 7,00,000 Debtors 14,00,000
Sundry Creditors 12,00,000 Balance at Bank 4,50,000
71,00,000 71,00,000
In order to facilitate the redemption of preference shares it was decided:
(a) To sell all the investments for 3,00,000.
(b) To finance part of the redemption from company funds subject to leaving the balance
in Profit and Loss Account at 2,00,000.
(c) To issue sufficient equity shares of 10 each at premium of 2 per share to raise the
balance of funds required.
1. True 2. True
3. Fixed 4. Irredeemable
5. (d) 6. Bonus
7. Share Premium 8. Cash
9. False 10. False
11. False 12. fresh issue of shares.
13. (b) 14. (a)
15. (c)


Accounting for Companies-I Gopika Juneja, Lovely Professional University
Notes Unit 6: Debentures: Concept, Types, Issue
CONTENTS
Objectives
Introduction
6.1 Meaning
6.2 Kinds of Debentures
6.3 Distinction between Share and Debenture
6.4 Distinction between Debentures and Debenture Stock
6.5 Issue of Debentures
6.6 Calls-in-Advance and Calls-in-Arrear on Debentures
6.7 Issue of Debentures for Consideration Other Than Cash
6.8 Issue of Debentures as a Collateral Security for a Bank Loan
6.9 Summary
6.10 Keywords
Objectives
 Explain the meaning of Debentures
 Define kinds of Debentures
 Explain the distinction between Share and Debenture
 Explain distinction between Debenture and Debenture Stock
 Know issue of Debentures
Introduction
A debenture is a document that either creates a debt or acknowledges it, and it is a debt without
collateral. In corporate finance, the term is used for a medium- to long-term debt instrument
used by large companies to borrow money. In some countries the term is used interchangeably
with bond, loan stock or note. A debenture is thus like a certificate of loan or a loan bond
evidencing the fact that the company is liable to pay a specified amount with interest and
although the money raised by the debentures becomes a part of the company’s capital structure,
it does not become share capital. Senior debentures get paid before subordinate debentures, and
there are varying rates of risk and payoff for these categories.
Debentures are generally freely transferable by the debenture holder. Debenture holders have
no rights to vote in the company’s general meetings of shareholders, but they may have separate
meetings or votes e.g. on changes to the rights attached to the debentures. The interest paid to
them is a charge against profit in the company’s financial statements.

Unit 6: Debentures: Concept, Types, Issue
6.1 Meaning Notes
When a company desires to borrow a huge amount of money for a long period, it can obtain the
same from financial institutions as IDBI or ICICI, or from the general public. A company can
obtain a long-term loan from general public by issuing debentures. A debenture may be defined
as a written instrument acknowledging a debt by a company under its carmon seal to some
person or persons. It is a bond by a company and is offered to the public by means of a prospectus
containing the terms and condition for repayment of the principal sum and for payment of
interest at a fixed rate. It may or may not be secured by a charge on the company’s assets. Section
2 (12) of the Companies Act defines the term: “debenture includes debenture stock, bonds any
other securities of a company whether constituting a charge on the assets of the company or
not”. In fact this is no definition and hardly tells us what the term debenture really means. In
simple words, a debenture is a certificate that:
1. acknowledges that company has taken a stated loan from a person/persons named in the
certificate and this amount will be redeemed on a specified date or on the expiry of a
stipulated period.
2. contracts to pay a fixed rate of interest periodically to the person named in the certificate.
Usually, the rate of interest is prefixed for the debentures as 10% debentures.
3. gives the details of the security.
6.2 Kinds of Debentures
Debentures can be classified into different categories on the basis of following characteristics:
1. Permanence or redemption: On the basis of permanence or redemption, debentures can be

classified into two:
(a) Redeemable debentures: These are those debentures which are redeemed/repaid either
at the expiry of a specific period or within a period by the company. The redemption
of these debentures takes place either by annual drawings in lump sum or by purchase
in the open market at any time at the prevailing rate in the market.
(b) Irredeemable or perpetual debentures: In this case, the company does not fix any date for
repayment of debentures. The holder of these debentures cannot demand payment
from the company during its lifetime. Generally, the debentures are repayable after
a long period or on liquidation of the company.
2. Security: On the basis of security, debentures can be classified into two:
(a) Secured or mortgage debentures: These are those debentures which are secured by a
charge on the assets or properties of the company. When the charge is of a particular
assets, such as land or buildings, it is called a fixed charge. When the charge is on all
the fee assets of the company, it is called general charge or floating charge. The
terms of debentures or trust deed will decide the rights of the debenture-holders in
the case of default of a company.
(b) Naked or simple debenture: Those debentures which carry no security are unsecured.
The debenture-holders of these debentures have no priority over other creations of
the company. Their position is equal to that of unsecured creditors.
3. Priority in payment: On the basis of priority in payment of interest and principal amount
of debenture, they can be classified into:

Notes (a) First debentures: Those debentures that are to be repaid and on which interest is to be
paid in priority to other debentures, are called first debentures.
(b) Second debentures: Those debentures that are repaid and in which interest is to be
paid after the payment of first debentures, are called second debentures.
4. Record or Negotiability: On the basis of records, debentures maybe classified into:
(a) Registered debentures: Those debentures whose debentures-holders are registered in

the books of the company. According to the provisions of the Companies Act
(Sections 108 to 118), transfer of registered debentures requires a transfer deed,
which has to be lodged with the company for the necessary changes to the recorded
in the register of debenture-holders. The register of debenture-holders is similar to
the register of shareholders containing names, addresses and holding of debentures.
Interest on debenture is paid only to that person whose name appears in the register
of the debenture-holders.
(b) Bearer debentures: Those debentures which can be transferred by mere delivery,
because the company does not maintain any records of names and addresses of the
debenture-holders. These are like negotiable instruments. On producing the coupons
attached to the debentures, interest is paid to the bearer. The bearer is also entitled
to obtain the payment of the principal sum on presenting the document at the time
to its redemption.
5. Convertibility: From the point of convertibility, debentures may be classified into

(i) convertible debentures and (ii) non-convertible.
(a) Convertible debentures: Those debentures which can be converted into shares of the
company on certain dates, or during a certain period at the option of the debenture-
holder according to the terms of issue. These debentures can be fully convertible
(FCD) or partly convertible (PCD).
(b) Non-convertible debentures: Those debentures whose debenture-holders do not have

a right to convert them into equity or preference debentures.
Some important points regarding issue of debentures:
1. Objectives of issuing debentures: According to the guidelines issued by the Controller of

Capital Issue, the objects of issue can be one or more of the following:
(i) Setting up of new projects.
(ii) Expansion or diversification of existing projects.
(iii) Normal capital expenditure for modernisation.
(iv) Merger/amalgamation of companies in pursuance of schemes approved by banks,

financial institutions and/or any legal authority.
(v) To augment the long-term resources of the company for working capital
requirements.
2. Issue of fully convertible debentures (FCD) having a conversion period of more than 36
months will be permissible, unless conversion is made with “put” and “call” option.
3. Compulsory credit rating will be required if conversion is made for FCDs after 18 months.
4. Issue of debentures with maturity of 18 months or less are exempt from the requirement
of appointment of debenture trustee or creating a debenture redemption reserve.

5. Any conversion in part or whole of the debentures will be optional at the hands of Notes
debenture-holders, if the conversion takes place at or after 18 months from the date of
allotment, but before 36 months.
6. The premium amount at the time of conversion for PCD shall be predetermined and
stated in the prospectus. The redemption amount, period of maturity, yield on redemption
for the PCDs/NCDs shall be indicated in the prospectus.
7. There is no debt-equity ratio prescription now.
8. The repurchase procedure of NCDs must be stated at the time of issue itself.
9. In case one series of debentures is extinguished by another series, debenture-holders must

have the right to opt out and receive the cash. There must be credit rating six months
before the debentures are rolled over.
6.3 Distinction between Share and Debenture
Shares and debentures can be distinguished on the basis of the following points:
1 Ownership Security vs Creditors Security: A person having a share is called a shareholder

and has ownership security while a person having a debenture is called a debenture-
holder, who is creditor of the company.
2. Return on Investment: A debenture-holder will get a fixed rate of interest on debentures.

This is paid in all circumstances whether there is a profit or loss. Shareholders will receive
a part of the profit in the form of dividend. This dividend depends upon the profit of the
company. It can be more or less; it is always declared by the directors, out of the profits.
3. Priority as to repayment of principal on liquidation: In the case of winding up of the

company, the amount of debentures will be redeemed before any amount is paid to
shareholder to refund share capital.
4. Secured by charge: Shares are not secured, while the debenture can be secured or mortgaged
(i.e. secured by assets).
5. Restrictions on issue at the discount: There are some restrictions on the issue of shares at
discount but there is no restriction on issue of debentures at discount.
6. Voting Right: A shareholder is the owner of the company and has a voting right and also
takes part in the management of the company, while a debenture-holder is a creditor of
the company and cannot take a part in management.
7. Convertibility: Equity shares can never be converted into debentures, while debentures
can be converted into shares at the discretion of the debenture-holders.
8. Redemption: A debenture-holder may get refund during the lifetime of the company,
while the equity share-holder cannot claim refund on his shares during the lifetime of the
company.
Did u know? In case one series of debentures is extinguished by another series, debenture-
holders must have the right to opt out and receive the cash. There must be credit rating six
months before the debentures are rolled over.

Notes 6.4 Distinction between Debentures and Debenture Stock
There are three main differences between debentures and debentures stock.
1. Debenture stock are always fully paid while debentures can be partly paid up.
2. Debentures stock can be transferred in friction while debentures are transferred wholly.
3. Debentures stock are not allotted any serial number while debentures are allotted a serial
number.
Stages of Debentures
There are the following three main stages of accounting for debentures:
1. Accounting at the time of issue of debentures.
2. Accounting at the time of making a provision for redemption of debentures.
3. Accounting at the time of redemption of debentures.
Note Shares are not secured, while the debenture can be secured or mortgaged (i.e.
secured by assets).
6.5 Issue of Debentures
The procedure for issue of debentures is exactly similar to the procedure of issue of shares. The
company prepares a prospectus and issues it in the market; applications for debentures are
invited along-with some application money. After scrutiny, letters of allotment are issued and
so on. The only difference is that the names of accounts are changed and the rate of interest is
prefixed to debentures. For instance, if rate of interest is 10%, the name given will be 10%
Debenture. Debentures may also be issued at par, at premium or at discount similar to shares.
Accounting treatment for the issue of debentures maybe understood properly from the following
points of view:
(I) Consideration
(II) Conditions for redemption
Consideration
Debentures maybe issued in the following ways:

1. Issue of debenture for cash.
2. Issue of debenture other than cash.
3. Issue of debenture as collateral security.
Issue of debentures for cash

When debentures are issued for cash, the amount of debenture maybe collected in different
instalments or in lump sum and the issue of debentures maybe at par, at premium, or at discount.

1. Issue of debentures at par: When the price of the issue is equal to the face value or nominal Notes
value of debenture, it is said that debentures are issued at par e.g., the issue of a debenture
of 1,000 for 1,000. The following accounting entries are adopted when debentures are
issued at par:
A. If the whole value of debenture is payable in one lump sum with application.
(i) On receipt of debenture application money:
Bank Account Dr
To Debenture Application Account
(ii) On allotment of debentures
Debenture Application Account Dr
To Debentures account.
In the place of above two entries, only the following single entry can be
passed Bank Account Dr
To Debentures Account.
B. If the amount of debenture is payable in different instalments:
(i) On receipt of debenture application money
Bank Account
To Debenture Application Account
(ii) When applications are accepted –
Debenture Application Account Dr.
To Debentures Account
Bank Account Dr.
To Debenture Account
(iii) When allotment money is due to debentures–
Debenture Allotment Account Dr.
Instead of opening two separate accounts-debenture application account and

debenture allotment account, one combined account for application and
allotment may be opened. In that case for above (ii) & (iii) entries, the following
single entry will be passed:
Debenture Application & Allotment Account Dr.
To Debenture Account.
(iv) When allotment money is received-
Bank Account Dr.
To Debenture Allotment Account.
(v) When call money is due to Debenture-holders-
Debenture Call Account Dr.

Notes To Debenture Account.
(vi) When call money is received-
Bank Account Dr.
To Debenture Call Account
Note If the issue of debentures is oversubscribed by the public, excess application money
may be retained by the company for adjustment towards allotment and respective calls. If
no debenture is allotted to the applicant, his money will be refunded and the following
journal entry will be passed.
Debenture Application Account Dr
To Bank Account
Example 1: Issue of Debentures at Par Payable in Installment and Lump Sum

Sonex Co. Limited issued 5,000; 12% Debentures of 500 each payable as under:
100 on application, 200 on allotment and balance on final call.
In addition, the company offers 2,000; 10% Debentures of 100 each and the entire amount was
payable with application.
In the case of 10% Debentures, the company received applications for 2,500 debentures.
The directors of the company made the allotment on a pro-rata basis and excess money was
refunded to the application. All the moneys were duly received. Journalise the transactions.
Solution:
Sonex Limited Journal
( ) ( )
To 12% Debenture Application Account 5,00,000
(Being the receipt of application money on 5,000; 12% debenture @ 100 per
debenture)
12% Debenture Application Account Dr. 5,00,000
To 12% Debenture Account 5,00,000
(Being application money transferred to debenture account).
12% Debenture Allotment Account Dr. 10,00,000
(Being allotment money due on 5,000 debenture @ 200 per debenture)
To 12% Debenture Allotment Account 10,00,000
(Being receipt of allotment money on debenture)
12% Debenture Final Call Account Dr. 10,00,000
(Being final call money due on 5000 debenture @ 200 per debenture)
Bank Account Dr. 10,00,000 Contd...
To 12% Debenture Final Call Account 10,00,000
(Being receipt of final call money on debentures)
(Being receipt of when money on 2000 debenture @ 100 each in lump sum)
(Being allotment money due on 5,000 debenture @ 200 per debenture)
(Being receipt of allotment money on debenture)
12% Debenture Final Call Account Dr. 10,00,000
(Being final call money due on 5000 debenture @ 200 per debenture)
Bank Account Dr. 10,00,000 Notes
To 12% Debenture Final Call Account 10,00,000
(Being receipt of final call money on debentures)
(Being receipt of when money on 2000 debenture @ 100 each in lump sum)
(Being application money transferred to debenture accounts)
10% Debenture Application Account Dr. 50,000
(Being excess money refunded to the applicants)
2. Issue of Debentures at Premium: When the issue price of a debenture is more than the face
value or nominal value of the debentures, it is said that debentures are issued at premium.
Take for example, the issue of a debenture of 500 for 550. Here, the excess of issue price
of 50 (550-500) is termed as premium on debenture. The amount of premium is not a
revenue profit. This amount is kept in a separate account known as “Debenture Premium
Account.” At the end of accounting period this should be transferred to Capital Reserve
account. The amount of premium can be utilized for writing off capital losses and useless
fictitious assets as preliminary expenses, under-writing commission, amortization of
goodwill etc. The balance debenture premium is shown in the liabilities side of the balance
sheet under the head of Reserve and Surplus. In the absence of any contra information,
premium should be due on allotment. The journal entry will be as follows:
Debenture allotment account Dr
To Debenture Premium Account
Example 2: Issue of Debenture at Premium

Ashutosh Company Limited issued 5,000; 10% Debenture of 100 each at a premium of 15%
payable as follows: 20 on application, 40 on allotment including premium, and balance on
first and final call.
The public applied for 6,000 debentures. Applications for 4,750 debentures were accepted in full,
applications for 500 were allotted 250 debentures and the remaining applicants were rejected.
All moneys were duly received. Pass the necessary cash book and journal entries.
Solution:
Ashutosh Co. Ltd. Journal

To 10% Debenture Account 5,000
(Being utilisation of application money)
To Debenture Premium Account 75,000
Contd...
(Being allotment money due with premium on 5,000 debenture @ 40)
10% Debenture First & Final Call Account Dr. 2,75,000
(Being first and final call money due on 5,000 debentures @ 55 per
debenture)
Debenture Premium Account Dr. 75,000
(Debenture premium transferred to capital reserve account)
To 10% Debenture Account 5,000
(Being utilisation of application money)
Notes To Debenture Premium Account 75,000
(Being allotment money due with premium on 5,000 debenture @ 40)
10% Debenture First & Final Call Account Dr. 2,75,000
debenture)
Debenture Premium Account Dr. 75,000
(Debenture premium transferred to capital reserve account)
Cash Book
( ) ( )
To 10% Debenture Application 1,20,000 By 10% Debenture Application 15,000
(6,000 × 20) (750 × 20)
Account
To 10% Debenture Allotment Account 1,95,000 By Balance C/d 5,75,000
(2,00,000 – 5,000)
To 10% Debenture First and Final Call Account 2,75,000
5,90,000 5,90,000
!
Caution The procedure for issue of debentures is exactly similar to the procedure of issue
of shares.
Self Assessment
Fill in the blanks:
1. Debenture-holders are entitled to get …………… at a fixed rate.
2. Debentures are shown under the heading of …………… in the liability side of the balance
sheet.
3. Debenture-holders are the …………… of a public limited company.
4. Select the best alternative:
Which of the following debentures is transferred by transfer deed only:
(i) Bearer debenture

(ii) Registered debenture
(iii) Mortgage Debenture
5. The procedure for issue of …………… is exactly similar to the procedure of issue of shares.
3. Issue of Debentures at a Discount: When the issue price of the debenture is less than the
face value or nominal value of the debenture, it is said that debentures are issued at
discount. Take for example, the issue of a debenture of 100 at 85. Here, the deficit of
price of 15 (100-85) will be termed as ‘Discount on Issue of Debenture Account’, which is
debited due to a capital loss. There is no statutory restriction as to the maximum limit for
discount on debenture as there is in the case of shares. According to the Companies Act
1956, ‘Discount on Issue of Debentures’ must be shown on the assets side of the Company’s

Balance Sheet under the heading of Miscellaneous Expenditure, until it is written off Notes
completely. Discount on issue of debentures may be written off either out of revenue
profits (credit balance of Profit and Loss Account) or out of capital profits (share premium
account or debenture premium account) during the lifetime of the debentures. In the
absence of any contra information in the examination question, discount should be allowed
on allotment. The journal entry will be as follows –
Debenture Allotment Account Dr
Discount on Issue of Debenture Account Dr
Example 3: Issue of Debentures at a Discount

Surjeet Mills Limited issued 5,000 12 % Debentures of 100 each at a discount of 15% payable as
below:
With application 20 per debenture
On allotment 50 per debenture
On final call the balance
The public applied for 7,000 debentures. Applications for 4500 debentures were accepted in full,
the applicants for 1000 debentures were allotted 500 debentures and the remaining applicants
were rejected . Show the journal entries including those for cash assuming that all the instalments
were duly collected.
Solution:
Surjeet Mills Limited
Journal Entries

(Being receipt of application money on 7,000 debentures @ 20 per
debenture).
To 12% Debentures Account 1,00,000
(Being transfer of application money to Debentures Account and
amount of rejected application refunded)
Discount on Issue of Debenture Account Dr. 75,000
(Being allotment money due on 5,000 debentures @ 50 per debenture
at discount).
12% Debenture Application account Dr. 10,000
(Being receipt of allotment money and excess of application money
adjusted in allotment)
12% Debenture First and Final Call Account Dr. 1,50,000
Contd...
Debenture)
Bank account LOVELY PROFESSIONALDr.
UNIVERSITY
1,50,000 139
(Being receipt of first and final call money)
(Being allotment money due on 5,000 debentures @ 50 per debenture
at discount).
12% Debenture Application account Dr. 10,000
(Being receipt of allotment money and excess of application money
adjusted in allotment)
Notes 12% Debenture First and Final Call Account Dr. 1,50,000
Debenture)
Bank account Dr. 1,50,000
(Being receipt of first and final call money)
Issue of Debentures for Consideration Other than Cash
When a company purchases some assets or services of an.otlier company., it has to pay purchase
consdd.eration, which can be paid by many methods. If it paid by issue of fully paid debentures
such issue of debentures is said issue of debentures for consideration other than cash.
Issue of Debentures as a Collateral Security for a Bank Loan
A collateral security means a subsidiary or secondary security_ When a company takes a loan or
overdraft from a ban.k, it may give its own debenture to the bank as collateral security against
the loan or overdraft, in addition to principal security_ Generally" a company delivers its own
debentures as collateral security to bank only in that case,. when principal security is not sufficient
for the loan. Collateral security is not utilised or realised by the bank until the company makes
its payment (interest and repayment of loan). It means that this collateral security can be used by
the bank in the case of default regarding the repayment of the loan_ The bank, may either keep
the debentures and become a debenture-hoildE,:..r or sell them and realise money But upon the
repa.yment of the loan, the bank must ret'urn these debentures and the company should then
cancel them. This type of issue by the company is called issue of debenture as collateral security.
Conditions of Redemption
Sometimes, debentures are issued with specific conditions on which the redemption of debenture
is made by the company. There can be the following five possibilities for redemption:
Possibility Condition of Rssue Condition of Redemption

1 Issued at par Redeemable at par
2 Issued at premium Redeemable at par
3 Issued at discount Redeemable at par
4 Issued at par Redeemable at premium
5 Issued at discount Redeemable at premium
It may be noted that the debentures can be issued at par, at premium, or at discount, but
redemption will be either at par or at premium. This is possible only when the condition of
redemption of debentures is made in advance by the company. If a company redeems its debentures
by purchasing them from the open market at a price below the par valueothe, difference (par
value and purchase price) is treated as profit on redemption or redemption of debentures at
discount.
6.6 Calls-in-Advance and Calls-in-Arrear on Debentures
If the Articles of Association of a company can accept calls-in-advance on debentures and will
pay interest on calls-in-advance to the debenture-holders. This interest is the loss of the company
and therefore, it is transferred to the debit side of Profit and Loss Account. Calls-in-advance are
shown in the liabilities side of the balance sheet. When the amount of debenture is payable in

various instalments and any or some instalments are not paid by the debenture-holder, that Notes
amount which is not paid by the debenture-holder is known as calls-in-arrear. For unpaid
amount on any call, no separate account is maintained in the books. The amount of calls-in-
arrear is substracted from the paid-up value of debenture in the liabilities side of the balance
sheet. If there is no provision regarding the interest in calls-in-arrear on debentures, interest is
not calculated on arrears.
Example 4: Calls-in-Arrear and Calls-in-Advance on Debenture

Golu Limited issued 10,000; 12% Debentures of 100 each at premium of 5% payable as under:
With application 15 per debenture
On first call 10
On final call 30
One of the conditions of issue of 12% Debentures was that the entire amount of 12% Debenture
can be paid at the time of allotment of 12% Debenture and in this case interest @ 3% per annum
will be paid by Golu Limited on the advance money received and this interest will be paid on
the date of payment of the last call. All the debentures were subscribed. A holder of 3,000; 12%
Debentures paid whole of the amount of 12% debentures on allotment in accordance with this
condition. Another holder of 300; 12% Debentures could not pay the final call. The date of
application and allotment was 1st November 2005 the date of first call was 1st January 2006; the
date of final call was 1st May, 2006.
Pass necessary journal entries in the books of Golu Limited, assuming that all other payments
were duly received.
Solution:
Journal Entries

2005
Nov. 1 Bank Account Dr. 1,50,000
(Being receipt of application money in 10,000 debentures @ 15 per
debenture)
Nov. 1 12% Debenture Account Dr. 1,50,000
(Being transfer of application money to debenture account)
Nov. 1 12% Debenture Allotment Account Dr. 4,50,000
To Premium on Debenture Account 50,000
(Being allotment money due on 10,000 debentures @ 45 per
debenture on premium)
(Being receipt of allotment money and also calls-in- advance on 3,000
debentures @ 40 per debenture)
2006 Contd...
Jan. 1 12% Debenture First Call Account Dr. 1,00,000
(Being first call money due on 10,000LOVELY
debenturePROFESSIONAL
@ 10 each) UNIVERSITY 141
Call-in-Advance Account Dr. 30,000
To 12% Debenture First Call Account 1,00,000
(Being receipt of first call money and calls-in-advance adjusted)
To Premium on Debenture Account 50,000
(Being allotment money due on 10,000 debentures @ 45 per
debenture on premium)
(Being receipt of allotment money and also calls-in- advance on 3,000
debentures @ 40 per debenture)
Notes 2006
Jan. 1 12% Debenture First Call Account Dr. 1,00,000
(Being first call money due on 10,000 debenture @ 10 each)
Call-in-Advance Account Dr. 30,000
To 12% Debenture First Call Account 1,00,000
(Being receipt of first call money and calls-in-advance adjusted)
May, 1 12% Debenture Second & Final Call Account Dr. 3,00,000
(Being second and final call money due on 10,000 debenture @ 30
per debenture)
Calls-in-advance Account Dr. 90,000
To 12% Debenture Second and Final Call Account 2,91,000
(Being receipt of second and final call on 6,700 debenture and calls-
in-advance adjusted)
Interest on calls in advance Account Dr. 1,500
(Interest on calls in advance paid to Debenture-holders)
Working Note:
1. Total amount receivable on second and final call ( )
10,000 × 30 3,00,000
Less: amount already received on 3,000 debentures
3,000 × 30 90,000
Amount receivable 2,10,000
Less: Calls-in-Arrear
300 × 30 9,000
Amount received in second call 2,01,000
2. Interest on Calls in advance for two months
(Nov & Dec 2005)
30,000 × 3 2
× = 150
100 12
Interest on calls-in-advance for six months
(Nov, Dec, 2005, Jan, Feb, March, April 2006 150)
90,000 × 3 6
× = 1350
100 12
1500

Fill in the blanks:
6. A 10% debenture of nominal value of 100 has been issued at 90 is said to be issued at
…………… .
7. A 9% debenture of a nominal value of 100 has been issued at 120 debentures are said to
be issued at …………… .
8. 100 8% debentures of 100 each has been issued to vendors for plant purchased the
debentures are said to be issued …………… .
9. A company can issue its debentures at a discount if a provision in this regard has been
made in its ...........................
10. If there is no provision regarding the interest in calls-in-arrear on debentures, interest is

not calculated on …………… .
6.7 Issue of Debentures for Consideration Other Than Cash
When a company purchases some assets or services of another company, it has to pay purchase
consideration, which can be paid by many methods. If it paid by issue of fully paid debentures
such issue of debentures is said issue of debentures for consideration other than cash.
These debentures can be issued to the vender at par, at premium or at a discount. In this case
following journal entries are passed:
1. On purchase of assets/business:
Sundry Assets Account Dr.
*Goodwill Account Dr
To Sundry Liabilities Account
To Vendors’ Account
**To Capital Reserve Account
*If the value of net assets acquired is less than the value of debentures issued, the difference
(value of debentures-net assets acquired) will be goodwill and will be debited.
**If the value of net assets acquired is more than the value of debentures issued, the
difference will be treated as Capital Reserve and will be credited.
2. When debentures are allotted in lieu of purchase consideration:
(i) If the debentures are issued at par to the vendor:
Vendors Account Dr
(ii) If the Debentures are issued at premium to vendor:
Vendors’ Account Dr.
To Debentures Premium Account

Notes (iii) If Debentures are issued at discount to the vendor:

Vendors’ account Dr.
To Discount on issue of debentures Account Dr.
Example 5: Issue of Debentures to Vendor

Sunder Mills Limited acquired the business of Sohan Brothers. This business consists of building
of 10,00,000, Plant and Machinery of 4,00,000 and Patents of 2,00,000 and Sundry Liabilities
2,00,000. The purchase price was of 16,00,000, which will be paid by the issue of 12% debentures
of 100 each. Pass necessary journal entries if these debentures are issued (i) at par (ii) at 25%
premium.
Solution:
Journal Entries
Date Particular L.F. ( ) ( )

Building Account Dr. 10,00,000
Plant & Machinery Account Dr. 4,00,000
Patents Account Dr. 2,00,000
Goodwill Account Dr. 2,00,000
To Sohan Brothers 16,00,000
To Sundry Liabilities Account 2,00,000
(Being acquisition of assets and liabilities of Sohan Brothers)
Sohan Brothers Dr. 16,00,000
(Being debentures issued at par for consideration of purchase price)
Sohan Brothers Dr. 16,00,000
To Debentures Premium Account 3,20,000
(Being debentures issued at 25% premium to Sohan Brothers)
Working Note:
Purchase price
No of debentures Issued =
Issue price of debenture
16,00,000
= = 12,800
125
Face value of 12,800 debentures = 12800 100 = 12,80,000
Example 6: Issue of Debentures to Vendor with part payment in cash

AK Limited Company acquired the buildings of 25,00,000 and liabilities of 4,00,000 of G.K.
& Sons. There was an agreement to pay the purchase consideration 20,00,000 by issuing the
10% Debentures of 100 each at a premium of 10%. The debentures of AK Limited are quoted in
the market at 145.
You are required to give journal entries for recording the transactions in the book of AK Limited.

Solution: Notes
Journal Entries

Buildings Account Dr. 25,00,000
To Sundry Liabilities Account 4,00,000
To GK & Sons 20,00,000
To Capital Reserve Account 1,00,000
(Being purchase Sundry Liabilities and Buildings of GK & Sons)
G.K. & Sons Dr. 20,00,029
To Debenture Premium Account 1,81,810
To Cash Account 119
(Being debentures issued at 10% premium to G.K. & Sons for
purchase consideration)
Working Note:
Purchase Consideration
No. of debentures Issued to G.K. & Sons =
Issue price of debentures
20,00,000
= = 18,181.818
100 10
As the fractional debentures cannot be issued to the vendor, AK Limited can issue only 18,181
debentures. And for fractional debenture of 0.818, payment will be made in cash. The amount
payable for fractional debenture will be computed on market price and not on paid up value.
The reason is that the vendor can always dispose his debentures in the market.
Therefore, the fractional value of debentures will be = 0.818 145 = 118.61 or 116 Now, the
real purchase consideration will be:
Nominal value of debentures ( )
18,181 100 18,18,100
10% Debenture Premium 1,81,810
Cash for fractional debentures 119
20,00,029
6.8 Issue of Debentures as a Collateral Security for a Bank Loan
A collateral security means a subsidiary or secondary security. When a company takes a loan or
overdraft from a bank, it may give its own debenture to the bank as collateral security against
the loan or overdraft, in addition to principal security. Generally, a company delivers its own
debentures as collateral security to bank only in that case, when principal security is not sufficient
for the loan. Collateral security is not utilised or realised by the bank until the company makes
its payment (interest and repayment of loan). It means that this collateral security can be used by
the bank in the case of default regarding the repayment of the loan. The bank, may either keep
the debentures and become a debenture-holder or sell them and realise money. But upon the
repayment of the loan, the bank must return these debentures and the company should then
cancel them. This type of issue by the company is called issue of debenture as collateral security.

Notes Accounting Treatment
There are two methods of dealing with such debentures in the books of accounts of the company:
First Method: No accounting entry is recorded in the books of the company (as such debentures
are really not alive) for such debenture. Only a note is given below the item of the loan in the
liabilities side of the balance sheet that it has been secured by the issue of debentures as collateral
security as under:
Balance Sheet
Liability Side only ( )

Secured loans:
Loan from the State Bank of India 1,50,000
(secured by 2,000; 12% Debentures of 100 each as collateral security)
Debentures:
10,000; 12% Debentures of 100 each 10,00,000
Second Method: If an accounting entry for debentures issued as collateral security is to be passed
in the books of accounts, the following journal entry will be made.
(i) On the issue of such debentures:
Debentures Suspense Account Dr. (with face value of debentures)
Debenture suspense account will appear in the asset side and Debentures account will
appear in the liabilities side of the Balance Sheet of the company.
(ii) On the repayment of bank loan such debentures will be cancelled by passing the following
journal entry:
Debentures Account Dr.
To Debentures Suspense Account.
Note In practice this method is seldom followed.
Example 7: Issue of Debentures as Collateral Security

Pankaj Limited took a loan of 90,000 from Punjab National Bank by depositing 1,000; 12%
Debentures of 100 each as a collateral security. How will you treat the issue of such debentures.
Solution:
First Method:
Balance Sheet of Pankaj Limited as on...
Secured loans:
Loan form Punjab National Bank (secured by 1,000; 90,000
12% Debentures of 100 each as collateral security)

Second Method: Notes

Journal of Pankaj Limited

Debentures Suspense Account Dr. 1,00,000
(Being 1,000; 12% Debentures of 100 each issued to Punjab National
Bank as collateral security)
Balance Sheet of Pankaj Limited as on...
Secured loans: Miscellaneous Expenditure 1,00,000
Debenture Suspense
Loan from Punjab National Bank (secured by 1,000; 90,000
12% Debentures of 100 each as collateral security)
Debentures:
1,000; 12% Debenture of . 100 each issued as collateral 1,00,000
security.
!
Caution There are some restrictions on the issue of shares at discount but there is no
restriction on issue of debentures at discount.
Self Assessment
Name them:
11. Name the security which is issued in addition to the principal security.
12. Which account is debited while making a journal entry in the books of the company on
issue of debentures as collateral security?
13. On which side of the balance sheet of a company issuing debentures as collateral security
is written the Debentures Suspense A/c?
14. When does a company issue debentures as collateral security?
Did u know? Collateral security is not utilised or realised by the bank until the company
makes its payment (interest and repayment of loan).

Case Study RFU Debenture Sales
The Brief
The Rugby Football Union (RFU) issued, in 2005 debentures, ensuring that the holder had
first refusal to purchase at face value, one ticket for Rugby Union events at Twickenham
Stadium over a ten year period. The principle sum invested would then be returned 75
years from date of issue.
Contd...

Notes The RFU approached Goodform to help generate sales of these debentures.
The Work
Telesales
Goodform carried out an ambitious telesales and database marketing campaign with the
goal of selling all 4,000 personal debentures at £6,000 each.
Administration
Goodform looked after all areas of administration of the sales, including payment
processes. Our handling of this labour-intensive work meant that the RFU could operate
most effectively in this area of their business.
Database Management
Goodform established a database which was fundamental to the scheme. Our effective
management gave the RFU the platform to build relationships with the sport’s core
enthusiasts, and by providing an established definitive database of rugby enthusiasts,
were able to assist with the RFU’s future marketing of the sport.
The Result
1. All 4,000 personal debentures were sold in a 4 month period generating £24 million
in revenue.
2. In addition, we established a definitive database of rugby enthusiasts to aid the

RFU’s marketing of the sport.
Source: http://www.goodform.info/page.asp?section=177&sectionTitle=RFU
6.9 Summary
 A Debenture is a unit of loan amount issued to the lenders of the company. Debenture
includes debenture stock, bond and any other security whether constituting a charge on
the company’s assets or not.
 Issue of debentures: Debentures can be issued for cash at par, for consideration other than
cash, as collateral security debentures are said to be oversubscribed when the company
receives application for number of debentures than the company has offered for
subscription.
 Debenture can be issued at premium, at discount and in consideration other than cash.
 Debentures can be issued with conditions stipulated to their redemption as:
 Issued at par redeemable at par
 Issued at discount redeemable at par
 Issued at premium redeemable at par
 Issued at par redeemable at premium
 Issued at discount redeemable at premium
 Issue of debentures as collateral security means issuing debentures to the lending agency
that has given loan as additional/secondary security.
 Issue of fully convertible debentures (FCD) having a conversion period of more than 36
months will be permissible, unless conversion is made with “put” and “call” option.

 Equity shares can never be converted into debentures, while debentures can be converted Notes
into shares at the discretion of the debenture-holders.
6.10 Keywords
Collateral Security: A collateral security means a subsidiary or secondary security.

Convertible Debentures: Those debentures which can be converted into shares of the company
on certain dates, or during a certain period at the option of the debenture-holder according to
the terms of issue.
Debenture Holder: A person having a debenture is called a debenture-holder, who is creditor of
the company.
Debenture: A debenture is a document that either creates a debt or acknowledges it, and it is a
debt without collateral.
First Debentures: Those debentures that are to be repaid and on which interest is to be paid in
priority to other debentures, are called first debentures.
Irredeemable or Perpetual Debentures: In this case, the company does not fix any date for repayment
of debentures. The holder of these debentures cannot demand payment from the company
during its lifetime.
Naked or Simple Debenture: Those debentures which carry no security are unsecured. The
debenture-holders of these debentures have no priority over other creations of the company.
Non-convertible Debentures: Those debentures whose debenture-holders do not have a right to
convert them into equity or preference debentures.
Redeemable Debentures: These are those debentures which are redeemed/repaid either at the
expiry of a specific period or within a period by the company.
Registered Debentures: Those debentures whose debentures-holders are registered in the books
of the company.
Second Debentures: Those debentures that are repaid and in which interest is to be paid after the
payment of first debentures, are called second debentures.
Secured or Mortgage Debentures: These are those debentures which are secured by a charge on
the assets or properties of the company. When the charge is of a particular assets, such as land or
buildings, it is called a fixed charge.
Shareholder: A person having a share is called a shareholder and has ownership security.
1. What do you mean by a Debenture? Explain.
2. Explain the different types of Debentures.
3. Distinguish between share and debenture.
4. Explain the meaning of Issue of Debentures as Collateral Security.
5. What is a sinking fund? Explain how is it created?
6. Write the various forms in which debentures can be issued.
7. A company issued 10000 10% debentures of 100 each. 30 per debenture was to be paid
along with application. Applications were received for 12000 debentures. What can the
company do with the excess application money i.e. 60000 (2000 30).

Notes 8. A company purchased a building for 315000 and issued 10% debentures of 100 each at
a premium of 5%. Calculate (i) the number of debentures issued to the vendors (ii) make
journal entry for the issue.
9. Rama Company Limited issued 2000; 12% Debentures of 100 each payable as follows:
20% on application, 30% on allotment, 30% on first call and balance on final call.
Applications for all debentures were received and the company received all moneys
except in the case of one debenture-holder of 50 debentures who failed to pay his first and
final call money.
Make the necessary journal entries and draw cash book.
10. Subhneet Ltd. issued 50,000; 15% debentures of 100 each for public subscription at a
discount of 10%. Application money was 25 and the balance was payable as follows:
On allotment 30
On first call 25
On final call 20
Applications were received for 48,000 debentures and the amount were received when
due, except in the following cases:
(i) Mr. Sohan who holds 200 debentures did not pay first and final call.
(ii) Mr. Rohan who holds 400 debentures did not pay the final call.
Pass journal entries to record the transaction and cash book.
11. Lohit Limited issued 4,00,000; 10% Debentures of 100 each at 25% premium, payable
15% on application, 50% on allotment (including premium), 25% on first call and balance
on final call, after one month of the first call. The public applied for 4,800 debentures.
Applicants for 2,800 were accepted in full; applicants for 1,500 debentures were allotted.
1,200 debentures and applications were rejected. All moneys were duly received. Pass
journal entries and balance sheet of the company.
1. Interest, 2. Secured Loans,
3. Members, 4. (b)
5. debentures 6. Discount
7. Premium 8. for considerations other than cash
9. Articles of Association 10. Arrears
11. Collateral security 12. Debenture suspense A/c
13. Assets side 14. When lender demands additional security

6.12 Further Readings Notes
Books Glossary: D on the Financial Industry Regulatory Authority (FINRA) website,

United States
What is a debenture? Company Law Club, referring to United Kingdom usage
Chandra Gopalan (2007); Company Law in Singapore 3rd Edition; McGraw-Hill

Education (Asia)
Online links www.caclubindia.com › Articles › Accounts

www.publishyourarticles.org/.../8-main-difference-between-debentur...
www.nos.org/srsec320newe/320el26.pdf
www.mondaq.com/article.asp?articleid=102462

Notes Unit 7: Debentures: Conditions of Issue of Debentures

from Redemption Point of View
CONTENTS
Objectives
Introduction
7.1 Meaning
7.2 Discount on Issue of Debentures
7.3 Loss on Issue of Debentures
7.4 Interest on Debentures
7.5 Some Points to be Noted Regarding Interest on Debentures
7.6 Summary
7.7 Keywords
Objectives
 Understand the discount on issue of debentures
 Explain loss on issue of debentures
 Know interest on debentures
Introduction
The issue of debentures by public limited companies is regulated by Companies Act 1956.
Debenture is a document, which either creates a debt or acknowledges it. Debentures are issued
through a prospectus. A debenture is issued by a company and is usually in the form of a
certificate, which is an acknowledgement of indebtedness. They are issued under the company’s
seal. Debentures are one of a series issued to a number of lenders. The date of repayment is
invariably specified in the debenture. Generally debentures are issued against a charge on the
assets of the company. Debentures may, however, be issued without any such charge. Debenture
holders have no right to vote in the meetings of the company.
The procedure for the issue of debentures is very much similar to that of the issue of shares.
Accounting treatment for the issue of debentures is also the same as in the case of issue of shares.
The only difference is that ‘Debenture A/C’ will be opened in place of ‘Share Capital A/C’.
Debenture account will be opened with prefix rate of interest, e.g. 10% Debentures.
!
Caution Debenture holders have no right to vote in the meetings of the company.

Unit 7: Debentures: Conditions of Issue of Debentures from Redemption Point of View
7.1 Meaning Notes
Sometimes, debentures are issued with specific conditions on which the redemption of debenture
is made by the company. There can be the following five possibilities for redemption:
Possibility Condition of Issue Condition of Redemption

1 Issued at par Redeemable at par
2 Issued at premium Redeemable at par
3 Issued at discount Redeemable at par
4 Issued at par Redeemable at premium
5 Issued at discount Redeemable at premium
It may be noted that the debentures can be issued at par, at premium, or at discount, but redemption
will be either at par or at premium. This is possible only when the condition of redemption of
debentures is made in advance by the company. If a company redeems its debentures by
purchasing them from the open market at a price below the par value the, difference (par value
and purchase price) is treated as profit on redemption or redemption of debentures at discount.
The following journal entries are made at the time of issue of debentures for the above conditions:
1. When debentures are issued at par and redeemable at par:
Bank Account Dr.
(face value of debentures)
2. When debentures are issued at premium and redeemable at par:
Bank Account Dr.
(amount received)
To Debenture Account (face value of debentures)
To Debenture Premium Account (amount of premium)
3. When debentures are issued at discount and redeemable at par:
Bank Account Dr.
(with amount received)
Discount on Issue of Debentures Account Dr.
(discount allowed)
To Debentures Account (face value of debentures)
4. When debentures are issued at par and redeemable at premium:
Bank Account Dr.
(with amount received)
Loss on Issue of Debentures Account Dr.
(amount of premium payable in redemption)
To Debentures Account (Face value of debentures)
To Premium on Redemption of Debentures Account (premium on redemption)

Notes 5. When debentures are issued at discount and redeemable at premium.

Bank Account Dr. (with amount received)
Discount on Debentures Account Dr. (discount allowed)
Loss on issue of Debentures Account Dr. (premium on redemption)
To Debentures Account (face value of debentures)
To Premium on Redemption of Debentures Account (premium payable on redemption)
Alternatively, discount in issue of debentures and premium payable on redemption are
the loses of the company. Therefore, a combined account for these two losses can be made.
Then entry will be:
Bank Account Dr. (amount received)
Loss on Issue of Debentures Account Dr. (discount allowed and premium
on redemption)
To Debentures Account (false value of debentures)
To Premium on Redemption of Debentures Account
(premium payable on redemption)
It is to be noted that “premium on redemption of debentures account” is a personal account,

because it is the liability of the company to pay the Debenture-holder at a premium as per the
condition of redemption. This account will continue to appear in the liability side of the balance
sheet until redemption of debentures is made. At the time of redemption, this account will be
transferred to Debenture-holders.
The ‘loss on issue of debentures account’ is a nominal account. This is due to the promise made
by the company to pay more amount (premium) at the time of redemption of debentures. This
is a capital loss, tantamount to gradually writing off every year, during the life of the debentures.
The unwritten off portion of this loss appears in the assets side in the balance sheet of the
company under the head ‘Miscellaneous Expenditure’.
Note Debentures can be issued at par, at premium, or at discount, but redemption will
be either at par or at premium.
Example 1: Issue of Debentures in Different Conditions of Redemption

Pass the necessary journal entries in the books of B Ltd. in the following cases:
(i) 2,000, 7% Debentures of 100 each have been issued at par and are redeemable at par.
(ii) 2,000, 7% Debentures of 100 each have been issued at par and are redeemable at 4%
premium.
(iii) 2,000, 7% Debentures of 100 each have been issued at 5% discount and are redeemable at
par.
(iv) 2,000, 7% Debentures of 100 each are issued at 5% discount and are redeemable at 2.5%
premium.
(v) 2,000, 7% Debentures of 100 each are issued at 4% premium and are redeemable at par.
(B.Com., Garhwal University, 1998)

Solution: Notes
Journal Entries

(i) Bank Account Dr. 2,00,000
(Being the issue of 2,000, 7% Debentures at par and redeemable at par)
(ii) Bank Account Dr. 2,00,000
Loss on Issue of Debentures Account Dr. 8,000
To Premium in Redemption of Debentures Account 8,000
(Being issue of 7% debentures at par and redeemable at premium)
(iii) Bank Account Dr. 1,90,000
Discount on Issue of Debentures Account Dr. 10,000
(Being issue of 7% debentures at discount and redeemable at par)
(iv) Bank Account Dr. 1,90,000
Loss on Issue of Debentures Accounts Dr. 15,000
To Premium on Redemption of Debentures Account 5,000
(Being issue of 7% debentures at discount and repayable at premium)
(v) Bank Account Dr. 2,08,000
To Debentures premium Account 8,000
(Being issue of 7% debentures at premium and redeemable at par).
Example 2: Issue of Debentures on Different Conditions of Redemption and Presentation

in Balance Sheet
Pass the necessary journal entries in the books of the companies for the following and also show
how they would appear in the balance sheets of the companies:
(a) Sunita Limited issued at par 10,000; 15% Debentures of 500 each and redeemable at par.
(b) Sanjay Limited issued 15,000 Debentures of 500 each at a discount of 10% redeemable at
par.
(c) Ajay Limited issued 20,000; 15% Debentures of 100 each at a premium of 10% redeemable
at par.
(d) Vijay Limited issued 25,00,000; 15% Debentures of 100 each at par redeemable at 105
each.
(e) Anuj Limited issued 60,000; 15% Debentures of 100 each at a discount of 10% redeemable
at a premium of 5%.
Solution:
(a) Journal of Sunita Limited

(Being issue of 15% Debentures at par and redeemable at par)

Notes Balance Sheet of Sunita Ltd. as on....
Secured Loans: Current Assets:
15% Debentures 50,00,000 Cash at Bank 50,00,000
(b) Journal of Sanjay Limited

Discount on Issue of Debenture Account Dr. 7,50,000
(Being issue of 15% Debentures at discount and redeemable at par)
Balance Sheet of Sanjay Limited as on....
Miscellaneous Expenditure:
Discount on Issue of Debentures 7,50,000
(c) Journal of Ajay Limited

To Debentures Premium Account 2,00,000
(Being issue of 15% Debentures at premium and redeemable at par)
Balance Sheet of Ajay Limited as on...
Debentures Premium 2,00,000 Cash at Bank 22,00,000
Secured Loans:
15% Debentures 20,00,000
(d) Journal of Vijay Limited

Loss on Issue of Debentures Account Dr. 1,25,000
To Premium on Redemption of Debentures Account 1,25,000
(Being issue of 15% Debentures at par and redeemable at premium)
Balance Sheet of Vijay Limited as on...
Premium on Redemption of Debentures. 1,25,000 Misc. Expenditure:
Loss on Issue of Debentures 1,25,000

(e) Journal of Anuj Limited Notes

To Premium on Redemption of Debentures Account 3,00,000
(Being issue of 15% debentures at discount and redeemable at
premium)
Balance Sheet of Anuj Limited as on…
Premium on Redemption of Debentures. 3,00,000 Miscellaneous Expenditure:
Loss on Issue of Debentures 9,00,000
Self Assessment
Fill in the blanks:
1. …………… can be issued at par, at premium, or at discount, but redemption will be either
at par or at premium.
2. If a company …………… its debentures by purchasing them from the open market at a
price below the par value the, difference (par value and purchase price) is treated as profit
on redemption or redemption of debentures at discount.
3. The …………… of debentures by public limited companies is regulated by Companies Act

1956.
4. The procedure for the issue of debentures is very much similar to that of the issue of
shares. …………… treatment for the issue of debentures is also the same as in the case of
issue of shares.
5. Debentures are one of a series issued to a number of …………… .
Did u know? The unwritten off balance of this account should be treated as a deferred
revenue expenditure and should be shown in the assets side of the balance sheet under the
head “Miscellaneous Expenditure”.
7.2 Discount on Issue of Debentures
Discount on issue of debentures is a capital loss and therefore must be written off as early as
possible. It can be written off against capital reserve or share premium. The unwritten off
balance of this account should be treated as deferred revenue expenditure and should be shown
in the assets side of the balance sheet under the head of Miscellaneous Expenditure. If a company
does not have any capital reserve it must be written off against the profits of the company in an
equitable basis until debentures are redeemed. The total amount of discount on the issue of
debentures can be written off in the following two ways:

Notes (i) When the redemption of debentures is in lump sum after specified period: Equal Instalment
Method – When debentures are redeemable at the end of a specified period, total discount
on the issue of debentures is spread over the life of debentures equally.
For example, if total discount allowed is ` 15,000 and debentures are redeemable at the
end of fifteen years, total discount will be divided by 15 and the amount so arrived
15,000
(i.e. = ` 1,000) will be transferred to Profit and Loss account every year for 15
15
years. Thus at the end of 15 years, the total amount of discount will be eliminated from
books. This method is suitable only when debentures are redeemable at the expiry of a
specified period.
(ii) When redemption of debentures is made in instalments: Proportion Method – In such case,
the total amount of discount on issue of debentures should be written off in the proportion
to the benefit received from the money collected by the issue of debentures or outstanding
balance every year. The reason is simple: the years which enjoy the use of the larger
proportion of cash should bear the larger proportion of discount.
Note It is to be noted that “premium on redemption of debentures account” is a personal

account, because it is the liability of the company to pay the Debenture-holder at a premium
as per the condition of redemption.
Accounting Treatment: When discount on issue of debentures is written off against the profits of
the company, the following journal entry is passed:
To Discount on Issue of Debentures Account.
Example 3: Debentures Discount – Proportion Method

Suresh Co. Ltd. issued 2,00,000; 15% Debentures of ` 100 each at 5% discount. These debentures
are redeemable in instalments of ` 40,00,000 every year. Open discount on issue of Debentures
Account in the books of Suresh Limited. The working note will be a part of the solution.
Solution:
Discount on Issue of Debentures Account
Year Particulars (`) Year Particulars (`)

To 15% Debentures Account 10,00,000 By P&L Account 3,33,333
By Balance c/d 6,66,667
10,00,000 10,00,000
To Balance b/d 6,66,667 By P&L Account 2,66,667
6,66,667 6,66,667
4,00,000 4,00,000
Contd...
By Balance c/d 66,667
2,00,000 2,00,000
To Balance b/d 66,667 By P&L Account 66,667

66,667 66,667
10,00,000 10,00,000
6,66,667 6,66,667
To Balance b/d
Unit 7:4,00,000
Debentures: Conditions of Issue of Debentures
By P&L Account 2,00,000
from Redemption Point of View

4,00,000 4,00,000
To Balance b/d 2,00,000 By P&L Account 1,33,333 Notes
2,00,000 2,00,000
To Balance b/d 66,667 By P&L Account 66,667
66,667 66,667
Working Note: Table showing Debenture Discount to be written off every year—
Year Nominal value of Period of use Product Ratio Amount of Discount to be

Debentures used (`) in months (Product) written off every year
2,00,00,000 12 months 24,00,00,000 5 5
10,00,000 × = 3,33,333
15
1,60,00,000 12 months 19,20,00,000 4 4
10,00,000 × = 2,66,667
15
1,20,00,000 12 months 14,40,00,000 3 3
10,00,000 × = 2,00,000
15
80,00,000 12 months 9,60,00,000 2 2
10,00,000 × = 1,33,333
15
40,00,000 12 months 4,80,00,000 1 1
10,00,000 × = 6,66,667
15
15
200,00,000 × 5
Total discount on Debentures = = ` 10,00,000
100
Example 4: Debentures Discount – When first redemption is made in next accounting

period
Rita Ltd. issued 12% Debentures at 94% for ` 2,00,000 on 1st April, 2,000 repayable by five equal
annual drawings of ` 40,000 each. The company closes its account on a calendar year basis.
Indicate the amount of discount to be written off every accounting year assuming that the
company decides to write off the debenture discount during the life of debentures.
Solution:
2,00,000 6
Total Discount = ` 12,000
100
Table showing the discount to be written off each year
Year Nominal value of Period of use in Product Equivalent Ratio

debentures (`) months amount
1.4.2000 – 31.12.00 2,00,000 9 18,00,000 18,00,000 15
1.1.01 – 31.3.01 2,00,000 3 6,00,000 17
1.4.01 – 31.12.01 1,60,000 9 14,40,000 20,40,000
1.1.02 – 31.3.02 1,60,000 3 4,80,000 15,60,000 13
1.4.02 – 31.12.02 1,20,000 9 10,80,000
1.1.03 – 31.3.03 1,20,000 3 3,60,000 10,80,000 9
Contd...
1.4.03 – 31.12.03 80,000 9 7,20,000
1.1.04 – 31.3.04 80,000 3 2,40,000 6,00,000 5
1.4.04 – 31.12.04 40,000 9 3,60,000
1.1.05 – 31.3.05 40,000 3
LOVELY 1,20,000
PROFESSIONAL 120,000
UNIVERSITY 1 159
60
Year Nominal value of Period of use in Product Equivalent Ratio
debentures ( ) months amount
1.4.2000 – 31.12.00 2,00,000 9 18,00,000 18,00,000 15
1.1.01 – 31.3.01 2,00,000 3 6,00,000 17
1.4.01 – 31.12.01 1,60,000 9 14,40,000 20,40,000
1.1.02 – 31.3.02 1,60,000 3 4,80,000 15,60,000 13
1.4.02 – 31.12.02 1,20,000 9 10,80,000
Notes 1.1.03 – 31.3.03 1,20,000 3 3,60,000 10,80,000 9
1.4.03 – 31.12.03 80,000 9 7,20,000
1.1.04 – 31.3.04 80,000 3 2,40,000 6,00,000 5
1.4.04 – 31.12.04 40,000 9 3,60,000
1.1.05 – 31.3.05 40,000 3 1,20,000 120,000 1
60
Amount of discount to be written off
Year Calculation Amount of discount to be written off ( )

2000 15 3,000
12,000 ×
60
2001 17 3,400
12,000 ×
60
2002 13 2,600
12,000 ×
60
2003 9 1,800
12,000 ×
60
2004 5 1,000
12,000 ×
60
2005 1 200
12,000 ×
60
12,000
Self Assessment
State whether the following statements are true or false:
6. If debentures are issued at par and redeemable at premium, loss on issue of debentures
will be equal to the amount of premium payable on redemption.
7. If debentures are issued at discount and redeemable at premium, loss on issue of debentures
will not be equal to the total of discount on issue of debentures and premium payable on
redemption of debentures.
8. When debentures are redeemable at the end of a specified period, total discount on the
issue of debentures is spread over the life of debentures equally.
9. The ‘loss on issue of debentures account’ is a nominal account.
!
Caution If a company does not have any capital reserve it must be written off against the
profits of the company in an equitable basis until debentures are redeemed.
7.3 Loss on Issue of Debentures
The loss on issue of debentures will be computed in the following manner:
(a) If debentures are issued at par and redeemable at premium, loss on issue of debentures
will be equal to the amount of premium payable on redemption.

(b) If debentures are issued at discount and redeemable at premium, loss on issue of debentures Notes
will be equal to the total of discount on issue of debentures and premium payable on
The loss on issue of debentures in both the above cases will be treated as capital loss and will be
dealt with the same method as discount on issue of debentures discussed earlier.
To write off the loss on issue of debentures, the following entry will be passed:
Profit & Loss account Dr.
To Loss on Issue of Debentures Account.
Example 5: Writing off Loss on Issue of Debentures

On 1st January, 2001 Shubham Ltd. issued 2,000, 12% Debentures of 100 each at a discount of 5%,
redeemable at a premium of 10%. Show the loss on issue of Debentures Account, if (i) such
debentures are redeemable after 5 years and (ii) such debentures are redeemable by annual
drawings in 5 years. Shubham Ltd. follows the calendar year as its accounting year.
Solution:
(a) When these debentures are repayable after 5 years:
(i) Amount of discount on issue of debentures
2,00,000 5
= 10,000
100
(ii) Amount of premium payable on redemption:
2,00,000 10
= 20,000
100
(iii) Thus total loss = 10,000 + 20,000 = 30,000
30,000
= 6,000
5
Amount of loss to be written off every year:

Loss on Issue of Debentures Account
2001 To 12% Debentures Account 10,000 2001 By P. & L. Account 6,000

Jan. 1 To Premium on Redemption of 20,000 Dec. 31 By Balance c/d 24,000
Debentures Account
30,000 30,000
2002 2002
Jan. 1 To balance b/d 24,000 Dec. 31 By P. & L. Account 6,000
24,000 24,000
2003 2003
18,000 18,000
2004 2004 Contd...
By balance c/d 6,000
12,000 12,000
2005 2005
6,000 6,000
2002 2002
24,000 24,000
2003 2003
Accounting for Companies-I Jan. 1 To balance b/d 18,000 Dec. 31 By P. & L. Account 6,000
18,000 18,000
Notes 2004 2004
12,000 12,000
2005 2005
6,000 6,000
(b) When such debentures are repayable by equal annual drawing in 5 years:
Year Nominal value of Period of Issue Product Ratio Amount of loss to be w/o
debentures used ( ) ( )
( )
2001 2,00,000 12 Months 24,00,000 5 5
30,000 × = 10,000
15
2002 1,60,000 12 Months 19,20,000 4 4
30,000 × = 8,000
15
2003 1,20,000 12 Months 14,40,000 3 3
30,000 × = 6,000
15
2004 80,000 12 Months 9,60,000 2 2
30,000 × = 4,000
15
2005 40,000 12 Months 4,80,000 1 1
30,000 × = 2,000
15
15 30,000
Loss on Issue of Debentures Account
Date Particulars ( ) Date Particulars ( )

2001 2001
Jan., 1 To 12% Debentures Account 10,000 Dec. 31 By P. & L. Account 10,000
To Premium on Redemption of 20,000 By balance c/d 20,000
Debentures A/c
30,000 30,000
2002 2002
Jan., 1 To balance b/d 20,000 Dec. 31 By P. & L. Account 8,000
20,000 20,000
2003 2003
12,000 12,000
2004 2004
6,000 6,000
2005 2005
2,000 2,000

7.4 Interest on Debentures Notes
When a company issues the debentures, it is necessary to pay interest on debentures at a fixed
percentage (which is prefixed to debentures) periodically (generally half yearly) until the
debentures are redeemed. Interest on debentures is a charge against the profits of the company
and is payable irrespective of the fact whether there is profit or not. Interest is calculated at a
fixed rate on the face value of debentures and not on issued price. Thus, issues of debentures at
par, at a discount, or at a premium will not make any difference in the calculation of interest
payable on debentures. In certain cases, Income Tax Act, 1961 has instructed that a company has
to deduct income-tax at a prescribed rate from the gross amount of interest on debentures. The
amount of tax so deducted from the gross interest is to be deposited into a government account
within a prescribed time.
Note When a company issues the debentures, it is necessary to pay interest on debentures
at a fixed percentage (which is prefixed to debentures) periodically (generally half yearly)
until the debentures are redeemed.
Accounting Treatment: Regarding the interest of on debentures, the following entries are recorded
in the books of the company:
1. When interest on debentures is due:
Debentures Interest Account Dr. (Total interest)
To Debenture-holders account (Net amount)
To Income tax payable account (Tax deducted from interest)
2. When amount of interest is paid to debentures:
Debenture-holders Account Dr.
To Bank Account.
3. When income tax is deposited to government account:
Income tax payable Account Dr.
To Bank Account.
7.5 Some Points to be Noted Regarding Interest on Debentures
1. Interest is not paid on debentures issued as collateral securities.
2. If income tax deducted from interest on debentures is not paid to government, it will be
shown in the liability side of balance sheet.
3. Interest on debentures for the full year is transferred to profit and loss account at the end
of accounting year.
4. If interest is accrued but not paid, it will be shown in the liabilities side of the balance
sheet.

Notes
Example 6: Payment of Interest on Debentures
Apex Limited has 20,000, 8% Debentures of 100 each on which interest is payable on 30th June
and 31st December. Pass the necessary journal entries relating to debentures interest for the year
2005, assuming that income tax is deducted @ 20% on the amount of interest.
Solution:
Journal Entries

2005
June 30 Debentures Interest Account Dr. 80,000
To Debenture-holders’ Account 64,000
To Income tax Payable Account 16,000
(Being interest due for 6 months and income tax deducted @ 20%)
June 30 Debenture-holders’ Account Dr. 64,000
(Being payment made to debenture-holders)
June 30 Income Tax Payable Account Dr. 16,000
(Being payment of income tax deducted from interest)
Dec. 31 Debentures Interest Account Dr. 80,000
To Debenture-holder Account 64,000
To Income tax Payable Account. 16,000
(Being interest due for 6 month and income tax deducted @ 20%)
Dec. 31 Debenture-holders Account Dr. 64,000
(Being payment made to Debenture-holders)
Dec. 31 Income Tax Payable Account Dr. 16,000
(Being payment of Income tax to government)
Dec. 31 Profit & Loss Account Dr. 1,60,000
To Debentures Interest Account 1,60,000
(Being transfer of debenture interest to profit and loss account)
Self Assessment
Fill in the blanks:
10. Under the Sinking Fund method of redemption the interest on S.F. Investment is ………… .
11. Nature of Premium a Issue of Debentures is ………….… .
12. ‘Discount on Issue of Debentures’ is written off through …………… .

Select the best alternative: Notes
13. Interest on own debentures is transferred to:
(a) Capital reserve
(b) Sinking fund
(c) General reserve
14. If there is any balance in Debenture Redemption Fund, that will be transferred to:
(a) Profit and Loss Account
(b) General Reserve
(c) Capital Reserve
15. The following entry is passed in the books of A company:
To 10% Debentures Account 10,000
To Premium on Redemption of Debentures A/c 500
Here, debentures are issued at a discount of:
(a) 10%
(b) 5%
(c) 15%

Case Study Debenture Trustees can be Made to Pay
T
he National Commission has held that a Debenture Trustee can be held liable
under the Consumer Protection Act (CPA). (Judgment dated July 4, 2008 in Revision
Petition No. 1299 of 2003-Central Bank of India v/s Tadepalli Padmaja & Ors.)
Case Study
Synergy Financial Exchange Ltd, a non-banking financial company, had issued debentures
with Central Bank of India as the Trustee. One of the clauses in the agreement required the
company to pay all amounts of principal and interest due under the debenture by crossed
account-payee cheques or bank drafts drawn on a bank in Mumbai. It was agreed and
undertaken to redeem the debentures in full on the expiry of three years from the date of
allotment.
The debentures carried interest of 15% per annum payable on June 30 and December 31
each year, subject to deduction of tax. Failure to pay the interest would result in an additional
levy of compound interest at the same rate. All such compound interest was a charge
secured by the debentures. In case of default in redemption, the company would have to
pay liquidated damages of a further compound interest of 2% per annum for the period
and the amount of the default, and this too would be a charge secured by the debentures.
Contd...

Notes The financial safety of the debentures was to be ensured by the company and the trustee as
creating a Debenture Redemption Reserve by transferring suitable amounts from time to
time. The proof of such transfer was to be furnished by the company to the Trustee in the
form of a certificate issued by the auditors.
The facts
The company failed to pay the interest or the redemption amount as agreed. So the
debenture holders filed complaints before various district forums, which were allowed
and the Trustee was found liable to reimburse the complainants. Appeals to the various
state commissions against these orders were dismissed. The Trustee then filed revision
petitions before the National Commission.
The Trustee contended that debenture holders, who have not paid any money for the
services of the Trustees, are not consumers. Also, there was no privity of contract between
the Trustees and the debenture holders. They claimed that their duty as Trustee ended
immediately on filing a suit against the company for recovery of the debenture amounts
on the basis of the Mortgage Deed. Thereafter no further proceedings would be
maintainable.
Findings
The National Commission overruled the arguments of the Trustee Bank. It held that the
services of the Trustee were not free but were paid for by the company to protect the
interest of the debenture holders. Hence the debenture holders were consumers and entitled
to approach the consumer fora.
The Commission relied on Halsbury’s Laws of England which state that “a higher duty of
care is due from a trust corporation which carries on specialised business of trust
management and a professional corporate trustee is liable for breach of trust if loss is
caused to the trust fund through neglect to exercise special care and skill which it professes
to have’’ . The Commission found that in the present case the Trustee Bank had not done
anything except merely write letters. Accordingly, the National Commission held Central
Bank as the Debenture Trustee liable to compensate the complainant debenture holders
for the default of Synergy Financial Exchange Ltd. The Revision Petition was thus dismissed
and the orders of the District Forum and State Commission were upheld.
The National Commission further directed that its order be sent to SEBI to consider action
against Central Bank as per the regulations governing the Code of Conduct of Debenture
Trustees.
Impact
Debenture Trustees must realise their responsibility instead of merely collecting fat fees
for services, which they fail to render. Now consumers can hold errant Trustees responsible
and recover their money even if the company defaults.
Source: http://articles.timesofindia.indiatimes.com/2008-08-04/mumbai/27909882_1_debentures-
interest-central-bank
7.6 Summary
A company may issue debentures at different terms and just as the issue can be made at par, at a
premium or at a discount, the redemption of debentures can also be made at par, at a premium
or at a discount. Combining the various conditions/terms of issue and redemption of debentures,
there may be the following six possibilities:

(a) Issued at par – redeemable at par; Notes
(b) Issued at discount – redeemable at par;
(c) Issued at premium – redeemable at par;
(d) Issued at par - redeemable at premium;
(e) Issued at a discount – redeemable at premium;
(f) Issued at premium - redeemable at premium;
It may be noted that in the above mentioned six possibilities, the debentures can be redeemed at
a discount and this situation is possible only when the terms and conditions of redemption are
laid down in advance. When the debentures are to be redeemed at a discount, amount payable
at the time of redemption will be less than the face value of debentures resulting in a gain.
However, as per the accounting convention of conservatism expected losses are to be taken into
account but not expected gains. Therefore, there is no change in the journal entries passed. Thus
journal entries for issue of debentures in the case of redemption at a discount are similar to
journal entries for issue of debentures when redemption is at par.
7.7 Keywords
Debenture: It is a document that either creates a debt or acknowledges it, and it is a debt without
collateral. In corporate finance, the term is used for a medium- to long-term debt instrument
used by large companies to borrow money.
Discount on Issue of Debentures: It is a capital loss and therefore must be written off as early as
possible.
Debentures Issued at Premium: Debentures are said to be issued at premium when these are
issued at a value which is more than their nominal value.
Deferred Revenue Expenditure: It can be written off against capital reserve or share premium.
The unwritten off balance of this account should be treated as deferred revenue expenditure.
Debentures Issued at Discount: When debentures are issued at less than their nominal value they
are said to be issued at discount.
Issue of Debentures: By issuing debentures means issue of a certificate by the company under its
seal which is an acknowledgement of debt taken by the company.
1. For how many considerations the debentures can be issued?
2. What do you mean by issue of debenture as collateral securities? Give its accounting
treatment.
3. Explain the following terms:
(a) Loss on Issue of Debentures.
(b) Interest on own Debentures.
Practical questions:
4. Show by the means of journal entries the followings, at the time of issue on 1st January
2006.

Notes (i) X Limited issues 10,000, 10% Debentures of 100 each at a discount of 3% to be
redeemed at par at the end of 5th year.
(ii) Y Limited issues 15,000; 10% Debentures of 100 each at a discount of 4% to be

redeemed at a premium of 4% at the end of 5th year.
(iii) Z Limited issues 20,000; 10% Debentures of 100 each at par to be redeemed at a
premium of 4% at the end of fifth year.
(iv) XA Limited issues 25,000; 10% Debentures of 100 each at a premium of 5% to be

redeemed at par at the end of 5th year.
5. Hari Mohan Limited issues 1000; 12% debentures of 500 each. Pass journal entries in the
following cases:
(i) Debentures are issued at par and redeemable at par.
(ii) Debentures are issued at par and redeemable at 5% premium.
(iii) Debentures are issued at 5% discount and redeemable at par.
(iv) Debentures are issued at 5% discount and redeemable at 10% discount.
(v) Debentures are issued at 5% discount and redeemable at 2.5% premium.
(vi) Debenture are issued at 5% premium and redeemable at par.
(vii) Debentures are issued at 5% premium and redeemable at 10% premium.
6. Show by means of journal entries how will you record the following issues. Also, show
how they will appear in their respective balance sheets:
(i) A Ltd. issued 10,000; 15% Debentures of 100 each at a discount of 10% redeemable
at the end of 10 year at par.
(ii) B Ltd. issued 10,000; 15% Debentures of 100 each at par redeemable at the end of 10
year at a premium of 10%.
(iii) C Ltd. issued 10,000; 15% Debentures of 100 each at a premium of 10% redeemable
at the end of 10 years at a premium of 10%.
(iv) D Ltd. issued 10,000; 15% Debentures of 500 each at a discount of 5% redeemable at
the end of 10 years at a premium of 5%.
1. debentures 2. redeems
3. issue 4. accounting
5. lenders 6. true
7. false 8. true
9. true 10. Also Invested,
11. Personal, 12. P. & L. Account.
13. (b) 14. (b)
15. (a)

7.9 Further Readings Notes
Books Glossary: D on the Financial Industry Regulatory Authority (FINRA) website,

United States
What is a debenture?, Company Law Club, referring to United Kingdom usage
Chandra Gopalan (2007); Company Law in Singapore 3rd Edition; McGraw-Hill

Education (Asia)
Online links http://en.wikipedia.org/wiki/Debenture

http://www.nos.org/srsec320newe/320el26.pdf
http://taxguru.in/income-tax-case-laws/loss-on-sale-of-debentures-
%E2%80%93-deduction-allowed-even-if-loss-was-known-at-time-of-applying-
for-debentures.html

Notes Unit 8: Methods of Redemption–I
CONTENTS
Objectives
Introduction
8.1 Meaning
8.2 Sources of Finance for Redemption
8.2.1 Redemption Out of Capital
8.2.2 Redemption of Debentures by Conversion
8.2.3 Redemption of Debentures Out of Profit
8.2.4 Non-cumulative Sinking Fund
8.3 Insurance Policy Method
8.4 Summary
8.5 Keywords
Objectives
 Know redemption meaning and its methods
 Explain sources of finance for redemption
 Define redemption by conversion
 Understand some important points related to debentures redemption fund

 Know non-cumulative Sinking Fund
 Understand insurance policy method
Introduction
Redemption of debentures is the process of discharging the liability on account of debentures in

accordance with the terms of redemption stated in the debenture trust deed. Discharge of
debenture liability is usually by paying cash to the debenture holders. But this can take other
forms such as conversion or rolover. In the case of conversion debentures are converted into
preference shares or equity shares. Rollover refers to the issue of new debentures, in exchange
for the old ones. Both conversion and rollover are subject to detailed SEBI guidelines. When a
company issues debentures it must also plan the resources required for such redemption. This
can be done by setting aside profits every year and investing them wisely in investments
outside, so that there will be no liquidity problem at the time of redemption. Alternatively the
company can take an insurance policy by paying regular premium, so that the policy matures
coinciding with the time of redemption. With the amount received on the maturity of policy the
company faces no problem in carrying out the redemption.

Unit 8: Methods of Redemption–I
8.1 Meaning Notes
Redemption of debentures means repayment of the amount of debentures to debenture-holders

or the discharge of the liability of debentures according to the terms of redemption given in the
Trust Deed of the debentures, or in the prospectus inviting the application for the debentures.
The redeemed debentures can be reissued if the conditions laid down in Section 121 of the
Companies Act are satisfied.
SEBI Guidelines for the Protection of Debenture-holders’ Interest
From the accounting point of view some important guidelines of SEBI are as follows:
1. All companies that raise resources through the issue of debentures must create a Debentures
Redemption Reserve (DRR). This reserve must be equal to 50% of the amount of debentures
issued before the redemption of debentures takes place.
Drawal from Debentures Redemption Reserve is permissible for the purpose of redemption
only after 40% of debentures liability has been actually redeemed by the company.
2. Thus, a company cannot redeem its debentures purely out of capital or out of profit.
3. There is no need to create a DRR in the following cases:
(i) if the debentures are issued for a period of 18 months or less.
(ii) if convertible debentures are issued by the company.
(iii) if a company has created a sinking fund of the equivalent amount of debentures
issue (but no redemption will commence unless the sinking fund accumulates a sum
of 50% of the amount of debenture issue).
(iv) if the debentures are issued for raising project finance, a moratorium upto the date
of commercial production can be provided for the creation of DRR.
4. In case of convertible debentures, DRR should be created for the non-convertible component.
DRR should be treated as general reserve for considering proposals of bonus issue.
5. If there is any balance in the DRR after the redemption of debentures, it is transferred to
general reserve (as being the nature of undistributed profits) and will be available for the
distribution of dividend.
6. For the determination of rate of interest on debentures, companies are independent.
7. There should be clear information in the prospectus regarding the premium payable and
time of redemption.
8. Thus a company can not redeem its debentures purely out of capital or out of profit.
Notes Discharge of debenture liability is usually by paying cash to the debenture holders.
8.2 Sources of Finance for Redemption
In order to avoid financial difficulties when debentures become due for redemption, it is necessary
to make arrangements for the accumulation of addition funds for the purpose of redemption. A
company may use the following options in this regard:
1. Redemption of debentures out of capital.
2. Redemption of debentures by conversion into shares or new debentures.

Notes 3. Redemption of debentures out of profit.

4. Redemption by purchase in the open market.
8.2.1 Redemption Out of Capital
When the redemption of debentures is made out of capital, no amount is transferred from Profit and
Loss Account to the Debenture Redemption Reserve Account (DRR). Its effect will be that credit
balance of Profit and Loss Account will not be reduced. This might result in the payment of dividends
sometime in the future. It will also indicate that redemption is being done out of that money which
is not earned during the course of business. Therefore, such redemption is out of capital.
But in the SEBI guidelines, the Controller of Capital Issue has placed restrictions on this method
indirectly. Every company has to create a Debenture Redemption Reserve (DRR) equivalent to
50% of the amount of debentures issue before commencement of redemption on 14.1.1987. Now
it is doubtful if the debentures could be redeemed purely out of capital.
Did u know? In order to avoid financial difficulties when debentures become due for
redemption, it is necessary to make arrangements for the accumulation of addition funds
for the purpose of redemption?
The following journal entries are made to record the redemption of debentures out of capital:
1. When the amount of debentures becomes due:
(a) If the debentures are redeemable at par
To Debenture-holders’ Account.
(b) If the debentures are redeemable at discount:
To Profit on Redemption Account
(c) If the debentures are redeemable at premium:
Premium on Redemption of Debentures Account Dr.
To Debenture-holders’ Account
2. When payment is made to debenture-holders:
Debenture-holders’ Account Dr.
To Bank Account
Illustration 1 (Redemption Out of Capital)
Seema Ltd. issued 2000, 12% Debentures of 100 each on 1st January, 2001 at a discount of 10%
redeemable at a premium of 5% out of capital. Pass journal entries both at the time of issue and
redemption of debentures if (a) the Debentures are redeemable in lump sum at the end of the

third year (b) the Debentures are redeemable in equal annual drawings in the fourth year. Notes
Assuming the calendar year to be the accounting year of Seema Ltd., ignore the treatment of loss
on issue of debentures and interest thereon.
Solution:
(a) If the debentures are redeemed in lump sum at the end of third year:

2001
Jan. 1 Bank Account Dr. 1,80,000
(Being issue of debentures at discount and redeemable at premium)
2004
Dec. 31 12% Debentures Account Dr. 2,00,00
Premium on Redemption of Debentures Account Dr. 10,000
To 12% Debenture-holders’ Account 2,10,000
(Being amount due to debenture-holders on redemption)
Dec. 31 12% Debenture-holders’ Account Dr. 2,10,000
(Being payment made to Debenture-holders on redemption)
(b) If debentures are redeemed by equal annual drawings:

2001
(Being issue of 12% debentures at discount and redeemable at
premium)
2001
Dec. 31 12% Debentures Account Dr. 50,000
Debenture-holders’ Account Dr. 52,500
2002
To Debenture-holders’ account 52,500
(Being amount paid to debenture-holders on redemption)
2003
Debenture-holders’ account Dr. 52,500
(Being amount paid to debenture-holder)
2004
Accounting for Companies-I 2003
Notes (Being amount due to debenture-holders on redemption)
Debenture-holders’ account Dr. 52,500
2004
Debenture-holders Account Dr. 52,500
(Being amount paid to debenture-holders)
Illustration 2 (Redemption Out of Capital by Drawings and Purchase of Debentures)
On 1st January 2003 Pankaj Ltd. issued 2,000, 11% Debentures of 500 each at a discount of 10%.
The terms of issue provided that beginning with 2006 2,50,000 of debentures should be redeemed
either by drawings at par or by purchase in the market every year. The expenses of the issue
amounted to 4,000 which were written off in 2003. The company wrote off 20,000 from the
discount on debentures every year. In 2006, the debentures to be redeemed were repaid at the
end of the year by drawings. In 2006, the company purchased for cancellation 500 debentures at
a running rate of 480 on 31st December, the expenses being 200. Interest is payable yearly.
Ignore income tax.
Pass journal entries to record the above mentioned transactions in the books of Pankaj Ltd. on
31st December 2006.
Solution:
Pankaj Ltd.
Journal Entries

2003
Discount on Debentures Account Dr. 1,00,000
(Being issue of 11% Debentures at discount)
Jan. 1 Debenture Issue Expenses Account Dr. 4,000
(Being payment of expenses on issue of debentures)
Dec. 31 Interest on Debentures Account Dr. 1,10,000
(Being payment of interest on debentures)
Dec. 31 Profit and Loss Account Dr. 1,34,000
To Debenture Issue Expenses Account 4,000
To Discount on Debentures Account 20,000
To Interest on Debentures Account 1,10,000
(Being written off of discount on debentures, debenture issue
expenses and interest on debentures)
2004

174 (Being
LOVELY transfer of interest on debentures
PROFESSIONAL UNIVERSITYand discount on debentures)
2005
(Being the payment of interest on debentures)
To Debenture Issue Expenses Account 4,000
2004
2004
Dec. 31 Interest on Debentures Account Dr. 1,10,000 Unit 8: Methods of Redemption–I
Dec. 31 Profit and Loss Account Dr. 1,30,000 Notes

(Being transfer of interest on debentures and discount on debentures)
(Being transfer of interest on debentures and discount on debentures)
2005
2005
(Being transfer of interest and discount on debentures)
(Being transfer of interest and discount on debentures)
2006
2006
To Profit on Redemption of Debentures Account 10,000
(Being purchase of 500 debentures @ Rs. 480 per debentures from
(Being purchase of 500 debentures @ Rs. 480 per debentures from
the market for cancellation)
the market for cancellation)
2006 Expenses on Redemption of Debentures Account Dr. 200
2006 Expenses on Redemption of Debentures Account Dr. 200
(Being the payment of interest and expenses on debentures)
(Being the payment of interest and expenses on debentures)
To Expenses on Redemption of Debentures Account 200
To Expenses on Redemption of Debentures Account 200
(Being written off of expenses interest and discount on debentures)
(Being written off of expenses interest and discount on debentures)
Profit on Redemption of Debentures Account Dr. 10,000
Profit on Redemption of Debentures Account Dr. 10,000
(Being transfer of profit on redemption to P. and L. Account)
(Being transfer of profit on redemption to P. and L. Account)
Self Assessment
Fill in the blanks:

1. In order to avoid financial …………………… when debentures become due for redemption,
it is necessary to make arrangements for the accumulation of addition funds for the purpose
of redemption.
2. When the redemption of …………………… is made out of capital, no amount is transferred
from Profit and Loss Account to the Debenture Redemption Reserve Account (DRR).
3. With the amount received on the …………………… of policy the company faces no problem
in carrying out the redemption.
4. Every company has to create a ……………………
Notes Debenture Redemption Reserve (DRR) equivalent to 50% of the amount of

debentures issue before commencement of redemption on 14.1.1987.

Notes 8.2.2 Redemption of Debentures by Conversion
When a company redeems its debentures by converting them into a new class of shares or
debentures, this method is called redemption of debentures by conversion. In other words, it is
an option given by a company to its debenture-holders to convert their debentures into shares
or new debentures within a prescribed time. This option will be used by the debenture-holders
only when they find it beneficial from their view point, or as agreed as per terms of issue. The
new shares or debentures can be issued by the company either at par or at a premium or at a
discount.
In the process of conversion of debentures (which were originally issued at discount) into
shares, the provisions of Section 79 of Companies Act 1956 should not be violated. Only actual
proceeds realised (Face value – Discount) from debentures at the time of issue should be treated
as the basis for determining the number of shares to be issued in exchange. Thus, the issue price
of shares must be equal to the amount actually received from the debenture-holders at the time
of issue of these debentures. If this rule is not followed it will be the violation of the provision
of Section 79. Under this rule, at the time of making the amount payable, due to the debenture-
holders in this case, the discount on issue of debentures should be credited. But this will not be
applicable where debentures (originally issued at discount) are redeemed by conversion in new
debentures. Therefore, the discount on issue of debentures will not be credited.
Accounting treatment: On the redemption of debentures by conversion into shares or debentures,

the following journal entries are made:
1. When new shares or debentures are issued at par:
Old Debentures Account Dr.
To New Shares/Debentures Account
2. When new shares/debentures are issued at discount:
Discount on Issue of new Shares/Debentures Dr.
To New Shares/Debentures Account.

3. When new shares/debentures are issued at premium:
To New Shares/Debentures Account
To Premium on Issue of New Shares/Debentures Account.
Illustration 3 (Conversion of Debentures into Preference Shares)
On 1st January 2005, Rajesh Limited issued 5,000; 15% Debentures of 100 each at 5% discount.
Debenture-holders have an option to convert their holdings into 12% preference shares of 100
each at a premium of 25% at any time within three years.
On 31st December 1998, one year’s interest was accrued on these debentures and remained
unpaid. Mr. Om, a holder of 250 debentures notified his intention to convert his holdings in 12%
preference shares. Pass the necessary journal entries in the books of Rajesh Limited and show
how the items would appear in the balance sheet of the company on 31st December 2005.

Solution: Notes
Rajesh Limited
Journal Entries

2005
(Being 15% Debentures issued at 5% discount)
Dec. 31 Interest on Debentures Account Dr. 75,000
To Debenture-holders Account 75,000
(Being one year’s interest due on debentures but unpaid)
To 12% Preference Shares Account 19,000
To Discount on Issue of Debentures Account 1,250
(Being 250 debentures redeemed by conversion in 12% preference
shares at premium)
To Interest on Debentures Account 75,000
(Being transfer of interest to P. & L. A/c)
Balance Sheet of Rajesh Limited as on 31st December 2008
Share Capital: Current Assets
190, 12% Preference Shares of Rs. 100 each fully paid 19,000 Cash at Bank 4,75,000
Share Premium 4,750 Miscellaneous Expenditure
Secured Loans: Discount on Issue of debentures 23,750
15% Debenture: 4,750 Debentures of Rs. 100 each 4,75,000
Accrued Interest (Debenture-holders’ Account) 75,000 Debit Balance of Profit and Loss
Account 75,000
5,73,750 5,73,750
Working Note: Calculation for number of preference shares given to Mr. Om:
Face value of debentures held by Om ` (250 100) 25,000
Less: 5% discount allowed 1,250
23,750
Face value of preference share 100
+ premium 25% 25
Issue Price of 12% Preference Share 125
23,750
No. of shares given to Mr. Om = ` 190
125
Face value of 12% shares 190 100 = ` 19,000

Premium 25% of face value ` 4,750
If the debenture-holders have a clear right, they can demand the conversion of unpaid interest
into shares.

Notes Illustration 4 (Redemption by Conversion of Shares at Premium and Discount)
Shobhit Limited redeemed, 5,000, 15% Debentures of ` 100 each, which were originally issued at
a discount of 5%, by converting them into equity shares of ` 10 each. Pass the journal entries
relating to redemption of debentures if (i) the new shares are issued at 25% premium, (ii) the
new shares are issued at 5% discount (iii) the shares are issued at ` 9.50 paid up value.
Solution
Shobhit Limited
Journal
Date Particulars ` `
15% Debentures Account Dr. 5,00,000
To Debenture-holders Account 4,75,000
(Being the amount due to debenture-holders on redemption)
Debenture-holders Account Dr. 4,75,000
(Being the conversion of 5,000 debentures into share at premium)
15% Debenture A/c Dr. 5,00,000
(Being the amount due to debenture-holders on redemption)
(Being redemption of 5,000 debentures by conversion into shares
at discount)
(Being conversion of 5,000 debentures of ` 100 each in 50,000
equity shares of ` 10 each at ` 9.50 paid up)
Did u know? Alternatively the company can take an insurance policy by paying regular
premium, so that the policy matures coinciding with the time of redemption.
Self Assessment
5. A company cannot purchase its own debenture.
6. Profit on sale of sinking fund investment is transferred to general reserve.
7. If a debenture is issued at a discount it cannot be redeemed at premium.
8. A company is bound to write off ‘The Discount on Issue of Debentures’ to profit and loss
account.

9. Profit on cancellation of debentures is transferred to Debenture Redemption Fund A/c. Notes
10. Own debentures cannot appear in the asset side of the balance sheet.
8.2.3 Redemption of Debentures Out of Profit
When a company wants to redeem its debenture out of profit, it would accumulate its divisible
profits so that they maybe utilised for the redemption of debentures. For the redemption of
debentures out of profit, an amount equal to that utilised for repayment of debenture-holders is
transferred from the divisible profits to the D.R.R. account so that it may not be utilised for the
distribution of dividend. These retained profits maybe used in the following two methods for
the redemption of debentures.
(A) These accumulated profits can be retained in the business as a source of internal finance.
(B) These accumulated profits can be invested outside in the marketable securities or insurance
policy.
Accounting treatment for first case: (when profit is retained in the business not invested outside):
1. When the amount of debentures becomes due to debenture-holders on redemption:
Premium on Redemption of Debentures Account Dr. (if any)
To Debenture-holders Account
2. When profits are transferred for redemption:
To Debenture Redemption Reserve Account.
3. When amount is paid to debenture-holders:
To Bank Account
4. After redemption of debentures the balance of D.R.R. is transferred to general reserve:
Debenture Redemption Reserve Account Dr.
To General Reserve Account.
Illustration 5 (Redemption Out of Profit)
Raj Shree Industries Limited issued 7,000; 12% Debentures of 100 each on 1st January 2003 at a
discount of 10%, redeemable at a premium of 5% out of profits. Pass journal entries both at the
time of issue and redemption of debentures if (a) the debentures are redeemable at the end of
three years (b) the debentures are redeemable in three annual installments of 1,000, 2,000 and
2,000 debentures, assuming accounting year as a calendar year.

Notes Solution:
Raj Shree Industries Limited
Journal
(a) When redemption is in lump-sum

2003
2005
To Debenture Redemption Reserve A/c 7,00,000
(Being profit transferred from P. & L. account to DRR)
Debenture Redemption Reserve Account Dr. 7,00,000
To General Reserve Account 7,00,000
(Being balance of DRR transferred to general reserve)
(b) When redemption is in three annual instalments of 1000, 2,000 and 2,000 debentures.

2003
(Being amount payable to debenture-holders on redemption)
To Debenture Redemption Reserve Account 1,00,000
(Being transfer of profits to debenture redemption reserve)
2004
180 To BankPROFESSIONAL
LOVELY Account UNIVERSITY 2,10,000
2005
Premium on Redemptions of Debentures Account Dr. 10,000
2004
Dec. 31 12% Debentures Account Dr. 2,00,000 Unit 8: Methods of Redemption–I
Profit and Loss Account Dr. 2,00,000 Notes
2005
Premium on Redemptions of Debentures Account Dr. 10,000
(Being amount due to debenture-holder on redemption)
(Being transfer of profit to debenture redemption reserve)
Debenture Redemption Reserve Account Dr. 7,00,000
(Being the balance of DRR transferred to general reserve)
Accounting Treatment for Second Case: (when profits are invested outside in marketable securities
or insurance policy)
Sinking Fund or Debenture Redemption Fund Method: A fund is created by a charge against
profits of the company to redeem the debentures after a specified period. This fund is invested
in some safe securities and the interest thereon is also invested. And at the end, when debentures
are to be redeemed, all these investments are sold in order to enable the company to redeem the
debentures without disturbing its working capital. Such a fund is called Debenture Redemption
Reserve Fund/Sinking Fund Account or Cumulative S.F. Account. Here the word ‘fund’ indicates
that the amount is invested in outside securities. The amount of annual instalment that is invested
in safe securities every year by setting aside out of profits, is calculated with the help of Annuity
Table or Sinking Fund Table. Sinking fund account is shown in the liability side of the balance
sheet while the amount of sinking fund invested in safe securities (sinking fund investment) is
shown in the assets side of the balance sheet. Sinking fund investment is the replacement of
liquid assets, while sinking fund is the replacement of profits of the company.
Accounting treatment: Journal entries for making Sinking Fund/Debenture Redemption Reserve
Fund for the redemption of debentures would be as under:
1. At the end of first year—
(a) When a fixed instalment of amount is set aside from profits—
Profit and Loss Appropriation Account Dr.
To Debenture Redemption Fund Account.
The fixed annual instalment is determined with the help of Annuity Table/Sinking
Fund Table and total amount payable on redemption.
(b) When the amount set aside from profits is invested in safe securities—
Debenture Redemption Fund Investments Account Dr.
To Bank Account

Notes 2. At the end of second and subsequent years, ascertaining last year in which redemption is
to be made.
(a) When amount of interest on Debenture Redemption Fund Investment made in the
previous year is received—
Bank Account Dr.
To Interest on Debenture Redemption Fund Investment Account.
(b) When the interest on Debenture Redemption Fund Investment is transferred to

Debenture Redemption Fund Account—
Interest on Debenture Redemption Fund Investment Account Dr.
For Entries (a) & (b); the following one combined entry can be passed:
Bank Account Dr.
(c) When a fixed annual instalment is set aside from profits—
(d) When the amount set aside from profit is invested—
Debenture Redemption Fund Investments Account Dr.
To Bank Account
3. At the end of last year – (when the debentures are to be redeemed)
(a) When the amount of interest on all previous debentures redemption reserve fund
investments is received—
Bank Account Dr.
To Interest on Debenture Redemption Fund Investment Account.
(b) When the interest on debenture redemption fund investments is transferred to

debenture redemption fund account—
To Debenture Redemption Fund Account
(c) When a fixed annual instalment is set aside from profits—
(d) When the proceeds from the sale of all investments at profit is received—
Bank account Dr.
To Debenture Redemption Fund Investment Account
(profit on sale of investment)

Or Notes
If investments are sold at a loss—
Bank Account Dr.
Debenture Redemption Fund Account Dr. (Loss on sale of investments)
To Debenture Redemption Fund Investments Account.
(e) When amount is due to debenture-holders for redemption—
(f) When payment is made to debenture-holders—
Debenture-holders Account Dr
To Bank Account
(g) When the balance of Debenture Redemption Fund Account, after the redemption of
all debentures, is transferred to General Reverse—
Debenture Redemption Fund Account Dr.
Some important points relating to debenture redemption fund for redemption of debentures:
1. If the debentures are redeemable at premium as per the terms of issue of debentures, total
amount to be accumulated by the means of Debenture Redemption Fund must include the
amount of premium payable on redemption.
2. Amount of profit to be set aside will be calculated as under:
Amount of profit to be set aside = Amount of redeemable debentures × Present value of

1 for a given number including premium payable on redemption of years at a prescribed
rate of interest.
3. Interest on investment will be calculated on the nominal value of investments not on the
purchase price of investments.
4. In the last year no investment is made for another one year, because the redemption is to
be made in this year.
5. If all the debentures have been repaid, the balance of Debenture Redemptions Fund should
be transferred to General Reserve, because the purpose of its creation is solved by the
redemption of debentures and its corresponding investments are also sold.
6. The profits on sale of investment and profit on cancellation of debentures are of capital
nature. If these profits have been transferred to Debenture Redemption Fund, these should
be transferred to capital reserve by the following journal entry:
and the balance should be transferred to general reserve.
7. If only some of the debentures are redeemed, only the face value of the debentures redeemed
(plus any premium payable on redemption) should be transferred from Debenture
Redemption Fund to General Reserve.

Notes Illustration 6 (Debenture Redemption Fund Method)
A company issued 1,000 debentures of 100 each on 1 st January, 2003 repayable after 3, years at
par. It was decided to set up a Debenture Redemption Fund for the purpose of redeeming these
debentures. Sinking Fund Table reveals that an amount of 0.317208 set aside every year and
invested in 5% securities will yield 1 after three years.
On 31st December, 2005 the investments were sold for 60,000 and debentures were redeemed.
Pass journal entries and necessary accounts.
[B. Com. Rohilkhand University 1994]
Solution:
Journal Entries

2003
To Debentures Account 1,00,000
(Being issue of debentures at par redeemable at par)
Dec. 31 Profit and Loss Appropriation Account Dr. 31,721
To Debenture Redemption Fund Account 31,721
(Being annual provision made for redemption)
Dec. 31 Debenture Redemption Fund Investment Account Dr. 31,721
(Being the amount of D.R.F. invested)
2004
Dec. 31 Bank Account Dr. 1,586
To Interest on Debenture Redemption Fund Investment A/c 1,586
(Being receipt of interest on investment)
Dec. 31 Interests on Debenture Redemption Fund Investment A/c Dr. 1,586
(Being interest transferred to D.R.F.)
Dec. 31 Profit and Loss Appropriation Account Dr. 31,721
(Being annual provision made for redemption)
Dec. 31 Debenture Redemption Fund Investment Account Dr. 33,307
(Being amount of debenture redemption fund invested)
2005
Dec. 31 Bank Account Dr. 3,251
To Interest on Debenture Redemption Fund Investment A/c 3,251
(Being receipt of Interest on investment)
Dec. 31 Interest on Debenture Redemption Fund Investment Dr. 3,251
(Being interest on investment transferred to debenture redemption
fund account)
Profit and Loss Appropriation Account Dr. 31,721
“ “ To Debenture Redemption Fund Account 31,721
(Being annual provision made from profits)
“ “ Debenture Redemption Fund Account Dr. 5,028
To Debenture Redemption Fund Investment Account 65,028
(Being investments sold for 60,000 at a loss of 6,614) Contd...
“ “ Debentures Account Dr. 1,00,000
To debenture-holders’ Account 1,00,000
“ “ Debenture-holders’ Account Dr. 1,00,000
To General Reserve Account 93,386
(Being the transfer of balance of DRF account to general reserve)
Dec. 31 Interest on Debenture Redemption Fund Investment Dr. 3,251
(Being interest on investment transferred to debenture redemption
fund account)
Profit and Loss Appropriation Account Dr. 31,721
“ “ To Debenture Redemption Fund Account Unit 8: Methods of Redemption–I
31,721
(Being annual provision made from profits)
To Debenture Redemption Fund Investment Account 65,028 Notes
(Being investments sold for 60,000 at a loss of 6,614)
“ “ Debentures Account Dr. 1,00,000
To debenture-holders’ Account 1,00,000
“ “ Debenture-holders’ Account Dr. 1,00,000
(Being the transfer of balance of DRF account to general reserve)
Ledger Debenture Redemption Fund Account

2003 2003
Dec. 31 To Balance c/d 31,721 Dec. 31 By P. & L. Appropriation Account 31,721
31,721 31,721
2004 2004
Dec. 31 To Balance c/d 65,028 Jan. 1 By Balance b/d 31,721
Dec. 31 By P. & L. Appropriation Account 31,721
By Interest on DRF Investment A/c 1,586
65,028 65,028
2005 2005
Dec. 31 To D.R.F. Investment A/c 5,028 Jan. 1 By balance b/d 65,028
Dec. 31 To General Reserve A/c 94,972 Dec. 31 By P. & L. Appropriation Account 31,721
By Interest on DRF Investment A/c 3,251
1,00,000 1,00,000
Debenture Redemption Fund Investment Account

2003 2003
Dec. 31 To Bank Account 31,721 Dec. 31 By balance c/d 31,721
31,721 31,721
2004 2004
Jan. 1 To Balance b/d 31,721 Dec. 31 By balance c/d 65,028
Dec. 31 To Bank Account 33,307
65,028 65,028
2005 2005
Jan. 1 To Balance b/d 65028 Dec. 31 By Bank Account 60,000
Dec. 31 By DRF Account 5,028
65,028 65,028
Debentures Account
2003 2003
Dec. 31 To Balance c/d 1,00,000 Jan.1 By Bank Account 1,00,000
1,00,000 1,00,000
2004 2004
Dec. 31 To Balance c/d 1,00,000 Jan. 1 By Balance b/d 1,00,000
1,00,000 1,00,000
2005 2005
Dec. 31 To Debenture-holders’ Account 1,00,000 Jan. 1 By Balance b/d 1,00,000
1,00,000 1,00,000

Notes Interest on Debenture Redemption Fund Investment A/c
2004 ` 2004 `
Dec. 31 To D.R.F. Account 1,586 Dec. 31 By Bank Account 1,586
1,586 1,586
2005 2005
Dec. 31 To D.R.F. Account 3,251 Dec. 31 By Bank Account 3,251
3,251 3,251
!
Caution Every company has to create a Debenture Redemption Reserve (DRR) equivalent
to 50% of the amount of debentures issue before commencement of redemption on 14.1.1987
Illustration 7 (Redemption of Debentures Out of Sinking Fund)
On 1st January, 2006 the following balances stood in the books of a company:
`
12% Mortgage Debenture 3,00,000
Debenture Redemption Fund 3,19,620
Debenture Redemption Fund Investments:
` 1,05,000; 6% Haryana State Electricity Board Bonds 1,06,890
` 1,20,000; 8% U.P. Water Board Bonds 96,102
` 90,000; 6% Government of India Loan 92,565
` 24,000; 9% I.C.I.C.I. Bonds 24,063
On the same day investments were sold: Haryana State Electricity Board Bonds at par, 6%
Government of India loan at ` 109, 8% U.P. Water Board Bonds at ` 91 and ICICI Bonds at ` 103.
On the same day, debentures were redeemed at a premium of 5%.
Write up the accounts concerned (other than cash account) bring down the balances, if any, after
the above transactions have been completed and stating how such balances should be dealt with
the next balance sheet of the company.
Solution:
Debenture Redemption Fund Account
Date Particulars ` Date Particulars `

Jan. 1 To Premium on Red. of Jan. 1 By Balance b/d 3,19,620
Debenture A/c 15,000
To General Reserve 3,04,620 By Debenture
To Capital Reserve 17,400 Redemption Fund Investment A/c 17,400
3,37,020 3,37,020
Debenture-holders’ Account
Date Particulars ` Date Particulars `
Jan. 1 To Bank Account 3,15,000 Jan. 1 By 12% Mortgage Debenture Account 3,00,000
By Premium on Redemption A/c 15,000
3,15,000 3,15,000
12% Mortgage Debenture Account
Date 2006 `
Jan. 1 To Debenture-holders A/c 3,00,000 Jan. 1 By Balance b/d 3,00,000
3,00,000 3,00,000

Debenture Redemption Fund Investment Account Notes

2006 2006
Jan. 1 To Balance b/d: Jan.1 By Bank Account:
1,05,000 Electricity Bonds 1,06,890 1,05,000 Electricity Bonds 1,05,000
1,20,000 UP Water Bonds 96,102 1,20,000 UP Bond @ 91 1,09,200
90,000 G.O.I. Bonds 92,565 90,000 G.O.I. Bonds @ 109 98,100
24,000 ICICI Bonds 24,063 24,000 ICICI Bonds @ 103 24,720
By Debenture Redemption
Fund A/c 17,400
3,37,020 3,37,020
Premium on Redemption of Debentures Account
2006 2006
Jan. 1 To Debenture-holders’ A/c 15,000 Jan. 1 By Debenture Redemption Fund A/c 15,000
15,000 15,000
Working Note:
1. In the next balance sheet 12% Mortgage Debentures and D.R.F. investment will not be
shown and cash of 22,020 (3,37,020 – 3,15,000) will be shown.
2. Profit on sale of D.R.F. investment is a capital profit, therefore it is transferred to Capital

Reserve.
Illustration 8 (Redemption by Sinking Fund and Calculation of Profits set aside)
Ram Chandran Company Limited issued 12,610. 12% Debentures of 100 each on 1st January
2003. They are paid at the end of three years. A sinking fund account is to be opened in the books
of the company and every year on 31st December, a fixed amount is to be transferred to this
account. The first investment was made on 31st December, 2003 at 5% per annum compound rate
of interest. Prepare necessary account in the books of the company.
Solution:
The annually transferable amount from Profit and Loss Account to sinking fund will be calculated
as follows:
In 2003 Investment of 1 1.000
In 2004 Balance of 2003 1.000
5
1
100
+ Interest @ 5% 0.050
+ Investment of 1 1.000
2.050
In 2005
Balance of 2004 2.050
2.05  5
100
+ Interest @ 5% 0.1025

Notes Investment of 1 1.0000
3.1525
1 appropriated every year for three years will be accumulated 3.1525.
Total amount required for redemption of debentures 12,61,000
12,61,000
Amount of each instalment = = 4,00,000
3.1525
Sinking Fund Account

Dec. 31 To Balance c/d 4,00,000 Dec. 31 By Profit & Loss
4,00,000 4,00,000
2004 2004
Dec. 31 By Interest on S.F. Investment A/c 20,000
Dec. 31 By Profit and Loss Appropriation A/c 4,00,000
8,20,000 8,20,000
2005 2005
Dec. 31 To General Reserve Account 12,61,000 Jan. 1 By Balance b/d 8,20,000
Dec. 31 By Interest on S.F. Investment A/c 41,000
Dec. 31 By Profit and Loss Appropriation A/c 4,00,000
12,61,000 12,61,000
Sinking Fund Investment Account

Dec. 31 To Bank Account 4,00,000 Dec. 31 By Balance c/d 4,00,000
4,00,000 4,00,000
2004 2004
Jan. 1 To Balance b/d 4,00,000 Dec. 31 By Balance c/d 8,20,000
Dec. 31 To Bank account 4,20,000
8,20,000 8,20,000
2005 2005
Jan.1 To Balance b/d 8,20,000 Dec. 31 By Bank Account 8,20,000
8,20,000 8,20,000
12% Debenture Account

Dec. 31 To Balance c/d 12,61,000 Jan. 1 By Bank Account 12,61,000
12,61,000 12,61,000
2004 2004
12,61,000 12,61,000
2005 2005
Dec. 31 To Debenture-holders account 12,61,000 Jan. 1 By Balance b/d 12,61,000
12,61,000 12,61,000
8.2.4 Non-cumulative Sinking Fund
In a non-cumulative sinking fund, interest received on debenture redemption fund investment

is neither transferred to a sinking fund nor is invested in the marketable securities. In its place,

this interest is directly transferred to profit and loss account, being treated as interest earned on Notes
general investments. In this case annual appropriation from profits will be more because interest
on investments in not reinvested.
Accounting Treatment: In the case of non-cumulative sinking fund, the following entries are
passed in the books of the company:
1. At the end of first year:
(a) When annual provision is made-
(b) When amount of sinking fund is invested—
Debenture Redemption Fund Investment Account Dr.
To Bank Account.
2. At end of second year and subsequent years except the last year:
(a) When interest on investment is received—
Bank Account Dr.
To Interest on Debenture Redemption Fund Investment A/c
(b) When interest on investment is transferred to profit and loss account—
To Profit and Loss Account
(c) When annual provision is made—
(d) When amount of annual installment of profit is invested—
Debenture Redemption Fund Investment Account Dr.
To Bank Account
3. At the end of last year:
All the same entries will be passed which were in the case of cumulative sinking fund.
Illustration 9 (Redemption by Non-Sinking Fund)
Good Fortune Ltd. issued 30,000, 8% Debentures of 100 each at a discount of on 1st January,
2003. As per term of issue, the company is required to maintain a non-cumulative sinking fund
but with a provision that the company shall have the power to apply the sinking fund investments
in the purchase of debentures in the open market, if below par at any time. The annual sinking
fund contribution is 72,000. The followings are the relevant facts for the years 2004 & 2005:
A. Interest received by the company on investments:
(i) 2004 2,364
(ii) 2005 3,648
B. Realisation of sinking fund investments:
(i) 31st Dec. 2004 33,516 (original cost 33,612)
(ii) 31st Dec., 2005 46,800 (original cost 46,440)

Notes C. Debentures purchased in open market:
(i) 31st December 2004 at the cost of 33,498 (paid up value 35,178)
(ii) 31st December 2005 at the cost of 46,800 (paid up value 46,980). You are required
to prepare the necessary ledger accounts for two years.
[Adapted from C.A. (final) May 1973]
Solution:
Good Fortune Limited

Dec. 31 To Balance c/d 72,000 Dec. 31 By Profit and Loss Appropriation A/c 72,000
72,000 72,000
2004 2004
Dec. 31 To General Reserve A/c 35,178
To Balance c/d 1,08,822 Jan. 1 By Balance b/d 72,000
Dec. 31 By P. & L. Appropriation A/c 72,000
1,44,000 1,44,000
2005 2005
Dec. 31 To General Reserve A/c 46,980 Jan.1 By Balance b/d 1,08,822
Dec. 31 To Balance c/d 1,33,842 Dec. 31 By Profit and Loss Appropriation A/c 72,000
1,80,822 1,80,822
Sinking Fund Investments Account

Dec. 31 To Bank Account 72,000 Dec. 31 By Balance c/d 72,000
72,000 72,000
2004 2004
Jan. 1 To Balance b/d 72,000 Dec. 31 By Bank A/c 33,516
Dec. 31 To Bank A/c 72,000 Dec. 31 By Profit and Loss A/c
(33,516 – 33,612) 96
1,44,000 1,44,000
2005 2005
Jan.1 To Balance b/d 1,10,388 Dec. 31 By Bank Account 46,800
Dec. 31 To Bank Account 72,000 Dec. 31 By Balance c/d 1,35,948
Dec. 31 To Capital Reserve 360
1,82,748 1,82,748
8% Debentures Account

Dec. 31 To Balance c/d 30,00,000 Jan. 1 By Bank Account 30,00,000
2004 2004
Dec. 31 To Bank A/c 33,498 Jan. 1 By Balance b/d 30,00,000
Dec. 31 To Capital Reserve A/c 1,680
Dec. 31 To Balance c/d 29,64,822
30,00,000 30,00,000
2005 2005
Dec. 31 To Bank Account 46,800 Jan. 1 By Balance b/d 29,64,822
To Capital Reserve 180
To Balance c/d 29,17,842
29,64,822 29,64,822

Profit and Loss Account (2004) Notes
To Sinking Fund Investments A/c (loss) 96 By Interest on Sinking Fund Investments 2,364
Profit and Loss Account (2005)
By Interest on Sinking Fund Investments 3,648
8.3 Insurance Policy Method
In this method too, a part of profit is set aside and is transferred to the Debenture Redemption
Fund Account. Like the method of sinking fund, appropriated profits are not invested in safe or
marketable securities. Instead, an insurance policy is taken by the company to get the money for
redemption of debentures after a specified period of time. The premium of this insurance policy
equals to profit set aside annually. At the time of redemption of debentures or on the date of
maturity of policy, the amount is received from insurance company and from this amount
debentures are redeemed. The period of insurance policy will be equal to the period of issue of
debentures. The main differences between Sinking Fund Method and Insurance Policy Method
are as below:
1. In sinking fund method profits are invested at the end of the year while premium is paid
in the beginning of the year in the case of insurance policy method.
2. In last year no investment is made in sinking fund method, while in the insurance policy
method, the amount of premium is paid in the beginning of the last year.
3. When money is invested in marketable securities in sinking fund method, there will be no
certainty about the amount to be received from the sale of securities, due to market
fluctuations. In the case of insurance policy method, there is certainty about the receipt of
a fixed sum at maturity.
Notes At the time of redemption of debentures or on the date of maturity of policy, the
amount is received from insurance company and from this amount debentures are
redeemed.
4. Annual interest on investment is received in the case of sinking fund method, while no
such annual income is received in the case of insurance policy method. But many accountants
like to record the amount of interest every year which is based on expected rate of interest
and they pass the following journal entry:
Debenture Redemption Fund Policy Account Dr.
Accounting treatment: The following entries are passed in the insurance policy method—
(a) For all years (including last year) following entries are passed:
(i) When the amount of premium is paid—
To Bank Account
(ii) When profit is set aside at the end of the year—

Notes (b) In the last year, in addition to the above two entries, the following entries will also be
passed-
(i) When amount is realized from insurance policy on its maturity—
Bank Account Dr.
To Debenture Redemption Fund Policy Account
(ii) When the profit on policy (difference of total instalment paid and amount received
on maturity of policy) is transferred to debenture redemption fund—
Alternatively, in the place of above (i) and (ii) entries, the following single combined
entry can be passed—
Bank Account Dr.
(iii) When amount is due to debenture-holders at premium—
Debenture Account Dr.
Premium on Redemption of Debenture Account Dr.
To Debenture-holders’ Account.
(iv) When the premium payable on redemption of debentures is transferred to debenture

redemption fund account—
To Premium on Redemption of Debentures Account
(v) When payment is made to debenture-holders—
Debenture-holders’ Account Dr.
To Bank Account
(vi) When after the redemption of debenture, the balance of debenture redemption fund
is transferred to general reserve.
Did u know? In sinking fund method profits are invested at the end of the year while
premium is paid in the beginning of the year in the case of insurance policy method.
Illustration 10 (Redemption by Insurance Policy Method)
Nimish Limited issued 2,100; 12% Debentures of 100 each at par on 1st January 2003, repayable
at par after three years on 31st December 2005. It was decided to take over an insurance policy for
2,10,000 to provide the necessary cash for redemption of debentures. The annual premium of
the policy was 65,000.
Prepare the necessary accounts in the books of Nimish Limited relating to issue and redemption
of debentures.

Solution: Notes

Dec. 31 To Balance c/d 65,000 Dec. 31 By Profit and Loss Appropriation A/c 65,000
65,000 65,000
2004 2004
Dec. 31 To Balance c/d 1,30,000 Jan.1 By Balance b/d 65,000
Dec. 31 By Profit and Loss Appropriation A/c 65,000
1,30,000 1,30,000
2005 2005
Dec. 31 To Bank Account 2,10,000 Jan. 1 By Balance b/d 1,30,000
Dec. 31 By Profit and Loss Appropriation A/c 65,000
Dec. 31 By Debenture Redemption Fund
Policy Account 15,000
2,10,000 2,10,000
Debenture Redemption Fund Policy Account

Jan.1 To Bank Account 65,000 Dec. 31 By Balance c/d 65,000
65,000 65,000
2004 2004
Jan.1 To Balance b/d 65,000 Dec. 31 By Balance c/d 1,30,000
Jan. 1 To Bank account 65,000
1,30,000
1,30,000
2005 2005
Jan. 1 To Balance b/d 1,30,000 Dec. 31 By Bank Account 2,10,000
Jan. 1 To Bank Account 65,000
Dec. 31 By Debenture R. Fund A/c 15,000
2,10,000 2,10,000

Jan. 1 To Balance c/d 2,10,000 Jan. 1 To Bank Account 2,10,000
2,10,000 2,10,000
2004 2004
Dec. 31 To Balance c/d 210,000 Jan. 1 By Balance b/d 2,10,000
2,10,000 2,10,000
2005 2005
Dec. 31 To Bank Account 2,10,000 Jan.1 By Balance b/d 2,10,000
2,10,000 2,10,000
Illustration 11 (Redemption by Insurance Policy with Interest)
Manish Mills Limited issued on 1st January, 2003 15,00,000, 12% Debentures which are to be
redeemed at the end of three years. For the redemption of 12% Debentures the company took an
insurance policy on which annual premium of 4,71,160.72 is paid. The rate of interest may be
estimated 3% per annum. Show Debenture Redemption Fund Account and Debenture
Redemption Policy Account for 3 years in the books of the company.

Notes Solution:
Manish Mills Limited

Dec. 31 To Balance c/d 4,85,295.52 Dec. 31 By Profit and Loss
Appropriation account 4,71,160.72
Dec. 31 By Debenture Redemption Policy
Account 14,134.80
4,85,295.52 4,85,295.52
2004 2004
Dec. 31 To Balance c/d 9,85,149.93 Jan. 1 By Balance b/d 485,295.52
Dec. 31 By Profit and Loss Appropriation A/c 4,71,160.72
Dec. 31 By Debenture Redemption A/c
(interest) 28,693.69
9,85,149.93 9,85,149.93
2005 2005
Dec. 31 To General Reserve Account 15,00,000 Jan. 1 By Balance b/d 9,85,149.93
Dec. 31 By Profit and Loss
Appropriation A/c 4,71,160.72
Dec. 31 By Debenture Redemption Policy
Account (interest) 43,689.35
15,00,000 15,00,000
Debenture Redemption Policy Account

Jan. 1 To Bank Account 4,71,160.72 Dec. 31 By Balance c/d 4,85,295.52
Dec. 31 To Debenture Redemption
Fund Account (interest) 14,134.80
4,85,295.52 4,85,295.52
2004 2004
Jan. 1 To Balance b/d 4,85,295.52 Dec. 31 By Balance c/d 9,85,149.93
Jan. 1 To Bank Account 4,71,160.72
Fund Account (interest) 28,693.69
9,85,149.93 9,85,149.93
2005 2005
Jan. 1 To Balance b/d 9,85,149.93 Dec. 31 By Bank Account 15,00,000
Jan. 1 To Bank Account 4,71,160.72
Fund Account (Int.) 43,689.35
15,00,000 15,00,000
!
Caution At the time of redemption of debentures or on the date of maturity of policy, the
amount is received from insurance company and from this amount debentures are
redeemed.

Fill in the blanks:
11. Profit on cancellation of debentures is transferred to .......... account.
12. ……………….. is maintained for the redemption of debentures.
13. Debentures cannot be ……………….. by a company.
14. Loss on issue of debentures is a …………… loss for the company.
15. Profit on cancellation of debentures is transferred to:
(a) Profit and Loss Account

(b) Sinking Fund Account
(c) Capital Reserve
8.4 Summary
 Redemption of debentures means repayment of the amount of debentures to the debenture

holders or discharge of the liability on account of debentures.
 Debentures are normally redeemed at the expiry of the period for which they were
originally issued. But the company may also, if so authorized by the articles of association
and the terms of issue as stated in the prospectus, redeem the debentures before the expiry
of the fixed period either by instalments or by purchasing them in the open market.
 Unlike shares, a company can purchase its own debentures without any conditions and
then cancel them or even sell them again.
 The question of provisioning was earlier left to the discretion of company and many
companies did provisioning routinely, as a matter of financial prudence.
 Now under the SEBI guidelines, the matter is no more a matter of discretion or financial
prudence. SEBI guidelines provide for compulsory provisioning and also restrictions on
the payment of dividends till debentures are redeemed.
 We will first deal with SEBI guidelines before proceeding with the accounting aspects of
creating sinking fund for redemption of debentures.
8.5 Keywords
Redemption of Debentures: It means repayment of the amount of debentures to debenture-

holders or the discharge of the liability of debentures.
Redemption of Debentures by Conversion: When a company redeems its debentures by converting

them into a new class of shares or debentures, this method is called redemption of debentures by
conversion.
1. Explain the following:
(a) Redemption of Debentures out of Capital.
(b) Redemption of Debentures out of Profit.

Notes 2. How are debentures redeemed? What is a sinking fund? How and why is sinking fund
account prepared?
Practical Questions
3. (a) Zeba Hussain Company Limited issued 20,000; 10% Debentures of 100 each to a
discount of 10% but redeemable at a discount of 5% at the end of 5 years. Give the
necessary journal entries both at the time of issue and redemption of the debentures.
(b) Akram Ltd. issued 3,000; 10% Debentures of 100 each on 1st Jan., 1990 at a discount
of 10%. Redeemable at a premium of 10% in equal annual drawings in 4 years. Give
journal entries both at the time of issue and redemption of debentures.
4. Ankit Mills Limited issued 12% Debentures for 50,000 on 1st January. 2002, redeemable
at the end of the third year from the date of their issue. It was decided to make provision
for the redemption of debentures by means of a three-year insurance policy purchased on
1st January, 2002 for an annual premium of 16,000. Pass journal entries and prepare the
necessary ledger accounts to record these transactions relating to debentures in the books
of Ankit Mills Limited, on the assumption that accounting year of the company ends 31st
December.
Ans: Transfer from insurance policy account to debenture redemption fund account is 2,000
5. On 31st December, 2002, the following balances stood in the books of the company:
10% Mortgage Debenture Stock 3,00,000

Debenture Redemption Fund Investment at cost:
1,20,000; 8% Government Loan 1,06,890
120,000; 7% Conversion Stock 96,102
90,000; 10% Corporate Stock 92,565
30,000; 8% Funding Loan 24,063
On the same day the investments were sold: Government Loan at par, Conversion Stock at
91, and Corporation Stock at 99 and Funding Loan at 93. On the following day, the
debentures were redeemed at a premium of 5%.
Write up the accounts concerned, other than cash book, after the above transactions have
been completed.
Ans: Transfer to General Reserve 3, 04,620.
Transfer to Capital Reserve 26,580.
1. Difficulty 2. Debentures
3. Maturity 4. Debenture
5. false 6. false
7. false 8. true
9. true 10. false

11. Capital Reserve 12. D.R.R. Notes
13. Forfeited 14. Capital

15. (c)
Books Magazines and Journals

Invest in an IPO or DPO. Chicago: Dearborn Trade, 1998.
Barker, William W. SEC Registration of Public Offerings under the Securities Act of
1933. Chicago: American Bar Association, 1997.
Brown, Meredith, ed. Mechanics of Global Equity Offerings: Structuring the Offering
and Negotiating the Underwriting Agreement. Cambridge, MA: Kluwer Law and
Taxation Publishers, 1995.
Goldblatt, Jennifer. “Market Ho-Hum about New Revenue Limit on Securities

Underwriting.”American Banker, 26 December 1996, 20.
Johnson, Hazel J. The Banker’s Guide to Investment Banking: Securities and
Underwriting Activities in Commercial Banking. New York: McGraw-Hill Professional
Book Group, 1996.
Lipman, Frederick D. Going Public: Everything You Need to Know to Successfully
Turn a Private Enterprise into a Publicly Traded Company. Upland, PA: DIANE
Publishing, 1998.
Shillinglaw, Gordon. Accounting: A Management Approach. 9th ed. New York:
McGraw-Hill Higher Education, 1992.

Case Study Buyback of Shares by MNCs in India
The Buyback Option

In October 2000, Royal Philips Electronics of Netherlands (Philips), the Dutch parent of
Philips India Limited, announced its first offer to buyback the shares of its Indian subsidiary.
The open offer was initially made for 23% of the outstanding shares held by institutional
investors, private bodies and the general public. The offer was made at ` 105, a premium
of 46% over the then prevailing stock market price. With this, Philips became one of the
first multinational companies (MNCs) in India to offer buyback option to its shareholders.
Soon after, the buyback option was offered by several multinational companies (MNCs)
to increase their stake in their Indian ventures. Some of these companies were Cadbury
India, Otis Elevators, Carrier Aircon, Reckitt Benkiser etc. Fund managers which held
these companies’ stocks felt that allowing buyback of shares was one of most favorable
developments in the Indian stock markets.
It provided a much needed exit option for shareholders in depressed market conditions.
Buyback by the company usually indicated that the management felt that its stock was
undervalued.
Contd...

Notes This resulted in an increase in the price, bringing it closer to the intrinsic value and
providing investors with a higher price for their investment in the company. However,
critics of the buyback option claimed that large multinationals had utilized the buyback
option to repurchase the entire floating stock from the market with the objective of delisting
from the stock exchange and eliminating an investment opportunity for investors.
Moreover, most MNCs that offered buyback option reported a steep decline in the trading
volumes of the shares of their Indian ventures. The declining liquidity of these shares
prompted critics to say that the Government of India’s attempt to revive capital markets
by allowing buyback of shares had failed.
The Buyback Act
The buyback ordinance was introduced by the Government of India (GOI) on October 31,
1998. The major objective of the buyback ordinance was to revive the capital markets and
protect companies from hostile takeover bids.
The buy back of shares was governed by the Securities and Exchange Board of India’s
(SEBI) Buy Back of Securities Regulations, 1998, and Securities and Exchange Board of
India’s (SEBI) Substantial Acquisition of Shares and Takeover Regulations, 1997. The
ordinance was issued along with a set of conditions intended to prevent its misuse by
companies and protect the interests of investors. According to guidelines issued under
SEBI’s Buy Back of Securities Regulations, 1998, a company could buyback its shares from
existing shareholders on a proportionate basis:
 From the open market, through the book building process or the stock exchange.
 From odd lot holders.
The ordinance allowed companies to buy back shares to the extent of 25 per cent of their
paid up capital and free reserves in a financial year.
The buyback had to be financed only out of the company’s free reserves, securities premium
account, or proceeds of any earlier issue specifically made with the purpose of buying
back shares. The ordinance also prevented a company that had defaulted in the repayment
of deposits, redemption of debentures or preference shares, and repayment to financial
institutions from buying back its shares. Moreover, a company was not allowed to buy
back its shares from any person through a negotiated deal, whether through a stock
exchange, spot transactions, or any private arrangement. It also allowed the promoters of
a company to make an open offer (similar to an acquisition of shares) to purchase the
shares of its subsidiary...
Buyback Offer By MNCs
In the financial year 2001-2002, twenty MNCs made buyback offers. Some of the well-
known MNCs which offered to buy back their shares were Philips India Limited (Philips),
Cadbury India Limited (Cadbury), Britannia Industries Limited (Britannia), Carrier Aircon
(Carrier) and Otis Elevators (Otis).
All these companies made open offers for the non-promoter shareholding in their Indian
subsidiaries. To buy back shares, Cadbury paid 9 billion, Philips 2 billion, and Carrier,
Otis and Reckitt Benkiser all paid over 1 billion. According to analysts, the increased
buyback activity by MNCs was due to three reasons. They felt that the share prices of most
MNCs were under priced and did not reflect the true value of the company. Moreover, the
buyback of shares allowed MNCs to convert their Indian ventures into wholly owned
subsidiaries (WOS). It also allowed them to delist the shares of these ventures from the
stock markets and thus protect them from the volatility of the stock markets (caused by
scams and other market manipulations)...
Contd...

Investor Grievances Notes
Analysts felt that the buyback option may be misused by MNCs to increase their equity
stakes in their Indian ventures, escape public scrutiny and accountability and prevent
them from the Indian regulatory environment.
Moreover, the option to convert their Indian ventures into wholly owned subsidiaries
and delist their shares from the stock markets provided MNCs with complete control over
their Indian ventures, allowed them to repatriate profits and make more independent
investment decisions.
A section of investors felt that government regulations must have provided them with a
choice.
However, minority shareholders claimed that they had no option and were forced to sell
their shares once MNCs bought back shares from the majority shareholders...
Buy or Not to Buyback?
The dilemma that faced small investors in India was whether the buyback option, along
with the SEBI guidelines, actually protected their interests and offered them an exit option
at a fair price or was it a tool that provided them with no options allowing large MNCs to
gain complete control of their subsidiaries.
Investors felt that the regulations framed by SEBI did not have provisions for preventing
good stocks from delisting. Moreover, the buyback price, which was determined using
the parameters specified in the SEBI Takeover Code, did not consider the future potential
of the stock.
They felt that SEBI should have looked at various financial parameters such as future cash
flows, value of brands and the value of fixed assets to determine a pricing formula for
open offers which ensured that investors who had been holding the stock for several years
received a fair price for their investment.
Source: http://www.icmrindia.org/casestudies/catalogue/Finance/Buyback%20of%20Shares%20by%20MNCs%20in%20
India%20-%20Finance.htm

Notes Unit 9: Methods of Redemption-II
CONTENTS
Objectives
Introduction
9.1 Redemption by Purchase of Debentures in the Open Market
9.2 Interest on Own Debentures
9.3 Cum-Interest and Ex-Interest Quotations
9.4 Summary
9.5 Keywords
Objectives
 Know redemption by purchase of debentures in open market
 Explain interest on own debentures
 Understand Cum-interest and Ex-interest Quotations
Introduction
The amount required for the redemption of debentures is usually large and as such unless
adequate provision is made, the company may not have sufficient funds to repay the debentures
at their maturity date.
From the legal point of view, there are no restrictions on the sources of funds for redeeming
debentures – even assets can be sold for the purpose. However, in order to accumulate funds for
redeeming the debentures, prudent companies try to retain sufficient profits. In this case, it is
said that the debentures are redeemed out of the profits and of course, new shares or debentures
may also be issued for carrying out the redemption.
It is therefore necessary to make adequate provisions for additional funds required for the
redemption of debentures. For this purpose, a company may adopt any of the following methods:
(a) Raise fresh capital: A company may issue new shares or debentures and the proceeds of
fresh issue of share capital and/or debentures may be utilized for redeeming the debentures.
(b) Utilise profits: A part of the profits of the company may be withheld from distribution to
the shareholders and are utilized for the purpose of redemption of debentures.
(c) Sale of assets: A company may also utilize the sale proceeds of the fixed assets for redeeming
the debentures
(d) Surplus funds: Apart from the above, a company may also use its surplus profits for the

Unit 9: Methods of Redemption-II
Notes
Notes It is said that the debentures are redeemed out of the profits and of course, new
shares or debentures may also be issued for carrying out the redemption.
9.1 Redemption by Purchase of Debentures in the Open Market
If the Articles of Association of a company empowers the directors, they can purchase the
company’s own debentures from the open market. Such an act of purchase of debentures can be
for the following any one of the objectives:
1. Immediate cancellation of these debentures.

2. When debentures are purchased for investment, these are called own debentures and
appear in the assets side until they are cancelled.
A company purchased its own debentures from open market not only for cancellation but
also for the following savings:
(i) When debentures are purchased from the open market at a discount, it enables the
company to save the money equal to the amount of discount, which could have been
required to be paid by the company in case the debentures are redeemed in general.
(ii) If the debentures are redeemable at premium and the company purchases its own
debenture from the open market, it saves that amount equal to the premium which
would have been payable on debentures in the ordinary course of redemption.
(iii) Interest burden also reduces if own debenture are purchased from the open market.
Did u know? When debentures are purchased from the open market at a discount, it enables
the company to save the money equal to the amount of discount, which could have been
required to be paid by the company in case the debentures are redeemed in general.
Accounting treatment: When the debentures are purchased from the open market, the following
entries are required to be passed.
A. When debentures are purchased for immediate cancellation, there can be two cases:
1. If sinking fund is not maintained in the books:
(i) when debentures are purchased for immediate cancellation—
To Bank Account
(ii) If there is any profit or loss on cancellation (due to difference in market price
of debentures and nominal value of debentures) of debentures, that will be
the capital reserve account because its nature is that of a capital item and its
treatment will be as below:
(a) when profit on cancellation of debentures is transferred to capital

reserve—
Profit on Redemption of Debentures Account Dr.

Notes (b) when loss on cancellation of debentures is written off against capital
reserve—
Capital Reserve Account Dr.
To Loss on Redemption of Debentures Account.
(iii) When debentures are purchased and cancelled, an amount equal to the nominal
value of debentures cancelled is transferred from the divisible profits to general
reserve account. For this, the journal entry will be:
To General Reserve Account
2. If a sinking fund is maintained in the books—
(i) When sinking fund investments are sold for the purchase of debentures:
Bank Account Dr.
To Sinking Fund Investment Account
Profit or loss on the sale of sinking fund investments will be transferred to the
sinking fund.
(ii) When debentures are purchased for cancellation.
To Bank Account
If there is any profit or loss on the cancellation of debentures, the same will be
transferred to sinking fund account.
(iii) When debentures are purchased and cancelled, an equal amount to the nominal
value of debentures is transferred to general reserve from the sinking fund
account. For this, the entry will be:
Sinking Fund Account Dr.
To General Reserve Account
B. When debentures are purchased as investment:
1. If the sinking does not exist in the books and debentures are purchased as
investment—
Own Debentures Account Dr. (value paid)
To Bank Account
2. If a sinking fund account is maintained in the books, the first sinking fund investment
will be sold—
Bank Account Dr.
To Sinking Fund Investments Account.
If there is any profit or loss on the sale of sinking fund investment, the same will be
transferred to the sinking fund.
3. When own debentures are cancelled—
Debentures Account Dr. (nominal value)

Loss on Redemption of Debentures Account Dr. (any loss) Notes
To Own Debentures Account (Book value of debentures

to be cancelled)
To Profit on Redemption of Debentures Account (any profit)
If there is any loss or profit on redemption of debentures, that will be transferred to sinking fund
account. An amount equal to the nominal value of debentures cancelled will be transferred from
the divisible profit to the general reserve in case of no sinking fund is maintained. And in case
sinking fund is maintained, this transfer will be from the sinking fund to the general reserve.
Illustration 1 (Redemption of Debentures by Purchase from Open Market)
On 1st January, 2004 Surjeet Company Limited made an issue of 5,000; 12% Debentures of 500
each at 5% discount. The terms of issue provided for the redemption of 50,000 debentures every
year commencing from the end of 2005, either by purchase or by drawings at par at the company’s
discretion. 25,000 was also written off the debenture discount account in each of the years, 2004
and 2005.
On 31st December 2005 the company purchased for cancellation, debentures of the face value of
20,000 at 450 per debenture and of 38,000 at 400 per debenture, the brokerage being 2%.
Journalize the above transactions and show how the profit on redemption would be treated,
ignoring the interest on debentures.
Solution:
Journal

2004
Discount on Issue of Debentures A/c Dr. 1,25,000
(Being issue of 12% debentures at discount)
Dec. 31 Profit and Loss account Dr. 25,000
(Being discount on debentures written off from P & L account)
2005
(Being cancellation of 40 debentures by purchasing them
@ 450 per debenture)
Profit on Redemption of Debenture Account Dr. 2,000
(Being profit on redemption of debentures transferred to capital
reserve account)
12% Debentures Account Dr. 30,000
(Being cancellation of 60 debentures)
(Being transfer of profit on cancellation of debentures)
Own Debentures Account Dr. 8,000
Contd...
(Being own debenture purchased as own debentures
(38,000 – 30,000)
Profit & Loss Account LOVELY PROFESSIONAL Dr. UNIVERSITY
50,000 203
(An equal amount to nominal value of debentures redeemed
transferred to general reserve)
(Being profit on redemption of debentures transferred to capital
reserve account)
Accounting for Companies-I (Being cancellation of 60 debentures)
(Being transfer of profit on cancellation of debentures)
Notes Own Debentures Account Dr. 8,000
(Being own debenture purchased as own debentures
(38,000 – 30,000)
Profit & Loss Account Dr. 50,000
(An equal amount to nominal value of debentures redeemed
transferred to general reserve)
(Being discount on issue of debentures written off against profits)
Illustration 2 (Redemption by Purchase of Debentures from Open Market)
The following information are available in the balance sheet of Sumeet Company Limited on
31st December, 2005:
(a) 15% Debentures of 100 each 14,00,000
(b) Debenture Redemption fund 59,50,000
(c) Debenture Redemption Fund Investment represented by 1,40,000 own debentures

purchased at 98 each and the remaining amount by 4,90,000; 10% Government of India
loan.
On the above date the directors redeemed all the debentures. For this purpose they realised 10%
Government of India loan at par. They realized 2, 10,000 for redemption out of current year’s
profits. Pass journal entries in the books of the company.
Solution:
Journal Entries

Dec. 31 Bank Account Dr. 4,90,000
To Debenture Redemption Fund Investment Account 4,57,800
(Being sale of DRF investment for redemption of debentures)
To Debenture Redemption Fund A/c 2,10,000
(An amount transferred from profits to D.R. fund account)
15% Debenture Account Dr. 12,60,000
(Being redemption made)
To Own Debentures Account 1,37,200
(Being cancellation of own debentures and profit thereon
transferred to D.R.F.)
Debenture Redemption Fund Account Dr. 8,40,000
(Being profit on sale of investment and profit on cancellation of
debentures transferred to capital reserve and balance to general
reserve account)

Working Note: Notes

1. Profit on sale of investments
Total amount for D.R.F. Investment 5,95,000
– Amount invested to purchase own debentures 1,37,200
Amount invested in 10% Government of India loan 4,57,800
Sale of 10% Government of India loan at par 4,90,000
– Cost price of investments 4,57,800
Profit on sale of investment 32,200
2. Opening balance of Debenture Redemption Fund 5,95,000
Add: Profit on sale of investments 32,200
Add: Profit on cancellation of own debentures 2,800
Add: Transfer from P & L account 2,10,000
8,40,000
Less: Transfer to capital reserve
(profit on sale of investment + profit on
cancellation of own debentures) 35,000
Balance transferred to general reserve 8,05,000
Illustration 3 (Redemption by Cancellation of Own Debentures)
On 1st January, 2005, Shiwalik Breweries Limited had 8, 00,000; 5% debentures outstanding in
its books, redeemable on 31 st December, 2005.
On 1st January, 2005, the balance of sinking fund was 7, 49,000 represented by:
(i) 1, 00,000 own debentures purchased at an average price of 99 and
(ii) 6, 60,000 nominal value of 3% war loan.
The amount annually credited to the sinking fund was 28,400.
The interest on the debentures was paid by the company every year on 31 st December and the
interest on war loan was received also on 31 st December annually.
On 31st December, 2005, the outside investments were realized at 98 per cent and all the outstanding
debentures were redeemed on that date.
You are required to write up the necessary ledger accounts for the year 2005 in the book s of the
company.
Solution:
Ledger of Shiwalik Breweries Ltd.
2005 2005
Dec. 31 To Loss on Sale of War Loan A/c 3,200 Jan. 1 By Balance b/d 7,49,000
To Capital Reserve Account 1,000 Dec. 31 by Profit and Loss Appropriation A/c 28,400
To General Reserve Account 7, 99,000 Dec. 31 By Interest on Own Debentures A/c 5,000
Dec. 31 by Interest on War Loan A/c 19,800
Dec. 31 by Own Debentures Account
(Profit on cancellation) 1,000
8,03,200 8,03,200

Notes Sinking Fund Investment Account

(a) 3% War Loan Account
2005 2005
Jan. 1 To Balance b/d 6,50,000 Dec. 31 By Bank Account (98% of 6,50,000) 6,46,800
By Sinking Fund A/c (loss on sale) 3,200
6,50,000 6,50,000
(b) Own Debentures Account
2005 2005
Jan. 1 To Balance b/d 99,000 Dec. 31
Dec. 31 To Sinking Fund Account
(profit on cancellation) 1,000 By 5% Debentures Account 1,00,000
1,00,000 1,00,000
2005 2005
Dec. 31 To Debenture-holders Account 7,00,000 Jan. 1 By Balance b/d 8,00,000
Dec. 31 To Own Debentures A/c 1,00,000
8,00,000 8,00,000
Debenture-holder’s Account
2005 2005
Dec. 31 To Bank Account 7,00,000 Dec. 31 By 5% Debentures Account 7,00,000
7,00,000 7,00,000
Working Note:
`
Loss on sale of 3% War Loan
Total amount available of S.F. Investment 7,49,000
Less: own debentures purchased 99,000
Cost price of 3% War Loan 6,50,000

Selling price of 3% War Loan 6,46,800
Loss on sale of 3% War Loan 3,200
!
Caution From the legal point of view, there are no restrictions on the sources of funds for
redeeming debentures – even assets can be sold for the purpose.
Self Assessment

1. It is compulsory to maintain D.R.R. 50% of debenture before the redemption of debentures.
2. Premium on debentures and premium on redemption of debentures carry same meaning.
3. If a company buys its own debenture at cum-interest basis, it will pay interest (in addition
to purchase price) from the last date of interest payment to the date of transaction.
4. If there are same prices at cum-interest and ex-interest basis, there will be more profit on
the purchase of ex-interest basis.

5. The following entry is passed in the books of a company: Notes
To Profit on Cancellation of Debenture A/c 8,400
Here, debentures are redeemed:
(a) 90
(b) 91.2
(c) At discount
9.2 Interest on Own Debentures

Debentures purchased by a company, if not cancelled immediately, are retained as investment
(popularly known as own debentures). These are deemed to be outstanding. Interest will be due
on the total debentures (including the retained debentures by the company as investment).
However, interest will be paid only on those debentures that are held by outsiders and interest
on own debentures will be retained by the company itself and will be transferred to interest on
own debentures account.
Accounting Treatment: The following journal entries will be passed to record the interest on
own debentures:
1. When interest on debentures become due—
Debenture Interest Account Dr.
To Interest on Own Debentures Account
If any income tax is deducted at source from interest on debentures belonging to outsiders,
that (income tax payable) will be credited and the balance will be given to debenture-
holders.
2. When interest is paid to debenture-holders—
To Bank Account
3. When interest on debentures is transferred to Profit and Loss Account—
To Debenture Interest Account
4. There can be any one of the following treatment regarding interest on own debentures:
(a) If the sinking fund account is not maintained by the company, it will be transferred
to profit and loss Account.
Interest on Own Debentures A/c Dr.
To Profit and Loss Account.
(b) If the sinking fund account is maintained by the company, interest on own debenture
will be transferred to sinking fund account.
Interest on Own Debentures Account Dr.
To Sinking Fund Account

Notes
Notes Debentures purchased by a company, if not cancelled immediately, are retained as

investment (popularly known as own debentures). These are deemed to be outstanding.
Interest will be due on the total debentures (including the retained debentures by the
company as investment).
Self Assessment
Fill in the blanks:
6. The amount required for the ………………… of debentures is usually large and as such
unless adequate provision is made, the company may not have sufficient funds to repay
the debentures at their maturity date.
7. ………………… purchased by a company, if not cancelled immediately, are retained as

investment (popularly known as own debentures).
8. If the debentures are purchased exactly on the date of payment of interest by a

…………………, interest of the previous period is paid to the former debenture-holder.
9. If the interest for ………………… period is included in the price of debenture, that will be
the capital portion. If some extra payment is made towards the interest for expired period
in addition to the price of debentures to the debenture-holder, that will be the revenue
portion.
10. If the Articles of Association of a company ………………… the directors, they can purchase
the company’s own debentures from the open market.
11. From the ………………… point of view, there are no restrictions on the sources of funds
for redeeming debentures – even assets can be sold for the purpose.
9.3 Cum-Interest and Ex-Interest Quotations
If the debentures are purchased exactly on the date of payment of interest by a company, interest
of the previous period is paid to the former debenture-holder. If the debentures are purchased
by the company between interest dates, it is necessary to find out whether the price paid for such
debentures includes the interest of expired period or not. If the interest for expired period is
included in the price of debenture, that will be the capital portion. If some extra payment is
made towards the interest for expired period in addition to the price of debentures to the
debenture-holder, that will be the revenue portion. The price paid depends upon the quotation.
There can be two types of quotations:
(i) Cum-interest price
(ii) Ex-interest price
(i) Cum-interest price: It is the price of the debenture which includes the interest of the
expired period. If cum-interest price is quoted, it means that no extra payment is to be
made for interest of expired period by the company to the debenture-holder. But the
interest has to be calculated from the last date of payment of interest to the date of purchase
of debentures. This can be understood properly with an example. If a company buys its 100
ow n 10% D ebentures of 100 each on 1 st May, 2005 at 96 cum-interest and the dates of
interest are 30th June and 31st December. Here, the expired period is four months (Jan., Feb.,
March & April).

And price paid for these 100; 10% Debentures is 96 × 100 = 9,600 Notes
Here, the cost portion in price is 9,600 – 333.33 = 9,266.67
And the revenue portion in price is 333.33
(a) For this cum-interest quotation purchase, the company will pass the following entry:
Debenture interest account Dr. 333.33
To Bank Account 9600
To Profit on Redemption of Debenture A/c 733.33
(b) If these debentures are purchased as an investment:
Own Debentures Account Dr. 9266.67
Debenture Interest Account Dr. 333.33
To Bank Account 9600
In future, when these debentures are cancelled, profit on cancellation on these debentures
will be transferred to the capital reserve account.
(ii) Ex-Interest price: It is the price which does not include the interest of expired period. If ex-
interest price is quoted, it means the company has to make extra payment for interest for
expired period in addition to the price paid for debenture. In the previous example, if a
company purchases those debentures at ex-interest quotation, it has to pay 9,600 for
debentures and 333.33 for interest for expired period.
(a) The following journal entry will be passed by the company:
Interest on Debentures Account Dr. 333.33
To Bank Account 9,933.33
To Profit on Redemption of Debentures Account 400
(b) If these debentures are purchased as an investment:
Own Debentures Account Dr. 9,600
Debenture Interest Account Dr. 333.33
To Bank Account 9,933.33
The profit on cancellation of these debentures will be transferred to the capital reserve account
at the time of cancellation of these debentures. If a sinking fund is maintained by the company,
profit on cancellation of these debentures will go to the sinking fund.
Illustration 4 (Purchase of Own Debentures at Ex-Interest Quotation, and Interest on Own

Debentures)
On 31st December, 2004, the balance sheet of Ranu Limited showed 20,000; 15% Debentures of
100 each outstanding. Interest on debentures is payable on 30 th June and 31st December every
year. On 1st May, 2005, the company purchased 1,000 of its own debentures as investment of 98
ex-interest. Pass the necessary journal entries for the following cases:
(a) The company cancelled all its own debentures on 1 st December, 2005.
(b) The company resells all its own debentures at 108 cum-interest on 1st December, 2005.

Notes Solution:
(a) Journal

May 1 Own Debentures Account Dr. 98,000
Debenture Interest Account Dr. 5,000
(Being own debentures purchased at ` 98 each ex-interest)
June 30 Debenture Interest Account Dr. 1,45,000
To Interest on Own Debenture Account 2,500
(Being 6 months interest on 19,000 debenture paid and 2 months
interest on 1,000 own debentures due)
To Own Debentures Account 98,000
To Profit on Cancellation of Own Debenture Account 2,000
(Being cancellation of 1,000 own debentures)
Dec. 1 Profit on Cancellation of Own Debenture Account Dr. 2,000
(Being transfer of profit on cancellation of own debentures to capital
reserve account)
Dec. 1 Debenture Interest Account Dr. 6,250
To Interest on Own Debenture Account 6,250
[Being interest due for 5 months (from 30th June to 1st Dec. on own
debentures)]
Dec. 31 Debenture Interest Account Dr. 1,42,500
(Being payment made for 6 months’ interest on 19,000 debentures)
Dec. 31 Interest on Own Debentures Account Dr. 8,750
(Being interest on own debentures i.e., ` 6,250 + 2,500 transferred
to profit and loss account)
To Debentures Interest Account 2,85,000
(Being transfer of debenture interest to profit and loss account)
(b) Journal

Dec. 1 Bank Account Dr. 1,08,000
To Own Debentures Account 1,01,750
To Interest on Own Debentures Account 6,250
(Being sale of 1,000 debentures cum-interest at ` 108).
Dec. 1 Own Debentures Account Dr. 3,750
To Profit on Resale of Own Debentures Account 3,750
Profit on resale (1,01,750-98,000) of own debentures transferred
to profit on resale of own debentures account
Dec. 1 Interest on Own Debentures Account Dr. 6,250
Profit on Resale of Own Debentures Account Dr. 3,750
(Being transfer of interest on own debentures and profit on resale of
own debentures to profit and loss account)

Illustration 5 (Purchase of Own Debentures at Cum-interest Quotation by Sale of D.R.F. Notes

Investments)
Purohit Limited furnishes you the following information on 1 st January 2005:
12% Debentures of 100 each 4,00,000
Debenture Redemption Fund Investment 1,50,000
(in 8% IDBI Bonds of the face value of 1,80,000)
Interest on debentures was payable on 30 th June and 31 st December every year and interest on
IDBI Bonds was also receivable on the same dates.
On March 1, 2005, the company purchased for immediate cancellation 480 debentures in the
open market at 98 each cum-interest. The amount required for this was raised by selling 8%
IDBI Bonds of the face value of 54,000.
On 31st December, 2005, 40,000 was appropriated for the Debenture Redemption Fund and on
the same date, 8% IDBI Bonds were purchased for the amount plus the interest on investments.
The face value of the 8% IDBI Bonds purchased was 60,000.
You are required to show the journal entries in the books of the company to record the above
mentioned transactions.
Solution:
Journal Entries
2005 Particulars L.F.

March 1 12% Debentures Account Dr. 48,000
Debenture Interest Account Dr. 960
To Bank Account (480 × 98) 47,040
To Profit on Cancellation of Debentures Account 1,920
(Being 480 debentures purchased cum-interest at 98 for
immediate cancellation).
March 1 Profit on Cancellation of Debentures Account Dr. 1,920
To debenture redemption fund account 1,920
(Being profit on cancellation of debentures transferred to D.R. fund)
To Debenture Redemption Fund Investment Account 46,320
To Interest on D.R. Fund Investment A/c 720
(Being D.R.F. investments sold)
Debenture Redemption Fund Investment Account Dr. 1,320
To Debenture Redemption Fund A/c 1,320
(Being transfer of profit on sale of investment)
(Being profit transferred to debenture redemption fund for redemption
of debentures)
June 30 Debenture Interest Account Dr. 21,120
(Being payment of interest on 3,520 debentures for 6 months)
To Interest on D.R. Fund Investment Account 5,040
(Being interest received on investment of 1,26,000 @ 8% for
6 months)
Contd...
To Interest on D.R. Fund Investment A/c 5,040
(Being interest received on investmentLOVELY PROFESSIONAL
of 1,26,000 @ 8% for UNIVERSITY 211
6 months)
Interest on D.R. Fund Investment Account Dr. 10,800
To D.R. Fund Account 10,800
(Interest on D.R.F. investment transferred to D.R. Fund account i.e.,
720 + 5,040 + 5,040)
(Being profit transferred to debenture redemption fund for redemption
of debentures)
Accounting for Companies-I Bank Account Dr. 5,040
To Interest on D.R. Fund Investment Account 5,040
6 months)
Notes Dec. 31 Debenture Interest Account Dr. 21,120
To Interest on D.R. Fund Investment A/c 5,040
6 months)
Interest on D.R. Fund Investment Account Dr. 10,800
(Interest on D.R.F. investment transferred to D.R. Fund account i.e.,
720 + 5,040 + 5,040)
(Being annual profit transferred to D.R. Fund account)
Debenture Redemption Fund Investment Account Dr. 41,800
(Being 8% IDBI Bonds purchased with the amount of annual profits
and interest i.e., 40,000 + 1,800)
To Debenture Interest Account 43,200
(Being interest on debentures transferred to P/L account i.e.,
21,120 + 21,120 + 960)
Debenture Redemption Fund Account Dr. 48,000
(Being an amount equal to the nominal value of debentures
redeemed transferred from D.R. Fund to General Reserve)
Illustration 6 (Sale and Purchase of Debentures at Cum-interest and Ex-interest Price)
Jaslin Company Limited issued 20,000; 12% Debentures of 100 each at par on 1 st April, 2004.
According to the terms of issue, interest was payable half yearly on 30 th September and 31st
March and the company reserved the right to buy any number of debentures in the open market
to be held as an investment or to be cancelled at any time.
During the accounting year ended 31 st March, 2005, the company purchased 160 of its debentures
at 102 cum-interest on 31 st July and 640 of its debentures at 99 ex-interest on 28 th February
2005.
On 30th June, 2005, the company sold one-half of the debentures purchased on 28 th February 2005
at 104 cum-interest. On 30 th November 2005, the company purchased 1,200 debentures at 97.50
and on 31 st December 2005 it cancelled 480 debentures purchased in 2004 and still lying with it.
Prepare important journal entries ignoring the creation of debenture redemption reserve.
Solution:
Journal Entries

April 1 Bank Account Dr. 20,00,000
(Being 20,000 debentures issued at par)
July 31 Own Debentures Account Dr. 15,680
(Being 160 debentures purchased at 102 cum-interest)
Sep. 30 Debenture Interest Account Dr. 1,19,360 Contd...
To Interest on Own Debenture A/c 320
(Being payment of interest on 19,840 debentures belonging to
outsiders)
2005
Feb. 28 Own Debentures Account Dr. 63,360
(Being purchase 640 debentures at 99 ex-interest)
April 1 Bank Account Dr. 20,00,000
(Being 20,000 debentures issued at par)
July 31 Own Debentures Account Dr. 15,680 Unit 9: Methods of Redemption-II
(Being 160 debentures purchased at 102 cum-interest)
Sep. 30 Debenture Interest Account Dr. 1,19,360 Notes
To Interest on Own Debenture A/c 320
outsiders)
2005
Feb. 28 Own Debentures Account Dr. 63,360
(Being purchase 640 debentures at 99 ex-interest)
March 31 Debenture Interest Account Dr. 1,16,800
To Interest on Own Debenture A/c 1,600
(Being payment of interest on 19,200 debentures belonging to outsiders)
To Debenture Interest Account 2,40,000
(Being debenture interest transferred to P & L account)
March 31 Interest on Own Debentures A/c Dr. 1,920
(Being interest on own debentures transferred to P & L account)
June 30 Bank Account Dr. 33,280
To Interest on Own Debentures Account 960
(Being sale of 320 debentures at 104 cum-interest)
Own Debentures Account Dr. 640
To Profit on Sale of Own Debentures Account 640
(Being profit on sale of own debentures)
Sep. 30 Debenture Interest Account Dr. 1,20,000
outsiders)
Nov. 30 Own Debentures Account Dr. 1,17,000
(Being purchase of 1,200 debentures at 97.50 ex-interest)
To Profit on Cancellation of Own Debentures Account 640
(Being cancellation of 480 debentures and profit transferred)
Dec. 31 Profit on Cancellation Account Dr. 640
(Being profit on cancellation transferred to capital reserve)
(Being 3 months’ interest cancelled)
March 31 Debenture Interest Account Dr. 1,14,720
To bank account 1,09,920
To interest on own debentures account 4,800
March 31 Profit on Sale of Own Debentures Account Dr. 960 Contd...
Interest on Own Debentures A/c Dr. 10,080
(Being profit on sale of own debentures and interest on own
debentures transferred to P & L account)
Profit and Loss Account LOVELY PROFESSIONAL Dr. UNIVERSITY
2,38,560 213
To Debenture Interest A/c 2,38,560
(Being debenture interest transferred)
(Being profit on cancellation transferred to capital reserve)
(Being 3 months’ interest cancelled)
Accounting for Companies-I March 31 Debenture Interest Account Dr. 1,14,720
To bank account 1,09,920
To interest on own debentures account 4,800
Notes March 31 Profit on Sale of Own Debentures Account Dr. 960
Interest on Own Debentures A/c Dr. 10,080
(Being profit on sale of own debentures and interest on own
debentures transferred to P & L account)
To Debenture Interest A/c 2,38,560
(Being debenture interest transferred)
Illustration 7 (Purchase of Debentures as Investment and Cancellation after Some Time)
On 1st July, 2003, a company issued 1,000; 6% debentures of 100 each. The interest is payable on
30th June and 31st December every year. The company is allowed to purchase its own debentures,
which may be cancelled or kept or reissued at the company’s option. The company made the
following purchases by cheque in the open market.
On 31st May 2004, 100 debentures @ 98 ex-interest.
On 30th September 2005, 50 debentures @ 97 cum-interest.
The debentures which were purchased on 31 st May 2004 were cancelled on 31 st December 2005.
All payments were made on due dates.
Pass the journal entries to record the above mentioned transactions (including receipt and
payments) and also the relevant items in the balance sheet as on 31 st December 2005. Ignore
income tax.
[Adapted from C.A. (Inter) Nov. 1975]
Solution:
Journal Entries

July Bank Account Dr. 1,00,000
(Being issue of 1,000 debentures of 100 each)
(Being payment of debenture interest to debenture-holders)
Dec. 31 Profit and Loss Account Dr. 3,000
To Debenture Interest A/c 3,000
(Being debenture interest transferred to P & L accounts)
2004
May 31 Own Debentures Account Dr. 9,800
(Being 100 debentures purchased as investment @ 98 ex-interest)
(Being payment of interest on 900 debentures belonging to outsiders)
To Interest on Own Debentures A/c 300
(Being payment of interest on debentures belonging to outsiders)
Dec. 31 Profit and Loss Account Dr. 6,000 Contd...
(Being transfer of debenture interest)
Interest on Own Debentures A/c Dr. 350
214 To Profit and Loss Account
(Being transfer of interest on own debentures to P & L account)
(Being 100 debentures purchased as investment @ 98 ex-interest)
(Being payment of interest on 900 debentures belonging to outsiders)
Dec. 31 Debenture Interest Account Dr. 3,000 Unit 9: Methods of Redemption-II
Dec. 31 Profit and Loss Account Dr. 6,000 Notes
(Being transfer of debenture interest)
Interest on Own Debentures A/c Dr. 350
To Profit and Loss Account 350
(Being transfer of interest on own debentures to P & L account)
Sep. 30 Own Debentures Account Dr. 4,725
(Being 50 debentures purchased at 97 cum-interest as
investments)
To Profit on Cancellation of Debentures Account. 200
(Being cancelled 100 debentures)
Dec. 31 Profits on Cancellation of Debentures A/c Dr. 200
(Being transfer of profit on cancellation to capital reserve)
Interest on Own Debentures Account Dr. 675
To Profit and Loss Account 675
(Being interest on own debentures transferred to P & L account)
(Being debenture interest transferred to P & L account)
Debenture Redemption Fund Account Dr. 10,000
(Being an amount equal to the nominal value of debentures redeemed
transferred from D.R.F. to general reserve)
Balance Sheet as on 31st December 2005
Liabilities Assets
Secured Loans:
900; 6% Debenture of 100 each 90,000 Investments:
Own debentures (face value 5000) 4,750
Reserve & Surplus:
Capital reserve 200
Notes If the debentures are redeemable at premium and the company purchases its own
debenture from the open market, it saves that amount equal to the premium which would
have been payable on debentures in the ordinary course of redemption.

Fill in the blanks:
12. In cum ………………… price, no extra payment is to be made for interest of expired period
by the company to the debenture-holder.
13. If the debentures are purchased by the company between interest dates, it is necessary to
find out whether the price paid for such debentures includes the interest of …………………
period or not.
14. Interest burden also reduces if own debenture are purchased from the ……………… market.
15. If the debentures are redeemable at premium and the company ………………… its own
debenture from the open market, it saves that amount equal to the premium which would
have been payable on debentures in the ordinary course of redemption.
9.4 Summary
Redemption of debenture is the discharge of debenture liability. It can be done either by repaying
the money to debenture holders or converting the debenture into shares. The conditions of
redemption are clearly stated at the time of issue of debenture in the prospectus. Debentures can
be redeemed at par, premium or discount as per the terms of issue. The period of maturity,
redemption amount, yield on redemption etc. will be mentioned in the prospectus. In case the
non convertible debentures proposed to be rolled over (repayment extended for an additional
period), a compulsory option should be given to the debenture holders who wish to withdraw
from the debenture programme, as per the guidelines issued by SEBI.
Sources of Funds for Redemption of Debentures
Redemption of debentures is an important commitment to be fulfilled by a joint stock company.

Failure to redeem debentures will disqualify the directors of the company. Moreover, such a
default will invite strict penalties and loss of reputation. As the redemption of debentures drains
a large amount of resources, companies will make advance preparations to meet this need.
(i) Redemption of Debentures - from the proceeds of fresh issue of share capital and debentures
(ii) Redemption of Debentures - out of accumulated profits
Methods of Redemption of Debentures
(i) Redemption In lump-sum, at the end of stipulated period: Under this method the entire
debentures are redeemed at the stipulated date stated in the prospectus for the issue of
debentures. The drawback of this method is that the company has to arrange a large
amount at the time of redemption. Usually companies prepare well advance for the
(ii) By Draw of Lots: Under this method the company does not redeem all the debentures at
the same time. Instead it will call back only a portion of its debentures in the market for
redemption each year. The company select the debentures of a predetermined value, by
drawing lot and they are redeemed that year. This method of redemption reduces the
burden of redemption. Planning is relatively easy and the impact of redemption on the
finance of the company is limited.
(iii) By Purchasing in the Open Market: Debentures can be redeemed by purchasing them
from the open market. If a company finds its debentures are available in the open market
at cheap rate it will purchase those debentures and cancel them.

(iv) By Conversion into New Debentures or Shares: Conversion of debentures into shares is Notes
another method of redemption. When debentures are converted to shares, the company
does not pay money to debenture holders. Instead the company issues share certificates in
place of debentures. It may look good for the company because there is no need of cash
payment. But the company is selling its shares. Selling shares is actually selling part of the
ownership. Debenture holders become shareholders. Creditors become owners. It is better
to pay off creditors rather than selling them part of the company. But sometimes company
agree to give some shares to make the issue of debentures more attractive to buyers.
Debenture Redemption Reserve: The newly introduced Section 117C in the Companies Act,
1956 by Companies (Amendment) Act, 2000 has made a bold step in protecting the interests
of debenture holders by making it mandatory for the company to create security and
debenture redemption reserve. Accordingly, it shall now be mandatory for the companies
to create a debenture redemption reserve for the redemption of debentures. The company
shall have to credit adequate amount from out of its profits every year till such debentures
are redeemed.
The debenture reserve shall be used by the company only for the redemption of debentures.
Such redemption shall be in accordance with the terms and conditions of the issue of
debentures. The company shall pay interest due on outstanding debentures as per the
terms and conditions of the issue only.
If a company fails to redeem the debenture on due dates or on maturity, any or more than
one or all the debenture holders can make an application to the Tribunal and then Tribunal
on hearing all the parties concerned may direct by way of an order to redeem the debentures
forthwith by payment of principal and interest due on such debentures.
If default is made in complying with the order of the Tribunal, every officer of the company
who is in default shall be punishable with imprisonment which may extend to 3 years and
shall also be liable to a fine of not less than 500 for every day during which such default
continues.
9.5 Keywords
Cum-interest Price: It is that price of the debenture which includes the interest of the expired
period.
Debentures: It is purchased by a company, if not cancelled immediately, are retained as investment

(popularly known as own debentures).
Draw of Lots: Under this method the company does not redeem all the debentures at the same
time.
Ex-Interest Price: It is that price which does not include the interest of expired period. If ex-
interest price is quoted
Redemption in Lump-sum: Under this method the entire debentures are redeemed at the stipulated
date stated in the prospectus for the issue of debentures.
1. What is a sinking fund? Explain how it is created.
2. What is debenture interest?
3. Explain the meaning of Ex-interest and Cum-interest.

Notes Practical Questions:
4. A Limited had 2, 00,000; 12% Debentures on 1 st January, 2005. In accordance with the
power under the deed, the directors acquired from the open market for immediate
cancellation of debentures as follows:
March 1, 2005 40,000 at 98 cum-interest. August 1, 2005 80,000 at cum-interest. 15

December, 2005 20,000 at Ex-interest. Debenture interest is payable half yearly i.e., 30 th
June and 31 st December every year.
Show the ledger accounts of (i) 12% Debentures Account (ii) Debenture Interest.
Ans: Profit on cancellation of debentures is: (i) on 1st March, 1,600 (ii) On 1 st August, 600 (iii)
On 15th December, 300.
5. On 31st March 2004 Varun Ltd.’s balance sheet showed 10,000 12% Debentures of 100 each
outstanding. Interest on debentures is payable on 30 th September; and 31st March every
year. On 1st August 2004, the company purchased 500 of its own debentures as investment
at 97 ex-interest.
Pass journal entries for purchase and disposal of own debentures in each one of the following
cases:
(i) The company cancels all its own debentures on 1 st March 2005.
(ii) The company resells all its own debentures at 105 cum-interest on 1st March 2005.
Also show journal entries relating to debenture interest and interest on own debentures as
on 31st March 2005 in case (i) mentioned above.
6. (i) Swati Associates Limited has issued 10,000; 12% Debentures of 100 each on 1.1.2003.
These debentures are redeemable after three years at a premium of 5 per debenture.
Interest is payable annually.
(ii) On October 1, 2004 it buys 1,500 debentures from the market at 98 per debenture.
These are sold away on June 30, 2005 at 105 per debenture.
(iii) On January 1, 2005, it buys 1,000 debentures at 104 per debenture from the open
market. These are cancelled on April 1, 2005.
(iv) On October 1, 2005 it buys 2,000 debentures of 106 per debenture from the open
market. These debentures, along with other debentures, are redeemed on 31st
December, 2005.
Prepare the relevant ledger accounts, showing the above transactions. Working should
form part of you answer.
Ans: Profit on cancellation of own debentures transferred to capital reserve are 1, 57,833.
1. True 2. False
3. False 4. False
5. a 6. Redemption
7. Debentures 8. Company
9. Expired 10. Empowers
11. Legal 12. Interest

13. Expired 14. Open Notes
15. Purchases

Barker, William W, SEC Registration of Public Offerings under the Securities Act of

Goldblatt, Jennifer, “Market Ho-Hum about New Revenue Limit on Securities

Johnson, Hazel J, The Banker’s Guide to Investment Banking: Securities and

Book Group, 1996.
Lipman, Frederick D, Going Public: Everything You Need to Know to Successfully

Publishing, 1998.
Shillinglaw, Gordon, Accounting: A Management Approach. 9th ed. New York:

Online links http://www.articlesbase.com/college-and-university-articles/redemption-of-

debentures-5644906.html
http://www.scribd.com/doc/24202747/Study-Note-7-4-Page-542-564
http://dynamictutorial.blogspot.in/2012/02/company-account-debentures.html

Case Study 18 January. For Immediate Release
THFC Bond deal breaks 5% Cost barrier!
At a time when bank pricing is once again increasing for housing associations, THFC took
advantage of continued low Gilt yields to issue a £131m follow on (tap) issue of its 32 year
THFC Funding (3) deal. The deal was lead managed by Royal Bank of Canada and Royal
Bank of Scotland and was for ten underlying borrowers. The yield on the deal was 4.94%.
The 5% barrier is an important psychological barrier on long term deals for investors and
borrowers alike. “Since 2006 out of £3.6bn of HA public bond issuance, only £180m has
priced below 5% - and we had been responsible for £69m of that” said Piers Williamson,
Chief Executive of THFC. THFC had to pay a credit spread on the deal of 2%, the highest it
Contd...

Notes has paid in recent years. Williamson said “Sterling investors are no fools, they know that
housing associations are increasingly looking to the capital markets as banks are no longer
prepared to do long term deals. This reflects the new reality for Associations. They can still
do funding deals that most banks and many sovereign nations can only dream of”.
There is more HA issuance waiting in the wings, with public ratings announced for Radian,
Hastoe and Midland Heartand with a significant number of larger HAs waiting in the
wings to issue.
Another question in the market at the moment is whether the Bank of England will extend
its Quantitative Easing (so called QE2) programme beyond the end of February. The
programme is helping keep long term borrowing rates at levels last seen in Victorian
Britain. The most recent sharp fall in annual Consumer Price Inflation, targeted by the
Banks Monetary Policy Committee (MPC) combined with fears of a double dip recession,
suggest that QE may be extended beyond February. This would help keep the cost of
issuance down for HAs considering entering the capital markets later in the year.
THFC’s bond had a strong regional showing with two Scottish, three Welsh and two
Northern Irish Borrowers. The largest participant (£40m) was Dumfries and Galloway
HA, the largest Scottish Association outside Glasgow.
Source: http://www.thfcorp.com/whatsnew/pressreleases.html

Manpreet Kaur, Lovely Professional University Unit 10: Underwriting of Shares
Unit 10: Underwriting of Shares Notes
CONTENTS
Objectives
Introduction
10.1 Meaning of Underwriting
10.2 Underwriting Commission
10.3 Types of Underwriting
10.4 Advantages and Objectives of Underwriting
10.5 Requirement of Disclosure of Underwriting Agreement
10.6 Rates of Underwriting Commission, Brokerage and Remuneration to Managers
10.6.1 Marked and Unmarked Applications
10.6.2 Determination of the Liabilities of the Underwriters
10.7.1 Partial Underwriting Agreement
10.7.2 When Partial Issue is underwritten by More than One Underwriter
10.7.3 Firm Underwriting Agreements
10.8 Accounts of Underwriter
10.9 Sub-Underwriting
10.10 Overall or Overriding Commission
10.10.1 Accounting Treatment
10.10.2 Miscellaneous Illustrations
10.11 Summary
10.12 Keywords
Objectives
 Explain the meaning of underwriting
 Understand the concept of underwriting commission
 Describe types, advantages and objectives of underwriting
 Identify various underwriting agreements to be disclosed
 Define determinants of the liabilities of underwriting

Notes Introduction
Underwriting of Shares means the contract in which underwriter agrees to take shares which
will not be subscribed by public. For getting fast minimum subscription from public of his
issued shares, company has to do this type of contract. With this, headache of selling and getting
minimum subscription will be of underwriter not company. For this, company gives
underwriting commission to underwriter which is controlled by SEBI. Still 5% on issue of
shares or actual rate which is agreed in article of association which is less, is accepted to give it
to underwriter.
10.1 Meaning of Underwriting
If an existing company issues its debentures or shares to the public, it is necessary to receive 90%
of the issued amount (minimum amount) from the public within 120 days from the date of
opening the issue. If the company does not get this amount it cannot begin the process of
allotment and has to refund the amount of applications to the applicants. In the case of a new
company, it cannot obtain the Certificate of Commencement of Business on the failure of receiving
this amount. In order to ensure the minimum subscription from public, the companies resort to
underwriting. Underwriting is an agreement whereby the underwriters give the guarantee to
the company that in case the shares or debentures offered to the public are not subscribed by the
public to an extent, the balance (shares not subscribed by the public) of shares or debentures will
be taken up by the underwriters. The underwriters can be some individuals, firms or companies.
There can be more than one underwriters. Nowadays, underwriting of shares or debentures is
also done by specialized financial institutions such as Industrial Finance Corporation of India,
Industrial Development Bank of India (IDBI), Industrial Credit and Investment Corporation of
India (ICICI), Unit Trust of India (UTI) etc. Nationalised banks also have jumped into the business
of underwriting.
10.2 Underwriting Commission

For this guarantee, a commission is paid to underwriters which is called underwriting
commission. This commission is calculated on the issue price of shares or debentures underwritten.
Underwriting commission is paid to underwriters in the whole of the issue underwritten
irrespective of the fact whether shares are subscribed by the public or not, but the company
should be authorized by its Articles of Association to pay this commission to underwriters. The
following points should be kept in account regarding underwriting commission:
(i) Rate of commission of underwriter should not be more.
(a) In the case of shares 5% of the issue price of shares or the amount or rate authorized
by the Articles of Association whichever is less, and
(b) In case of debentures, of the issue price of the debentures or the amount or rate
authorized by the Articles of Association whichever is less.
(ii) The commission paid or to be paid must be disclosed in the Prospectus or in the Statement
in lieu of prospectus.
(iii) The number of shares or debenture which the underwriters have agreed to take, should be
clearly shown in the prospectus.
(iv) A copy of contract with the underwriters regarding the payment of commission should be
given to the Registrar.
(v) No underwriting commission is paid on those shares or debentures which are allotted to
promoters group, employees, directors, their friends and business associates.

Unit 10: Underwriting of Shares
10.3 Types of Underwriting Notes
There can be the following three main types of underwriting agreements between the company
and underwriters:
(i) Complete Underwriting Agreement: When the underwriter gives the guarantee to the
company that whole issue will be subscribed by the public, it is called complete
underwriting. In this case the whole issue is underwritten by one or more underwriters
and collectively or individually they agree to take the entire risk.
(ii) Partial Underwriting Agreement: When only a part of issue of shares or debentures is
underwritten by the underwriters, it is called partial underwriting. This underwriting can
also be done by one or more persons or institutions.
(iii) Firm Underwriting: When an underwriter makes an agreement to purchase a certain

number of shares or debentures of the company, in addition to the shares or debentures he
has to take under the underwriting agreement, it is called firm underwriting. The
underwriters under such agreement get the priority over general public in relation to
allotment of shares or debentures in the conditions of oversubscription. For example, if
underwriter has entered into an agreement for firm underwriting of 2,000 shares out of
total 10,000 shares issued, only 8,000 shares will be available for the public even, if there
are applications for 15,000 shares.
10.4 Advantages and Objectives of Underwriting
(i) Certainty regarding subscription on part of the public: If a company enters into an
agreement with underwriters at the time of issue of an shares or debentures, there will be
certainty that shares will be taken over by the public. In the absence of underwriting
agreement, there will be uncertainty regarding its subscription by public. This uncertainty
is automatically removed when underwriters give their guarantee to the company.
(ii) More Confidence Amongst Public: If a company has concluded an agreement with
underwriters, the names and addresses of the underwriters are given in the prospectus.
Appearance of names and addresses of the underwriters leads to more confidence amongst
the public. They feel that the company has a good position which is why the underwriters
have entered into an underwriting agreement with the company; which would not have
been the case otherwise.
(iii) Underwriting creates goodwill for the company: Underwriting increases goodwill of the
company. Generally, underwriters enter in an agreement for guaranteeing the shares and
debentures with those companies which have a sound position and whose future is bright.
The underwriters know that if the shares or debentures are not subscribed by the public
they will have to take up these shares or debentures, hence the ultimate burden will fall on
them. Due to this reason, underwriting agreement creates an impression regarding the
sound status of the company.
10.5 Requirement of Disclosure of Underwriting Agreement
According to the provisions of Companies Act 1956, an underwriting agreement should be

disclosed in the following:
(i) In the Prospectus: If an underwriting agreement is concluded with the underwriters by

the company, their names and addresses and the opinion of the directors regarding the
discharge of the obligations of the underwrites should be disclosed in the prospectus of
the company. Alongwith this information, the number of shares or debentures, which the

Notes underwriters have agreed to underwrite and to take up, and the amount or rate of
commission should also be disclosed in the prospectus as per provision of Section 76 of the
Companies Act.
(ii) In Statutory Report: The extent to which each underwriting contract, if any, has not been
carried out and the reason therefore, should be stated. This is merely because the directors
at the time of issuing a prospectus give a declaration that in their opinion, the underwriters
have the resources to carry out their obligations.
(iii) In the Balance Sheet: As per the requirements of the Schedule VI of the Companies Act, all
underwriting commission or brokerage payable must be shown in the assets side of the
balance sheet under the heading ‘Miscellaneous Expenditure’.
Distinction between Underwriter and Broker
As discussed earlier, an underwriter is that individual who agrees to take over a certain number
of shares or debentures if the public does not subscribe to them. An amount for this consideration
payable to the underwriter is called underwriting commission. On the other hand, a broker is a
person who provides services in bringing a settlement between a seller and purchaser of the
shares or debentures for a reward which is called brokerage. A broker can also procure the
subscription to the shares or debentures from the public on the behalf of the company. Such a
broker can only procure the subscription and does not undertake the responsibility of subscribing
to the shares or debentures of the company. As per Section 76(3) of the Companies Act, a
company is permitted to pay a reasonable amount of brokerage in addition to the payment of
underwriting commission.
10.6 Rates of Underwriting Commission, Brokerage and

Remuneration to Managers
Following the SEBI guidelines, the following rates regarding the payment of underwriting
commission, brokerage and remuneration to manager to the issue were issued by the Ministry
of Finance on 7th May 1985:-
1. Maximum Limit of underwriting Commission for Payment:
On amounts developing on the On amounts subscribed

underwriters (percent) by the public (percent)
(A) Equity Shares 2.5 2.5
(B) Preference shares/Convertible & Non-
Convertible debentures:
(i) Up-to the amount of 5 Lakhs. 2.5 1.5
(ii) For months in excess of 5 Lakhs. 2.0 1.0
2. Maximum Limit of Brokerage:
(i) Brokerage is fixed at 1.5% in respect of all types of public issue of the industrial
securities whether the issue is underwritten or not.
(ii) No company will pay any postage (mailing cost) or other cost out of pocket expenses
for canvassing the public etc., to any broker.
(iii) The listed companies are permitted to pay brokerage on private placement of capital
at a maximum rate of 0.5%.
(iv) No brokerage will be paid in respect of employees, directors, their friends and
promoters quota and rights issue.

(v) No brokerage will be paid on the shares subscribed by the institutions or banks Notes
against their underwriting agreements.
3. Fees of Managers to the Issue: Companies are free to appoint one or more agencies as
managers, but the total amount of fees to such persons should not exceed the following
limits:
(i) For issue up to 5 crore: 0.5%.
(ii) For issue over 5 crore: 0.2%.
In respect of the following, no fees shall be paid:
(a) On the amount of shares to be taken by institutions as investors or underwriters.
(b) Promoter’s quota of shares capital.
(c) On the amount of shares subscribed on right basis.
10.6.1 Marked and Unmarked Applications
Those applications which bear the official stamp of an underwriter or broker are called marked
applications and those which do not bear the official stamp of an underwriter, are called unmarked
applications. When there are more than one underwriters to underwrite the issue of a company
in an agreed ratio, importance of marked application arises. In this case each of the underwriter
makes an effort to sell the maximum shares or debentures through him in order to reduce his
risk. The least subscription of an underwriter will count to the advantage to some other
underwriter. Therefore an official seal is put on the application from each underwriter. This
official seal helps the company in recognizing as to which underwriter should get the credit for
that application. When applicants do not get application from any underwriter, but get the
application directly from the company (means unmarked application), the advantage of such
application is given to all underwriters in the ratio of gross liability of the underwriters. If there
is only one underwriter, he will get the credit of all applications whether it is marked (sealed) or
unmarked.
Notes Those applications which bear the official stamp of an underwriter or broker are
called marked applications and those which do not bear the official stamp of an underwriter,
are called unmarked applications.
10.6.2 Determination of the Liabilities of the Underwriters
The liability of the underwriter is determined on the basis of the nature of the underwriting
agreement. Therefore, the method of calculating the liability of the underwriters under different
type of agreement is given below:
1. Complete Underwriter Agreements: Complete underwriting is discussed in the following

two cases:
(a) When the entire issue of shares or debentures is underwritten only by one underwriter: If
the entire issue of shares or debentures is underwritten only by one underwriter,
the net liability of the underwriter will be determined by deducting marked and
unmarked applications received by the company from the gross liability of the
underwriter. Thus, underwriter will be liable to take up only those shares or
debentures which are not taken up by the public. If the issue of shares or debentures

Notes is fully subscribed or oversubscribed, the underwriter will be free from his liability.
But he is entitled to receive his commission on the total issue price of shares or
debentures. Here, the issue price means the nominal value of shares or debentures
in case the issue is at par. In case of discount, issue price means nominal value of
shares or debentures minus discount allowed and in case of premium issue, price
will be nominal value + premium on issue of shares or debentures.
Journal entries in the books of the insured company:
(i) When underwriting commission is due to underwriters-
Underwriting Commission Account Dr.
To Underwriters Account.
(ii) When underwriting commission is paid to underwriter in cash, debentures or shares-
Underwriters Account Dr.
To Bank Account
(iii) When the entire issue of shares or debentures is fully subscribed and liability for shortfall
in public subscription is taken by underwriters-
Underwriters Account Dr.
To Shares Capital Account.
(iv) When the amount is received for shares or debentures taken from underwriter-
Bank Account Dr.
To Underwriters Account .
(v) When the underwriting commission is written off from the profit or shares premium
account-
To Underwriting Commission Account.
Illustration 1 (When the Entire Issue is Underwritten by Only One Underwriter)
Sholapur Limited was formed with a capital of 1,000,000 divided into 10,000 equity shares of
100 each. All these shares were offered for subscription by prospectus to the public at par. The
whole issue has been underwritten by Shabnam & Co. for a commission of 4%. The company
received the applications for only 9,500 shares. All the applications were accepted by the company
and the balance were taken up by the underwriter. You are required to pass the journal entries
to record the above transactions in the books of Sholapur Limited and prepare the balance sheet
at this stage, assuming that all amounts due have been received.

Solution: Notes
Sholapur Limited
Journal Entries

1 Bank Account Dr. 9,50,000
To Equity Share Capital Account. 9,50,000
(Being 9,500 equity shares of 100 each issued at par)
2 Shabnam & Company (Underwriter) Dr. 50,000
(Balance of equity shares i.e., 500 shares allotted to underwriter
as per commitment)
3 Underwriting Commission Account Dr. 40,000
To Shabnam & Company (underwriter) 40,000
(Being commission due to Shabnam & Co. @ 4% on 10,00,000).
4 Bank Account Dr. 10,000
To Shabnam & Co. 10,000
(Being receipt the balance due from Shabnam & Co. i.e.,
50,000 – 40,000).
Balance Sheet of Sholapur Ltd.
Liabilities Assets
Shares Capital : Fixed Assets: —
Authorized, issued, Called up & Paid up capital Current Assets:
10,000 Equity shares of 100 each fully paid up. 10,00,000 Cash at Bank 9,60,000
Underwriting Commission 40,000
10,00,000 10,00,000
When the Entire Issue of Shares or Debentures is Underwritten by more than one
Underwriter in an Agreed Ratio
Where the issue of shares or debentures is underwritten by more than one underwriter following
procedure is adopted to determine the liability of the underwriters:
(i) Gross Liability of all underwriters is calculated on the basis of their agreed ratio.
(ii) Marked applications of all underwriters are subtracted from gross liability (which is
calculated in No. 1 above).
(iii) Credit is given to all underwriters for unmarked applications in the ratio of gross liability
(means unmarked application are subtracted from No. 2 above).
(iv) If some figures are in minus (surplus), that is subtracted from the liability (balance of No.
3) of other underwriters in the ratio of gross liability.
Alternatively, the credit for unmarked applications can be given to all underwriters in the ratio
of gross liability as reduced by marked applications.
In this case, individual net liability of underwriters will differ from the liability calculated as for
earlier procedure. Therefore, it is essential to mention the method in the underwriting agreement.
Students can adopt any one of two methods in solving the examination problem but they should
give a footnote regarding the method. These two methods are discussed in this illustration.

Notes Illustration 2 (When the Entire Issue is Underwritten by More Than One Underwriter)
Sudhir Limited was incorporated on 1st January, 2006 and issued a prospectus inviting
applications for 20,000 equity shares of 10 each. The whole issue was underwritten by ‘A’, ‘B’
and ‘C’ as follows:
‘A’ 10,000 shares, ‘B’ 6,000 share, ‘C’ 4,000 shares. Applications were received for 16,000 shares of
which marked applications were as follows:
‘A’ 8,000 shares, ‘B’ 2,850 shares, ‘C’ 4,150 shares. Find out the liability of individual underwriters
and pass the journal entries in the books of Sudhir Limited.
Solution:
Statement of Underwriter’s Liability in Shares
Particulars Underwriters Total

A B C
Gross Liability as per agreement. 10,000 6,000 4,000 20,000
Less: Marked Applications 8,000 2,850 4,150 15,000
Resultant Liability 2,000 3,150 –150 5,000
Less: Credit of unmarked applications in the ratio
of gross liability (i.e., 5:3:2) 500 300 –200 1,000
Resultant Liability 1,500 2,850 –350 4,000
Less: Surplus of ‘C’ distributed between ‘A’, ‘B’ in the ratio
5:3 (gross liability ratio) 219 131 350 —
Net Liability in shares 1,281 2,719 Nil 4,000
Alternatively, the second method can be adopted.

Statement of Underwriter’s Liability in Shares
Particulars Underwriters Total

A B C
Gross Liability 10,000 6,000 4,000 20,000
Resultant Liability 2,000 3,150 –150 5000
Less: Surplus of C distributed in gross
liability ratio (5:3) 94 56 150 –
Gross Liability as reduced by marked applications 1,906 3,094 Nil 5,000
Less: Credit for unmarked applications
Distributed in the ratio 1906 : 3094 381 619 – 1,000
Net Liability 1,525 2,475 – 4,000
Journal Entries (Based on First Method)

(Being allotment of 16,000 shares of 10 each to the public)
‘A’s Account Dr. 12,810
‘B’s Account Dr. 27,190
(Being allotment of 4,000 shares to underwriters as per agreement).
Underwriting Commission Account Dr. 10,000
To A’s account 5,000
To B’s account 3,000
To C’s account 2,000
(Being commission due to underwriter @ 5% on 2,00,000)
Contd...
To A’s Account 7,810
To B’s Account 24,190
(Being receipt of the balance from A & B)
C’s Account Dr. 2,000
(Being payment of commission to C)
(Being allotment of 16,000 shares of 10 each to the public)
‘A’s Account Dr. 12,810
‘B’s Account Dr. 27,190
(Being allotment of 4,000 shares to underwriters as per agreement).
Underwriting Commission Account Dr. 10,000
To A’s account Unit 10: Underwriting of Shares
5,000
To B’s account 3,000
To C’s account 2,000
(Being commission due to underwriter @ 5% on 2,00,000)
Bank Account Dr. 32,000 Notes
To A’s Account 7,810
To B’s Account 24,190
(Being receipt of the balance from A & B)
C’s Account Dr. 2,000
(Being payment of commission to C)
Notes It is assumed that rate of underwriting commission is 5%.
10.7.1 Partial Underwriting Agreement
Partial underwriting means that only a portion of the issue is underwritten by the underwriter.
In such case, balance of the issue of shares or debentures is treated as underwritten by the
company itself. Partial underwriting can be done by one underwriter or more than one
underwriter. In these cases the net liability of the underwriters will be calculated as below:
(a) When partial underwriting of the issue is done by one underwriter only
In this case the liability of the underwriter is determined as:
Net liability of the underwriter = Gross liability – Marked applications received by
company.
All unmarked applications are treated as marked by the company itself and no credit is
given to the underwriter regarding unmarked applications.
Thus, if marked applications exceed or are equal to the gross liability of the underwriter,
he will be free from his liability. And similarly, if the issue is fully subscribed by the
public, underwriter will also be free from his liability. Here, one point is to be noted that
if no information is given in the question regarding marked and unmarked applications,
to find out marked applications, total applications received by the company must be
multiplied by the percentage of the issue underwritten.
Did u know? Net liability of the underwriter = Gross liability – Marked applications
received by company.
Illustration 3 (Partial Underwriting by one Underwriter Only)
Negi Limited issued 5,00,000 equity shares of 100 each, of which 80% were underwritten by
Purohit & Company.
Applications were received for 300,000 shares out of which 240,000 shares applications were
marked in favour of Purohit and Company.
Determine the net liability of Purohit and Co. and pass the necessary journal entries in the books
of Negi Limited.
Solution:
Calculation of Net Liability of Purohit & Co.
Gross Liability of Purohit and Co. No. of shares
(80% as per commitment)
500,000 4,00,000

Notes Less: Marked applications 2,40,000
Net Liability of Purohit and Co. 1,60,000

Journal Entries in the Books of Negi Limited

(Being allotment of 30,00,00 shares to the public)
Purohit & Company Dr. 16,00,000
(Being taken over the net liability of 160,000 shares by Purohit & Co.
as per Commitment)
Underwriting Commission Account Dr. 2,00,000
To Purohit & Company 2,00,000
(Being commission due to underwriter assumed 5% of the issue)
Purohit & Co. Dr. 14,00,000
(Being receipt of the balance)
Illustration 4
XY Co. Ltd. issued 5,00,000 equity shares of 10 each at a premium of 10% and 10,000; 12%
Debentures of 100 each at 95. 75% of the issue is underwritten by Apex & Company at the
maximum rate of the commission allowed by Law. Applications were received for 4,00,000
shares and 6,000 debentures, which were accepted and payment for these was received in full.
Pass the necessary journal entries in the books of XY Co. Ltd.
Solution:
Calculation of Net Liability of the Underwriter
Particulars No. of shares No. of

Debentures
Total issue of the company 5,00,000 10,000
Total applications received by the company 4,00,000 6,000

Issue underwritten 75% 3,75,000 7,500
Application treated as marked by underwriter
(75% of total applications) 3,00,000 4,500
Net Liability of Apex Company (3,75,000 – 3,00,000) (7,500 – 4,500)

(in form of shares & debentures) = 75,000 = 3,000
In the absence of information it is assumed that 75% of the total applications are marked
by Purohit & Company.
5% commission will be payable to underwriter on the issue price of equity shares and
commission on the issue price of debentures.
Underwriting commission–
Shares Debentures
Issue Price ( ) 10 + 10% = 11 100 – 5% = 95
Issue Underwritten (75%) 3,75,000 shares 7500 debentures

Rate of Commission 5% Notes

Amount of Commission = ` 2,06,250 = ` 35,625
Journal Entries

(Being allotment of 4,00,000 shares of ` 10 each at 10% premium)
(Being allotment of 12% Debentures of ` 100 each at ` 95)
Apex & Company Dr. 8,25,000
(Being net liability of 75,000 shares taken over by underwriter as
per agreement)
Apex % Company Dr. 2,85,000
(Being net liability of 3,000 debentures taken over by the underwriter)
Underwriting Commission on Shares A/c Dr. 206,250
Underwriting Commission on Debentures A/c Dr. 35,625
To Apex & Co. 2,41,875
(Being commission due to underwriter)
To Apex & Company 8,68,175
(Being receipt of the balance from Apex & Company)
Receipt of balance of amount = ` 8,25,00 + ` 2,85,000 - ` 2,41,825
= ` 8,68,175.
Notes In the case of undersubscription, to determine the liability of underwriters, the

benefit of firm underwriting can be given to all underwriters if firm underwriting is
included in the unmarked application or if the benefit of firm underwriting is to be given
this to individual underwriters, firm underwriting should be included in marked
applications.
10.7.2 When Partial Issue is underwritten by More than One Underwriter
In this case too, only a part of the entire issue is underwritten by a number of underwriters and
the rest of the issue is treated as underwritten by the company itself. The unmarked applications
are treated as marked by the company and the net liability of the underwriters is determined by
the same method as explained in the case of partial underwriting by one underwriter only.

Notes
!
Caution Partial underwriting means that only a portion of the issue is underwritten by the
underwriter. In such case, balance of the issue of shares or debentures is treated as
underwritten by the company itself. Partial underwriting can be done by one underwriter
or more than one underwriter.
Net Liability of Underwriters = Total gross liability – Marked applications received by company.
Illustration 5 (Partial Underwriting by More than One Underwriter)
A public limited company issued 1,00,000 equity shares of ` 100 each at a discount of 10%. This
issue was underwritten as follows:
X - 40%, Y - 20%, Z - 20%.

The company received a total number of 70,000 applications of which marked applications were
as follows:
X – 30,000, Y- 15,000 Z – 17,000
Determine the Liability of each of the underwriter.
Solution:
Statement Showing the Net Liability of Underwriters in Shares
Underwrites
Total
Particulars X Y Z
Liability in Percentage 40% 20% 20% 80%
Gross Liability in Shares 40,000 20,000 20,000 80,000
Less : Marked Application 30,000 15,000 17,000 62,000
Net Liability of underwriters 10,000 5,000 3,000 18,000
10.7.3 Firm Underwriting Agreements
In case of firm underwriting agreements, the underwriters agree to accept an additional liability
along with the shares or debentures they have to take under the underwriting agreement. In this
case, the underwriters get priority over the general public at the time of allotment of shares. In
the case of under subscription the total liability of the underwriters will be the addition of net
liability for unsubscribed shares on the basis of underwriting agreement and liability under
firm underwriting. In the absence of information in the question, firm underwriting should be
treated as included in the given marked application forms because firm underwriting shares are
subscribed by the underwriters themselves under their seal.
In the case of undersubscription, to determine the liability of underwriters, the benefit of firm
underwriting can be given to all underwriters if firm underwriting is included in the unmarked
application or if the benefit of firm underwriting is be given this to individual underwriters,
firm underwriting should be included in marked applications. Actually, this depends upon the
terms of agreement with underwriters. This entire procedure can be explained in the following
steps:
1. Gross liability of all underwriters is calculated in their agreed ratio:
2. Marked applications of each underwriter are deducted.
3. Then from the balance (2) above, unmarked applications from gross liability are deducted
in their gross liability ratio.

4. From the balance (3) above, firm underwriting is deducted (firm underwriting can be Notes
deducted in the ratio of gross liability, or benefit may be given to individual underwriters.
It depends upon the agreement).
5. If any figure comes into minus (surplus) for any underwriter, that will be transferred to
other underwriters into their gross liability ratio. This will be the net liability.
6. To calculate the total liability of underwriters, firm underwriting is added to net liability.
Self Assessment
Fill in the blanks:

1. The maximum rate of underwriting commission in the case of debenture is ……………….
percent.
2. When an underwriter makes an agreement to take a certain number of shares, it is called
………….
3. Brokerage is fixed at …………… in respect of all types of public issues.
4. To calculate profit or loss on underwriting, ………….. is prepared by the underwriter.
5. Sub-Underwriting Commission is shown in the …………. side of the underwriting account.
Illustration 6
A Limited was formed with a capital of ` 20,00,000 divided into 1,00,000 shares of ` 20 each. The
whole amount was offered to the public. The company entered into as underwriting agreement
with the following individuals who have underwritten the whole issue as under:
P-30,000; Q-25,000; R-20,000; S-7,500; T-15,000; U-2,500.
All marked forms were to go in relief of underwriters whose names they bear. Applications for
20,000 shares were received but not marked. The applications on forms marked by the
underwriters were P-12,500, Q-25,000 R-10,000 S-10,000, T-7500, U-Nil. Show the ultimate liability
of each underwriter in respect of his agreement in A Ltd.
[M. Com. Rohilkhand University]
Solution:
Statement Showing the Liability of Underwriters in Shares
Underwriters
Particulars
Total P Q R S T U
Gross Liability in shares 1,00,000 30,000 25000 20,000 7,500 15,000 2500
Less: Marked Applications 65,000 12,500 25,000 10,000 10,000 7,500 Nil
35,000 17,500 Nil 10,000 –2,500 7,500 2,500
Less: Unmarked Applications
in the ratio: 12:10:8:3:6:1.
20,000 6,000 5,000 4,000 –1,500 3,000 500
15,000 11,500 –5000 6,000 –4000 4,500 2,000
Less: Surplus of ‘Q’& S
(divided amongst P, R, T & U.
in the gross liability ratio i.e.,
(12:8:6:1)
– 4,000 5,000 2,667 4000 2,000 333
Net Liability 15,000 7,500 Nil 3,333 Nil 2,500 1,667

Notes Illustration 7 (Marked Application and Firm Underwriting)
The following underwriting of shares takes place: A-3,000 shares, B-1,000 shares, C-1,000 Shares.
In addition there is firm underwriting: A 100 shares, B 50 shares, C 50 shares. The issue is 5,000
shares. The total subscription including firm underwriting was 4,000 Shares and the form included
the following marked forms: A-500 shares, B-600 shares, C-200 shares. Show the allocation of
liability of underwriters assuming that the marked forms included the firms underwriting.
Solution:
Underwriters
Particulars Total
A B C
Shares Shares Shares Shares
Gross Liability 3,000 1,000 1,000 5,000
Less: Marked Applications (excluding firm underwriting) 400 550 150 1,100
Less: Unmarked Applications 26, 00 450 850 3,900
Divided into gross liability 3:1:1 (4,000-1,300) 1,620 540 540 2,700
980 –90 310 1,200
Less: Firm Underwriting 100 -50 50 200
Less: Credit for Surplus of B divided into 880 –140 260 1000
Gross liability ratio between A & C (3:1) 105 140 35 —
Net Liability 775 Nil 225 1,000
Add: Firm Underwriting 100 50 50 200
Total liability 875 50 275 1,200
Illustration 8 (When Benefit of Firm Underwriting is given to all Underwriters)
Todi Company Limited issued prospectus inviting applications for 30,000 shares. The entire
issue is underwritten by Ajay, Vijay and Sanjay in the following manner:
Ajay –18,000 shares, Vijay – 7,500 shares and Sanjay - 4,500 shares. In addition to the above, the
underwriters signed a contract with the company for the following firm underwriting:
Ajay–2,550 shares; Vijay–900 shares and Sanjay–2,850 shares. The company received the
applications for the purchase of 21,300 shares which included the following marked applications:
A – 3,000 shares, B-6,000 shares and C-1,500 shares.
Calculate the total liability of each underwriter treating firm applications as unmarked.
Solution:
Statement Showing the Total Liability of Underwriters in Shares
Underwriters Total
Particulars Ajay Vijay Sanjay
shares share share
Gross Liability 18,000 7,500 4,500 30,000
Less: Marked Applications given Resultant Liability 3,000 6,000 1,500 10,500
Less: Unmarked Application in gross 15,000 1500 3000 19500
Liability Ratio (12:5:3) 6,480 2,700 1,620 10,800
8,520 –1,200 1,380 8,700
Less: Surplus of Vijay distributed between Ajay and Contd...
Sanjay in the gross liability ratio (12:3) –960 –1200 240 —
+
Net Liability 7,560 Nil 1,140 8,700
Add: Firm underwriting 2,550 900 2,850 6,300
Total Liability 10,110 900 3,990 15,000
Underwriters Total
Particulars Ajay Vijay Sanjay
shares share share
Gross Liability 18,000 7,500 4,500 30,000
Less: Marked Applications given Resultant Liability 3,000 6,000 1,500 10,500
Less: Unmarked Application in gross 15,000 1500 3000 19500
Liability Ratio (12:5:3) 6,480 2,700 1,620 10,800
8,520 –1,200 1,380 8,700
Less: Surplus of Vijay distributed between Ajay and Notes
Sanjay in the gross liability ratio (12:3) –960 –1200 240 —
+
Total Liability 10,110 900 3,990 15,000
Working Note:
1. Total applications received by the company 21,300
Less: Marked applications received
Ajay – 3,000
Vijay – 6,000
Sanjay – 1,500 10,500
Unmarked applications (including firm applications) 10,800
2. Gross Liability Ratio:
Ajay Vijay Sanjay
18,000 : 7,500 : 4500
180 : 75 : 45
12 : 5 : 3
Illustration 9
Sardar Limited issued to the public 1, 50,000 equity shares of 100 each at par. 60 per share was
payable along with the application and the balance on allotment. The issue was underwritten
equally by Ali, Bali and Charlie for a commission of 5%. Applications for 1, 40,000 shares were
received as per details below:
Underwriters Firm Marked Total

Applications Applications
Ali 5,000 40,000 45,000
Bali 5,000 46,000 51,000
Charlie 3,000 34,000 37,000
Unmarked Applications 7,000

Total 140,000
It was agreed to credit unmarked applications equally to Ali & Charlie. Sardar Limited
accordingly made the allotment and received the amounts due from public. The underwriters
settled their accounts.
You are requited to:
(i) Prepare a statement showing the liability of underwriters
(ii) Journalize the above transactions (including cash) in the books to Sardar Limited.

Notes Solution:
Sardar Limited
A. When the benefit of firm applications is given to individual underwriters, or when firm
applications are treated as marked application.
Underwriters
Particulars Total
Ali Bali Charlie
Gross Liability 50,000 50,000 50,000 1,50,000
Less: Marked Applications 40,000 46,000 34,000 1,20,000
Less: Relief for Unmarked Applications 10,000 4000 16,000 30,000
3,500 – 3,500 7,000
6,500 4000 12,500 23,000
Less: Firm Application 5,000 5,000 3,000 13,000
1,500 –1,000 9,500 10,000
Less: Surplus of Bali distributed to Ali and
Charlie in gross
Liability ratio 500 1000 500 –
Add: Firm underwriting 5,000 5,000 3,000 13,000
Total Liability 6,000 5,000 12,000 23,000
Calculation of Net amount Receivable from Underwriters
Ali Bali Charlie Total

Total liability in shares (as calculated) 6,000 5,000 12,000 23,000
Amount due @ 60 per share 3,60,000 3,00,000 7,20,000 13,80,000
Less: Commission @ 5% on the nominal value 2,50,000 2,50,000 2,50,000 7,50,000
of shares
Final amount receivable 1,10,000 50,000 4,70,000 6,30,000
B. When the benefit of firm underwriting is not given to individual underwriters, or when
firm applications are treated as unmarked applications.
Particulars Ali Bali Charlie Total

Gross Liability 50,000 50,000 50,000 1,50,000
Less: Marked Applications 40,000 46,000 34,000 1,20,000
Less: Unmarked Applications 10,000 4000 16,000 30,000
(Including firm applications) 10,000 — 10,000 20,000
Net Liability Nil 4,000 6,000 10,000
Add: Firm Underwriting 5,000 5,000 3,000 13,000
Total liability in shares 5000 9000 9000 23000

Calculation of Net Amount Receivable from Underwriters Notes
Ali Bali Charlie Total

Total Liability in shares 5,000 9,000 9,000 23,000
Amount due @ 60 per share 3,00,000 5,40,000 5,40,000 13,80,000
Less: Commission @ 5% on the normal value of
Underwritten shares 2,50,000 2,50,000 2,50,000 7,50,000
Final amount receivable 50,000 2,90,000 2,90,000 6,30,000
Journal entries in the books of Sardar Ltd.

1,40,000 shares @ 60 Per share)
capital account)
(Being receipt of allotment money on
1,40,000 shares @ 40 Per share)
Underwriters’ Account Dr. 10,00,000
(Being allotment of 10,000 shares to
underwriters as per commitment)
Underwriting Commission Account Dr. 7,50,000
To Underwriters’ Account 7,50,000
(Being underwriting commission due @ 5%
on the nominal value of 1,50,000 shares)
To Underwriters’ Account 2,50,000
(Being receipt of final amount due from
underwriters)
Illustration 10
Plentiful Ltd. comes out with a public issue of share capital on 1.1.2005 of 10, 00,000 equity shares
of 10 each at a premium of 5%, 2.50 is payable on application (on or before 31.1.2005) and
3.00 on allotment (31.3.2005) including premium.
The issue is underwritten by two underwriters – Seth and Shetty – equally the commission being
5% of the issue price. Each of the underwriters underwrites 20,000 shares firm.
Subscriptions total 9,60,000 shares, the distribution of forms being:
Seth 5,20,000, Shetty 3,60,000 and unmarked forms 80,000.

Notes One of the allottees (using forms marked with the name of the Seth) for 2,000 shares, fails to pay
the amount due to allotment all other money due being received in full including any due from
the share devolving upon the underwriters. The commission due is paid separately.
The shares of the indifferent allottees are finally forfeited by 30.6.2005 and are reallotted for
payment in cash of 4 per share.
You are required to pass summary journal entries to record the above events and transactions
(including cash).
Solution:
Statement showing the Liability Underwriters of underwriters in Shares
Underwriters
Particulars Total
Seth Shetty
Gross Liability 10,00,000 5,00,000 5,00,000
Less: Marked applications (excluding firm applications) 8,40,000 5,00,000 3,40,000
1,60,000 Nil 1,60,000
Less: Relief of Unmarked Applications 80,000 40,000 40,000
80,000 –40,000 1,20,000
Less: Firm underwriting 40,000 –20,000 20,000
40,000 –60,000 1,00,000
Less: Surplus of Seth given to Shetty – +60,000 –60,000
Net Liability 40,000 Nil 40,000
Add: Firm Underwriting 40,000 20,000 20,000
Total Liability 80,000 20,000 60,000
Notes Firm applications are assumed to be included in marked applications.

Journal Entries in the books of Plentiful Ltd.

2005
March 31 Equity Share Allotment Account Dr. 24,00,000
share Capital Account)
shares @ 3 per share including
premium)
March 31 Bank Account Dr. 28,74,000 Contd...
(Being receipt allotment money on
9,60,000 shares expect 2000 shares)
March 31 Shetty Dr. 2,20,000
To Shares Premium Account 20,000
Shetty as per underwriting agreement)
March 31 Bank Account Dr. 2,20,000
share Capital Account)
To Share Premium Account 4,80,000 Unit 10: Underwriting of Shares
shares @ 3 per share including
premium)
March 31 Bank Account Dr. 28,74,000 Notes
(Being receipt allotment money on
9,60,000 shares expect 2000 shares)
March 31 Shetty Dr. 2,20,000
To Shares Premium Account 20,000
Shetty as per underwriting agreement)
March 31 Bank Account Dr. 2,20,000
To Shetty 2,20,000
(Being receipt of the money on 40,000
shares)
March 31 Underwriting Commission Account Dr. 5,25,000
To Seth 2,62,500
To Setty 2,62,500
(Being commission due @ 5% in the
issue price 10.50 of 10,00,000 shares
distributed equally)
March 31 Seth Dr. 2,62,500
Shetty Dr. 2,62,500
(Being payment of underwriting
commission)
June 30 Share Capital Account Dr. 10,000
To Share Forfeited Account 5,000
(Being forfeiture of 2,000 shares for non
payment of allotment money)
June 30 Bank Account Dr. 8,000
Shares Forfeited Account Dr. 2,000
To Equity Share Capital Account. 10,000
(Being forfeited shares reissued @ 4
per share)
June 30 Shares Forfeited Account Dr. 3,000
(Being transfer of profit on sale of
reissue of forfeited shares)
10.8 Accounts of Underwriter
To determine the profit or loss on the underwriting business, the underwriters can maintain two
types of accounts:
Type I – When only one account is maintained by the underwriter i.e., Underwriting Account.
Type II – When more than one account is maintained by the underwriter.

Notes I. When Only One Account is Maintained by the Underwriter i.e. Underwriting Account
To calculate the profit or loss on underwriting of particular issue, the underwriters maintain
only one account – Underwriting Account. This account is also called by the name of “Investment
in Shares or Debentures of XYZ Company Limited Account.” This account is practically like
Profit and Loss Account. All expenses relating to the underwriting contract are debited to this
account. All revenuers are credited to this account.
1. When the underwriter has to take up the shares or debentures under agreement or firm
underwriting-
Underwriting Account Dr.
(With amount paid for shares or debentures)
To Bank Account
2. When payment is made by underwriter for expenses relating to the underwriting-
To Bank Account
3. When underwriting commission is received in cash or shares-
Bank Account Dr.
Shares in Co. Ltd. Dr.
4. When Underwriting Commission is transferred to underwriting account-
To Underwriting Account.
5. When shares received in commission are transferred to underwriting account-
To Shares in Co. Ltd.
6. When shares or debentures are sold by the underwriters-
Bank Account Dr.
To Underwriting Account
7. At the end of the year shares or debentures in stock are valued at cost or market price
which is less.
Self Assessment
6. The maximum rates of underwriting commission on shares is 5%.
7. The minimum rates underwriting commission on debentures, is
8. The nature of underwriting account is a nominal account.
9. Only in the condition of under subscription an underwriter can take up shares.

10. If an underwriter wants to reduce his liability, he can do so by entering into another Notes
contract with sub-underwriter.
11. Commission received from a company is credited in the underwriting account.
12. Amount in shares or debentures given to sub-underwriter is debited to underwriting

account.
10.9 Sub-Underwriting
In order to reduce the liability of underwriting contract, the underwriter may enter into a
contract with a number of persons who we called sub-underwriters. The sub-underwriting
contract is signed between the main underwriter and sub-underwriter. Sub-underwriter has
nothing to do with the company. Therefore he gets his commission from the main underwriter
which is called sub-underwriting commission. Sub-underwriting commission is debited to the
underwriting account. In case of undersubscription, the sub-underwriter has to take shares or
debentures as may fall to his share from the main underwriter. The underwriting account is
credited with the allotment money on these shares.
10.10 Overall or Overriding Commission
This is an additional commission which is paid by the company to the underwriter for providing
the services of sub-underwriters. This is calculated on the entire underwritten amount of shares
or debentures at a fixed percentage. On account of being the income of the underwriter, this is
credited to the underwriting account. When the maximum rate of underwriting commission is
decided, this commission also includes in underwriting commission as per Section 76 of
Companies Act.
II. When more than one account is maintained by the underwriter
In this system, the underwriter opens the following accounts in the place of underwriting
account.
(i) Investment in Shares Debentures in Co. Ltd. or Underwriting Account.
(ii) Underwriting Commission Account.
(iii) Issuing Company Account.
(iv) Sub-underwriting Account.
Notes In order to reduce the liability of underwriting contract, the underwriter may enter
into a contract with a number of persons who we called sub-underwriters.
10.10.1 Accounting Treatment
(i) When shares or debentures are taken up under underwriting agreement –

Underwriting Account (Shares or Debentures in X Co.) Dr.
To Issuing Company.
(ii) When the amount is paid by underwriting regarding the expenses of underwriting–
Underwriting Shares or Debentures in X Co.) Dr.
To Bank Account.

Notes (iii) When the underwriting commission is due–

Issuing Company Account Dr.
(iv) When the amount due on shares or debentures is paid to the issuing company–
Issuing company Dr.
To Bank Account.
(v) When the underwriting commission is received in cash or shares–
Bank Account Dr.
Shares or Debentures A/c Dr.
To Issuing Company Account.
(vi) When shares or debentures are given to sub-underwriter on the basis of the sub-
underwriting agreement-
Sub-Underwriter Account. Dr.
To underwriting (Shares or Debentures in X Co.)
(vii) When the sub-underwriting commission is due to the sub underwriter-
To Sub-underwriters Account.
(viii) When the amount due on shares or debentures given to the sub-underwriter is received-
Bank Account Dr.
To Sub-underwriters Account.
(ix) When the sub-underwriting commission is paid to the sub-underwriter in cash or shares-
Sub-underwriters Account Dr.
To Bank Account.
To underwriting (shares or Debentures of X Co.).
(x) When the shares or debentures are sold in the market-
Bank Account. Dr.
To Underwriting Shares or Debentures in X Co.)
(xi) When the balance of underwriting commission account is transferred to underwriting
(shares or debentures in X Co.) A/c-
To Underwriting (shares or debentures in X Co.) A/c
(xii) Closing the shares or debentures in stock will be valued at cost or market price, whichever
is less, and profit or loss on these share due to price fluctuation will be transferred to Profit
and Loss Account.
In case of profit
Underwriting (Shares or Debentures in X Co.) A/c Dr.
To Profit and Loss Account.
In case of loss this entry will be reversed.

Notes
Did u know? This is an additional commission which is paid by the company to the
underwriter for providing the services of sub-underwriters. This is calculated on the
entire underwritten amount of shares or debentures at a fixed percentage. On account of
being the income of the underwriter, this is credited to the underwriting account. When
the maximum rate of underwriting commission is decided, this commission also includes
in underwriting commission as per Section 76 of Companies Act.
Illustration 11 (When Only One Account is Maintained by the Underwriter)
A underwrites an issue of 10,000 shares of 10 each in consideration of a commission of 4%

payable in cash, the public having subscribed for 9,500 shares only. A, under the terms of his
contract, has to take up the remaining 500 shares. His expenses amount to 100 when he closes
his accounts for the year no shares were sold. The market value of the shares was 6 per share.
A few days after closing his above account for the year, the above mentioned underwriter sold
200 shares at the rate of 6 per share. The market value of the remaining shares at the close of the
year was 5 per share. In the next year the underwriter sells all the remaining shares at the rate
of 7 per share. Show the underwriting account for all the three years in the books of A.
Solution:
In the books of A Underwriting Account
Date Particulars Shares Amount Date Particulars Shares Amoun

t
I Year To Bank (Exps.) A/c – 100 I Year By Bank – 4,000
(Underwriting
commission)
To Bank Account 500 5,000 By Balance c/d 500 1,100
(shares taken up)
500 5,100 500 5100
II To Balance b/d 500 1,100 II By Bank Account 200 1,200
Year Year (Sale of 200 @ 6
per share)
To Profit & Loss A/c – 100 By Balance c/d 300 –
(profit on sale of
share)
500 1,200 500 1,200
III To Balance b/d 300 – III By Bank Account 300 2,100
Year Year (sale of 300 share
@ 7 per share)
To profit and Loss – 2,100
A/c (Profit on sale of
300 Shares)
300 2,100 300 2,100
Illustration 12 (Underwriting with Sub-Underwriting)
A Ltd. issued 4,000 shares of 10 each and entered into an underwriting agreement with B who
agreed to underwrite the whole issue at a commission of 4% and entered into sub-underwriting
agreement with C for 25% of the issue at a commission of 3%. The public applied only for 75%
of the issue, hence the balance was taken up by the underwriters. B sold the shares held by him
@ 8 per share. Find out profit or loss on underwriting from B’s point of view.

Notes Solution:
In the books of A (Underwriter)
Underwriting Account
To Bank Account (25% of the issue 10,000 By Bank Account underwriting 1,600
taken up i.e., 1,000 shares) commission
To Bank Account (3% commission 300 By Bank Account (250 shares taken 2,500
given to C) up by C)
By Bank Account (Sale of 750 shares @ 6,000
8 per share)
By Loss 200
10,300 10,300
Working Note:
40,000  4
1. Underwriting Commission =  1600
100
2. Sub-underwriting agreement is for
40,000  25
 1,000 Shares.
100
3. Commission for C (Sub-underwriter)
10,000  3
 300
100
4. Shares taken by C (Sub-underwriter)
1,000  25
 250 Shares
100
Illustration 13
Jagdamba Limited issued 4,00,000 equity shares of 10 each. The issue was underwritten by
Hanuman for a commission of 5%. Mr. Hanuman arranges with Bhima for sub-und erwriting to
the extent of 30% of shares for a commission of 4%. The shares were to be paid for as:
3.0 on Application
3.5 on Allotment
3.5 on First & Final call.
The public applied for 3,20,000 shares. Both Mr. Hanuman and Mr. Bhima fulfilled their obligations.
After the call Mr. Hanuman sold 36,000 shares at 9. At the close of the period the market value
of the shares was 9.50. Expenses of Mr. Hanuman were 13,000. Prepare the underwriting
account in the books of Mr. Hanuman.

Solution: Notes
In the books of Mr. Hanuman
Amount Amount
Date Particulars Shares Date Particulars Shares
To Bank Account – 13,000 By Bank Account – 2,00,000

(Expenses) (5% Commission
on 40 lacs)
To Bank Account 80,000 2,40,000 By Bank Account 24,000 1,56,000
(Payment of (Amount received
application from Bhima on
money) 24,000 shares @
6.5 per shares.
To Bank Account – 2,80,000
(Payment of
allotment money)
To Bank Account – 48,000 By Bank Account 36,000 3,24,000
(Commission to (Sale of 36,000
Bhima @ 4% on shares @ 9 each)
12,00,000 i.e., 30%
of the issue)
To Bank Account – 1,96,000 By balance c/d @ 20,000 1,50,356
(Payment of final 7.5178 at cost
call on 56,000 price.
share)
To Profit and Loss – 53,356
A/c.
80,000 8,30,356 80,000 8,30,356
Working Note:
Calculation of cost of shares
Total amount paid on 80,000 shares @ 6.50 5,20,000
Expenses 13,000
Underwriting Commission 48,000
5, 81,000
Less: Amount Received on 24,000 shares
@ 6.5 per share from Bhima 1,56,000
Underwriting Commission 2,00,000 3,56,000
2,25,000
Add: Payment of final call on 56,000 shares @ 3.5 1,96,000
Cost of 56,000 shares 4,21,000
4,21,000
Cost per share =  7.5178
56,000
Cost of 20,000 shares = 20,000 × 7.5178 = 1,50,356

Notes Illustration 14 (When More Than one Account are Maintained by the Underwriter)
Shubham Limited was registered with an authorized capital of 25, 00,000 divided into 2, 50,000
shares of 10 each. It issued a prospectus inviting applications for 25, 00,000 shares. The whole
issue was fully underwritten by Naranya Company Limited. The rate of underwriting
commission was settled at 5% which was payable as to 80% in fully paid shares and 20% in cash.
In addition to underwriting these shares Naranya Co. Ltd. made a firm application in the
ordinary course for a further 50,000 shares.
The issue was not fully subscribed by the public and the underwriter was obliged to take up 25%
of the issue underwritten. His expenses were 3,000. The shares in Shubham Limited were
subsequently quoted at a discount of 20%.
Prepare Underwriting Commission Account, Underwriting Account, Shubham Ltd. Account

and Bank Account in the books of Naranya Co. Ltd.
Solution:
In the books of Naranya Co. Ltd.
Underwriting Commission Account
To Underwriting Account (Transfer) 1,25,000 By Shubham Limited (5% on 25,00,000) 1,25,000
1,25,000 1,25,000
To Shubham Ltd. (10,000 shares 1,00,000 By Underwriting Commission A/c 1,25,000
received in commission)
To Shubham Ltd. (25% shares taken 6,25,000 By Profit and Loss Account 1,23,000
under agreement 62,500 shares)
To Shubham Ltd. (firm underwriting 5,00,000 By Balance c/d (market price 8) 9,80,000
50,000 shares)
To Bank Account (Exps.) 3,000
12,28,000 12,28,000
Shubham Ltd.’s Account
To Underwriting Commission 1,25,000 By Underwriting Account. 1,00,000
To Bank Account 11,00,000 By Underwriting Account. 6,25,000
By Underwriting Account. 5,00,000
12,25,000 12,25,000
Bank Account
To Shubham Ltd. 25,000 By Underwriting Account. 3,000

By Shubham Ltd. 11,00,000
Working Note:
1. Total no. of shares required to take up under agreement (25% of the issue) 62,500
Firm underwriting 50,000

2. Calculation for cost price of shares. Notes
Amount paid for 62,500 shares 6,25,000
Amount paid for 50,000 shares 5,00,000
Amount paid for (commission) 10,000 shares Nil
Expenses 1,22,500 shares 3,000
11,28,000
Less: Underwriting Commission Received 1,25,000
Cost of 1,22,500 shares 10,03,000
10,03,000
Cost of one share = = ` 8.188
1, 22, 500
Market value is 10 – 2 = ` 8.
10.10.3 Miscellaneous Illustrations
Illustration 15
The Hopeful Ltd. issued 20,000 shares which were underwritten by three different persons as
follows:
A– 1,000 shares, B-6,000 shares, C-1,500 shares. In addition, there was firm underwriting by:
A –1,000 shares, B-500 shares, C-1500 shares.
The company received application for 15,200 shares including firm applications and number of
marked forms were as below:
A-3,000 shares, B-4,500 shares, C-1,700 shares. Show the allocation of liability of the underwriters
assuming that the underwriting agreement did not provide any relief for firm application.
Solution:
Statement Showing Underwriters’ Liability in Shares
Underwriters
Particulars Total
A B C
Gross Liability 10,000 6,000 4,000 20,000
7,000 1,500 2,300 10,800
Less: Unmarked Applications Including firm applications
(divided in the ratio of Gross Liability) 5:3:2 4,500 2,700 1,800 9,000
Less: Surplus of ‘B’ distributed between A & C in the ratio

of gross liability 5:2 2,500 –1,200 500 1,800
Net Liability 857 +1200 343 –
1,643 Nil 157 1,800
Total Liability (in Shares) 2,643 500 1,657 4,800

Notes Working Note:
Total application received by the company. 15,200 shares
Less : Marked Applications (3,000 + 4,500 + 1,700) 9,200 shares
Unmarked Application 6,000 shares
As no relief is given on firm applications to underwriters, firm application will be treated as

unmarked.
Total unmarked applications 6,000 + 3,000 = 9,000 including firm applications = 6,000 + 3,000 =
9000 shares
Illustration 16
A Ltd. has an authorized capital of 50,00,000 divided into 5,00,000 shares of 10 each. The
company issued 1,00,000 shares for subscription to the public at a premium of 5 each. The entire
issue was underwritten as follows:
A – 60,000 shares (Firm underwriting – 10,000 shares)
B – 30,000 shares (Firm underwriting – 4,000 shares)
C –10,000 shares (Firm underwriting – 2,000 shares)
On the total issue only 90,000 shares including.
Firm underwriting were subscribed for. Marked applications were as follows:
A – 32,000 shares
B – 20,000 shares
C – 8,000 shares
Calculate the liability of each underwriter.
Solution:
Statement Showing the Liability of Underwriter in Shares
Underwriters
Particulars Total
A B C
Gross Liability 60,000 30,000 10,000 1,00,000
28,000 10,000 2,000 40,000
Less: Unmarked applications divided in the
gross liability
ratio (6:3:1) 18,000 9,000 3000 30,000
10,000 1000 –1,000 10,000
Less: Surplus of C distributed between A & B in 667 333 +1,000 –
gross liability ratio (2:1)
Net liability 9,333 667 Nil 10,000
Add : Firm underwriting 10,000 4,000 2,000 16,000
Total liability 19,333 4,667 2,000 26,000
Unmarked Applications = 90,000 - (32,000 + 20,000 + 8000) = 30,000.

Notes
Did u know? RRBs are specialized rural financial institutions for catering to the credit
requirements of the rural sector.
!
Caution RBI has also directed its own training centres and NABARD training centres to
conduct training programmes for RRBs staff in keeping with the requirements of the day.
Self Assessment
Select the best alternative:

13 Underwriting agreement in made to–
(a) Collect the capital easily.
(b) Get company registered.
(c) Enter into contracts with others.
(d) Get accounts audited.
14. Underwriting commission may be paid in the issue price of shares @–
(a) 10%
(b) 5%
(c) (c)
(d) 3%
15. Maximum limit of brokerage on all type of public issues is–
(a) 0.5%
(b) 2%
(c) 1.5%
(d) 3%
16. On the debit side of the Underwriting Account, entry is made for–
(a) Price of total issue.
(b) Value of shares held.
(c) Sale of shares.
(d) Expenses in respect of underwriting.
17. Which items are not shown in the credit side of underwriting account–
(a) Value of unsold shares.
(b) Sales proceeds of the shares.
(c) Commission of the underwriter.
(d) Expenses of the underwriter.

Notes 10.11 Summary
 Underwriting involves the orderly process of security registration for the financial sourcing
of a public offering through the purchase of securities for resale to the public. The
underwriting may be a firm commitment to purchase the entire amount of the company’s
securities regardless of the ability to resell them. The underwriting of such a low-priced
initial public offering (IPO) and other less-well-known stock (e.g., over-the-counter stock)
may be done on a best-efforts basis where the underwriter acts only as an agent and
accepts no financial liabilities.
 A successful underwriting not only sells the securities, but does so at a fair price. In
addition, underwriters maintain a stable, liquid aftermarket for the trading of securities.
 Until the 1950s, underwriting was the only function performed by a number of specialty
houses. Thereafter, underwriters merged their talents with retail and institutional sales in
order to bolster their sagging bottom lines. Today there is little distinction between
wholesale underwriting, which serves institutional clients including broker-dealers, and
retail underwriting, which sells directly to individual investors.
 Most underwriting in the 1990s was handled by investment banks and brokerage firms. In
1996 the Federal Reserve Board lifted the revenue limit on securities underwriting by
commercial banks and their subsidiaries from 10 to 25 percent. Although the ruling
represented another falling barrier between investment banking and commercial banking,
it was expected to have little effect on the underwriting industry.
 Large underwriting firms assist the largest corporations with secondary offerings and
maintain a financial advisory role for the long term. As full-service houses, large firms
need to handle IPOs in excess of $15 million for the fees to be profitable.
 Medium-size underwriting firms generally serve regional interests and handle offerings
within the $5 to $15 million range. Although established companies, they lack the full
range of services and number of personnel dedicated to underwriting and distribution.
These firms are not likely to maintain a financial advisory capacity to their clients.
10.12 Keywords
Complete Underwriting Agreement: When the underwriter gives the guarantee to the company
that whole issue will be subscribed by the public, it is called complete underwriting.
Firm Underwriting: When an underwriter makes an agreement to purchase a certain number of
shares or debentures of the company, in addition to the shares or debentures he has to take
under the underwriting agreement, it is called firm underwriting.
Investment in Shares or Debentures: To calculate the profit or loss on underwriting of particular
issue, the underwriters maintain only one account – Underwriting Account. This account is also
called by the name of “Investment in Shares or Debentures.
Partial Underwriting Agreement: When only a part of issue of shares or debentures is
underwritten by the underwriters, it is called partial underwriting.
Underwriting of Shares: It means the contract in which underwriter agrees to take shares which
will not be subscribed by public.
Underwriting Commission: A commission is paid to underwriters which is called underwriting
commission.
Unmarked Applications: Those applications which bear the official stamp of an underwriter or
broker are called marked applications and those which do not bear the official stamp of an
underwriter, are called unmarked applications.

10.13 Review Questions Notes
1. What do you understand by underwriting commission?
2. What are the objectives of underwriting?
3. Give the different types of underwriting.
4. Explain marked and unmarked applications.
5. What do you understand by firm underwriting?
6. Explain the meaning of sub-underwriting.
7. What restrictions are imposed by the Companies Act, on the payment of underwriting
commission?
8. What do you mean by underwriting of shares and debentures? What are the various
provisions in the Companies Act regarding underwriting commission? Mention accounting
problems regarding underwriting.
9. What do you understand by underwriting, sub-underwriting and firm underwriting?

What are the duties of the directors with regard to underwriting contracts?
10. What are the provisions regarding payment of underwriting commission on issue of
share and debentures? Explain.
11. Write short notes on–
(i) Underwriting account
(ii) Sub-underwriting
(iii) Overriding commission
(iv) Marked and Unmarked Application
(v) Firm underwriting.
Practical Questions:
1. Meerut Ltd. was formed with a capital of ` 1,00,000 divided into 10,000 shares of ` 10 each.
All these shares were offered for subscription by prospectus to the public. The shares were
underwritten as follows:
A B C
40% 30% 30%
Marked applications were received in favour of A for 1,600 shares, B for 2,800 shares C for
1,600 shares. Applications for 1,000 shares were unmarked.
Prepare a statement showing the net liability of each underwriter.
Ans: A-1,943 shares, B-nil, C-1,057 shares.
2. Chhotey Co. Limited issued 25,000 equity shares of ` 100 each at par and 1,250 debentures
of ` 1,000 each at ` 950. The whole of the issue has been underwritten by Kashi & Co. for a
consideration of 4% on shares and 2% on debentures (nominal value). The whole of the
shares were applied for but applications for 1,000 debentures were received. All the
applications were accepted. Give journal entries to record the above transactions and
prepare the balance sheet at this stage assuming that all amounts due have been received.
Ans: Total of Balance Sheet ` 37,50,000.

Notes 3. Ranu Limited issued 75,000 equity shares of 10 each at a premium of 10 per share and
3,000 debentures of 100 each at 95. 80% of the issue is underwritten by Shalini Singh and
Co. at a maximum rate of commission allowed by law. Applications were received for
60,000 equity shares and 2,250 debentures, which were accepted and the payment for these
was received in full. Journalize the above transactions and show the entries in the balance
sheet, assuming that the amounts due from the underwriter have been received.
Ans: Total of Balance Sheet 10,77,000.
4. Kusum Ltd. has an authorized capital of 25,00,000 divided into 1,00,000 equity shares of
25 each. The company issued for subscription, 25,000 shares at a premium of 10 each.
The entire issue was underwritten as follows:
A – 15,000 shares (Firm underwriting – 2,500 shares)
B – 7,500 shares (Firm underwriting – 1,000 shares)
C – 2,500 shares (Firm underwriting – 500 shares)
Out of the total issue 22,500 shares including firm underwriting were subscribed.
The following were the marked forms:
A – 8,000 shares
B – 5,000 shares
C – 2,000 shares.
Calculate the liability of each underwriter, assuming that marked forms include firm
underwriting also.
Ans: A-4,833; B-1,176; C-500 shares.
5. J. Ltd. issued 20,000 shares which were underwritten as follows:
A-12,000 Shares, B-5,000 Shares, and C-3,000 Shares. The underwriters made applications
for firm underwriting as under:
A-1,600 Shares, B-600 Shares, and C-2,000 Shares.
The total subscriptions excluding firm underwriting but including marked applications
were for 10,000 shares.
The marked applications were as under:
A-2,000 Shares, B-4,000 Shares, and C-1,000 Shares.
You are required to show the allocation of the liability of underwriters.
Ans: Liability of underwriters in shares A-7,400, B-600 and C-2,000.
6. Shilpa Limited issued 1,20,000 Equity Shares of 10 each. The whole issue was underwritten
by Yogita & Company at an agreed commission of 5% payable as to 75% in fully paid
shares and 25% in cash. In addition to underwriting of these shares, Yogita & Co. also
made a firm application for 30,000 equity shares. 75% of the issue was subscribed by the
public and Yogita & Co. was obliged to take 25% of the shares underwritten. The shares of
Shilpa Ltd., were subsequently quoted at a discount of %. Prepare the necessary accounts
in the books of Yogita & Co.
Ans: Loss 20,625.

Answers: Self Assessment Notes
1. 5% 2. Firm underwriting
3. 1.5% 4. Underwriting Account
5. Debit 6. True
7. False 8. True
9. False 10. True
11. True 12. False
13. (a) 14. (b)
15. (c) 16. (d)

17. (d)

Arkebauer, James, Going Public: Everything You Need to Know to Take Your Company
Public or Invest in an IPO or DPO. Chicago: Dearborn Trade, 1998.
Barker, William W, SEC Registration of Public Offerings under the Securities Act of

Goldblatt, Jennifer, “Market Ho-Hum about New Revenue Limit on Securities

Johnson, Hazel J, The Banker’s Guide to Investment Banking: Securities and

Book Group, 1996.
Lipman, Frederick D, Going Public: Everything You Need to Know to Successfully

Publishing, 1998.
Shillinglaw, Gordon, Accounting: A Management Approach. 9th ed. New York:

Online links http://www.svtuition.org/2010/10/underwriting-of-shares-and-

debentures.html
http://www.enotes.com/underwriting-securities-reference/underwriting-
securities
http://s3.amazonaws.com/caclubindia/cdn/forum/files/
146271_945934_underwriting.pdf

Notes

Case Study Share Capital Purchase Requires Quick Turn-Around
Lee & Priestley has clients based all over the UK. With the use of e-mail and the operation
of efficient client service levels in relation to returning telephone calls Lee & Priestley can
provide a first class service wherever a client’s location.
A recent transaction involved an entrepeneur from Essex who was looking to purchase the
share capital of a company in Suffolk. The client had used local firms in the past but was
recommended to Lee & Priestley by his accountant.
The transaction timetable required a quick turn around of the documentation and regular
contact with the client. The volume of paperwork involved was typical for a standard
share sale.
Notwithstanding the distances involved the transaction proceeded to completion on

schedule and without any location based difficulties.
The client’s comments on his post-deal feedback form were “I was very pleased with all of
the services provided by the team from Lee & Priestley. Over the years I have dealt with
several solicitors and am finding it increasingly difficult to find effective legal firms,
particularly in the South East, where at first point of contact one is told of ever increasing
hourly rates only to experience an ever slower service and lack of commitment to advice
given”
“The work that has been carried out has been executed in an effective and speedy manner.
I have always received prompt and informative replies to my communications, some of
which have been within minutes. Certainly as a client my expectations have been far
exceeded when compared with the service, quality and price of other firms that I have
dealt with.
Source: http://www.leepriestley.com/Case-Study/items/share-capital-purchase-requires-quick-turn-around.html

Manpreet Kaur, Lovely Professional University Unit 11: Profit and Loss Prior to Incorporation
Unit 11: Profit and Loss Prior to Incorporation Notes
CONTENTS
Objectives
Introduction
11.1 Meaning of profit or loss prior to incorporation (pre- incorporation profit or loss)
11.2 Nature & Use of Profit or Loss
11.3 Method of Ascertainment of Profit or Loss Prior to Incorporation
11.4 Statutory Report
11.5 Summary
11.6 Keywords
Objectives
 Explain the meaning of profit and loss prior to incorporation
 Understand the nature and use of profit and loss account
 Learn method of Ascertainment of Profit or Loss Prior to Incorporation
 Describe statutory Report
Introduction
When a running business is taken over by the promoters of a company, from a date before the
company which is to manage and own is registered, the amount of profit or loss of such a
business for the period prior to the date the company came into existence is referred to as pre
incorporation profits or losses. Such profits or losses, though belonging to the company or
payable by it, are of capital nature; it is necessary to disclose them separately from trading
profits or losses.
The general practices in this concern are as follows:
1. If there is a loss.
(a) It is either written off by debit to the Profit and Loss Account or to a special account
described as Loss Prior to Incorporation and show as an asset in the Balance Sheet.
(b) In the alternative, it is debited to the Goodwill Account.
2. On the other hand, if a profit has been earned by business prior to the same being taken
over and the same is not fully absorbed by any interest payable for the period, it is
credited to Capital Reserve Account or to the Goodwill Account, if any goodwill has been
adjusted as an asset. The profit will not be available for distribution as a dividend among
the members of the company.

Notes 11.1 Meaning of Profit or Loss Prior to Incorporation

(Pre-incorporation Profit or Loss)
Generally, it is found that a newly-formed company may purchase a running business from a
certain date which is prior to incorporation.
Example 1: A company incorporated or registered on 1 st May, 2011 may acquire the

business of a partnership firm from 31 st December, 2010.
Usually it is found that this prior date coincides with the date of the Vendor’s previous Balance
Sheet. If this date does not coincide with the date of Vendor’s previous Balance Sheet, stock
taking has to be completed and balances of various assets and liabilities has to be extracted. To
avoid this trouble, the business is acquired, from the date of the previous Balance Sheet. As a
running business is acquired, profit or loss earned by the business from the date of purchase to
the date of incorporation is called Profit or Loss Prior to Incorporation. And profit or loss made
by the business from the date of incorporation to the date of closing of accounts at the end of first
financial year is called Profit or Loss Subsequent to Incorporation.
11.2 Nature & Use of Profit or Loss
As per the Companies Act, a company cannot earn profit before its incorporation. Therefore,
profits earned by the business from the date of acquisition to the date of its corporation cannot
be treated as profit earned by the company. But due to these profits the net assets acquired by the
company on its formation have been increased. Therefore, these profits cannot be treated as
revenue profit but should be treated as capital profits and should be placed in a special account
i.e., capital reserve. These profits will not be available for distribution as dividends to
shareholders. These profits can be utilized in writing off capital losses as goodwill, preliminary
expenses, discount on issue of shares and debentures, etc. In the absence of any writing off, these
profits are transferred to Capital Reserve and are shown in the Liability side of the Balance Sheet
under the heading ‘Reserve and Surplus’. It is therefore, necessary to calculate the amount of
such profits. If there is a loss during this period, it will be in the nature of a capital loss. This loss
should be added to the amount of goodwill (if given). If the amount of goodwill is not given
with this amount, goodwill account will be opened. Alternatively, this loss can be transferred to
a suspense account and will be shown in the Assets side of Balance Sheet under the heading
‘Miscellaneous Expenditure’, until it is completely written off against profits.
Did u know? Usually it is found that this prior date coincides with the date of the Vendor’s
previous Balance Sheet. If this date does not coincide with the date of Vendor’s previous
Balance Sheet, stock taking has to be completed and balances of various assets and liabilities
has to be extracted. To avoid this trouble, the business is acquired, from the date of the
previous Balance Sheet.
In the absence of any contrary information, profit prior to incorporation in both private and
public companies means the profit prior to incorporation and not to commencement of business.
Notes As per the Companies Act, a company cannot earn profit before its incorporation.
Therefore, profits earned by the business from the date of acquisition to the date of its
corporation cannot be treated as profit earned by the company.

Unit 11: Profit and Loss Prior to Incorporation
11.3 Method of Ascertainment of Profit or Loss Prior to Incorporation Notes
There are two methods-
1. By preparation of separate profit and loss account for pre-incorporation and post-
incorporation periods: When a running business is acquired, its separate profit and loss
account can be prepared up to the date of incorporation. It will give the accurate amount
of profit for pre-incorporation period and post-incorporation period. But this method is
not easy, because to prepare separate profit and loss account, stocking and balancing of
books is required. It would create a number of problems in the normal functioning of
business and would increase cost unnecessarily. Hence this method for the determination
of pre and post-incorporation profits or losses is rarely used by a company.
2. By apportioning the whole profits of the year into pre-incorporation period and post-
incorporation period: Under this method, first of all trading account for the whole
accounting year is prepared to find out the gross profit. Then, the following two ratios are
calculated:
(i) Time Ratio: This ratio is calculated on the books of time falling between the last date
of the Balance Sheet and the date of incorporation or registration and the date of
current final account.
Example 2: If a company acquires a business on 1st April, 2010 and is incorporated on 1 st

June, 2010 and final accounts are prepared on 31 st March 2010, time ratio will be 2:10 or 1:5.
(ii) Sales Ratio or Turnover Ratio: On the basis of pre-incorporation period sales and post-
incorporation period sales this ratio is calculated.
Gross profit calculated by the preparation of profit and loss account is divided into two parts (for
pre-incorporation period and post-incorporation period) on the basis of time ratio. And then a
statement is prepared to find out the net profit. In this statement, all the items appearing in the
debts side (expenses) and credit side (income) are shown. These items are apportioned on the
basis of their characteristics. These can be as follows:
(i) Some expenses are distributed on the basis of Time Ratio: All those expenses which have
fixed or standing nature, should be distributed on the basis of time ratio in pre-acquisition
period and post-acquisition period e.g., salary of staff or workers, rent, depreciation, etc.
(ii) Some expenses are distributed on the basis of Sales/Turnover Ratio: All those expenses
which are related to sales, are distributed on the basis of sales ratio e.g., commission on
sales, discount allowed to customers, selling expenses, etc.
(iii) Some expenses are exclusively for prior to incorporation period: Some expense are
exclusively incurred in the pre-incorporation period, and are therefore these are not
apportioned but charged completely in the pre-incorporation period e.g., salaries payable
to vendors and interest payable on purchase price for the pre-incorporation period.
Did u know? Gross profit calculated by the preparation of profit and loss account is divided
into two parts (for pre-incorporation period and post-incorporation period) on the basis
of time ratio.
(iv) Some expenses are exclusively for post-incorporation period: Some expenses are incurred
exclusively in the post acquisition period, therefore these are not apportioned but charged
completely in the post-acquisition period e.g., directors’ fees, preliminary expenses, interest
on debentures, etc.

Notes Basis of Apportionment of Expenses at a Glance
Name of Expenditure Basis of Apportionment

1. Gross Profit or Gross Loss Turnover/Sales Basis
Or
If the sales of the respective periods are not
given in the question, on the basis of direct
expenses relation to sales in the respective
period.
Or
If both the above information are not available
on the basis of time.
2. Fixed Nature Expense e.g., Salaries, Rent, On the basis of time.
General Expenses, Rates, Depreciation,
Postage, Telephone, Printing and Stationery,
Electricity, Audit Fees, Trade Expenses,
Insurance Expenses, Bank Expenses, Interest,
Repairs, Administrative Expenses etc.
3. Variable Expenses e.g., Commission on Sales, Turnover Basis.
Carriage Outwards, Discount, Advertisements,
Salesman’s salary, Bad Debts, Packing, Sales
Expenses.
4. Expenses exclusively for pre-incorporation Not apportioned but are charged to pre-
period: e.g., interest payable on purchase price incorporation period.
to vendor for pre-incorporation period,
vendor’s salary, loss or gain on the sale of
investment before incorporation, etc.
5. Expenses exclusively for post-acquisition Not apportioned but are charged to post-
period e.g., Preliminary Expenses, Directors’ incorporation period.
Fees, Formation, Expenses, Discount on Issue
of Shares and Debentures, Underwriting
Commission, Salary to Managing Director,
Interest on debentures, etc.
Illustration 1 (Division of Expenses on Both Time and Turnover Basis)
Sangita Ltd. was incorporated on 1 st March, 2010 and received its Certificate of Commencement
of Business on 1st April, 2010. The company bought the business of M/s Sohan & Sons with effect
from 1st November, 2009. From the following figures relating to the year ending October 31,
2010, find out the profit available for dividends:
(a) Sales for the year were 9,00,000 out of which sales upto 1 st March were 3,75,000.
(b) Gross Profit for the year was 2,70,000.
(c) The Profit and Loss Account for the year ending October 31, 2010.
Solution:
To Rent and Rates 12,000 By Gross Profit 2,70,000
To Insurance 3,000
To Electricity Charges 2,400
To Salaries 36,000
To Directors’ Fees 7,200
To Interest on Deb. 7,500
To Audit Fees 2,250
To Discount on Sale 5,400
To Depreciation 36,000 Contd...
To Advertisement 7,200
To Stationery & Printing 27,000
To Commission on Sales 5,400
To Bad Debt ( 750 relating to pre-incorporation) 2,250
To Interest to vendor (upto 1st May, 2010). 4,500
To Net Profit 1,11,900
2,70,000 2,70,000
To Rent and Rates 12,000 By Gross Profit 2,70,000
To Insurance 3,000
To Electricity Charges 2,400
To Salaries 36,000
To Directors’ Fees 7,200 Unit 11: Profit and Loss Prior to Incorporation
To Interest on Deb. 7,500
To Audit Fees 2,250
To Discount on Sale 5,400
To Depreciation 36,000 Notes
To Stationery & Printing 27,000
To Commission on Sales 5,400
To Bad Debt ( 750 relating to pre-incorporation) 2,250
To Interest to vendor (upto 1st May, 2010). 4,500
2,70,000 2,70,000
Solution:
Working Notes:
1. Time Ratio:
1st November 2009 to 1st March, 2010 = 4 months
1st March, 2010 to 31 st October, 2010 = 8 months
Time Ratio- = 4:8 or 1:2
2. Turnover Ratio:
Turnover for prior period is 3,75,000
Turnover for post period is 9,00,000 – 3,75,000
= 5,25,000
Turnover Ratio is 3,75,000:5,25,000 or 5:7

Profit and Loss Account for the year ending 31st October, 2010
Pre- Pre- Post-

Basis of Post-
incorpo- incorpor incorpo
Particulars Allocatio incorporati Particulars
ration ation ration
n on period
period period period
To Rent & Rates Time 4,000 8,000 By Gross Profit 1,12,500 1,57,500
To Insurance Time 1,000 2,000 (Turnover ratio)
To Electricity Time 800 1,600
Charges
To Salaries Time 12,000 24,000
To Directors’ fees — — 7,200
To Interest on — 7,500
Debentures
To Audit fees Time 750 1,500
To Discount Turnover 2,250 3,150
To Depreciation Time 12,000 24,000
To Advertisement Turnover 3,000 4,200
To Stationery and Time 9,000 18,000
Printing
To Commission on Turnover 2,250 3,150
Sales
To Bad Debts Turnover 750 1,500
To Interest to 4:2 3,000 1,500
Vendors
To Net Profit 61,700 50,200
1,12,500 1,57,500 1,12,500 1,57,500

Notes Illustration 2 (Division of Profit on Monthly Basis)
A Limited that acquires a business as on 1st April, 2010 is being incorporated on 1 st August, 2010.
The first account were drawn upto 31 st December, 2010. The gross profit is 60,000. The general
expenses are 9,000, Directors fees 30,000 per annum and Preliminary expenses 2,500. Rent to
30th September, 2010 was 1,800 per annum after which it was increased to 3,600 per annum.
The salary of the manager who upon incorporation was made a Director, was 4,800 per annum
(since incorporation included in Directors’ fees above).
Prepare a Profit and Loss Account in the books of A Limited showing the profit for the period
prior to and after incorporation. The total sales were 9,30,000 the monthly average of which for
the four months of April to July, 2010 being one-fourth of that of the remaining period. The
company earned a uniform profit.
(Adapted from B. Com. Rohilkhand Uni. 1995)
Solution:
Profit and Loss account for the year 2010
Particulars Pre- Post- Particulars Pre- Post-

incorporation incorporati incorporation incorporation
period on period period period
To General Exps. 4,000 5,000 By Gross Profit
(Time Ratio) (Turnover Ratio) 10,000 50,000
To Rent 600 1,200
To Manager’s 1,600 —
Salary
To Directors’ fees — 12,500
To Preliminary — 2,500
Exps.
To Net Profit 3,800 28,800
10,000 50,000 10,000 50,000
Working Note:
1. Time Ratio:
1st April, 2010 to 1 st August, 2010 = 4 months
1st August 2010 to 31 st December 2010 = 5 months.
Therefore, Time Ratio = 4:5
2. Turnover Ratio:
Assume the monthly average sales for first four months is 1
 Monthly average sales for the remaining five months will be 4.
Total sales for first four months = 1×4= 4
(Pre-acquisition period)
Total sales for next five months 4 x 5 = 20
(Post-acquisition period)
 Turnover Ratio = 4:20 or
1:5

3. Calculation of Rent Notes

For first four months @ 150 p.m. or 1800 p.a. (April, May, June & July 2010)
Pre-acquisition period Rent = 600
For next two months @ 150 p.m. or 1800 p.a.
Post-acquisition Period] August & September, 2010 = 300
For next three months @ 300 p.m. or 3600 p.a.
October, November & December, 2010 = 900
= 300 + 900 = 1200
4. Manager’s salary @ 4,800 p.a. for four months
(pre-incorporation period)
5. Directors’ fees @ 30,000 p.a. for five months.
Illustration 3 (Apportionment of Profit when unit cost of sales is given)
A Limited Company was incorporated on 1 st January, 2010 with an authorized capital of 5,00,00
equity shares of 10 each, to take over the running business of a partnership firm as from 1 st
October 2009.
Solution:
The following is the summarised Profit and Loss Account for the year ended 30 th September,
2010 :
Sales 1.10.2009 to 31.12.2009 6,000
1.1.2010 to 30.9.2010 19,000 25,000
Less :
Cost of Sales 16,000
Administrative Expenses 1,768
Selling Commission 875
Goodwill written off 200
Interest paid to vendor (loan repaid on 1.2.2010) 373
Distribution Expenses (60% variable) 1,250
Preliminary Expenses written off 330
Debentures Interest 320
Depreciation 444
Directors’ fees 100 21,660
3,340
The company deals in one type of the product.
The unit cost of sales was reduced by 10% in the post-incorporation period –
Apportion the net profit between pre-incorporation and post–incorporation period sowing the
basis of apportionment.

Notes Working Note:
1. Time Ratio:
Pre-incorporation period (from 1.10.2009 to 31.12.2009) = 3 months.
Post-acquisition period (1.1.2010 to 30.9.2010) = 9 months
Time ratio = 3 : 9 or 1:3
2. Sales Ratio 6,000 : 19,000 or
6 : 19
3. Assume ratio of cost of sales to sales in pre-acquisition period is x.
Ratio of cost of sales to sales in post-acquisition period will be
10x 9x
x 
100 10
According to question – The total cost of sales in the two periods will be:
9x
6,000x : 19,000 
10
6,000x : 17,100x
Thus, Cost of Sales Ratio will be 60 : 171

Statement showing Pre-incorporation and Post-incorporation
Profit for the year 2010
Pre-incorporation Post-incorporation
Particulars Basis of allocation
Sales
Less: Cost of sales Actual 6,000 19,000
(60:171) 4,156 11,844
1,844 7,156
Less: Administration Exps Time 442 1,326
Selling Commission Turnover 210 665
Goodwill written off — — 200
Interest to vendors (Time) 3:1 280 93
Distribution Expenses:
40% Fixed Time 125 375
60% Variable Turnover 180 570
Preliminary Expenses — — 330
Debenture Interest — — 320
Depreciation Time 111 333
Directors’ Fees — — 100
Net Profit 496 2,844
Did u know? RRBs are specialized rural financial institutions for catering to the credit
requirements of the rural sector.

Notes
!
Caution RBI has also directed its own training centres and NABARD training centres to
conduct training programmes for RRBs staff in keeping with the requirements of the day.
Self Assessment
Fill in the blanks:
1. Nature of pre-incorporation profits is ……………….
2. Post-incorporation profits are ready for the distribution of……………….
3. Director’s fees relates to …………… incorporation period.
4. Underwriting commission relates to …………… period.
5. Depreciation is allocated on the basis of …………….
6. Sales commission is allocated on the basis of ……………
7. Pre-incorporation profit is transferred to ………… account.
Illustration 4 (Interest on Purchase Price and Profit & Loss Account for More Than 12 Months)
The partners of Maitri Agencies decided to convert the partnership into a Private Limited
Company called M.A. (P) Ltd. with effect from 1st January, 2010. The consideration was agreed at
1,17,000 based on the firm’s balance sheet as on 31 st December, 2009. However, due to some
procedural difficulties, the company could be incorporated only on 1 st April, 2010. Meanwhile,
the business was continued on behalf of the company and the consideration was settled on that
day with interest at 12% per annum. The same books of accounts were continued by the company,
which closed its accounts for the first time on 31 st March, 2011 and prepared the following
summarized Profit and Loss Account:
Particulars
Sales 2,34,00,000
Cost of goods sold 1,63,80,000
Salaries 11,70,000
Depreciation 1,80,000
Advertisement 7,02,000
Discount 11,70,000
Managing Directors’ remuneration 90,000
Miscellaneous expenses 1,20,000
Office-cum-Show-Room rent 7,20,000
Interest 9,51,000
2,14,83,000
Profit 19,17,000
The company’s only borrowing was a loan of 50,00,000 at 12% p.a. to pay the purchase
consideration due to the firm and for working capital requirements.
The company was able to double the average monthly sales of the firm, from 1 st April, 2010 but
the salaries trebled from that date. It had to occupy additional space from 1 st July, 2010 for which
rent was 30,000 per month.

Notes Prepare a Profit and Loss Account in columnar from apportioning costs and revenue between
pre-incorporation and post-incorporation periods. Also, suggest how the pre-incorporation
profits are to be dealt with.
Solution:
Profit and Loss Account for 15 months ended
31 st March, 2011
Pre- Post- Pre- Post-

Basis of
Particulars incorpo- incorpo- Particulars incorpo- incorpo-
Allocation
ration ration ration ration
To Cost of Sales Turnover 18,20,000 1,45,60,000 By sales 26,00,000 2,08,00,000
To Salaries (1:2) Time 90,000 10,80,000 (Turnover) 19,000 —
To Depreciation Time 36,000 1,44,000 By Net Loss
To Advertisement Turnover 78,000 6,24,000
To Discount Turnover 1,30,000 10,40,000
To M.D. Remuneration. — — 90,000
To Misce. Office Expenses Time 24,000 96,000
To Rent: Old Premises Time 90,000 3,60,000
Add. Premises — — 2,70,000
To Interest Time 3,51,000 6,00,000
To Net Profit — — 19,36,000
26,19,000 2,08,00,000 26,19,000 2,08,00,000
Working Note:
1. Time Ratio –
Pre-incorporation period 1 st January 2010 to 1 st April 2010 = 3 months.
Post-incorporation period 1 st April 2010 to 31 st March, 2011 = 12 months.
Thus Time Ratio = 3:12 or 1:4.
2. Assume monthly sale was of 1 up to 1st April, 2010, then monthly sales would be 2 after
1st April 2010.
Pre-incorporation sales = 1 x 3 = 3
Post-incorporation sales = 2 x 12 = 24.
Turnover Ratio = 3 : 24 or 1 : 8
Illustration 5 (Division of Profit and Preparation of Balance Sheet)
Ashoka Company Limited was incorporated on 1 st April, 2010 to take over as from 1 st January,
2010, the existing business of Bijoy Brothers. Under the takeover agreement, all profits were
made from 1st January, 2010 are belong to the company. The purchase consideration was
7,00,000. The vendors received half of it in cash on 1 st July, 2000 together with interest at 10%
per annum. For other half of the purchase consideration they were allotted 3,500 fully paid up
shares of 100 each in the company. The following balances appeared in the company’s ledger
as at 31st December, 2010:

Liabilities Assets Notes

Sales capital 4,500 Shares of 100 each fully 4,50,000 Preliminary Expenses (These are to 8,000
paid (including vendor’s shares) be fully written off)
Bank Overdraft 1,65,000 Salaries and Wages 48,000
Sundry Creditors 65,000 Rent Received 13,000
Fixed Deposit Received 35,000 Rent and Taxes 7,000
Freehold Land at Cost 50,000 Repairs to Buildings 3,000
Building at Cost 1,30,000 Miscellaneous Expenditure 22,000
Furniture & Fixtures at Cost 35,000 Directors’ fees 2,400
Transport Vehicles at Cost 35,000 Interest of Vendors 17,500
Stock-in-Trade on 1st January 4,20,000 Purchases 7,70,000
Book Debits 95,000 Sales 9,10,000
Cash in hand 12,000 Goodwill 3,100
The Stock-in-Trade as on 31 st December, 2010 amounted to 4,80,000.
Bad debts amounting to 1,000 out of which 500 are related to book debts taken over by the
company, have to be written off and a provision of 5,000 to be made for doubtful debtors as on
31st December, 2010.
Depreciation has to be written off: Building at 5%, Furniture and Fixtures at 10% and Transport
Vehicles at 20%.
You are required to prepare (a) a Profit and Loss Account for the year ending 31 st December, 2010
and to compute the profit prior to incorporation. For the purpose of determining the profit prior
to incorporation you should assume the turnover to be spread evenly over the year and (b)
Balance Sheet as on 31 st December, 2010.
Solution:
Trading and Profit & Loss Account
of Ashoka Limited for the year ending 31st Dec. 2010
To Opening Stock 4,20,000 By Sales 9,10,000
To Purchases 7,70,000 By Closing Stock 4,80,000
To Gross Profit 2,00,000
13,90,000 13,90,000
Post-
Pre- Post- Pre-incorpo-
incorpo-
Particulars incorporation incorporation Particulars ration
ration
period period period
period
To Salaries (1:3) 12,000 36,000 By Gross 50,000 1,50,000
Profit b/d
(1:3)
To Miscellaneous
Exps. (1:3) 5,500 16,500 By Rent 3,250 9,750
Received
(1:3)
To Rates & Taxes (1:3) 1,750 5,250
To Repairs to 750 2,250
Buildings
Contd...
To Preliminary Exps. — 8,000
To Bad Debts 500 500
To Provision for
Doubtful LOVELY PROFESSIONAL UNIVERSITY 265
Debts — 5,000
To Interest to Vendors 8,750 8,750
To Depreciation:
Profit b/d
(1:3)
To Miscellaneous
Exps. (1:3) 5,500 16,500 By Rent 3,250 9,750
Received
Accounting for Companies-I (1:3)
To Rates & Taxes (1:3) 1,750 5,250
To Repairs to 750 2,250
Buildings
Notes To Preliminary Exps. — 8,000
To Bad Debts 500 500
To Provision for
Doubtful
Debts — 5,000
To Interest to Vendors 8,750 8,750
To Depreciation:
Building 6,500 1,500
Furniture 7,000 15,000
Vehicles 3,750 11,250
To Capital Reserve 20,250
To Net Profit 63,850
53,250 1,59,750 53,250 1,59,750
Balance Sheet of Ashoka Limited as on 31st December, 2010
Liabilities Assets
Authorized, Subscribed Called up and Paid 4,50,000 Goodwill 3,100
up 4,500 shares of 100 each fully paid
(issued to vendor for Purchase
Consideration of business)
Freehold land 50,000
Reserve & Surplus: Building 1,30,000
Capital Reserve (Pre-incorporation profit) 20,250 -Depreciation 6,500 1,23,500
Profit and Loss A/c. (Post-acquisition profit) 63,850 Furniture & Fixture 15,000
Secured Loans Nil Less Dep. 1,500 13,500
Unsecured Loans: Transport vehicles 35,000
Bank overdraft 1,65,000 – Dep. 7,000 28,000
Fixed Deposit 35,000 Investments Nil
Current Liabilities: Current Assets:
Sundry Creditors 65,000 Stock 4,80,000
Debtors 94,000
-D/D Provision 5,000 89,000
Cash in hand 12,000
Miscellaneous Exps. Nil
7,99,100 7,99,100
Working Note:
1. Time Ratio 3:9 or 1:3
2. Turnover Ratio will also be the same because sales are spread evenly over the year i.e., 1:3.
Self Assessment
8. Loss prior to incorporation must be transferred to goodwill account.
9. Profit prior to incorporation must be available for dividend.

10. Gross profit must be apportioned between prior to incorporation period and post- Notes
incorporation period in the Ratio of Turnover.
11. Directors’ fees are apportioned on time basis to pre-incorporation and post-incorporation
period.
12. Statutory meeting of a public limited company is held only once in the life of the company.
13. Statutory report must be signed and certified by at least two directors of the company.
Illustration 6
Dehra Udyog Ltd. incorporated on 1 st May, 2010 received the Certificate to Commence the
Business on 31 st May 2010. It had acquired a running business from M/s. Vohra & Co. with effect
from 1st January, 2010. The purchase consideration was 2,500,000 of which 500,000 was to be
paid in cash and 2,000,000 in form of fully paid shares. The company also issued shares for
2,000,000 for cash. Machinery costing 12,50,000 was then installed. The assets acquired from
the vendor were:
Machinery 15,00,000, Stock 300,000, Patents 2,00,000.
During the year 2010 the total sale was 90,00,000. The sale per months in the first half year was
one half of what was in the later half year. The net profit of the company after charging the
following expenses was 5,00,000.
Depreciation 2,70,000. Audit fees 37,500 Directors’ fees 1,25,000, Preliminary Exps. 30,000,
Office Expenses 1,95,000, Selling Expenses 1,80,000. Interest to vendor upto 31 st May 2010
12,500. Ascertain the pre-incorporation and post-incorporation amount of profits and prepare
the Balance Sheet as on 31 st December, 2010. Closing stock was valued at 3,50,000
Solution:
1. Calculation of Goodwill
Machinery 15,00,000
Stock 3,00,000
Patents 2,00,000
20,00,000
Less: Purchase Price 25,00,000
Goodwill 5,00,000
2. Calculation of Gross Profit:
Net Profit (given) 5,00,000
Add: Expenses –
Depreciation 2,70,000
Audit Fees 37,500
Directors’ Fees 1,25,000
Preliminary Expenses. 30,000
Office Expenses 1,95,000
Selling Expenses 1,80,000

Notes Interest to Vendor 12,500 8,50,000
Gross Profit 13,50,000
3. Time Ratio:
Pre-incorporation Period (1 st Jan., 2010 to 30 th April 2010) = 4 months
Post-incorporation Period (1st May to 31st December 2010) = 8 months
Time Ratio 4:8 or 1:2.
4. Sales Ratio: Assume monthly sales in first half is Re 1 hence sales in the second half will be
2. Sales will be
Jan. Feb. March April May June July Aug. Sep. Oct. Nov. Dec.
1 1 1 1 1 1 2 2 2 2 2 2
Sales in pre-incorporation period 4
sales in post-incorporation period 14.
Sales Ratio 4:14 or 2:7
Statement for pre-incorporation profit and post-incorporation profit.
Particulars Pre-incorporation Post-incorporation

Gross Profit (2:7) 3,00,000 10,50,000
Less: Expenses–
Depreciation 1:2 90,000 1,80,000
Audit fees — 37,500
Director’s fees –– 1,25,000
Preliminary Exps. 30,000
Office Exps. (1:2) 65,000 1,30,000
Selling Exps. (2:7) 40,000 1,40,000
Interest to vendors (4:1) 10,000 2,500
2,05,000 6,45,000
Net Profit 95,000 4,05,000
Balance Sheet as on 31st December, 2010
Liabilities Assets
Share Capital Subscribed & Paid 40,00,000 Fixed Assets:
up Capital
Reserve & Surplus: Goodwill
( 5,00,000 – 95,000) 4,05,000
Profit and Loss A/c. 4,05,000 Machinery 27,50,000
– Deb. 2,70,000 24,80,000
Patents 2,00,000
Current Assets:
Stock 3,50,000
Cash 9,70,000
44,05,000 44,05,000

Cash Account Notes
To Share Capital 20,00,000 By Vendor 5,00,000
To Sales 90,00,000 By Machinery 12,50,000
By Purchases (calculated as below) 77,00,000
To Expenses (except expenses) 5,80,000
To Balance c/d. 9,70,000
1,10,00,000 1,10,00,000
Trading Account (to find out purchases)
To Purchases (Balancing figure) 77,00,000 By Closing Stock 3,50,000
To Gross Profit 13,50,000
93,50,000 93,50,000
Notes It is assumed that all transactions are cash transaction therefore there is no debtor
and creditor.
Illustration 7
On 1st June, 2011 Sushil & Co. sold their business to Sushil Company Limited as on 1 st April, 2011
for a total consideration of 5,00,000: for Goodwill 1,50,000, Building 1,50,000, Machinery
75,000 and Stock 1,25,000
Sushil Company Limited was incorporated on 1st June, 2011 and the purchase consideration was
met by the issue of shares. The business was carried on by the vendors on the behalf of the
company from 1st April and the same set of account books was maintained till 30 th June, 2011
when the following Trial Balance was prepared:
Particulars Dr. Cr.

Capital Account - Sushil 1,80,000
Capital account - Mohan 1,50,000
Sundry creditors (including for June purchase of 25,000) 50,000
Sales 5,00,000
Salaries and Wages (including 5000 being sitting fees to Directors) 60,000
Rent 7,500
Purchases 1,80,000
Sushil Company Limited 50,000
Expenses 25,000
Bank 17,500
Goodwill 1,25,000
Buildings 1,00,000
Machinery (purchases after 1.4.2006 were 50,000) 1,25,000
Stock on 31.3.2006 1,25,000
Sundry Debtors (including sales of 40,000 in June) 65,000
8,80,000 8,80,000

Notes Stock on hand on 30 th June, 2011, were 90,000. Sushil & Co. paid 50,000 for additional shares
and out of this account, the company incurred preliminary expenses of 30,000 and purchased a
typewriter for 15,000. Debtors and Creditors prior to 1 st June, 2011, were to be taken over by
Sushil & Co.
Prepare the Profit and Loss Account of Sushil Company Limited for the period ended 30 th June,
2011 and a Balance Sheet as on that date. All workings are to form part of your answer.
Solution:
Sushil Company Limited
from 1st April, 2011 to 30th June, 2011
To Purchases 1,80,000 By Closing Stock 90,000
To Salaries & Wages 55,000
To Rent 7,500
To Expenses 25,000
To Profit 1,97,500
5,90,000 5,90,000
Alternatively, the first trading account can be made to find out gross profit and then gross profit
and all above expenses can be separated in pre-incorporation and post-incorporation periods
into time ratio i.e., 2:1. The result will be the same.
Pre- Post- Pre- Post-

incorporation incorporation incorporation incorporation
To Director’s fees — 5,000 By Profit
To Capital Reserve — 60,833 (2:1) 1,31,667 65,833
To Net Profit 1,31,667 —
1,31,667 65,833 1,31,667 65,833
Balance Sheet of Sushil Co. Limited as on 30 th June, 2011
Liabilities Assets
Issued & Paid up. Goodwill ( 1,50,000 – 60,833) 89,167
55,000 Equity shares of 10 each 5,50,000 Buildings 1,50,000
fully paid up
Reserve & Surplus: Plant and Machinery 1,25,000
Profit and Loss A/c 1,31,667 Type-writer 15,000
Current Liabilities: Current Assets, Loans &
Advances:
Sundry Creditors 25,000 Sundry Debtors 40,000
Stock (closing) 90,000
Due from vendor 1,62,500
Bank 5,000
Preliminary Expenditure 30,000
7,06,667 7,06,667

Working Note: Notes

1. Bank Account
To Vendors (amount received for 50,000 By Preliminary Exps. 30,000
shares)
By Typewriter 15,000
50,000 50,000
2. Adjustment Journal Entries

Goodwill Account Dr. 25,000
Building Account Dr. 50,000
To Vendor’s Account 75,000
(Being revaluation of assets)
Sushil’s Company Account Dr. 1,80,000
Mohan’s Capital Account Dr. 1,50,000
To Vendor’s Account 3,30,000
(Being the transfer of balance of capital accounts)
Vendor’s Account Dr. 50,000
To Shares in Sushil Company Limited 50,000
(Being allotment of shares)
Creditors Account Dr. 25,000
To Vendor’s Account 25,000
(Being the transfer of creditor prior to June 2006)
Vendor’s Account Dr. 25,000
To Debtors Account 25,000
(Being the transfer of debtors prior to June 2006)
Vendor’s Account Dr. 5,00,000
(Being issue of shares for the payment of purchase
consideration)
Vendor’s Account
To Shares in Sushil Co. Limited 50,000 By Goodwill A/c. 25,000
To Sundry Debtors 25,000 By Buildings A/c. 50,000
To Share Capital A/c. 5,00,000 By Creditors A/c. 25,000
To Bank (balance given) 17,500 By Sushil’s Capital A/c. 1,80,000
By Mohan’s Capital A/c. 1,50,000
5,92,500 5,92,500

Notes 11.4 Statutory Report
Under Section 165 of the Companies Act, 1956 a public limited company must convene a general
meeting of its members not less than one month nor more than six months from the date of its
certificate to commence the business. This meeting is called a statutory meeting. This is the first
meeting of the company and is convened once in its life. This meeting is called to provide an
early opportunity of meeting the directors and to discuss the formation and prospects of the
company and terms of any contract mentioned in the prospectus. Under Section 165(2) the Board
of Directors has to send a copy of the statutory report to every member at least 21 days before the
date of holding the statutory meeting. Under Section 165(3), the Statutory Report must contain
the followings:
1. Total number of shares allotted distinguishing the shares allotted as fully paid or partly
paid up.
2. Total amount of cash received by the company on the allotted shares.
3. An abstract of receipt and payment.
4. Names, addresses and occupations of the directors, auditors, manager and secretary of the
company.
5. Particulars of any contracts which are to be submitted to the meeting for its approval.
6. The extent to which each underwriting contract, if any, has not been carried out and the
reason therefore.
7. The arrears due to calls from every director and from the manager.
8. The particulars of any commission or brokerage paid or to be paid in connection with the
issue or sale of shares to any director or manager.
Notes Under Section 165 of the Companies Act, 1956 a public limited company must
convene a general meeting of its members not less than one month nor more than six
months from the date of its certificate to commence the business.
The statutory report shall be certified as correct by at least two directors of the company and of
these, one must be managing director.
After the certification of the directors regarding the correctness of the statutory report, the
auditor of the company must also certify it as correct in regarding the total allotment of shares,
receipt of cash on allotted shares and abstract of receipts and payment. A copy of the certified
statutory report is dispatched to the Registrar for registration after sending the copies of the
report to the members of the company.
!
Caution After the certification of the directors regarding the correctness of the statutory
report, the auditor of the company must also certify it as correct in regarding the total
allotment of shares, receipt of cash on allotted shares and abstract of receipts and payments.

Select the best alternative:
14. Pre-incorporation loss must be transferred to:
(a) Capital reserve
(b) Goodwill
(c) General reserve
(d) Dividends to members
15. On the sale of business, if a partner wants a preference in return of capital he must get:
(a) Cash
(b) Preference shares
(c) Equity shares
(d) Right shares
16. Pre-incorporation profit of a company is transferred to:
(a) General Reserve
(b) Capital Reserve
(c) P. & L. Account
(d) P. & L. Appropriation Account
17. For what purpose the pre-incorporation profits are used:
(a) To distribute dividend
(b) To write off goodwill
(c) To write off discount on issue of shares
(d) To make a reserve
16. Depreciation is allocated between pre- and post-incorporation period on the basis of:
(a) Turnover Ratio
(b) Time Ratio
(c) Both the above
(d) None of these.
!
Caution The statutory report shall be certified as correct by at least two directors of the
company and of these, one must be managing director.

Notes 11.5 Summary
 Profit or loss of a business for the period to the date company came into existence is
referred to as Pre-Incorporation Profits or Losses.
 Generally, there are two methods of computing Profit & Loss prior to incorporation.
 One is to close off old books and open new books with the assets and liabilities as they
existed all the date of incorporation. In this way, automatically the result to that date will
be adjusted.
 Other is to split up the profit of the year of the transfer of the business to the company
between pre- and post-incorporation periods. This is done either on the time basis or on
the turnover basis or by a method which combines the two.
 A company taking over a running business may also agree to collect its debts as an agent
for the vendor and may further undertake to pay the creditor on behalf of the vendors. In
such a case, the debtors and creditors of the vendors will be included in the accounts for the
company by debit or credit to separate total accounts in the General Ledger to distinguish
them from the debtors and creditors of the business and contra entries will be made in
corresponding Suspense Accounts. Also details of debtors and creditors balance will be
kept in separate ledger.
 The vendor is treated as a creditors for the cash received by the purchasing company in
respect of the debts due to the vendor, just as if he has himself collected cash from his
debtors and remitted the proceeds to the purchasing company.
 The vendor is considered a debtor in respect of cash paid to his creditors by the purchasing
company. The balance of the cash collected, less paid, will represent the amount due to or
by the vendor, arising from debtors and creditors balances which have been taken over,
subject to any collection expenses.
 The balance in the suspense accounts will be always equal to the amount of debtors and
creditors taken over remaining unadjusted at any time.
11.6 Keywords
Balance Sheet: A balance sheet is often described as a “snapshot of a company’s financial

condition”. Of the four basic financial statements, the balance sheet is the only statement which
applies to a single point in time of a business calendar year.
Capital Reserve: A type of account on a municipality’s or company’s balance sheet that is reserved
for long-term capital investment projects or any other large and anticipated expense(s) that
will be incurred in the future.
Loss: The harm or suffering caused by losing or being lost.
Pre Incorporation Profits or Losses: When a running business is taken over by the promoters of
a company, from a date before the company which is to manage and own is registered, the
amount of profit or loss of such a business for the period prior to the date the company came into
existence is referred to as pre-incorporation profits or losses.
Profit: Profit is the difference between the purchase price and the component costs of delivered
goods and/or services and any operating or other expenses.

1. What do you mean by Profit or Loss pre-incorporation?
2. Why is it necessary to compute profit or loss pre and post-incorporation?
3. How are the different expenses allocated between pre- and post-incorporation periods?
Explain.
4. Which items are distributed between pre- and post-incorporation period on the basis of
time ratio?
5. Which items distributed between pre- and post-incorporation period on the basis of
turnover ratio?
6. Describe the method of finding out profit or loss prior and after incorporation.
7. How are “Profits prior to incorporation” dealt with? How will you ascertain such profit?
8. Why is it necessary to find out profit prior and after incorporation? Explain it in detail.
9. Why and how are pre- and post-incorporation profits and losses calculated?
A. Pre-incorporation profits
1. Sethi Ltd. was incorporated on 30 th June, 2010 to acquire the business of Mr. X as from 1 st
January, 2010. The accounts for the year ended 31 st December, 2010 disclosed the following:
(i) There was a gross profit of 4,80,000.
(ii) The sales for the year amounted to 24,00,000 of which 10,80,000 were for the first
six months.
(iii) The expense debits to Profit and Loss Account included Director’s fees 30,000, Bad
Debts 7,200, Advertising 24,000 (under a contract amounting to 2,000 per month),
Salaries and General Expenses 1,28,000, Preliminary expenses written off 10,000.
Donation to political parties given by the company 10,000.
Prepare a statement showing the amount of profit made before and after incorporation
in the books of Sethi Ltd.
Ans: Profit pre-incorporation period 1,36,760.
Profit after incorporation period 1,34,040.
B. Division of profit on monthly basis
2. A company acquires a business on 1 st January, 2010; it is being incorporated on 1 st May,

2010. The first accounts are drawn upto 30 th September 2010. The gross profit for the period
is 56,000.
The General Expenses are 14,220, Director’s fees 12,000 per annum, formation expenses
1,500.
Rent to 30th June was 1,200 per annum after which it was increased to 3,000 per annum.
The salary of the manager who upto incorporation of the company, was made a director,
was 6000 per annum (since incorporation included in the director’s fees above).

Notes Show Profit and Loss Account assuming that the net sales were 8,20,000, the monthly
average of which for the first four months of 2010 being one-half of that of the remaining
period, the company earned a uniform profit. Interest and Taxation maybe ignored:
(B.Com. Rohilkhand 1992)
Ans: Pre-incorporation profit 7,280
Post-incorporation profit 24,650.
3. Bhaba Limited was incorporated on 30 th June, 2010 to take over the business of R. Kumar
as from 1st January 2010. The financial accounts of the business for the year ended. 31.12.2010
disclosed the following information:
Particulars
Sales – January to June 1,20,000
July to December 1,80,000 3,00,000
Less: Purchases–
January to June 75,000
July to December 1,20,000 1,95,000
Gross Profit 1,05,000
Less: Salaries 15,000
Selling Expenses 3,000
Depreciation 1,500
Director’s Remuneration 750
Debenture Interest 90
Administrative Exps. (Rent, Rates, etc.) 4,500 24,840
Profit for the year 80,160
You are required to prepare a statement apportioning the balances between periods prior
to and since incorporation and show the Profit & Loss Appropriation Account for the year
ended 31st December, 2010.
[Adapted from I.C.W.A. (Final) June, 1981]
Ans: Pre-incorporation profit 33,300
Post-incorporation profit 46,860.
D. Calculation of Sales Ratio
4. Mittal Rolling Mills Limited was registered on 1 st April, 2010 to take over the business of
Mittal Brothers from 1st January, 2010 From the following information given to you. You
are required to calculate the profit earned by the company in pre- and post-incorporation
periods.
(a) Sales during the period January-December 2010 4,80,000. The trend of the sales was
as under:
January and February : Half the average sales in each month.
May, June, July : Average sales in each month.
October : Average sales.
November & December : Half the average sales in each month.
(b) Cost of goods sold 1,20,000

(c) Salary and other administrative charges ` 12,000 Notes
(d) Bad Debts ` 4,800
(e) Interest on purchase price paid by the company to Mittal Brothers on 1 st August, 2010
` 4,200.
(f) Expenses exclusively related to the company ` 17,800.
Ans: Pre-incorporation profit ` 69,200.
Post-incorporation profit ` 252,000.
5. Sundir Ltd. is incorporated on 1st May, 2010. From January 1, 2010 it purchased the business
of Priyanka Limited for ` 4,00,000 out of which ` 3,20,000 was paid up fully paid equity
shares and the balance was paid in cash. The company also issued equity shares ` 3,00,000
for cash to public. Stock ` 40,000, Machinery ` 3,00,000 and Debtors ` 25,000 were acquired
from vendors.
The purchasing company installed a new machine of ` 2,00,000. During the year 2010 total
cash sales were ` 10,00,000. The sales per month in the first half of the year were one-half
of what they were in the later half year. The net profit of the company after charging the
following expenses was ` 90,000. The directors’ fees ` 20,000, Office exps. ` 7,500,
Preliminary expenses. ` 6,500, Depreciation ` 36,000, Selling expenses. ` 18,000, Interest to
vendor upto 31st May, 2010 is ` 2,000, Closing stock is valued at ` 40,000. Find out profit
before and after incorporation and prepare a Balance Sheet of Purchasing Company as on
31st December, 2010.
Ans: Pre-incorporation profit ` 19,900.
Post-incorporation profit ` 70,100.
Answers to Self Assessment
1. Capital 2. Divided
3. Post 4. Post-Incorporation
5. Time Ratio 6. Turnover Ratio

7. Goodwill 8. True
9. False 10. False
11. True 12. True
13. False 14. (b)
15. (b) 16. (b)
17. (b) 18. (b)

Invest in an IPO or DPO. Chicago: Dearborn Trade, 1998

Notes Brown, Meredith, ed. Mechanics of Global Equity Offerings: Structuring the Offering

Underwriting.”American Banker, 26 December 1996, 20

Book Group, 1996

Publishing, 1998

McGraw-Hill Higher Education, 1992
Online links http://220.227.161.86/19685ipcc_acc_vol2_chapter3.pdf

http://220.227.161.86/19668ipcc_acc_vol1_chapter-3.pdf
http://www.investopedia.com/terms/c/capitalreserve.asp#ixzz1xlZehyWb

Case Study Law Firm Profit and Growth Strategy Facilitated by
Law Business Management System™ (LBMS™)
Situation: Law firm had objective of increased revenue and profitability. The key strategy
was diversification, both geographically and into new practice areas. The approach
involved utilization of mergers & acquisitions that enabled this diversification.
Critical Issues: The firm’s strategy involved strategic placement of additional offices
dispersed throughout the United States on an accelerated timeframe. To achieve full and
fast recognition of increased revenues that translated to bottom-line profit, the firm had to
ensure the following issues were addressed:
 Acquired firms’ book of business had to be quickly integrated into the firm’s total
book of business. This meant clearing all lateral hire conflicts quickly and pulling
all client and matter information into the firm’s centralized accounting system.
 New offices had to be quickly assimilated into adherence into the firm’s policies and
procedures to ensure effective loss prevention, thereby ensuring profits were
protected.
 The firm wanted to grow its legal services delivery base without an increase in
staffing for new business intake, conflicts or billing, this way driving profitability
up significantly as revenue increased, but administrative overhead expense stayed
steady.
 Real-time analysis of effectiveness of mergers and acquisitions on overall practice

and geographic diversification required technology capable of supplying analytics
and sophisticated reporting.
Contd...

Reasons: The firm was over-committed to service of a particular market segment, which Notes
had strict demands of legal service providers (and historically mandated very low rates).
 Firm revenues and profitability were below the norm.
 Firm was at high risk if the market segment they serviced changed dramatically due
to over-specialisation.
 Required Capabilities:
 Globally consistent processes for New Business Intake and Client/Matter Change
Management
 Fast inclusion of new offices/users into the firm’s standard processes without overhead
of rollout/training
 Positive adoption of new processes by users to minimize resistance to change
 Targeted, high-value automation, to ensure that existing operational infrastructure

(personnel) could handle the substantially increased load without the need for hiring
new personnel.
Elegrity (the firm) delivered the following:
 Business process re-engineering and optimization consulting, focused on helping

the firm determine how to leverage the new capabilities automation affords to meet
their objectives.
 Law Business Management System (LBMS) – The only comprehensive cradle-to-grave

client/matter management business process automation platform specifically built
to accommodate all the sophisticated business process needs of the legal industry.
LBMS provides all of the technology capabilities required to meet the following functional
capability requirements:
 Automation to enable the same number of people and their teams to do significantly
more!
 Risk mitigation through the enforcement of consistent, codified firm business

processes and business rules.
 Visibility for all levels of users, secured appropriately.
 Flexibility for the organization as a whole through the ability to quickly add offices/
users, and make immediate adjustments to firm business process and business rules
as strategies or needs changed.
 System Integrity for automation of system interfaces and aggregation and

distribution of information to/from the appropriate system of record.
 Agility through the leveraging of active decision support in combination with

business process execution, decision-makers at all levels of the organization were
provided the ability to make better, more informed decisions faster.
 Reporting and Business Intelligence to provide information to various levels of the

organization, as needed.
 Process Development, User Interface Development & Customization and Business

Systems Integration Services to leverage the technology provided by LBMS to meet
the specific requirements of the firm’s unique business processes.
Contd...

Notes End-User Training and Floor Support to ensure positive and fast adoption rate Results:
 Significantly increased speed of new business intake (accelerating revenue

generation, recognition & cash flow).
 Increased billing accuracy and speed due to comprehensive billing guidelines

collection as part of the intake process.
 Enhanced conflicts management and clearing processes to process mass intakes and
lateral hires.
 Substantially improved loss prevention through the consistent and audited

application of firm policies and completed approval cycles.
 Streamlined client/matter lifecycle processes and automated many associated manual

and paper-intensive tasks.
 The firm has grown from approximately 10 offices at the time Elegrity’s LBMS®was
implemented to now 19 offices across 32 different practice areas.
 The firm has become one of the top AmLaw 200 law firms.
 The firm has enjoyed a substantial increase in revenue and achieved higher
profitability as a result of its leveraging of LBMS.
Source: http://www.elegrity.com/Portals/15318/docs/elegrity%20case%20study%20-%20lbms%20provides%20
foundation%20for%20law%20firm%20profit%20and%20growth.pdf

Manpreet Kaur, Lovely Professional University Unit 12: Divisible Profits and Managerial Remuneration
Unit 12: Divisible Profits and Managerial Remuneration Notes
CONTENTS
Objectives
Introduction
12.1 Principles of Divisible Profit
12.2 Meaning of Managerial Remuneration
12.3 Provisions Regarding Overall Maximum and Minimum Limits
12.4 Remuneration to Directors
12.5 Summary
12.6 Keywords
Objectives
 Know principles of divisible profits
 Explain meaning of managerial remuneration
 Define provisions
 Understand remuneration to the directors
Introduction
The management and administration of a company is delegated to the managerial personnel as

per the provisions of the Companies Act.
Divisible Profits: According to Black and White Publishing Company (1901) profit available for
dividend means net profits after making any deduction which the directors can duly make profit
which can be distributed legally in the form of dividends to the shareholders of the company are
called divisible profits.
!
Caution There is no any particular rule about the determination of profit. By company law
has laid down the following rules or a principle which guides us to determine the divisible
profits.
12.1 Principles of Divisible Profit
Following are the important principles of divisible profits :
1. According the Company Rules: The articles of association are the rules of the company.
The directors are entitled to distribute the profits under rules. They also follow the company
law. The dividend can be paid out of revenue profit.

Notes 2. Follow the court cases: While calculating the divisible profits, the court cases must be kept
in mind. The auditors must know the decisions of the courts announced time to time.
3. Profit not out of capital: The capital cannot be used to pay dividend. The revenue profits
can be used for the payment of dividend.
4. Approval of Shareholders: In the annual general meeting, shareholders may approve the
rate of profit recommended by the directors. So divisible profits can be used to pay as
dividend after approval.
5. Right of Proposal: The directors can propose the rate of dividend out of divisible profits.
After completing the legal formalities the directors can decide the dividend.
6. Undistributed Profit: It is the right of the directors to use such profit for the payment of
dividend at the end of a year. It is a revenue of the provision year.
7. Depreciation: Before declaring revenue profits, the depreciation on fixed assets must be
charged. In manufacturing company it is compulsory to charge depreciation before the
declaration of profits.
8. Secrete Reserves: If according the articles association it is allowed to create and use the such
reserves then these can be used for the payment of dividends.
9. Capital profits: Under certain conditions the capital profit can be used to pay dividend but
articles of association should allow the distribution of capital profit as dividend.
10. Capital loss: In spite of capital loss, the dividend can be paid out of revenue profits. The
capital profit must be used to eliminate capital loss first and then surplus can be used to
pay dividends.
11. Loss of provision year: If a company suffers a loss in one year but earns profit next year,
such loss can be adjusted by the company from benefit of the current year.
12. Revaluation of assets: After the revaluation of asset, if it becomes surplus then it can be
used after realization and profit may be paid after selling the assets.
13. Revenue profits: According the principle of divisible profit dividend must be paid out of
revenue profit but it is essential that calculation should be correct.
14. Asset goodwill written down & up: If a company has written down good will out of
profits, it may also write up this asset, with the appreciation. But the value written up
should not excess than the true value.
Self Assessment
True or False:
1. According the principle of divisible profit dividend must be profit
2. If a company does not have written down good will out of profits, it may also write up this
asset paid out of revenue.
Fill in the blanks:
3. In case there is only one whole-time director in a company, maximum remuneration

payable to director will be ............................. of the net profit calculated u/s 349.
4. A ............................. cannot be the manager of the company.

Unit 12: Divisible Profits and Managerial Remuneration
12.2 Meaning of Managerial Remuneration Notes
The managerial personnel include the following personnel:
(a) Director: Directors are the representatives of the company. They manage and control the
company. Directors are also the trustees for the company’s property. Therefore, it is their
duty to use company’s property for its benefit alone. It is compulsory for every company
to have a board of directors. Board of directors is a group of directors. A contract signed by
the directors on the behalf of the company is binding on the company and the concerned
third party. If the directors use their reasonable care and skill to perform their duties and
yet the company suffers a loss, the directors will not be responsible for such a loss. But if
the loss is due to the negligence of directors and breach of trust, they must have to
compensate the loss suffered by the company. There can be two types of directors in a
company i.e. full-time director and part-time directors. A whole-time director is not a new
category of managerial personnel. But a director who is in the whole-time employment of
the company is called a whole-time director. Managing directors are also called the whole-
time directors. Part-time directors are those who devote part of their time in the affairs of
the company. There can be more than one part-time director in a company.
(b) Managing director: A company can have one or more than one managing director. The
board of directors may appoint one of themselves as the managing director of the company
by giving more powers to manage the company. According to section 2(26) of the
Companies Act, a managing director is a director who (i) by virtue of an agreement with
the company, or (ii) of a resolution passed by the company in general meeting, or (iii) by
its board of directors, or (iv) by virtue of its memorandum or articles of association is
entrusted with substantial powers of management which would not otherwise be
exercisable by him and includes a director occupying the position of a managing director,
by whatever name called. Without unanimous approval of the board of directors, a
managing director cannot manage more than one company at a time.
(c) Manager: There cannot be a manager and a managing director both in a company. Like
managing director, a manager is also appointed by board of directors. His tenure cannot
be more than five years at a time. According section 2(24) of the Companies Act, a manager
means a person who, subject to the superintendence, controls and manages the company
according to the direction of the board of directors, has the management of the whole or
substantially the whole of the affairs of a company, and includes a director or any other
person occupying the position of a manager by whatever name called and whether under
a contract of service or not. A company cannot have more than one manager at a time. The
same disqualifications and restrictions will be applicable for the manager which exist for
a managing director.
The remuneration which is paid to the managerial personnel (directors, managing directors and
managers) by the company is called managerial remuneration. This remuneration is shown in
the debit side of profit and loss account of the company. Besides salary, dearness allowance
perquisites, commission and other allowances, the managerial remuneration includes the
following as per section 198:
(a) Expenditure incurred by the company in providing any rent-free accommodation, or any
other benefits or amenity in respect of accommodation free of charge,
(b) Expenditure incurred by the company in providing any other benefit or amenity free of
charge or at a concessional rate,

Notes (c) Expenditure incurred by the company in respect of any obligation or service which but for
such expenditure by the company, would have been incurred by them, and
(d) Expenditure incurred by the company to effect any insurance on the life of, or to provide
any pension, annuity, or gratuity for any of the managerial personnel, or his spouse or
child.
12.3 Provisions Regarding Overall Maximum and Minimum Limits
As per section 198 of the Companies Act 1956, these are several restrictions on the managerial
remuneration. These are as below:
Maximum Limit
Did u know? The managerial remuneration of the managerial personnel (as director,
manager and managing director) should not more than 11% of the net profit of that
company as per section 198 of the Companies Act 1956.
Any fees payable to the directors for attending the meeting of board of directors will not be
included in the above ceiling of the remuneration for this purpose the profit of the company will
be calculated as per sections 349, 350 and 351 of the Companies Act.
Minimum Limit
In case a company has no profit or its profits are inadequate in any financial year, the company
will pay the minimum amount of remuneration to the director, managing director, manager or
whole-time director. This minimum amount will vary from 75,000 to 2,00,000 p.m., which
will depend on the effective capital of the company as specified in part ii of schedule xiii of the
Companies Act as given below.
Schedule XIII, Part II
Section I - Remuneration payable by companies having profits-
Notes Subject to the provisions of sections 198 and 309, a company having profits in a
financial year may pay any remuneration by way of salary, dearness allowance, perquisites,
commission and other allowances, which shall not exceed 5% of its net profit for one such
managerial person and if there is more than one such managerial person, 10% for all of
them together.
Section II - Remuneration payable by companies having no profit or inadequate profit-
1. Notwithstanding anything contained in this part, wherein any financial year during the
currency of tenure of the managerial person, a company has no profits or its profits are
adequate, it may pay remuneration to a managerial person, by way of salary, dearness
allowance, perquisites and any other allowance, as per scale prescribed in part II which
have been revised vide Notification GSR no. 215(e) dated 2-3-2000. These revised scales are
as below:

Where the effective capital of the company is Monthly salary payable shall not exceed Notes
(i) less than 1 crore. 75,000

(ii) rupees 1 crore or more but less than 5 crore. 1,00,000
(iii) 5 crore or more but less than 25 crore. 1,25,000
(iv) 25 crore or more but less than 100 crore. 1,50,000
(v) 100 crore or more. 2,00,000
Explanation I: For the purpose of section II of this part, “effective capital” means the aggregate
of:
(i) Paid up share capital (excluding share application money or advances against shares).
(ii) Credit balance of share premium account.
(iii) Reserve and surplus (excluding revaluation reserve).
(iv) Long-term loans and deposits repayable after one year (excluding working capital, loans,
overdrafts, interest due on loans unless funded, bank guarantee etc., and other short-term
arrangements) as reduced by:
(a) Aggregate of any investments (except in the case of investment by an investment

company whose principal business is acquisition of shares, stock, debentures, or
other securities).
(b) Accumulated losses not written off.
(c) Preliminary expenses not written off.
Explanation II:
(a) Where the appointment of the managerial person is made in the year in which the company
has been incorporated, the effective capital shall be calculated as on the date of such
appointment.
(b) In any other cases, the effective capital shall be calculated as on the last date of the financial
year preceding the financial year in which the appointment of managerial person is made.
Perquisites
2. A managerial person shall be eligible to the following perquisites which shall not be
included in the computation of the ceiling on the remuneration specified in the paragraph
1 of this section:
(i) Contribution to provident fund, superannuation fund or annuity fund to the extent
these either single or put together are not taxable under the Income Tax Act 1961.
(ii) Gratuity payable at a rate not exceeding half a month’s salary for each completed
year of service.
(iii) Encashment of leave at the end of the tenure.
Perquisites for Expatriates
3. In addition to the perquisites specified in paragraph 2 of this section, an expatriate

managerial person (including Non-resident Indians) shall be eligible to the following
perquisites which shall not be included in the computation of the ceiling on remuneration
specified in paragraph 1 of this section:

Notes (a) Children’s education allowance: In case of children studying in or outside India, an
allowance limited to a maximum of 5,000 per month per child or actual expenses
incurred whichever is less. Such allowance is admissible upto a maximum of two
children.
(b) Holiday passage of children studying outside India or family studying abroad: return holiday
passage once in a year by economy class or once in two years by first class to
children and to the members of the family from the place of their study or stay
outside India, if they are not residing in India with the managerial person.
(c) Leave travel concession: Return passage for self and family in accordance with the
rules specified by the company where it is proposed that the leave be spent in home
country instead; anywhere in India.
Explanation: For the purpose of this part, family means the spouse, dependent children
and dependent parents of the managerial person.
Formula for computation of effective capital

Paid up share capital ----------------------
+ Credit balance of premium a/c. (securities) ----------------------
+ Reserve & surplus (excluding revaluation reserve) ----------------------
+ Long-term loans and deposit repayable after one year ----------------------
Total
–Investments ---------------------- ----------------------
Accumulated losses ---------------------- ----------------------
Preliminary expenses ---------------------- ----------------------
Effective Capital
12.4 Remuneration to Directors
Notes Remuneration to directors including managing directors, is determined either by

the articles of association or by a resolution or, if the articles so required, by a special
resolution, passed by the company in general meeting subject to the provisions of the
section 309 of the Companies Act.
Section 309 governs the remuneration of directors, including managing directors or whole-
time director of a public company and a private company which is a subsidiary of a public
company. Provisions of this section are as under:
(a) Remuneration to whole-time director or managing director: As per the provision of section
309(3), a whole-time director or a managing director may be paid remuneration either by
way of a monthly payment or at a specified percentage of the net profits of the company
or partly by one way and partly by the other. But except with the approval of the central
government, such remuneration shall not exceed:
(i) 5% of the net profit for one whole-time or managing director,
(ii) 10% of the net profit for more than one whole-time director.

(b) Remuneration of part-time directors: As per the provision of section 309(4) a part-time Notes
director (who is neither whole-time nor managing director) may receive monthly, quarterly
or annual payment of remuneration with the approval of Central Government or by way
of commission, if a special resolution of the company authorizes such payment. But except
with the approval of the Central Government, total remuneration shall not exceed:
(i) 1% of the net profit of the company if the company has managing directors or
whole-time directors or;
(ii) 3% of net profit of the company if the company has no manager, managing directors
or whole-time director.
It is to be noted that these rates of 1% and 3% respectively can be increased by the

company by a special resolution in a general meeting with the approval of the
Central Government. This special resolution will be valid for a period of five years.
(c) Director’s fees: In addition, a director may receive remuneration by the way of a fee for each
meeting of board of directors or a committee thereof attended by him according to the
Companies Act, but the government has decided that in case of whole-time directors or
managing directors, no sitting fee will be payable. As per notification of the Central
Government dated, 27.8.1993 a company can pay fees upto ` 2, 000 to its each director for
attending the meeting of board of directors or a committee thereof. As stated earlier, director’s
fees a not included in the managerial remuneration for the purpose of overall limit.
(d) Whole-time director or managing director shall not get any remuneration or commission
from subsidiary company: As per section 309(6) a whole-time or managing director who
is in receipt of any commission from a company is not entitled to receive any commission
or remuneration from the subsidiary company of such company.
(e) as per section 309(1) remuneration to a director will include any remuneration paid to him
for services rendered by him in any capacity except when-
(i) The services rendered by him are of a professional nature.
(ii) In the opinion of the Central Government, the director possesses the requisite
qualifications for the practice of the profession.
(f) The above-mentioned provision of section 309 regarding the remuneration of the
managerial personnel will not be applicable to a private company unless it is a subsidiary
company of a public company.
(g) As per section 310 of the Companies Act, if a public company or a private company, which
is the subsidiary of a public company, increases the remuneration payable to directors, such
an increase requires the approval of Central Government, except in the following cases–
(i) if schedule XIII is applicable and the increase is in accordance with the conditions
specified in that schedule and
(ii) if the increase is in the fee payable for attending each meeting of the board of
directors or a committee thereof and the increased rate does not exceed such sum as
may be prescribed.
(h) The net profit of the company for the purpose of calculating director’s remuneration
would be computed as per the provisions of sections 349 and 350 of the Companies Act.
(i) As per section 200, no company will pay its officers or employees any remuneration free
of any tax.

Notes Remuneration to Manager
Provisions regarding remuneration to manager are given in the section 387 of the Companies Act
1956. According to this section, a company can pay the remuneration to a manager by the way of
a monthly payment or by way of a specific percentage of the net profits of the company or partly
by way of monthly payment and partly by way of specific percentage of the net profits. The net
profit of the company is calculated according to sections 349 and 350 of the Companies Act.
!
Caution The total remuneration to the manager cannot exceed 5% of the net profit of the
company, except with the approval of the Central Government.
Determination of net profit for managerial remuneration
Determination of net profit of a public company for the purpose of calculating the managerial
remuneration will be as per the provision of the section 349 and section 350 of Indian Companies
Act. These provisions are summarized as under:
1. The following items are added to the gross profit of the company: Bounties and subsidies
received from any government or any public authority constituted or authorized in this behalf,
by any government, unless and except in so far as the Central Government otherwise directs.
2. The following items are not considered to calculate the net profit of the company:
(a) Profit by way of premium on the issue of shares or debentures of the company.

(b) Profits on the sale of forfeited shares. Notes

(c) Profits in capital nature.
(d) Profit arising from the sale of immovable property or fixed assets, if company’s
business is not the sale and purchase of such type of assets. In other words, if the
company is engaged in buying and selling of any assets of capital nature, profit
arising from such a sale is added to for gross profit of the company.
Under section 350 if amount of sale of any such assets exceeds the written down value
thereof, credit shall be given for so much of the excess as is not higher than the difference
between the original cost of the fixed assets and its written down value. For example-
Gujarat ltd., acquired fixed assets for ` 80,000 two years ago and now its written down
value is ` 60,000. The company sold these assets for ` 85,000. In this case, total profit is
` 25,000 (` 85,000–` 60,000) profit of ` 20,000 (difference of original cost and written down
value of the assets) will be added to gross profit and the excess of profit of ` 5,000
(` 25,000 – ` 20,000) will be excluded in computing the net profit for the purpose of
remuneration.
3. The following items shall be deducted from the gross profit of the company:
(a) all the usual working charges.
(b) bonus or commission paid or payable to any member of the company’s staff or to
any engineer, technician or person employed or engaged by the company whether
on a whole-time or a part-time basis.
(c) Any tax notified by the central government as being in the nature of a tax on the
excess or abnormal profits.
(d) Any tax on business profits imposed for special reason or in special circumstances
and notified by central government in this behalf.
(e) Interest on debentures issued by the company.
(f) Interest on mortgages executed by the company and on loans and advances secured
by a charge on its fixed or floating assets.
(g) Interest on secured loans and advances.
(h) Expenses on repairs if the repairs are not of capital nature.
(i) Outgoings inclusive of contribution made to charitable and other funds not directly
relating to the business of the company or welfare of its employees.
(j) Depreciation as per section 350 of the Companies Act. Under this section, the amount
of depreciation is calculated as per rates specified in the schedule XIV (which is
discussed in the chapter of final a/cs) on the written down value of the assets. The
amount of depreciation includes normal depreciation, which includes extra and
multiple shift allowance but excludes special depreciation, initial depreciation and
any development rebate. If any assets are sold, discarded, demolished or destroyed
before the expiry date of the assets, excess of w.d.v. of the assets over the sales
proceeds of the assets or scrap value of the assets as the case may be, is written off in
that financial year in which the assets are sold, discarded or demolished. This excess
of w.d.v. will be computed as below:
Excess of w.d.v. = w.d.v. – sale proceeds – scrap value.
(k) The excess of expenditure over income which had arisen in computing the net profit in
accordance with the section 349 of the Companies Act in any year which begins at or
after the commencement of this Act insofar as such excess has not been deducted in
any subsequent year preceding the year in which the net profits have to be ascertained.

Notes (l) Any compensation or damages to be paid by virtue of any legal liability including
a liability arising from a breach of contract.
(m) Any sum paid by way of insurance against the risk of meeting any liability such as
referred to in clause (l).
(n) Debts considered bad and written off or adjusted during the year of account.
4. But the following items shall not be deducted from the gross profits of the company:
(a) The income tax and super tax payable by the company under the Indian Income Tax
Act, 1961 or any other tax on the income of the company not covered under clauses
(c) and (d) above.
(b) Any compensation or damage paid by the company voluntarily.
(c) Loss of capital nature including loss on sale of undertaking or any part thereof not
including any excess of written down value over its sale proceeds or scrap value of
any excess of written down value of any assets sold, discarded, demolished or
destroyed as this excess is written off against p & l a/c.
Notes The profit calculated as per above provision is considered profits for the purpose of
remuneration to directors, managing directors and manager. On the basis of this profit,
the managerial remuneration is computed.
Self Assessment
Fill in the blanks:
5. The provisions regarding the manager's remuneration are found in section .........................
of the Companies Act.
6. Net profit for the purpose of managerial remuneration is calculated u/s .........................
7. Minimum amount of overall remuneration is determined on the bases of .........................
True or False:
8. Overall managerial remuneration is calculated u/s 198.
9. There can be more than one whole-time directors simultaneously in a company.
10. The managing director of the company must be a shareholder.
11. The maximum limit of manager's remuneration is 15% of profit u/s 387.
12. Section 209 relates to the provisions of managing director's remuneration.
13. If there is no whole-time director or managing director or manager in a company, part-

time director's maximum remuneration can be paid 5% of the profit of the company.
14. Net profit for the purpose of managerial remuneration is calculated u/ss 349 & 350.
15. Managerial remuneration is always calculated on the profit before tax.
Example 1: Determine the maximum remuneration available to the part-time directors

and managers of Babli and Bunty ltd. under sections 309 and 387 of the Companies Act, 1956
from the following particulars:

Before charging any such remuneration the profit and loss a/c, showed a credit balance of Notes
57,75,000 for the year ended 31st march, 2006 after taking into account of following balances:
(i) capital expenditure 13,12,500

(ii) subsidiary received from government 10,50,000
(iii) special depreciation 1,75,000
(iv) multiple shift allowance 2,62,500
(v) bonus to foreign technicians 7,87,500
(vi) provision for taxation 70,00,000
(vii) compensation paid to an injured workman 1,75,000
(viii) ex-gratia payment to an employee 87,500
(ix) loss on sale of fixed assets 1,75,000
(x) profit on sale of investment 5,25,000
company is providing depreciation as per section 350 of the companies act, 1956.
Solution:
Calculation of net profit for managerial
Remuneration u/s 349
Particulars
Credit balance of profit & loss (given) 57,75,000
Add: Inadmissible items:
(a) Capital expenditure 13,12,500
(b) Special depreciation 1,75,000
(c) Provision for depreciation 70,00,000
(d) Ex-gratia payment to an employee 87,500 85,75,000
1,43,50,000
Less: Non-trading profits:
Profit on sale of investment 5,25,000
Net profit for managerial remuneration u/s 349. 1,38,25,000
Calculation of Managerial Remuneration
1, 38, 25,000  1
(i) Maximum remuneration for part-time directors @ 1% = = 1,38,250
100
(ii) Net profit for the purpose of remuneration to manager = 1,38,25,000 – 1,38,500
= 1,36,86,750
1, 36,86,750  5
Remuneration for manager @ 5% = = 6,84,337.5
100
Example 2: Following is the profit and loss a/c of Puneet manufacturing company
limited for the year ending 31st December 2005. You are required to calculate the maximum
remuneration permissible to part-time directors. The company does not employ a manager or
managing director or whole-time director. Also calculate overall managerial remuneration under
section 198.

Notes
To salaries & wages 70,000 By gross profit 31,10,000
To director’s fees 40,000 By profit on sale of building:

To repairs 40,000
To general expenses 17,000 Cost 6,40,000
To compensation for breach of contact 10,000 W.D.V. 3,00,000 3,40,000
To depreciation (including 2,00,000 By subsidy from Central Government 60,000
development rebate of 20,000 and
initial depreciation of 10,000)
To loss on sale of vehicle (w.d.v. 3,000
5,500)
To loss on sale of investment 15,000
To scientific research (new laboratory) 2,00,000
To donation to charitable institutions 20,000
To interest on debentures 40,000
To interest on secured loans 10,000
To debenture trustee remuneration 10,000
To investment revaluation reserve 5,000
To brought forward trading losses 30,000
To income tax 10,00,000
To proposed dividend 10,00,000
To balance c/d. 8,00,000
35,10,000 35,10,000
Solution:
Calculation of net profit for managerial remuneration u/s 349
Particulars
Net profit as per p.& l. a/c (given) 8,00,000
Add: inadmissible items:
(a) Development rebate 20,000
(b) Initial depreciation 10,000
(c) Loss on sale of investment 15,000
(d) Scientific research 2,00,000
(e) Investment revaluation reserve 5,000
(f) Income tax 10,00,000
(g) Proposed dividend 10,00,000 22,50,000
30,50,000
Less: Capital profits on sale of building 40,000
Net profit for the purpose of managerial remuneration 30,10,000
alternatively, net profit for managerial remuneration may be calculated by taking gross profit
of the company.

Particulars Notes
Gross profit as per p. & l. A/c 31,10,000
Add: subsidy from Central Government. 60,000
Revenue profit on the sale of buildings
Sale (3,00,000 + 3,40,000) 6,40,000
Less: cost 6,00,000
Capital profit on sale of building 40,000
Revenue profit = (3,40,000 – 40,000) 3,00,000 3,60,000
34,70,000
Less: permissible items:
Salaries and wages 70,000
Director’s fees 40,000
Repairs 40,000
General expenses 17,000
Compensation on the breach of contact 10,000
Depreciation (2,00,000 – 20,000 – 10,000) 1,70,000
Loss on sale of vehicles 3,000
Donation to charitable institution 20,000
Interest on debentures 40,000
Interest on secured loans 10,000
Debenture trustee’s remuneration 10,000
Brought forward trading loss 30,000 4,60,000
Calculation of managerial remuneration
30,10,000  3
(i) Maximum remuneration for part-time directors @ 3% =  90, 300
100
30,10,000  11
(ii) Maximum overall remuneration @ 11% =  3, 31,100
100
Example 3: Calculate the managerial remuneration from the following particulars of

Jag Mohan & Co. Ltd. due to the managing director of the company. Remuneration is paid at the
rate of 5% of the profits. Also, determine the excess remuneration paid, if any:
Net profits 7,00,000
Net profit is calculated after considering the following:
(i) Depreciation 1,40,000
(ii) Preliminary expenses 35,000
(iii) Tax provision 10,85,000
(iv) Director’s fees 28,000
(v) Bonus 52,500
(vi) Profit on sale of fixed assets (original cost 70,000; written down value 38,500)
54,250
(vii) Provision for doubtful debts 31,500

Notes (viii) Scientific research expenditure (for setting up new machinery) 70,000
(ix) Managing director’s remuneration paid 1,05,000
Other information:
(i) Depreciation allowable under schedule XIV of the Companies Act 1,22,500
(ii) Bonus liability as per payment of bonus act 63,000
Solution:
Calculation of net profit for
managerial remuneration u/s 349
Particulars
(a) excess of depreciation ( 1,40,000 – 1,22,500) 17,500
(b) preliminary expenses 35,000
(c) provision for doubtful debts 31,500
(d) scientific research expenditures 70,000
(e) managing director’s remuneration 1,05,000
(f) tax provision 10,85,000 13,44,000
20,44,000
Less: deductible items
Liability of bonus under Payment of Bonus Act. 63,000
- bonus already debited 52,500 10,500
Profit on sale of fixed assets
Sales proceeds (38,500 + 54,250) 92,750
- Original cost of assets 70,000 22,750 33,250
Net profit for managerial remuneration 20,10,750
Calculation of managerial remuneration
Remuneration @ 5% on 20,10,750 1,00,537.50

–Managing director’s remuneration already paid 1,05,000.00
Excess remuneration paid 4,462.50
Example 4: The manager of XYZ Ltd. is entitled to get a salary of 5,000 per month plus
1% commission on the net profit of the company. After such salary and commission. The following
is the profit and loss account of the company for the year ended 31st December, 2005:
Profit and Loss A/c.
To salaries, wages & bonus 3,85,000 By gross profit b/d 18,00,000
To general expenses 1,48,000 By subsidy from govt. 1,20,000

To depreciation 1,64,000 By profit on sale of assets
To expenditure on scientific research
(Cost of apparatus) 28,000 Cost price 5,00,000
Contd...
To manager’s salary 60,000 W.D.V. 3,60,000 2,00,000
To commission to manager 12,000
To provision for bad & doubtful 35,000
debts
To provision for income tax 4,80,000
To proposed divided 2,00,000
To balance c/d 6,08,000
To salaries, wages & bonus 3,85,000 By gross profit b/d 18,00,000
To general expenses 1,48,000 By subsidy from govt. 1,20,000

To depreciation 1,64,000 Unit 12: Divisible Profits and Managerial Remuneration
By profit on sale of assets
To expenditure on scientific research

(Cost of apparatus) 28,000 Cost price 5,00,000
To manager’s salary 60,000 W.D.V. 3,60,000 2,00,000 Notes
To provision for bad & doubtful 35,000
debts
To proposed divided 2,00,000

21,20,000 21,20,000
Depreciation as per income tax rules amounts to 1,62,000. Calculate the remuneration payable
to the manager.
Solution:
Calculation of Net Profit for Managerial Remuneration u/s 349
Particulars
Net profit as per p. & l. A/c 6,08,000
Add: inadmissible items excess depreciation (1,64,000 – 1,62,000) 2,000
Expenditure on scientific research 28,000
Manager’s salary 60,000
Manager’s commission 12,000
Provision for bad & doubtful debts 35,000
Provision for income tax 4,80,000
Proposed dividend 2,00,000 8,17,000
14,25,000
Less: non-trading profits:
Capital profit on the sale of assets ( 3,60,000 + 2,00,000 – 5,00,000) 60,000 60,000
Net profit before manager’s salary & commission = 13, 65,000
- Manager’s salary (12× 5000) 60,000
Net profit before manager’s remuneration 13,05,000
13,05,000  1
Manager’s remuneration @ 1% = = 12,920
100  1
As the manager has already withdrawn 12,000 as commission,
Now the commission payable to manager will be (12,920 – 12,000) = 920
Total remuneration of manager ( 60,000 + 12,920) = 72,920
13,65,000  5
Maximum remuneration to manager @ 5% = = 65,000
100  5
Excess remuneration paid to manager 7,920

Notes
Notes As per the Companies Act, a company cannot pay commission to its managerial
staff on the profit left after charging such commission. But in this illustration, commission
to the manager is paid after charging his commission. Therefore, his commission is
calculated by the following formula:
Example 5: From the following profit and loss a/c of Slow and Steady Ltd., for the year
ended 31st December, 2005, calculate the commission payable to the managing director and
other directors of the company whose commission was fixed @ 5% and 2% respectively on the
profit of the company before charging their commission:
To salaries & wages 10,00,000 By gross profit 25,50,000
To rent, rates & taxes 2,25,000 By bounties and subsidies
Received from government 50,000
To repairs & renewals 30,000
To miscellaneous expenses. 70,000 By profit on sale of fixed assets 40,000
To workmen compensation including By premium on issues of shares 10,000
5,000, legal compensation 12,500
To interest on bank overdraft. 20,000 By profit on sale of forfeited shares 5,000
To director’s fees 9,000
To donation 17,500
To depreciation on fixed assets 50,000
To reserve for redemption of redeemable
Pref. Shares 75,000
To development rebate reserve 50,000
To provision for taxation 5,00,000
26,55,000 26,55,000
Notes
1. Original cost of fixed assets sold 95,000
Written down value of fixed assets sold 70,000
Sale proceeds of fixed assets 1,10,000
2. Donation allowable under Income Tax Act 12,500
3. Depreciation allowable for income tax purpose 40,000

Solution: Notes
Calculation of Net Profit for Managerial
Remuneration u/s 349
Particulars
Net profit as per p. & l. A/c. 5,58,500
Less: non–trading incomes
(i) Capital profit on sale of fixed assets ( 40,000 – 25,000) 15,000
(ii) Premium on issue of shares 10,000
(iii) Profit on sale of forfeited shares 5,000 30,000
5,28,500
Workmen compensation voluntary ( 12,500 – 5,000) 7,500
Excess depreciation on fixed asset ( 50,000 – 40,000) 10,000
Donations ( 17,500 – 12,500) 5,000
Loss on sale of investment 12,500
Reserve for redemption of preference shares 75,000
Development rebate reserve 50,000
Provision for taxation 5,00,000 6,60,000
As per section 309 of the Companies Act, if a company has a managing director, other part-time
directors will be entitled to get a commission @ 1%. Only with the approval of the Central
Government, a higher rate of remuneration can be given to the other directors.
Commission payable to managing director @ 5% on 11,88,500 59,425
Commission payable to other directors @ 2% (given) on 11,88,500 23,770
Example 6: Titu Tyres Limited, having three whole-time directors on its board, the
others being part-time directors earned profits during the year ended 31st march, 2005 to the
tune of 7,50,000 after taking into consideration the following:
Depreciation on Fixed Assets 1,43,400

(depreciation admissible as per Income Tax Rules 98,400)
Provision of Income Tax 3,67,500
capital expenditure included in general expenses charged to
Calculate the maximum remuneration payable to the whole-time directors, assuming that the
remuneration payable to the whole-time directors to be calculated on net profits remaining
after payment of commission to part-time directors, is to be calculated on net profits remaining
after payment of remuneration to whole-time directors.

Notes Solution:
Calculation of Net Profits for Managerial
Remuneration U/S 349
Particulars
Net profit as per p. & l. A/c 7,50,000
Excess depreciation on fixed assets ( 1,43,400 – 98,400) 45,000
Provision for taxation 3,67,500
Capital expenditure included in general expenses 37,500 4,50,000
10% will be the maximum remuneration payable to the whole-time director. This will be
calculated on that profit which is left after charging the commission to part-time directors.
1% will be the maximum remuneration payable to the part–time director and that will be
calculated on the profit left after charging the commission to the whole-time directors.
To compute both remunerations, we assume that the whole-time director’s remuneration is x

and part-time director’s remuneration is y.
 x = 10% of ( 12,00,000 – y) and
y = 1% of ( 12,00,000 – x)
Now we find the following two equations–
10x + y = 12,00,000 …(i)
100y +x = 12,00,000 …(ii)
On multiplying the (ii) equation by 10 and then subtracting it from (i)
10x + y = 12,00,000 …(i)

10x ± 1000y = 120,00,000
– 999y = –108,00,000
108,00,000
y= = 1,811 (approx).
999
On substituting the value of y in the (i) equation –
10x + 10,811 = 12,00,000
10x = 12,00,000 – 10,811
12,00,000  108,11
x 
10
x = 1,18,919 (approx).
Thus, remuneration to whole-time directors 1,18,919

Remuneration to part-time directors 10,811 Notes
Total managerial remuneration 1,29,730
Task The manager of Shanti Ltd., is entitled to annual salary of 35,000 and also a
commission of 5% on the profits available for dividend. Their profit and loss account for
the year ended 31st march, 2006 is as under:
To salaries & wages 2,80,000 By gross profit b/d 15,40,000
To general exps. 1,92,500
To manager’s salary 35,000
To depreciation (including 1,75,000
development Rebate 35,000)
To general reserve 2,10,000
To taxation 3,15,000
15,40,000 15,40,000
Assuming that general expenses are all admissible for tax purpose, income tax and super
tax are to be taken at 50% of the company profits (except capital gains of 30%). Calculate
the manager’s remuneration.
Self Assessment
State whether the following statements are “true” or “false”:
16. Maximum amount of director's fees can be 2,000 per head as per notification of central
government dated 27-8-1993.
17. Director's fees is a part of managerial remuneration.
Select the right alternative:
18. Which section of the Companies Act contains the provisions regarding overall managerial
remuneration?
(a) Section 349
(b) Section 198
(c) Section 387
(d) Section 79.
19. Which section of the Companies Act contains the provision regarding part-time director?
(a) Section 198
(b) Section 387
(c) Section 309(3)
(d) Section 309(4)

Notes 20. Which one of the following items is not included in the managerial remuneration?
(a) Dearness allowance
(b) Salary
(c) Commission
(d) Encashment of leaves

Case Study Managerial Remuneration/Incentives
The Company
A medium sized mortgage broker with 10 sales staff and 4 administration staff - two of
which handle complaints.
Current Practice
Currently the firm’s consultants earn commission for reaching sales targets, and bonuses
on top when certain milestones are passed. No other incentive system operates, but staff
are required to follow FSA Rules on complaint turnaround times.
The TCF Problem
As a result of the sales incentive programme, consultants are encouraged to complete as

many sales as possible in a given timeframe. The risk to customers is that, in their eagerness
to meet targets, advisers may be tempted to sell a suitable product with which they are
familiar when there are others equally or more suitable available for the particular
individual in question. As a result customer choice – and therefore fair treatment - may be
compromised.
At the same time, opportunities to encourage other staff members to implement TCF are
being lost. For example, as things stand staff who deal with customer complaints have no
incentives to spot and report opportunities to improve service and reduce future
complaints. Their only incentive is to turn complaints around within the FSA timeframes.
TCF Solution
Sales
To encourage a more balanced approach to sales, the firm could include risk and service
performance targets in its rewards programme and make it known that it monitors sales
of individual product type against each adviser.
The additional targets might require the consultant to document the range of suitable
products discussed with the client and the reason for the final choice out of these. Consultants
would only qualify for commission on satisfactory completion of these details - which
will be open to scrutiny during file checks and/or if sale statistics suggest undue emphasis
of a broker selling one product type. By making consultants aware that MI will monitor
sales of individual product by consultant the firm will further encourage them to consider
a wider range of similar products and be ready to justify the final choices they make.
Contd...

Complaints Notes
On the complaints side, a simple reward programme to encourage staff to suggest ways to
prevent complaints reoccurring would benefit both customers and the broker. The reward
programme could include points for the number of recommendations made and a financial
reward where a recommendation is implemented and shown through MI to reduce
complaints and improve service in that area.
12.5 Summary
 Profits available for the distribution among the shareholders of a company as dividend

are called divisible profits.
 The profits are calculated by comparing the income and expense of one year.
 The necessary adjustments are made before calculating the profit of a business concern.
 The accounting principles are followed.
 The directors have the right to create provisions, reserves and funds out of
business profits under the articles of association and the Companies Ordinance 1984.
 The remuneration which is paid to the managerial personnel (directors, managing directors
and managers) by the company is called managerial remuneration.
12.6 Keywords
Breach of Contract: Breaking rules of a legal duty.
Preliminary Expenses: All the costs that are incurred when a company is formed.
Remuneration: Money paid for service.
1. Who can be appointed a managing director of a company?
2. What do you mean by managerial remuneration?
3. How is net profit determined for managerial remuneration u/s 349?
4. What are the provisions of remuneration of a part-time director of a public company?
5. What are the provisions regarding the remuneration of a whole-time director u/s 309?
6. What do you mean by managerial remuneration? Describe the provisions relating to

maximum and minimum remuneration.
7. What is the meaning of managerial remuneration? How is the profit calculated for
managerial remuneration? Describe in detail.
8. What provisions have been made in the Companies Act in connection with depreciation
and remuneration of whole-time director? Describe.
9. Describe the provisions of the Companies Act, 1956 as amended up to date relating to the
ascertainment of remuneration of the members of managerial staff.
10. Give the main provisions of company law regarding managerial remuneration.

Notes 11. Net profit to Akash Ltd. is 7,00,000 for the year ending on 31st December, 2005. The
following amounts have also been recorded in the profit and loss a/c:
(a) Bounties received from government 1,00,000
(b) Bonus paid to foreign technicians 75,000
(c) Repair of capital nature 1,25,000
(d) Depreciation (extra shift allowance of 32,500 is included in it) 1,12,500
(e) Provision for taxation 10,00,000
(f) Investment allowance reserve 1,25,000
(g) Compensation paid to an injured employee 20,000
(h) Terminal depreciation of a machine 12,500
(i) profit on sale of investment 20,000
Now find out:
(i) Manager and directors are in the company. Find out maximum remuneration payable
to directors.
(ii) if there is one manager and three other directors in the company, what will be their
maximum remuneration?
12. Following is the profit and loss a/c of Sanjna Ltd. for the year ending 31st December, 2005:
To salaries 4,25,000 By gross profit 6,50,000
To discount 20,000 By profit on sale of machinery 75,000
To carriage outward 10,000
To general expenses 25,000
To interest on unsecured loans 25,000
To provision for tax 45,000
To net profit 1,75,000
7,25,000 7,25,000
Written down value of that machinery whose profit is given in the above p. & l. A/c is
1,00,000. Its cost is 1, 25,000. Find out the maximum remuneration payable to directors
when the company has a whole-time director or managing director or manager.
13. The manager of XYZ Ltd. is entitled to get a salary of 6,250 per month plus 1% commission
on the net profit of the company after such salary and commission. The following is the
profit and loss A/c of the company for the year ended 31st march, 2005:
To salaries, wages & bonus 4,81,250 By gross profit 22,50,000
To general exps. 1,85,000 By subsidy from government 1,50,000
To expenditure on 2,05,000 By profit on sale of assets (cost price 2,50,000
of 6,25,000 and written down value
4,50,000).
Scientific research (cost of an apparatus) 35,000 Contd...

302 To reserve for b/d.

LOVELY PROFESSIONAL43,750
UNIVERSITY
26,50,000 26,50,000
To salaries, wages & bonus 4,81,250 By gross profit 22,50,000
To general exps. 1,85,000 Unit 12: Divisible
By subsidy from government Profits and Managerial Remuneration
1,50,000
To expenditure on 2,05,000 By profit on sale of assets (cost price 2,50,000
of 6,25,000 and written down value
4,50,000).
Scientific research (cost of an apparatus) 35,000 Notes
To reserve for b/d. 43,750
26,50,000 26,50,000
Depreciation as per Income Tax Rules amounts to 2,02,000. Calculate the managerial
remuneration.
14. Following are the relevant balances taken from the books of Shashi Ltd. You are required
to calculate the remuneration of the managing director at 5% of the profit ascertained
according to the Companies Act. Find out the excess amount, if any, paid to him.
Net profit 69,279
Items considered for arriving at the above net profit:
(a) provision for taxation 1,05,455
(b) managing director’s remuneration 13,552
(c ) preliminary expenses 10,500
(d) director’s fees 7,000
(e) provision for doubtful debts 21,000
(f) depreciation 33,810
(g) depreciation allowed as per schedule XIV 31,500
(h) donation to sister concerns 10,500
(i) ex-gratia payment to employees 3,500
15. Determine the maximum remuneration available to the part-time director and manager
of the Ankit Tyres Co. Ltd., (a manufacturing company) under sections 309 and 387 of the
Companies Act, 1956, from the following particulars:
Before charging any such remuneration the profit and loss account showed a credit balance
of 9,90,000 for the year ended 31st December, 2005 after taking into account the following
matters:
(a) capital expenditure 2,25,000

(b) subsidiary received from central government 1,80,000
(c ) special depreciation 30,000
(d) multiple allowance 45,000
(e) bonus to foreign technicians 1,35,000
(f) provision for taxation 12,00,000
(g) compensation paid to injured worker 30,000
(h) ex-gratia payment to an employee 15,000

Notes (i) loss on sale of fixed assets 30,000
(j) profit on sale of investment 90,000
16. Calculate the managerial remuneration from the following particulars of Radha Krishna
& Company Ltd. due to the managing directors of the company at the rate of 5% of the
profits. Also determine the excess remuneration paid, if any:
Net profit is determined after considering the following:
(i) depreciation 1,20,000
(ii) preliminary exps. 35,000
(iii) tax provision 10,85,000
(iv) director’s fees 28,000
(v) bonus 52,500
(vi) profit on sale of fixed assets
(original cost: 70,000, written down value: 38,500) 54,250
(vii) provision for doubtful debts 31,500
(viii) scientific research expenditure (for setting up new machinery) 70,000
(ix) managing director’s remuneration paid 1,05,000
Other Information :
(i) depreciation allowable under schedule XIV of the companies act, 1956 1,22,500
(ii) bonus liability as per Payment of Bonus Act, 1965. 63,000
17. Following is the profit and loss a/c of Lakshmikant & Company Limited for the year
ending 31st march, 2005:
To salaries 63,875 By gross profit 8,75,000
To income-tax 67,375
To depreciation (including 8,750 96,250 By subsidy received form 2,10,000
terminal depreciation) government
To compensation for breach of contract. 14,000 By profit on sale of machinery
To provision for b/d. 3,500 Cost 3,85,000
To general reserve 10,500 Depreciation value 1,22,500
To general expenses 7,000 Sale price 4,37,500 3,15,000
To proposed dividend 43,750
14,00,000 14,00,000
Find out the permissible maximum commission payable for directors from the above
information when:

(a) there is a manager to assist the directors. Notes
(b) there is none other out of the manager, managing director and whole-time director
to assist the directors.
18. Babita Ltd. has 3 whole-time directors on its board, the others being part-time directors.
From the following particulars of the company, calculate the maximum remuneration
payable to the whole-time directors and the part-time directors, assuming that the
remuneration payable to the whole-time directors is to be calculated on net profits
remaining after payment of commission to part-time directors, and the commission to
part-time directors is to be calculated on net profits remaining after payment of
remuneration to whole-time directors.
Profit earned by the company 10,00,000
The above profits have been ascertained after taking into account the following:
Depreciation on fixed assets 1,91,200
Provision for income-tax made 4,90,000
Capital expenditure relating to cost of a showroom has been included in general
Expenses charged to profit and loss a/c 50,000.
You are informed that the depreciation admissible as
Per schedule XIV amounts to 1,31,200.
19. The following was the profit and loss account of Anand & Company Limited as on 31st
March, 2005:
To salaries 1,80,000 By gross profit 9,00,000
To depreciation 1,20,000
To general charges 1,26,000
To general reserve 90,000
To taxation 2,10,000
To net profit 93,000
9,00,000 9,00,000
All the expenses are allowable for taxation. Calculate income tax on company’s profit @
40%. The annual salary of the manager of the company is 24,000. He also gets 3%
commission on divisible profits arrived at after deducting his salary and taxation.
Depreciation includes 30,000 for development rebate. Find out the manager’s
remuneration and income tax.
20. Babli and Company Ltd. employs a manager and three whole-time directors. It pays 5%
commission to the manager and 2% to each whole-time director. The commission payable
to the manager is calculated on the profit left after charging his commission and the
commissions of whole-time directors and the commission payable to the whole-time
directors are calculated on profit left after charging their commission and commission of
manager as per Companies Act after taking into consideration the following information:

Notes Particulars ` Particulars `

To administrative & selling expenses 3,25,000 By gross profit 15,00,000
To bad debts 27,000 By subsidy from central bank 2,00,000
To salary & bonus 1,50,000 By profit on sale of plant 1,50,000
To development rebate reserve 40,000 Cost ` 6,00,000
To income-tax 30,000 Realised ` 7,00,000
To tax on abnormal profits 5,000
To managerial remuneration 75,000
To provision for depreciation 2,50,000
18,50,000 18,50,000
1. True 2. False
3. 5% 4. Shareholder
5. 387 6. 349
7. Effective capital 8. True
9. True 10. True
11. False 12. False
13. False 14. True
15. False 16. True
17. True 18. B
19. D 20. D


Manpreet Kaur, Lovely Professional University Unit 13: Final Accounts for Companies
Unit 13: Final Accounts for Companies Notes
CONTENTS
Objectives
Introduction
13.1 Meaning
13.2 Form and Contents of Balance Sheet
13.2.1 Schedule VI – Part I (see Section 211) Form of

Balance Sheet – A Horizontal Form
13.2.2 Vertical Form of Balance Sheet
13.3 Explanation of Major Items of Liabilities side of the Balance Sheet
13.4 Profit and Loss Account

13.5 Limitations of Financial Statements
13.6 Summary
13.7 Keywords
Objectives
 Explain meaning of final accounts

 Understand form and content of Balance Sheet
 Explain different Schedules of Balance Sheet
 Understand explanations of content items of Balance Sheet

 Explain limitations of Financial Statements
Introduction
It is quite natural that the businessman is interested in knowing whether his business is running
on Profit or Loss and also the true financial position of his business. The main aim of Bookkeeping
is to inform the Proprietor, about the business progress and the financial position at the right
time and in the right way.
In the present unit, you will study about the final accounts of the company. After studying this
unit, you will be able to understand the preparation of profit & loss account and balance sheet of
the company. The unit also discussed about the requirements of Schedule VI concerning the P&L
a/c and balance sheet. Financial statements of companies mean: (i) Profit and Loss Account, and
(ii) Balance Sheet. According to Section 209 of the Indian Companies Act, 1956, it is compulsory
for each and every company to prepare its profit and loss account as well as Balance Sheet. It is
also essential to maintain both the accounts in a proper form which is given in the Schedule VI
Part I and II of the Companies Act.

Notes
Example 1: A company ABC Ltd. is a non-banking financial company. During the financial
year 2009-2010 the company made some expenditure and earned revenue from its business
activities. The company took a loan of ` 100 crore from a bank for its new project during the
same year. In the financial year 2008-2009 the company earned a good amount of profit so the
company decides to hike the salary of its staff by 5% from the financial year 2009-2010. At the end
of the financial year 2009-2010 the company wants to calculate its net earnings/losses and
financial position. The accounts which are prepared to know the net profit/loss and financial
position of the business are called final accounts.
In the present unit, you will study about the final accounts of the company. After studying this
unit, you should be able to understand the preparation of profit & loss account and balance sheet
of the company. The unit also discussed about the requirements of Schedule VI concerning the
P&L a/c and balance sheet. Financial statements of companies mean: (i) Profit and Loss Account,
and (ii) Balance Sheet. According to Section 209 of the Indian Companies Act, 1956, it is
compulsory for each and every company to prepare its profit and loss account as well as Balance
Sheet. It is also essential to maintain both the accounts in a proper form which is given in the
Schedule VI Parts I and II of the Companies Act.
13.1 Meaning
To prepare final account by the sole trader or partnership firm is not a statutory obligation. But
as per Section 210 of the Companies Act, it is compulsory for every registered company to
prepare the final accounts. Final account of company includes Profit and Loss A/c, and Balance
Sheet. Profit and Loss Account is a combined account of Trading Account Profit and Loss Account
and Profit and Loss Appropriation Account. The general principles of preparing sheet of a
company are the same as used in the case sole trader or partnership firm. But in addition to these
principles, a company must conform to legal provisions in the Indian Companies Act, 1956
relating to the preparation of final accounts. The provision relating to the maintenance,
publication, form and contents of final accounts are given in the Sections 209 to 233 of the
Companies Act, 1956. A brief description of these sections is given below:
As per Section 209 of Indian Companies Act 1956, a company has to keep proper accounts
regarding (i) all receipts and disbursements of money (ii) all sales and purchases of goods (iii)
all assets and liabilities (iv) particulars relating to the utilization of material and labour, etc. (in
case of a manufacturing concern).
Section 210 is relating with the preparation and presentation of final account of a company. As
per this section-
1. “At every annual general meeting of company held in pursuance of Section 166, the Board
of Directors of the Company shall lay before the company:
(i) The balance sheet as at the end of the period specified in sub-section (3) and
(ii) A profit and loss account of that period.
2. In case of a company not carrying on business for profit, an income and expenditure
account shall be laid before the company at its annual general meeting instead of profit
and loss account, and all references to ‘profit and loss’ in this section and elsewhere in this
Act, shall be construed, in relation to such a company, as reference respectively to the
‘income and expenditure account’, and the ‘excess of expenditure over income’.
3. The profit and loss account shall relate to–
(i) The meeting of a company, to the period beginning with the incorporation of the
company and ending with a day which shall not precede the day of meeting by more
than nine months, and

Unit 13: Final Accounts for Companies
(ii) In case of any subsequent annual general meeting of the company, to the period Notes
beginning with the day immediately after the period for which the account was last
submitted and ending with a day which shall not precede the day of the meeting by
more than six months, or in cases where an extension of the meeting under the
second proviso to the sub-section (1) of Section 166, by more than six months and the
extension so granted.
4. The period to which the account aforesaid relates, is referred to in this Act as a ‘financial
year’ and it may be less or more than a calendar year, but it shall not exceed fifteen
months:
Provided that it may extend to eighteen months, where special permission has been
granted in that behalf by the Registrar.
As per Section 211 every profit and loss account and balance sheet of a company must show ‘true
and fair’ picture of the state of affairs of the company. For this, the balance sheet must be in the
form set out in the Part I of the Schedule VI and the requirements for the preparation of Profit
and Loss account given in the Part II of this Schedule must be followed.
!
Caution To prepare final account by the sole trader or partnership firm is not a statutory
obligation. But as per Section 210 of the Companies Act, it is compulsory for every registered
company to prepare the final accounts.
As per Section 212 of the Companies Act if any company is a holding of another company, the
holding company has to attach with its balance sheet the following documents relating to its
subsidiary company.
(a) A copy of balance sheet and profit and loss account of the subsidiary company.
(b) A copy of Director’s Report.
(c) A copy of Auditor’s Report
(d) A statement of the holding company’s interest in the subsidiary company.
Section 213 deals the extension of the financial year of the holding company and its subsidiary
company.
The provisions of Section 214 relate to the rights of holding company’s representative and
members to inspect the books of accounts of the subsidiary company.
Section 215 relates to the authentication of balance sheet and the profit and loss account of a
company. As per the provisions of this section the final accounts of a company shall be signed on
the behalf of the board of directors by its manager or the secretary, if any, and by not less than
two directors of the company, one of whom shall be a managing director, where there is one.
As per the Section 216 of the Companies Act, the profit and loss account shall be treated as an
annexure to the balance sheet the auditor’s report as an enclosure thereto.
Section 217 provides that Auditor’s Report and Director’s Report shall be attached to the Balance
Sheet laid before the shareholders in the general meeting.
As per Section 218 there would be a penalty for improper issue, circulation or publication of
Balance Sheet or Profit and Loss account.
Section 219 deals with the right of the member to obtain copies of Balance Sheet and Profit and
Loss Account, Auditor’s Report and every other document required by law to be annexed or
attached to the Balance Sheet which is to be presented in the general meeting.

Notes Section 220 is relating with the filing of accounts with register. As per this section three copies of
Balance Sheet, Profit and Loss A/c, and all other documents which are attached with the Balance
Sheet shall to be filed with the Registrar within thirty days after the annual general meeting.
Did u know? As per Section 212 of the Companies Act if any company is a holding of
another company, the holding company has to attach with its balance sheet the following
documents relating to its subsidiary company.
Task Discuss the rulings of different sections come under this final accounts of a company.
13.2 Form and Contents of Balance Sheet
Meaning of Balance Sheet
The balance sheet of a company is a statement which shows the total value of assets owned and
total of the company’s liabilities owed by of trading on a particular date or at the end of trading
period. Balance Sheet is also called the statement of assets and liabilities and net worth. Section
211 of the Companies Act provides that the Balance Sheet of the company shall give true and fair
view of the state of affairs of the company as at the end of the financial year. True and fair view
means that there should be no window-dressing on any item of the balance sheet. For the true
and fair view of the state of affairs of the company, assets and liabilities should be correctly
given, provisions should be shown in the sufficient amount, contingent assets and contingent
liabilities should be given as notes of the Balance Sheet and stock should be valued on the basis
of accounting principles.
According to Section 211(1) every balance sheet of the company shall be prepared in the form set
out in Part I of Schedule VI or as near thereto as circumstances permit, or in such other form as
may be laid down by the Central Government either generally or in a particular case. This Part
further states that in preparing the Balance Sheet due regard shall be had, as far as may be, to the
general instructions for preparation of Balance Sheet under the heading ‘Notes’ at the end of the
Part. Provisions of this Section do not apply to Banking. Insurance and Electricity Generation
and Supplying Companies because the Form of Balance Sheets of these companies are given in
the Act governing such class of companies. There are given two alternative formats of the
Balance Sheet in Part I of Schedule VI. These are the Horizontal form and the Vertical Form.
Companies are free to choose any one of these forms. Mostly, companies adopt the Horizontal
Form of Balance Sheet. These forms of Balance Sheet are given in Part I of Schedule VI of the
Companies Act given below:
13.2.1 Schedule VI – Part I (see Section 211) Form of Balance Sheet –

A Horizontal Form
(The balance sheet of a company shall be in Horizontal form or Vertical form)

Balance Sheet of ................ (Here, enter the name of company) as at ................ (Here, enter the date
at which the balance sheet in made out.)

Figures Figures Figures Figures Notes

for the of the for the for the
Liabilities Assets
previous current previous current
year ` year ` year ` year `
Share Capital Fixed Assets
Authorised ...... shares of ` each. Distinguishing as far as possible
Issued: (distinguishing between between expenditure upon:
the various classes of capital and (a) goodwill
stating the particular specified
(b) land
below, in respect of each class.)—
— shares of `———each. (c) buildings
Subscribed: (distinguishing (d) leaseholds
between the various classes of (e) railways sidings
capital and stating the particular (f) plant and machinery
specified below, in respect of each (g) furniture and fittings
class) — shares of ` — each ` ——
called up. (Of the above shares — (h) development of property
shares are allotted as fully paid (i) patents, trade marks and
up pursuant without payments designs
being received in cash). (j) livestock and
(Of the above shares —— shares (k) vehicles, etc.
are allotted as fully paid up Under each head the original
pursuant to a contract without cost and the additions thereto
payments being received in cash). and deductions therefrom
(Of the above shares —— shares during the year, and the total
are allotted as fully paid up by depreciation written off or
way of bonus shares). provided up to the end of the
Specify the source from which year is be stated. Depreciation
bonus shares are issued e.g. written off or provided shall be
capitalization of profits or
allotted under the different
Reserve or from shares Premium
assets heads and deducted in
Account. arriving at the value of Fixed
Less: Calls unpaid Assets. [Also see note (11)] In
(i) By directors. every case where the original
(ii) By others. cost cannot be ascertained,
without unreasonable expenses
Add: Forfeited shares: (Amount
or delay, the valuation shown
originally paid up) (Any capital
by the books is to be given. For
profit on reissue of forfeited
the purpose of this paragraph
shares should be transferred to
such valuation shall be the net
Capital Reserve)
amount at which an asset stood
in the company’s books at the
commencement of this Act after
deduction of the amounts
previously provided or written
off for depreciation of
diminution in value, and where
any asset is sold, the amounts of
sale proceeds shall be shown as
deduction.
Notes: 1. Terms of redemption or Where sums have been written
conversion (if any) of any off on a reduction of capital or a
redeemable preference capital are revaluation of assets, every
to be stated together with earliest balance sheet, (after the first
date of redemption or conversion. balance sheet) subsequent to the
2. Particulars of any option on reduction or revaluation shall
unissued share capital are to be show the reduced figures with
specified. the date of the reduction in
3. Particulars of the different place of the original cost. Each
classes of preference shares are to balance sheet for the first five
be given. These particulars are to years subsequent to the date of
be given along with shares capital the reduction, shall show also
In the case of subsidiary the amount of the reduction
companies, the number of shares made.
held of the holding company as Similarly, where sums have
well as by the ultimate holding been added by written up the
company and its subsidiaries assets, every balance sheet
shall be separately stated in subsequent to such writing up
respect of subscribed share shall show the increased figure
Contd...
capital. The auditor is not with the date of the increased in
required to certify the correctness place of the original cost. Each
of such share holding as certified balance sheet for the first five
by the management. years subsequent to the date of
the written up shall also show
LOVELY PROFESSIONAL
the amount ofUNIVERSITY
increase made. 311
Explanation: Nothing contained
in the preceding two paragraphs
shall apply to any adjustment
made in accordance with the
second paragraph.
Reserve and Surplus: Investment:
(1) Capital Reserve. Showing nature of investment
(2) Capital Redemption Reserve. and mode of valuation, for
3. Particulars of the different place of the original cost. Each
classes of preference shares are to balance sheet for the first five
be given. These particulars are to years subsequent to the date of
be given along with shares capital the reduction, shall show also
In the case of subsidiary the amount of the reduction
Accounting for Companies-I companies, the number of shares made.
held of the holding company as Similarly, where sums have
well as by the ultimate holding been added by written up the
company and its subsidiaries assets, every balance sheet
shall be separately stated in subsequent to such writing up
Notes respect of subscribed share shall show the increased figure
capital. The auditor is not with the date of the increased in
required to certify the correctness place of the original cost. Each
of such share holding as certified balance sheet for the first five
by the management. years subsequent to the date of
the written up shall also show
the amount of increase made.
Explanation: Nothing contained
in the preceding two paragraphs
shall apply to any adjustment
made in accordance with the
second paragraph.
Reserve and Surplus: Investment:
(1) Capital Reserve. Showing nature of investment
(2) Capital Redemption Reserve. and mode of valuation, for
(3) Shares Premium Account example, cost or market value
(showing details of its utilization and distinguishing between-
in the manner provided in Section (1) Investment in Government
78 in the year of utilization). or Trust Securities
(4) Other Reserve specifying the (2) Investment in shares,
nature of each Reserve and the debentures or bonds. (Showing
amount in respect thereof. separate shares fully paid up
Less: Debit balance in profit and and partly paid up and also
loss account (if any). (The debit distinguishing the different
balance in the Profit and Loss classes of shares and showing
Account shall be shown as a also in similar detail, investment
deduction from the uncommitted in shares, debentures or bonds
reserve, if any). details of subsidiary
companies).
(5) Surplus, i.e. balance in profit
and loss account after providing (3) Immovable properties
for proposed allocations namely: (4) Balance of the investments in
Dividend Bonus or Reserve. the capital partnership firm.
(6) Proposed additions to (5) Balance of unutilized monies
Reserves. raised by issue. (Aggregate
(7) Sinking Funds (Additions and amount of the company’s
deductions since last balance quoted investment and also the
sheet to be shown, under each of market value thereof shall be
the specified heads. The word shown).
‘Fund’ in relation to any (Aggregate amount of the
“Reserve” should be used only company’s unquoted
where such Reserve is specifically investments shall also be
represented by earmarked shown). (All unutilized monies
investments). out of issue must be separately
disclosed in the Balance Sheet of
the company) indicating the
manner in which such
unutilized funds have been
invested.
Secured Loans: Current Assets’ Loans
(1) Debentures and Advance:
(2) Loans and Advance from (A) Current Assets (1) Interest
Banks accrued in Investment (2) Store
(3) Loans and Advance from and spare paid (3) Loose Tools
Subsidiaries. (4) Stock-in-Trade (5) Work-in-
(4) Other Loans and Advance Progress [In respect of (2) and
(Loans from directors and/or (4), mode of valuation of stock
manager should be shown shall be stated and the amount
separately). Interest accrued and in respect of raw materials shall
due on Secured Loans should be also be stated separately where
included under the appropriate practicable. Mode of valuation
sub-heads under the head of work-in-progress shall be
“Secured Loans”. stated].
The nature of security to be (6) Sundry Debtors–(a) Debts
specified in each case. outstanding for a period
exceeding six months. (b) Other
Where loans have been
debts Less: Provision (The
guaranteed by manager and/or
amounts to be shown under
directors, a mountain thereof,
Sundry Debtors shall include
shall also be made and also the
the amount due in respect of
aggregate amount of such loans
goods sold or service rendered Contd...
under each head. In case of
or in respect of other contractual
Debentures, terms of redemption
obligations but shall not include
or conversion (if any) are to be
the amounts which are in the
stated together with earliest date
nature of loans or advances).
312 ofLOVELY
redemptionPROFESSIONAL
or conversion. UNIVERSITY In regard to Sundry Debtors
Unsecured Loans:
particulars to be given
1. Fixed Deposits separately of-
(2) Loans and Advance from (a) Debts considered good and
Subsidiaries. in respect of which the company
(3) Short-term Loans and is fully secured.
Advance. (b) Debts considered good for
(a) From Banks (b) From Others which the company holds no
(Short-term loans include those security other than the debtor’s
due on Secured Loans should be
included under the appropriate practicable. Mode of valuation
sub-heads under the head of work-in-progress shall be
“Secured Loans”. stated].
(6) Sundry Debtors–(a) Debts
The nature of security to be outstanding for a period
specified in each case. exceeding six months. (b) Other Unit 13: Final Accounts for Companies
Where loans have been debts Less: Provision (The
guaranteed by manager and/or amounts to be shown under
directors, a mountain thereof, Sundry Debtors shall include
shall also be made and also the the amount due in respect of
aggregate amount of such loans goods sold or service rendered Notes
under each head. In case of or in respect of other contractual
Debentures, terms of redemption obligations but shall not include
or conversion (if any) are to be the amounts which are in the
stated together with earliest date nature of loans or advances).
of redemption or conversion. In regard to Sundry Debtors
Unsecured Loans: particulars to be given
1. Fixed Deposits separately of-
(2) Loans and Advance from (a) Debts considered good and
Subsidiaries. in respect of which the company
(3) Short-term Loans and is fully secured.
Advance. (b) Debts considered good for
(a) From Banks (b) From Others which the company holds no
(Short-term loans include those security other than the debtor’s
which are due for repayment not personal security; and
late than one year as at the date of (c) Debts considered doubtful or
the balance sheet). bad. Debts due by directors or
(4) Other Loans and Advance other officers of the company
any of either severally or jointly
(a) From Banks (b) From Others
with any other person, or debts
(Loans from directors and/or due by firms or private
manager should be shown companies respectively in which
separately). any director is a partner or a
Interest accrued and due on director or a member to be
Unsecured Loans should be separately stated.
included under the appropriate Debts due from other companies
sub-head “Unsecured Loans” under the same management
where Loans have been within the meaning of sub-
guaranteed by manager and/or section (IB) of Section 370 to be
directors, a mention thereof shall disclosed with the names of the
be made together with the companies. The maximum
aggregate amount of such loans amount due by directors or
under each head. other officers of the company at
Current Liabilities and any time during the year to be
Provisions: shown by way of a note. The
(A) Current Liabilities provision to be shown under
1. Acceptance this head should not exceed the
amount of debts stated to be
2. Sundry Creditors
considered doubtful or bad and
3. Subsidiary Companies
any surplus of such provision, if
4. Advance Payments and already created, should be
unexpired discounts for the shown at every closing under
portions for which value has still “Reserve and Surplus” (in the
to be given e.g. in the case of the Liabilities side) under a separate
following classes of companies: sub- head “Reserve for Doubtful
Newspaper’s Fire Insurance, or Bad Debts.” (7A) Cash
Theatres, Clubs, Banking, balance on hand. (7B) Bank
Steamship Companies etc. balance-(a) with Scheduled
5. Unclaimed Dividends Banks and (b) with other. In
6. Other Liabilities (if any) regard to bank balance,
7. Interest accrued but not due on particulars to be given
loans. separately of- (i) the balance
lying with scheduled Banks on
(B) Provision
current account, call accounts
1. Provision for Taxation and deposit account. (ii) the
2. Proposed Dividend names of the bankers other than
3. For Contingencies scheduled Banks and the
4. For Provident Fund Scheme. balance lying with each such
5. For Insurance, Pension and banker on current accounts, call
similar staff benefit schemes. account and deposit accounts
and the maximum amount
6. Other Provision: A foot-note to
outstanding at any time during
the balance sheet may be added to
the year with each such bankers;
show separately:-
and (iii) the nature of the
1. Claims against the company interest, if any, of any director
not acknowledged as debts. or his relative in each of the
2. Uncalled liability on shares bankers [other than Scheduled
partly paid. Bankers referred in (ii) above.]
3. Arrears of fixed cumulative (iv) all unutilized monies out of
dividend. (The period for which the issue must be separately
the dividend are in arrear or if disclosed in the Balance Sheet of Contd...
there is more than one class of the company indicating the
shares, the dividend on each such manner in which such
class that are in arrear, shall be unutilized funds have been
stated. The amount shall be stated invested.
before deduction of income tax, (B) Loans andUNIVERSITY
LOVELY PROFESSIONAL Advance 313
except that in the case of tax and (8) (a) Advances and loans to
free dividends the amount shall subsidiaries. (b) Advances and
be shown free of income tax; the loans to partnership firms in
fact that is it is so shown shall be which the company or any
stated). subsidiaries is a partner (9) Bills
4. Estimated amount of contract of Exchange (10) Advance
remaining to be executed on recoverable in cash or in kind or
capital account and not provided for value to be received. e.g.
for. Rates, Taxes, Insurance etc. (11)
3. Arrears of fixed cumulative (iv) all unutilized monies out of

dividend. (The period for which the issue must be separately
Notes the dividend are in arrear or if disclosed in the Balance Sheet of
there is more than one class of the company indicating the
shares, the dividend on each such manner in which such
class that are in arrear, shall be unutilized funds have been
stated. The amount shall be stated invested.
before deduction of income tax, (B) Loans and Advance
except that in the case of tax and (8) (a) Advances and loans to
free dividends the amount shall subsidiaries. (b) Advances and
be shown free of income tax; the loans to partnership firms in
fact that is it is so shown shall be which the company or any
stated). subsidiaries is a partner (9) Bills
4. Estimated amount of contract of Exchange (10) Advance
remaining to be executed on recoverable in cash or in kind or
capital account and not provided for value to be received. e.g.
for. Rates, Taxes, Insurance etc. (11)
5. Other moneys for which the Balance with customs, Port
company is contingently liable. Trust etc. (where payable on
(The amount of any guarantee demand). The instructions
given by the company on behalf regarding Sundry Debtors apply
of directors or other officers for to “Loans and Advance” too.
the company shall be stated and The amounts due form other
where practicable the general companies under the same
nature and amount of each such management; within the
contingent liabilities, if material, meaning of sub-section (IB) of
shall also be specified). Section 370 should also be given
with the name of
companies the maximum
amounts due from every one of
these at any time during the
year must be shown.
Miscellaneous Expenditure
(To the extent not written off or
adjusted).
1. Preliminary expenses.
2. Expenses including
commission or brokerage on
underwriting or subscription of
shares or debentures.
3. Discount allowed on the issue
of shares or debentures.
4. Interest paid out of capital
during construction (also stating
the rate of interest).
5. Development expenditure not
adjusted.
6. Other sums (specifying
nature)
Profit and Loss Account (Show
here the debit balance of profit
and loss account carried
forward after deduction of the
uncommitted reserve, if any).
Notes
1. Paise can also be given in addition to Rupees, if desired.
2. Dividend declared by subsidiary companies after the date of the balance sheet should
not be included, unless they are in respect of a period which closed on or before the
date of the balance sheet.
3. Any reference to benefit expected from contracts to the extent not executed shall be
not made in the balance sheet but shall be made in the Board’s report.
4. Particulars of any redeemed debentures which the company has power to issue
should be given.
Contd...

5. Where any of the company’s redeemed debentures are held by a nominee or a Notes
trustee for the company, the nominal amount of the debentures and the amount at
which they are stated in the books of the company shall be stated.
6. A statement of investment (whether shown under: “Investment” or “Current Assets”
as Stock-in-trade) separately classifying trade investment and other investments
should be annexed to the balance sheet, showing the names of the bodies corporate
(including separately the name of the bodies corporate under the same management),
in whose shares or debentures, investments have been made (including all
investments whether existing or not, made subsequent to the date as on which the
previous balance sheet was made out); and the nature and extent of the investment
so made in each body corporate: provided that in the case of an investments company,
that is to say, a company whose principal business is the acquisition of shares, stock,
debentures or other securities, it shall be sufficient if the statement shows only the
investments existing on the date as on which the balance sheet has been made out. In
regard to the investment in the capital of partnership firm, the names of the firms
(with the names of all their partners, total capital and the shares of each partner)
shall be given in the statement.
7. If, in the opinion the Board, any of the current assets, loans and advances do not have
a value on realization in that ordinary course of business at least equal to the amount
at which they are stated, the fact that the Board is of that opinion shall be stated.
8. Except in the case of the first balance sheet laid before the company after the
commencement of the Act, the corresponding amounts of the immediately preceding
financial year for all items shown in the balance sheet shall be also given in the
balance sheet. The requirements in this behalf shall, in case of companies preparing
quarterly or half yearly account, etc., relate to the balance sheet for the corresponding
date in the previous year.
9. Current account with Directors and Manager, whether they are in credit or debit,
shall be shown separately.
10. The information required to be given under any of the items or sub-items in the
Form, if cannot be conveniently included in the balance sheet itself, shall be furnished
in a separate Schedule or Schedule to be annexed to any form part of the balance
sheet. This is recommenced when the items are numerous.
11. Where the original coat (of fixed assets) and additions and deduction thereto, relate
to any fixed assets which have been acquired from a country outside India, and in
consequence of a charge in the rate of exchange at any time after the acquisition of
such assets, there has been an increase or reduction on the liability of the company,
as expressed in Indian currency, for making payment towards the whole or a part of
the cost of the asset, or for repayment of the whole or a part of monies borrowed by
the company from any person, directly, in any foreign currency specifically for the
purpose of acquiring the asset (being in either cause the liability existing immediately
before the date on which the change in the rate of exchange takes effect), the amount
by which the liabilities are so increased or reduced during the year, shall be added
to, or as the case may be, deducted from the cost, and amount arrived at after such
addition or deduction shall be taken to the cost of the fixed assets.
!
Caution According to Section 211(1) every balance sheet of the company shall be prepared
in the form set out in Part I of Schedule VI or as near thereto as circumstances permit, or in
such other form as may be laid down by the Central Government either generally or in a
particular case.
Explanation 1: This paragraph shall apply in relation to all balance sheets that may be made out
as on the 6th day of June, 1966 or any day thereafter and where, at the date of issue of the

Notes notification of the Government of India, in the Ministry of Industrial Development and Company
Affairs (Department of Company Affairs) G.S.R. No. 129, dated the 3rd day of January, 1968 any
balance sheet in relation to which the paragraph applies has already been made in the first
balance sheet made out and laid before the company in its annual general meeting, the adjustment
referred to in this paragraph may be made out after the issue of the said notification.
Explanation 2: In this paragraph unless the context otherwise requires, the expression “rate of
exchange”, “Foreign currency” and “Indian currency” shall have the meanings respectively
assigned to them under sub-section (1) of Section 43A of the Income Tax Act (XLII of 1961) and
Explanation 2 and Explanation 3 of the said sub-section shall as far as may apply in relation to
the said paragraph, as they apply to the said sub-section (1).
Did u know? Except in the case of the first balance sheet laid before the company after the
commencement of the Act, the corresponding amounts of the immediately preceding financial
year for all items shown in the balance sheet shall be also given in the balance sheet.
13.2.2 Vertical Form of Balance Sheet

Name of Company ...................................
Balance Sheet as at ...................................
Figures as at the end Figures as at the end of the
Schedule No.
of the current year previous financial year
I Sources of Fund
1. Shareholder’s Funds
(a) Capital ................................ ..................... ..................... .....................
(b) Reserve and Surplus............................... ..................... .....................
2. Loan Funds
(a) Secured loans................................ ........... ..................... .....................
(b) Unsecured loans................................ ...... ..................... .....................
Total
II Applications of Funds
1. Fixed Assets
(a) Gross Block ................................ .............. ..................... .....................
(b) Less Depreciation................................ .... ..................... .....................
(c) Net Block................................ ..................
(d) Capital Work-in-Progress ......................
2. Investment
3. Current Assets, Loans and Advances
(a) Inventories ................................ .............. ..................... .....................
(b) Sundry Debtors ................................ ...... ..................... .....................
(c) Cash and Bank Balance .......................... ..................... .....................
(d) Other current Assets .............................. ..................... .....................
(e) Loans and Advance ............................... ..................... .....................
Less: Current liabilities And provisions
(a) Liabilities ................................ ................. ..................... .....................
(b) Provision ................................ ................. ..................... .....................
Net Current Assets
4. (a) Miscellaneous expenditure to
the extent not written off or
adjusted ................................ ................... ..................... .....................
(b) Profit and loss Account ......................... ..................... .....................
Total ..................... .....................

Notes
Notes
1. Details under each of the above items shall be given in separate Schedule. The
Schedules shall incorporate all the information required to be given under Part IA
of the Schedule VI read with Notes containing General Instructions for preparation
of Balance Sheet.
2. The Schedules referred to above, according polices and explanatory notes that may
be attached shall form an integral part of the balance sheet.
3. The figures in the balance sheet may be rounded to the nearest “000” or “00” as may
be convenient or may be expressed in terms of decimals of thousands.
4. A footnote to the balance sheet may be added to show separately contingent liabilities.
By notification No. GSR 388(E) dated May 15, 1995; the Central Government has
inserted Part IV in the Schedule VI to the Act.
Self Assessment
Fill in the blanks:
1. The Board of Directors is required to present its Profit and Loss Account and Balance Sheet
in every ………………… of the company.
2. The first Profit and Loss Account can be prepared from the date of incorporation upto a
period which initially cannot be more than ………………… after closing the accounts.
3. Preparation of balance sheet in the prescribed format is required u/s ................... of the
Companies Act.
4. If the rate of proposed divided does not exceed ................... no transfer of profit to reserve
will be compulsory.
5. Capital Redemption Reserve and ................... can be utilized only for the issue of fully paid
bonus shares and not meeting the partly paid equity shares into ....................
13.3 Explanation of Major Items of Liabilities Side of the Balance Sheet
1. Share Capital: Under the heading of Shares Capital, Authorised, Issued, Subscribed, Called
up and Paid up Capital are disclosed. If the company has issued the preference shares,
Preference Capital is also showed separately under this heading. These capital are given
stating the number and nominal value of the shares. Shares allotted for consideration other
than cash, shares issued as bonus shares and calls in advance are also shown separately. Calls
in arrear (the unpaid calls) are disclosed as deduction from the amount of called up capital.
2. Reserve & Surplus: Under this heading, the following items are shown separately:
(i) Capital Reserve
(ii) Capital Redemption Reserve
(iii) Securities Premium
(iv) Other Reserve

Notes (v) Sinking Fund
(vi) Surplus of Profit and Loss A/c.
Increase and decrease in the above reserves during the previous year should be shown
clearly. There is a difference between reserve and fund. When a reserve is invested in the
outside investment, that reserve is called fund.
3. Secured Loans: The loans which are secured against some tangible assets of the company
are called secured loans. If some secured loans are taken by directors, managing directors
and manager, those should be shown separately. Debentures are always secured because
they have floating charge or fixed charge on the assets of the company. Therefore these are
shown under this heading. If the company has taken a secured loans from a bank or
subsidiary company etc. that also should be disclosed under this heading. The nature of
security of the loan should also be given in each case. Interest accrued and due on the
secured loans is also shown under this head, but interest accrued but not due is not shown
here. Interest accrued but due is shown under current liabilities of this side of the balance
sheet. If the loans have been guaranteed by the manager or directors, this fact should also
mentioned in the Balance Sheet.
4. Unsecured Loans: The loans which do not carry any charge an the assets are called unsecured
loans. Fixed deposits and loans and advances from banks are included in the unsecured
loans. Unsecured loans are divided into two – (i) Long-term loans (ii) Short-term loans.
Loans which are taken for one year or less than one year, are called short-term loans. The
loans for more than one year are called long-term loans. Long-term loans and short-term
loans are shown separately; loans given by directors or manager should be shown
separately. ‘Interest accrued and due’ should be shown with the respective loans but
“interest accrued and not due” is shown in the current liabilities.
5. Current Liabilities & Provision: The following two sub-headings are included under this
head-
(a) Current liabilities; and
(b) Provision
Current liabilities are those which are payable within one year. These liabilities include
Bills Payable, Sundry Creditors, Advance Payments, Unclaimed Dividend etc. All these
are shown separately. In part (b) of this heading, Provision for Taxation, Proposed
Dividends, Provision for Contingencies. Provision for Employees Provident Fund and
Insurance Plans are shown separately.
13.4 Profit and Loss Account
Any standard form of profit and loss account or income statement is not prescribed in the
Companies Act, 1956. In the case of a company only one account (known as Profit and Loss A/c),
is maintained to calculate profit or loss. This account is divided into three parts. Its first part
contains all items of trading account, the second part profit and loss account and the third part
profit and loss appropriation account. As per Section 211(2) in every profit and loss account a
company shall give true and fair view of the profit and loss of the company for the financial year
and comply with the requirement of Part II of Schedule VI so far as they are applicable thereto
and disclose information accordingly. The requirement of this part does not apply to banking,
insurance and electricity-supplying companies as the forms of profit and loss account of these
companies are specified in the separate Acts governing such class of companies.

The student should note that there is no fundamental difference between the preparation of Notes
Trading and Profit and Loss A/c, for a sole trader, partnership firm or a company. The same
principles are adopted as all the expenses to earn an income in the concerned period are debited
in the Profit and Loss Account. Similarly, all the incomes in the revenue nature of the concerned
period are credited. And all the losses due to accident or depreciation in the value of assets due
to wear and tear and passage of time should be debited.
In spite of there being so many similarities, there are some difference which are listed below-
(a) Sole traders or partnership firms give the heading Trading and Profit and Loss A/c., while
companies give the heading Profit and Loss A/c, only.
(b) A company divides its profit and loss account into two i.e., profit and loss account proper
and profit and loss appropriation account, while in case of sale trader or partnership firm
it is not done so.
(c) Some special items such as interest on debentures, director’s fees etc., also appear in the
profit and loss account of a company while these do not appear in the case of profit and
loss account of a firm or sole trader.
(d) Income tax on profit is assumed an expenses in the case of a company, while it is not so in
the case of a firm or sole trader.
(e) Profit or losses of a non-corporate body are transferred to the capital account (or current
account of partners) while in the case of a company these are kept in a separate account.
(f) Part II of Schedule VI of the Companies Act, governs all the requirement of a profit and
loss account of a company. The profit and loss account should also be prepared as per
guidance of AS-1 Disclosure of Accounting Policies, AS-4 Contingencies and Events
Occurring after the Balance Sheet date and AS-5 Prior Period and Extraordinary Items and
Changes in Accounting Policies.
Contents of Profit and Loss Account
As per Part II of Schedule VI of the Companies Act, 1956, the following are the requirements as
to profit and loss account:
Requirements as to Profit and Loss Account
1. The provision of this part shall apply to the income and expenditure account referred to in
sub section (2) of Section 210 of the Act, in a likewise manner as they apply to a profit and
loss account, but subject to the modification of reference as specified in that sub-section.
2. The profit and loss account (a) shall be so made out as to clearly disclose the result of the
working of the company during the period covered by the account, and (b) shall disclose
every material feature including credits or receipts and debits or expenses in respect of
non-recurring transactions or transactions of an exceptional nature.
3. The profit and loss account shall set out the various items relating to the income and
expenditure of the company arranged under the most convenient heads; and in particular,
shall disclose the following information in respect of the period covered by the account:
(i) (a) The turnover, that is, the aggregate amount for which sales are effected by the
company, giving the amount of sales in respect of each class of goods dealt
with by the company and indicating the quantities of such sales for each class
separately.

Notes (b) Commission paid to sole selling agents within the meaning of Section 294 of
the Act.
(c) Commission paid to other selling agents.
(d) Brokerage and discount on sales, other than the usual trade discount.
(ii) (a) In the case of manufacturing companies :
(1) The value of the raw material consumed, giving items-wise break up
and indicating the quantities thereof. In this break-up, as far as possible,
all-important basic raw materials shall be shown as separate items. The
intermediates of components procured from other manufacturers may,
if their list is too large to be included in the break-up, be grouped under
suitable headings without mentioning the quantities, provided all those
items, which in value individually account for 10% or more to the total
value of the raw material consumed, shall be shown as separate and
distinct items with quantities thereof in the break-up.
(2) The opening and closing stock of goods produced giving break-up in
respect of each class of goods and indicating the quantities thereof.
(b) In the case of trading companies, the purchases made and the opening and
closing stocks, giving break-up in respect of each class of goods traded in by
the company and indicating the quantities thereof.
(c) In the case of companies rendering or supplying services, the gross income,
derived from services rendered or supplied.
(d) In the case of a company, which falls under more than one of the categories
mentioned in (a), (b) and (c) above, it shall be sufficient compliance with the
requirements therein, if the total amounts are shown in respect of the opening
and closing stocks, purchase, sales and consumption of raw material with
value and quantitative break-up and the gross income from services rendered
is shown.
(e) In the case of other companies, the gross income derived under different
heads.
Notes
1. The quantities of raw materials, purchases, stocks and the turnover, shall be expressed
in quantitative denominations in which these are normally purchased or sold in the
market.
2. For the purpose of the items (ii) (a), (ii) (b), (ii) (d) the items for which the company
is holding separate industrial licenses, shall be treated as separate classes of goods,
but where a company has more than one industrial license for production of items
covered, or the same items at different places or for expansion of the licensed capacity,
the items covered by all such licenses shall be treated as one class. In the case of
trading companies, the imported items shall be classified in accordance with the
classification adopted by the Chief Controller of Imports and Export in granting the
import licenses.
Contd...

3. In giving the break-up of purchase stock and turnover, items like spare parts and Notes
accessories, the list of which is too large to be included in the break-up, may be
grouped under suitable headings without quantities, provided all those items, which
in value individually account for 10% or more of the total value of the purchase,
stock or turnover, as the case may be, are shown as separate and distinct items with
quantities thereof in the breakup.
(iii) In the case of all concerns having work in progress the amounts for which such
works have been completed at the commencement and at the end of accounting
period.
(iv) The amount provided for is not made by means of a depreciation, renewals or
diminution in the value of fixed assets.
If such provision is not made by means of a depreciation charge, the method adopted
in making such provision.
If no provision is made for depreciation, the fact that no provision has been made
shall be stated and the quantum of arrears of depreciation computed in accordance
with Section 205(2) of the Act shall be disclosed by way of a note.
(v) The amount of interest on the company’s debentures and other fixed loans, that is to
say, loans for fixed assets periods, stating separately the amount of interest, if any,
paid or payable to the managing director and the manger, if any.
(vi) The amount of charge for Indian Income tax and other Indian taxation on profits,
including, where practicable, with Indian income tax, any transaction proposed
elsewhere to the extent of the relief, if any, from Indian income tax and
distinguishing, where practicable, between income tax other taxation.
(vii) The amounts reserved for:
(a) repayment of shares capital, and
(b) repayment of loans.
(viii) (a) the aggregate, if material, of any amount set aside or proposed to be set aside
to reserves but not including made to meet any specific liability contingency,
or commitment known to exist at the date as on which the balance sheet is
made up.
(b) The aggregate, if material, of any amounts withdrawn from such reserves.
(ix) (a) The aggregate, if material, of the amount set aside to provision made for
meeting specific liabilities, contingencies, or commitment.
(b) The aggregate, if material, of the amounts withdrawn from such provisions,
as no longer required.
(x) Expenditure incurred on each of the following items separately for each item:
(a) Consumption on stores and spare parts
(b) Power and fuel
(c) Rent
(d) Repairs to building
(e) Repairs to machinery
(f) (1) Salaries, wages and bonus.

Notes (2) Contribution to provident and other funds.
(3) Workmen and staff welfare expenses to the extent not adjusted from any
pervious or provision reserve.
Notes Information in respect of this item should also be given in the balance sheet under
the relevant provision or reserve account.
(g) Insurance
(h) Rates, and taxes, excluding taxes on income
(i) Miscellaneous expenses, provided that any item under which the expenses
exceed 1% of the total revenue of the company or 5,000 whichever is higher,
shall be shown as a separate and distinct item against an appropriate account
head in the profit and loss account and shall not be combined with any other
items to be shown under ‘Miscellaneous Expenses’.
(xi) (a) The amount of income from investment distinguishing between trade
investment and other investment.
(b) Other income by way of interest, specifying the nature of the income.
(c) The amount of income tax deducted if the gross income is stated under sub-
paragraphs (a) and (b) above.
(xii) (a) Profits or losses on investments showing distinctly the extent of the profit and
losses earned or incurred on account of membership of a partnership firm, to
the extent not adjusted from any previous provision or reserve.
Notes Information in respect of this item should also be given in the balance sheet under
the relevant provision or reserve account.
(b) Profits or losses in respect of transaction of a kind not usually undertaken by

the company or undertaken in circumstances of an exceptional or non-
recurring nature, if material, in amount.
(c) Miscellaneous income.
(xiii) (a) Dividend from subsidiary companies.
(b) Provision for issues of subsidiary companies.
(xiv) The aggregate amount of the dividend paid and proposed and stating whether such
amounts are subject to deduction of income tax or not.
(xv) Amount, if material by which any items shown in the profit and loss account are
affected by any change in the basis of accounting.
4. The profit and loss account shall also contain or give by way of a note, detailed information
showing separately the following payments provided or made during the financial year
to the directors (including managing directors) or manager, if any, by the company, the
subsidiaries of the company and any other person:
(i) managerial remuneration under Section 198 of the Act paid or payable during the
financial year to the directors (including managing directors) or manager, if any;

(ii) other allowances and commission including guarantee commission (details to be Notes
given);
(iii) any other perquisites and benefits in cash or in kind (stating approximately money
value where practicable);
(iv) Pension, etc.,
(a) pension,
(b) gratuities,
(c) payment from provident funds, in excess of own subscriptions and interest
thereon,
(d) compensation for loss of office,
(e) consideration in connection with retirement from office.
4A. The profit and loss account shall contain or give by way of a note, a statement showing the
computation of net profits in accordance with Section 349 of the Act with the relevant
details of the calculation of the commission payable by way percentage of such profit to
the directors (including managing directors) or manager, if any.
4B. The profit and loss account shall further contain to give by way of a note detailed
information in regard to amounts paid to the auditor, whether as fees, expenses or otherwise
for services rendered.
(a) as auditor, and
(b) as adviser in any other capacity in respect of:
(i) taxation matters,
(ii) company law matters,
(iii) management services; and
(c) in any other manner.
[The Institute of Chartered Accountants of India has stated, in its statement styled
‘Payment to Auditors for other Services’, that the remuneration to the auditor for
other services should be classified as follows:
(1) for tax representations;
(2) for company law matters;
(3) for management services;
(4) for internal auditing; and
(5) for other services.]
4C. In the case of manufacturing companies, the profit and loss account shall also contain by
way of a note, in respect of each class of goods manufactured, detailed quantitative
information in regard to the following, namely:
(a) the licensed capacity (where license is in force);
(b) the installed capacity; and
(c) the actual production.

Notes
Notes
1. The licensed capacity and installed capacity of the company as on the last date of the
year to which to profit and loss account relates, shall be mentioned against items (a)
and (b) above, respectively.
2. Against item (c), the actual production in respect of the finished products meant for
sale shall be mentioned, in cases where semi-processed products are also sold by the
company, separate details thereof shall be given.
3. For the purpose of this paragraph, the items for which the company is holding
separate industrial license shall be treated as separated classes of goods, but where
a company has more than one industrial license for production of the same item at
different places, or for expansion of the licensed capacity, the items covered by all
such licenses shall be treated as one class.
4D. The profit and loss account shall also contain by way of a note, the following information,
namely:
(a) value of imports calculated on C.I.F., basis by the company during the financial year
in respect of:
(i) raw material;
(ii) components and spare parts;
(iii) capital goods.
(b) expenditure in foreign currency during the financial year on account of royalty,
know-how, professional consultation fees, interest, and other matters.
(c) value of all imported raw materials, spare parts and components consumed during
the financial year and the value of all indigenous raw materials, spares and
components similarly consumed and the percentage of each of the total consumption.
(d) the amount remitted during the year in foreign currencies on account of dividends,
with a specific mention of the non-resident shareholders, the number of shares held
by them on which the dividends were due and the year to which the dividend
related.
(e) earnings in foreign exchange classified under the following heads, namely:
(i) export of goods calculated on F.B.O. basis,
(ii) royalty, professional know-how and consultation fees,
(iii) interest and dividend,
(iv) other income, indicating the nature thereof.
5. The Central Government may direct that a company shall not be obliged to show the
amounts set aside to provision, other than those relating to depreciation, renewal or
diminution in value of assets, if the Central Government is satisfied that the information
should not be disclosed in the public interest and would prejudice the company, but
subject to the condition that in any heading, stating an amount arrived at after taking into
account the amount set side as such, the provision shall be so formed or marked as to
indicate that fact.

6. (1) Except in the case of the first profit and loss account laid before the company after Notes
the commencement of the Act, the corresponding amount for the immediately
preceding financial year for all items shown in the profit and loss account shall also
be given in the profit and loss account.
(2) The requirement in sub-clause (1) shall in the case of companies preparing quarterly
or half-yearly accounts, relate to the profit and loss account for the period ended on
the corresponding date of the previous year.
At the time to preparation of Profit and Loss A/c of the company, the following
guidelines should also be kept in mind.
Self Assessment
Choose the best alternative:
6. Which one of the following does not relate to Profit and Loss Appropriation A/c?
(a) Contribution to General Reserve
(b) Proposed Dividend
(c) Provision for Depreciation
(d) Interim Dividend
7. Which of the following does not include the divisible profits?
(a) Revenue reserve
(b) General reserve
(c) Capital reserve
(d) Subsidies and credit balance of P./L. A/c
8. Advance payment of tax is shown:
(a) P. & L. A/c.
(b) Below the line

(c) Liabilities side of balance sheet
(d) Assets side of balance sheet
9. Employee provident fund is a:
(a) Liability
(b) Provision
(c) Loan
(d) None for the above
10. Dividend is calculated on:
(a) Called up capital
(b) Paid up capital
(c) Paid up capital & calls in advance
(d) Subscribed capital

Notes 13.5 Limitations of Financial Statements
Following of main limitations of financial statement analysis:
1. It is just study of interim reports.
2. It check just monetary aspect of company’s performance and position but it ignores non-
monetary aspect of company.
3. It does not analyze the changes in price level of different items of financial statements.
4. Many accounting concepts and conventions are used for preparing financial statement and
these concepts and conventions are accepted for analysis. So, analysis is totally affected
with these accounting concepts.
5. Analysis of financial statements are just source but not decision or result because person
who write its interpretation, may also affect the analysis. So, different interpretation by
different person may become its limitation.
6. LIFO vs FIFO and different depreciation methods usage may bring difference in result and
performance of financial statement, so it is also limitation of financial statement analysis.
7. If one company’s accounting period completes at 31 st Dec. and other company’s accounting
period completes at 31 st march, we will unable to compare both company’s financial
statement and it will be the limitation of financial statement analysis.
Task Discuss the various contents of the Balance Sheet.
Self Assessment
True or False:
11. As per Section 209 of the Companies Act, it is compulsory for every limited company to
prepare the final accounts.
12. The rate of dividend which is recommended by the board of directors can be increased by
the shareholders if they think it is too low.
13. Provision is made for any known liability of which the amount can not be determined
with accuracy in advance.
14. When the rate of proposed dividend is more than 20%, 10% of profit must be transferred
to revenue reserves.
15. No dividend will be payable on calls in advance.
13.6 Summary
 Balance Sheet as we have seen is one of the most important financial statements.
 It is a periodic summary of the position of the business.
 It is the statement of assets, liabilities and owners’ capital as of a particular point in time.
 This statement in itself does not reveal anything about the details of operations of the
business.
 However, a comparison of two balance sheets could reveal the changes in business position.

 A realistic understanding of the operations of the business would require two other Notes
statements - Profit and Loss Account and Funds Flow Statement.
13.7 Keywords
Asset: Anything, tangible or intangible, of monetary value to a business entity.
Contingent Liability: A liability which has not been recognised as such by the entity. It becomes
a liability only on the happening of a certain future event. An example could be the liability
which may arise out of a pending law suit.
Current Assets: All of the assets held by a firm with the objective of conversion to cash within the
operating cycle or within one year whichever is longer. Current Assets include items such as
cash, receivables, inventory and prepayments.
Current Liabilities: All those claims against the assets of the firm to be met out of cash or other
current assets within one year or within the operating cycle, whichever is longer. Usually
include items such as accounts payable, tax or other claims payable, and accrued expenses.
Fixed Asset: Tangible long-lived asset. Usually having a life of more than one year. Includes
items such as land, building, plant, machinery, motor vehicles, furniture and fixtures.
Intangible Assets: Any long-term assets useful to the business and having no physical
characteristics. Include items such as goodwill, patents, franchises, formation expenses and
copyrights.
Liability: Any amount owed by one person (the debtor) to another (the creditor). In a balance
sheet all those claims against the assets of the entity, other than those of the owners.
Owner’s Equity: It is the owner’s claim against the assets of a business entity. It could be expressed
as total assets of an entity less claims of outsiders or liabilities, includes both contributed capital
and retained earnings.
1. What are the legal requirements regarding the transfer of profit to the reserves?
2. What is the difference between final dividend and interim dividend?
3. Mention the various sources of dividend.
4. Explain the different methods of capitalization of profit.
5. What are the different types of balance sheets?
6. What are the statutory provisions relating to transfer of profit to reserve?
1. Annual General Meeting 2. 9 months
3. 211 4. 10%
5. Share Premium A/c and fully paid equity shares,
6. c 7. c
8. d 9. a
10. b 11. True

Notes 12. False 13. True
14. True 15. True

Horngren C.T. and Harrison, 01/23/2003, Financial Accounting, Prentice Hall :
New Delhi (Chapter 1)
Fraser Lyn M. and Aileen Ormiston, 04/10/2003, Understanding Financial

Statements, Prentice Hall : New Delhi (Chapter 2)
Glantier M. W. E., Underdown B. and A.C. Clark, 1979, Basic Accounting Practice,
Arnold Hieneman: Vikas Publishing House, New Delhi (Chapter 5, Section 2)
Bhattacharya, S. K. and John Dearden, 1984. Accounting For Management: Text

and Cases (2nd Ed.) Vani: New Delhi. (Chapters 3, 10 and 11)
Hingorani, N.L. and A. R. Ramanathan, 1986, Management Accounting, Sultan

Chand: New Delhi. (Chapter 3)


Case Study IXIS Accelerates Profit and Loss Analysis
October 23, 2006
Commentary by Damien Le Marchand, Project Manager, IXIS CIB
For the investment bank IXIS CIB, a subsidiary of the third largest banking group in
France, the process of calculating its profit and loss (P&L) on a daily basis involves analyzing
300 million transaction lines.
Until recently, IXIS CIB used a reporting system designed solely for trading floor operators.
This system relied on both a production database and an information database. Both of
these were transactional management databases.
“We carried out batch loading from the production database to the information database.
Requests from traders were made alongside this transaction processing, which could
cause performance problems. With the growing complexity of analysis required by traders,
loading times increased to four hours. Due to these constraints, background history was
gradually reduced to a period of no more than six months in the production database and
15 consecutive days in the information database,” explains Damien Le Marchand, project
manager at IXIS CIB. The huge volume of processing together with peak loadings caused
bottlenecks and affected response times. Complex requests could take up to three hours.
Contd...

To better support the activities of its risk managers, the bank realized it needed a more Notes
efficient and scalable system—a system that would enable it to reconcile P&L accounts.
The new system would have to combine P&L lines, the dynamic risk parameters in each
portfolio, and cash flow, which meant the target system would need the capacity to handle
much larger data volumes and a constantly increasing number of requests.
Evaluating Alternatives
IXIS CIB identified two ways to address this challenge. One involved reviewing working
patterns and changing operational procedures. The second involved consolidating all
transaction data into a central information database, isolating reporting and analysis
from transaction processing. The key to making this second method work was the ability
to deploy a robust, high-performance data management system with the capacity to scale
as data storage requirements increased, and to expedite loading and response times
regardless of the number of users and the complexity of requests.
IXIS CIB chose the second way and found its data management solution in the Sybase IQ
analytics server. After achieving positive results in testing, the bank began to integrate
P&L lines and the dynamic performance indicators coming from front-office trading
applications, namely Summit for fixed-income and foreign-exchange business, and Calypso
for credit derivatives and complex rates, in total representing 300 million lines.
The project went live within a month thanks to support from Sybase Professional Services,
which facilitated the porting of the previous central information database to Sybase IQ
and the transfer of skills to the P&L IT team.
A future phase will integrate two other front-office applications: Sophis for shares and
ACBS for financial accounting and cash flow lines. All data will be available through
Business Objects reporting tools via an intranet.
Sybase IQ Delivers in Real Time
Thanks to Sybase IQ, transactions from the previous day are available to trading operators
and risk managers before the markets open, with load times reduced to 30 minutes.
Sybase IQ provides risk managers with both the speed and the detail to allow them to
complete their tasks successfully by zooming right in on the minute details of each
transaction. This has all been achieved without impacting database availability or
performance.
“By separating out the transaction processing database, we’ve achieved response times
that are between 10 and 20 times faster than our earlier system. Responses do not exceed
four minutes, even for the most complex cases,” says Le Marchand. The speed of processing
calculations that are linked with the central information base, which consolidates all
transactions and cash flow lines, now provides full visibility of trading results the following
day. Moreover, daily consolidation gives the accounts department access to data following
the close of each day’s trading, allowing it to meet the reduced 15-day reporting cycle
required to comply with the IFRS standard.
The bank has also realized IT cost reductions, which by themselves constitute an impressive
ROI.
Source: http://tdwi.org/Articles/2006/10/23/IXIS-Accelerates-PL-Analysis.aspx?Page=2

Accounting for Companies-I Pooja, Lovely Professional University
Notes Unit 14: Preparation of Final Accounts
CONTENTS
Objectives
Introduction
14.1 Preparation of Final Accounts
14.1.1 Treatment of Special Items
14.1.2 Requirements of Schedule VI Concerning Profit and Loss Accounts
14.2 Preparation of Balance Sheet
14.3 Summary
14.4 Keywords
Objectives
 Understand meaning and preparation of final accounts
 Explain treatment of special items
 Know requirements of Schedule VI
 Understand preparation of Balance Sheet
Introduction
All business transactions are first recorded in Journal or Subsidiary Books. They are transferred
to Ledger and balanced it. The main object of keeping the books of accounts is to ascertain the
profit or loss of business and to assess the financial position of the business at the end of the year.
The object is better served if the businessman first satisfies himself that the accounts written up
during the year are correct or at least arithmetically accurate. When the transactions are recorded
under double entry system, there is a credit for every debit, when on a/c is debited; another
a/c is credited with equal amount. If a Statement is prepared with debit balances on one side and
credit balances on the other side, the totals of the two sides will be equal. Such a Statement is
called Trial Balance.
14.1 Preparation of Final Accounts
Though there is no prescribed form of Profit and Loss Account as per law, but all such information
are to be given which can help in presenting a true and fair view of the activities of the company.
According to section 211 of the Companies Act, Schedule 6 Part II (1) Every Profit and Loss
Account must disclose the result of the concerned period, and (2) Every expenses or item, which
is of debit or credit must be disclosed properly. Information relating to past year must also be
given along with the present year’s result in the form of figures.
Every profit and Loss Account is divided into two parts: (1) Profit and Loss Account, and (2)
Profit and Loss (Appropriation) Account.

Unit 14: Preparation of Final Accounts
14.1.1 Treatment of Special Items Notes
1. Interest on debentures: If interest on debentures is not paid then provision of interest for
the full year should be made. This provision of interest is not only for that interest which
has become due but also for that interest which is not due but has been earned. Interest on
debentures is generally paid half yearly.
2. Deduction of tax from interest on debentures: As per Income Tax Rules, income tax is
deducted from such interest and deposited with the Central Government, if security is
Government. Tax free securities or where Income Tax Officer is informed that the income
of the assesse is not taxable, then income tax should not be deducted. How much tax is to
be deducted is decided as per Finance Act every year. At present, income tax is deducted at
source. During 2006-07, it was a 10% + Education cess 2% if listed/Govt., otherwise 20% +
2% education cess.
3. Discount on the issue of debentures to be shown in the balance sheet but a reasonable
amount is written off every year from the Profit & Loss a/c.
4. Transfer to Reserves [Statutory requirement before dividend is proposed]: According to

Section 205 of the Companies Act, Companies are required to transfer a certain percentage
of profits not exceeding 10% to Reserves before declaring any dividend. Following are the
rates:
(a) 2.5% if the dividend proposed exceeds 10% but not 12.5%
(b) 5% if the dividend proposed exceeds 12.5% but not 15%
(c) 7.5% if the dividend proposed exceeds 15% but not 20%
(d) 10% if it exceeds 20%.
Task Analyse the profit and loss account of HDFC bank for FY 2009-10.
Notes As per Income tax Rules, income tax is deducted from such interest and deposited
with the Central Government, if security is Government. Tax free securities or where
Income Tax Officer is informed that the income of the assesse is not taxable, then income
tax should not be deducted.
14.1.2 Requirements of Schedule VI Concerning Profit and Loss Accounts
A company shall disclose the following notes to their accounts :
1. Revenues from operations: Revenue from operations shall be classified as:
(a) Sale of products;
(b) Sale of Services;
(c) Other operating revenues (specify nature);
Less:
(d) Discounts, allowances, and returns;
(e) Excise duty/service tax.

Notes These shall include sales or service charges to customers for the goods and/or services
provided during the period. This section shall include information about duties, taxes,
discounts, allowances and returns in order to determine net sales or net revenues.
2. Cost of sales/services: These are costs directly associated with generating revenues and
shall include (to be disclosed separately):
(a) Change in inventories – Opening (less closing) inventories of finished goods and
work-in-process;
(b) Cost of direct materials consumed arrived at by adding net purchases (purchases
less discounts, returns and allowances plus freight-in) to beginning inventory to
obtain direct materials available. From the cost of direct materials available, the
ending inventory is deducted;
(c) Other external charges (such as the hire of plant and machinery or the cost of casual
labour used in the productive process);
(d) Direct labour (ESOP and ESPP expenses to be disclosed separately);
(e) All direct production overheads;
(f) Depreciation and amortization that can reasonably be allocated to the production
function;
(g) Indirect overheads that can reasonably be allocated to the production function;
(h) Product development expenditure not qualifying for recognition as an intangible

asset and amortization of development expenditure recognized as an intangible
asset;
(i) Inventory write downs/reversals;
(j) All direct overheads in providing services;
(k) All allocable indirect overheads in providing services;
(l) Cost of goods traded-in arrived at by adding net purchases (purchases less discounts,
returns, and allowances plus freight-in) to beginning inventory to obtain the cost of
goods available for sale. From the cost of goods available for sale amount, the
ending inventory is deducted;
(m) Other cost of sales.
3. Operating expenses: Operating expenses are those that are incurred in order to generate
sales. Operating expenses shall be classified as:
(a) Selling and marketing expenses;
(b) Administrative expenses;
(c) Depreciation and amortization of assets;
(d) Foreign currency exchange gains/(losses), net.
(a) Selling and marketing expenses are those expenses that are directly related to the
company’s efforts to generate sales. These items shall include (to be disclosed
separately):
(i) Payroll costs of sales, marketing and distribution functions (ESOP and ESPP
expenses to be disclosed separately);
(ii) Advertising;

(iii) Sales persons’ travel and entertaining; Notes
(iv) Warehouse costs for finished goods;
(v) Transport costs arising on the distribution of finished goods;
(vi) All costs of maintaining sales outlets;
(vii) Agents commission payable;
(viii) Other selling and marketing expenses.
(b) Administrative expenses are expenses related to the general administration of the
company’s operations. These items shall include (to be disclosed separately):
(i) Payroll costs of office and administrative staff (ESOP and ESPP expenses to be
disclosed separately);
(ii) All costs of maintaining the administration buildings;
(iii) Bad debts;
(iv) Professional costs;
(v) Amount paid to the auditor, whether as fees, expenses or otherwise for services
(vi) Directors remuneration;
(vii) Insurance expense;
(viii) Utilities expense;
(ix) Other administrative expenses.
(c) Depreciation and amortization of assets other than used in the production process and
included in cost of sales.
4. Other income: This shall include (to be disclosed separately):
(a) Interest income;
(b) Dividend income;
(c) Rental on investment properties;
(d) Increase (decrease) in carrying amounts of investments;
(e) Gains and losses on trading derivatives;
(f) Amounts withdrawn, as no longer required, from provisions created previously for
meeting specific liabilities;
(g) Other miscellaneous income.
5. Other expenses: These shall be classified as:
(a) Finance costs.
(b) Others.
(a) Finance costs shall include (to be disclosed separately):
(i) Interest expense.
(ii) Dividends on preference shares classified as debt.
(b) Others shall include costs related to ‘other income’.

Notes 6. Tax Expense – Others
Others shall be specified separately.

7. Any item for which the expense exceeds one percent of the revenues from operations of
the Company or 1,00,000 whichever is higher, shall be shown as a separate and distinct
item under the appropriate head of expense in the notes to accounts and shall not be
combined with any other item.
8. Results from discontinued operations included in the statement of profit and loss i.e.
income (loss) from activities and gain (loss) from disposal of assets/settlement of liabilities
shall be disclosed separately in the notes to accounts.
Self Assessment
Fill in the blanks:

1. ……………… account enables the trader to find out Gross Profit or Loss.
2. ……………… account enables the trader to find out the Net Profit or Loss.
3. Direct Expenses appears on ……………… side of ……………… account.
4. Indirect Expenses appears on ……………… side of ……………… account.
5. If the Trial Balance contains both Trade Expenses and Office Expenses, the Trade Expenses.
6. Posted to ……………… account and office expenses posted to ……………… account.
14.2 Preparation of Balance Sheet
According to Institute of Chartered Accountants of India Balance Sheet as a statement of the

financial position of an enterprise at a given gate which exhibits its assets liabilities capital,
reserves and other account balances at their respective book values. The balance sheet of a
company is prepared on the same principles, which are followed as for the balance sheet of a
sole proprietor or a partnership firm. The only difference is that in case of a company, the
balance sheet is prepared in a prescribed form so that it can exhibit a true and fair view of the
financial position of the company at a point of time. The assets and liabilities must be shown at
the proper figures neither more or less. There should not be any secret reserve as per law. The
most important function of a balance sheet is to provide full and sufficient information to enable
the reader to judge the financial state of affairs (position) correctly and completely.
Task Analyse the balance sheet of HDFC bank for FY 2009-10.
Requirements of Schedule VI of Indian Companies Act
The balance sheet of a company must be in accordance with the proforma given in Schedule VI
Part I of the Indian Companies Act. This is as per section 211 of the Indian Companies Act, 1956.
Sub-sections (3A), (3B) and (3C) of section 211 have made it compulsory that Profit and Loss
account and Balance Sheet of a Company are prepared in accordance with Accounting Standards
prescribed by the Central Government in consolation with National Advisory Committee on
Accounting Standards (NACAS).
The Act has laid down two forms of Balance Sheet. The two forms are generally known as:
1. Horizontal Form
2. Vertical Form

The Balance Sheet must give a true and fair view of the company activities. This form may be in Notes
any other form with the consent of the Central Government.
Did u know? According to Institute of Chartered Accountants of India Balance Sheet as a

statement of the financial position of an enterprise at a given gate which exhibits its assets
liabilities capital, reserves and other account balances at their respective book values.
Form of Balance Sheet [Horizontal]
Balance Sheet of …………………………… Co. Ltd.
as on ………….........………
Figures Figures Figures

Figures for
for the for the for the
Liabilities Assets the previous
previous current previous
year
year year year
Reserves and surplus Investments
Secured loans Current assets.
Unsecured loans Loan and advances
Current liabilities and (a) Current assets
provisions (b) Loans and
(a) Current liabilities advances
(b) Provisions Miscellaneous
expenditure
Profit and loss account
As it is clear from the above form of Balance Sheet, that Assets are shown on right hand side
whereas liabilities are put up on left hand side and relevant figures for the previous year as well
as for the current year are given but in case of Balance Sheet which is shown in vertical form
liabilities are put under one head i.e. ‘Sources of funds’ which is immediately followed by assets
under the head ‘Application of Funds’. This would be clear from the following exhibit of Balance
Sheet in vertical form.
Form of Balance Sheet [Vertical Form]
Balance Sheet of ………………………… Co. Ltd.
as on …………………………
Schedule Figures for the Figures for the

Particulars
No. Current Year Previous Year
1 2 3 4
I. Sources of Funds
1. Share Holders Funds
Share Capital + Reserves and Surplus
2. Loan Funds
(a) Secured Loans
(b) Unsecured Loans
Total
II. Application of Funds:
1. Fixed Assets
(a) Gross Block
(b) Less Depreciation
(c) Net Block
(d) Capital work in progress
Contd...
2. Investments
(a) Inventories
(b) Sundry debtors
(c) Cash and Bank Balances
(d) Other Current Assets
(e) Loans and Advances
Less
(a) Secured Loans
(b) Unsecured Loans
Total
II. Application of Funds:
1. Fixed Assets
(a) Gross Block
(c) Net Block
Notes (d) Capital work in progress
2. Investments
(a) Inventories
(b) Sundry debtors
(c) Cash and Bank Balances
(d) Other Current Assets
Less
Current Liabilities and Provisions
(a) Current Liabilities
(b) Provisions
Net Current Assets
4. Miscellaneous Expenditure (to the
extent not written off)
5. Profit and Loss Account
Total
Notes Details are given by way of schedules.
Statutory Contents of Liabilities Side of Balance Sheet
There are two types of items shown on the liabilities side of the Balance sheet.
1. The items relating to owners equity and
2. The items relating to borrowers’ capital
The main items relating to owner’s capital: The main item are as follows:
1. Share capital
2. Reserves and surplus
1. Share Capital: It means the share of the owner’s in the company. There are different types
of capital.
(a) Authorized Share Capital: This is the amount of capital which the company is authorized
to raise from the public. Generally authorized capital is given in the memorandum
of association, popularly known as M/A at the time of incorporation of the company.
There are two types of share capital – (i) Equity share capital, and (ii) Preference
share capital. It is given by way of information in the balance sheet. It is not added
to the liabilities of the company, unless the entire share capital is issued, subscribed,
called up and received in full.
(b) Issued Share Capital: It is that part of issued share capital, which is offered for the
public to subscribe till the date of Balance Sheet. Various types of share capital along
with classes and face value etc. are given.
(c) Subscribed Capital:
(i) It is that part of issued share capital which is actually, subscribed by the public
alongwith share value called up.

(ii) Shares, which are issued other than cash for different consideration and issued, Notes
as bonus shares must also be given.
(iii) Shares on which calls are in arrear must also be shown by way of deduction
from called up capital.
(iv) Shares which are forfeited on account of non-payment must be shown

separately.
(v) If forfeited shares are re-issued in full or in part, in case of profit must be
transferred to capital reserve account only.
Notes There are two types of share capital – (i) Equity share capital, and (ii) Preference
share capital.
2. Reserves and Surplus: As per Companies Act, 1956 the following are the Reserves and
Surplus:
(a) Capital Reserves
(b) Capital Redemption Reserve Account
(c) Securities Premium Account
(d) Other Reserves such as – General Reserve, Reserve for depreciation, etc.
(e) Surplus – The net profit, as per profit and loss account, is to be given.
(f) Proposed Addition to Reserves
(g) Sinking Fund
Borrowers Capital Fund: There are the following types of loan capital:
1. Secured loans: If any security is given by way of a mortgage or charge on all or any of its
property, the loan is termed as secured loan and shown in the following order:
(i) Debentures: Types of debentures, redeemable and non-redeemable etc.
(ii) Loans and Advances from Banks
(iii) Loans and Advances from subsidiary company
(iv) Other Loans and Advances if any
2. Unsecured loans: If a company borrows loans without giving any security, then such loans
are termed as unsecured loans. Following are:
(i) Fixed deposits
(ii) Loans and Advances from Subsidiaries
(iii) Loans and Advances from the banks
(iv) Loans and Advances from others
3. Current Liabilities and Provisions:
(a) Current Liabilities: Which are payable within one year are shown in this such as
 Acceptances
 Sundry creditors

Notes  Investor Education and Protection Fund
 Advance payments
 unclaimed dividends
 Interest Accrued but not due
 Tax payable
 Tax deducted at source (TDS).
(b) Provisions: are shown separately such as
 Provision for taxation
 Proposed dividend
 Provision for contingencies
 Provision for provident fund
 Other provisions
Contingent liabilities are such liabilities which may exist or may not exist subject to happening
or not happening the event. It is given as a foot note in the Balance Sheet. Amount of such
liabilities is not included in the total liabilities.
The following are the examples of contingent liabilities:
1. Claims against company, which are still not accepted by the company.
2. Liability for amount uncalled on partly paid shares.
3. Arrears of fixed cumulative dividends.
4. Estimated amount of incomplete contracts.
5. Other contingent liability.
Investor Education and Protection Fund
According to section 205A of the Companies (Amendment) Act, 1999, any amount transferred to
unpaid dividend account of company which will remain unpaid or unclaimed in the said accounts
for a period of seven years from the date of such transfer is required to be transferred by the
company to Investor Education and Protection Fund. Such payment are:
1. Unpaid dividends
2. Matured deposit with companies for seven year
3. Matured debentures
4. Interest accrued on the above
5. Donations or Grants from Government
Did u know? According to section 205 A of the Companies (Amendment) Act, 1999, any
amount transferred to unpaid dividend account of company which will remain unpaid or
unclaimed in the said accounts for a period of seven years from the date of such transfer is
required to be transferred by the company to Investor Education and Protection Fund.

Statutory Contents of Assets Side of Balance Sheet Notes
1. Fixed Assets: Fixed assets are those assets, which are used for long-term in the business.
Different assets are shown separately at their original cost and addition to and deductions
for depreciation provided for. Fixed Assets include:
(a) Goodwill
(b) Land and Building
(c) Lease hold
(d) Railway sidings
(e) Plant & Machinery
(f) Furniture & Fixture
(g) Patents, Trade Marks and Designs
(h) Development of property
(i) Copyrights
(j) Live stock
(k) Vehicles
2. Investments: Investments are shown after fixed assets. It is necessary to disclose nature
and mode of its valuation of every investment. Market price or cost price, at which
investments are valued, must be disclosed. All investments must be shown separately
such as Govt., shares, debentures, etc.
3. Current Assets, loans and advances:
(a) Current assets are such assets which are likely to be converted into cash within one
year from one balance sheet. Such assets are. 1. Loose tools 2. Stock in trade 3. Work
in progress 4. Sundry debtors 5. Cash and Bank balance
(b) Loans and advances – it includes loans and advances against purchase of goods and
various expenses.
4. Miscellaneous Expenditure: Expenses not written off– 1. Preliminary Expenses 2. Discount

on issue of shares and debentures 3. Expenses including commission or brokerage on
underwriting 4. Interest paid out of capital 5. Other sums.
5. Profit and Loss Account: If there is any debit balance in profit and loss account, it will be
shown on the assets side of the balance sheet.
Form of Balance Sheet
(Horizontal Form)
Balance sheet of …………… as at …………
(Form of Balance Sheet as Per Schedule VI and Part I)
Figures Figures Figures Figures

for the for the for the for the
Liabilities Assets
previous Current previous current
year ( ) year ( ) year ( ) year ( )
1. Share Capital 1. Fixed Assets
Authorized (1) Goodwill
…………shares of (2) Land
…………each (3) Buildings
Issued……………….share Contd...
(4) Leaseholds
of …………each
(5) Railway Sidings
Subscribed and paid
(6) Plant & Machinery
up……… shares of LOVELY PROFESSIONAL UNIVERSITY 339
……………each (7) Furniture and Fittings
Less: Called unpaid (8) Development of

Property
Add: Forfeited shares
(9) Patents, Trade Marks
and Designs
Figures Figures Figures Figures
for the for the for the for the
Liabilities Assets
previous Current previous current
year ( ) year ( ) year ( ) year ( )
1. Share Capital 1. Fixed Assets

Authorized (1) Goodwill
…………shares of (2) Land
…………each (3) Buildings
Notes Issued……………….share (4) Leaseholds
of …………each
(5) Railway Sidings
Subscribed and paid
(6) Plant & Machinery
up……… shares of
……………each (7) Furniture and Fittings
Less: Called unpaid (8) Development of

Property
Add: Forfeited shares
(9) Patents, Trade Marks
and Designs
(10) Live Stock
(11) Vehicles etc.
2. Reserves and Surplus 2. Investments
(1) Capital Reserve (1) Investments in Govt.
(2) Capital Redemption or Trust securities
Reserve (2) Investments in
(3) Securities Premium Shares, Debentures
Account and Bonds
(4) Other Reserves (3) Immovable Properties
Less: Debit Balance of (4) Investment in the
P&L Account Capital of Partnership
(5) Surplus, i.e., Balance Firms
of P&L Account
(6) Proposed additions to
Reserves
(7) Sinking Funds
3. Secured Loans 3. Current Assets, Loans
(1) Debentures and Advances
(2) Loans and Advances A. Current Assets
from Banks (1) Interest accrued on
(3) Loans and advances Investments
from Subsidiaries (2) Stores and spare parts
(4) Other Loans & (3) Loose Tools
Advances (4) Stock in Trade
(5) Work in Progress
(6) Sundry Debtors
(a) Debt outstanding
for a period
exceeding six
months.
(b) Other Debts
Less: Provision
(7) Cash and Bank
Balances
B. Loans & Advances:
(1) Acceptances & Loans
to Subsidiaries
(2) Exchange
(3) Advances recoverable Contd...
for value to be
received by Rates,
Taxes, Insurance etc.
(4) Balance with Customs,
Port Trust etc.
4. Unsecured Loans 4. Miscellaneous
(1) Fixed Deposit Expenditure
(2) Loans and advances (1) Preliminary
(b) Other Debts
Less: Provision
(7) Cash and Bank
Balances
B. Loans & Advances: Unit 14: Preparation of Final Accounts
(1) Acceptances & Loans
to Subsidiaries
(2) Exchange
(3) Advances recoverable Notes
for value to be
received by Rates,
Taxes, Insurance etc.
(4) Balance with Customs,
Port Trust etc.
4. Unsecured Loans 4. Miscellaneous
(1) Fixed Deposit Expenditure
(2) Loans and advances (1) Preliminary
from subsidiaries Expenditure
(3) Short-term Loans & (2) Expenses including
Advances commission and
(a) From Banks brokerage of shares
(b) From Others and debentures
(3) Discount allowed on
issue of shares and
debentures
(4) Interest paid out of
capital during
construction (also
state the rate of
interest)
(5) Development
Expenditure not
adjusted.
(6) Other Items
(specifying nature)
5. Current Liabilities & 5. Profit and Loss A/c.
Provisions (1) Claims against the
A. Current Liabilities company not
(1) Acceptance acknowledged as
(2) Sundry Creditors debts.
(3) Advances payments (2) Uncalled liabilities
& unexpired on shares partly paid
discounts for the up
portion for which (3) Arrears of fixed
value has still to be cumulative
given dividends.
(4) Unclaimed Dividend (4) Estimated amount of
(5) Other liabilities but contracts remaining
not due on Loans to be executed on
(6) Interest Accrued capital account and
B. Provisions not provided for
(1) Provisions for (5) Other money for
taxation which company is
(2) Proposed Dividends, contingently liable.
(3) For Contingencies
(4) For Provident Fund
scheme
(5) Fire Insurance,
Contd...
Pension and similar
staff benefits scheme
(6) Other Provisions [A
footnote to the LOVELY PROFESSIONAL UNIVERSITY 341
balance sheet may be
added to show
separately]
not due on Loans to be executed on
(6) Interest Accrued capital account and
B. Provisions not provided for
(1) Provisions for (5) Other money for
taxation which company is
Accounting for Companies-I (2) Proposed Dividends, contingently liable.
(3) For Contingencies
(4) For Provident Fund
scheme
Notes (5) Fire Insurance,
Pension and similar
staff benefits scheme
(6) Other Provisions
[A footnote to the
balance sheet may be
added to show
separately]
Form of Balance Sheet

(Vertical Form)
Balance Sheet of …………….Company
(As on…………………..)
Figures as at Figures as at
Schedule
Particulars the end of the the end of the
No.
Current Year Previous Year
1 2 3 4
1. Sources of Funds
(1) Share holders funds
(a) Capital
(b) Reserves and Surplus
(2) Loan Funds
(a) Secured Loans
(b) Unsecured Loans
Total
2. Application of Funds
(1) Fixed Assets.
(a) Gross Block
(c) Net Block
(d) Capital work in progress
(2) Investments
(3) Current Assets, Loans and Advances
(a) Inventories
(b) Sundry Debtors
(c) Cash and Bank Balance
(d) Other current Assets
Less: current liabilities provisions
(a) Liabilities
(b) Provisions
Net Current Assets
(4) (a) Miscellaneous Expenditure to the extent
not written off or adjusted.
(b) Profit and Loss Account
Total

7. Proposed dividend is shown under the heading of current liabilities.
8. Unpaid dividend is shown under the heading of current liabilities.
9. Advance payment of income tax is shown under the heading of Advance in the assets side
of the balance sheet.
10. Goodwill appears under the heading of fixed assets of the balance sheet of a company.
Illustration 1:
Mention the major heads in the required serial order under which various assets of a company
are to be presented as per the requirements of the Companies Act.
Solution:
Various assets to be shown under the following heads.
1. Fixed Assets
2. Investments
(a) Current Assets
(b) Loans and Advances
4. Miscellaneous Expenditure (to the extent not written off)
5. Profit and Loss Account- Dr. Balance
Illustration 2:
Under what headings will you show the following items in the Balance Sheet of the Company.
1. Goodwill
2. Unclaimed Dividends
3. Provision for Tax
4. Securities Premium A/c.
5. Loose Tools
Solution:
Items Heading Sub-heading (if any)

Goodwill Fixed Assets –
Unclaimed Dividends Current Liabilities and Provisions Current Liabilities
Provision for tax Current Liabilities and Provisions Provisions
Securities Premium A/c Reserve and Surplus –
Loose Tools Current Assets, Loans and Advances Current Assets

Notes Illustration 3:
The following balances appear in the books of Excel books:
Particulars `
Goodwill 20,000
Plant and machinery 1,60,000
Building 1,45,000
Cash in hand 10,000
Stock in trade 70,000
Share Capital
1000 equity shares of 100 each is issued at par, Rs. 80 per share called up and paid up 80,000
8% Debentures 2,50,000
Preliminary Expenses 5,000
Creditors 55,000
Dividends Payable 25,000
Showing the above items under the major heads in accordance with section 211 and Part I of
Schedule VI of the Companies Act, 1956. Prepare a Balance Sheet of the company.
Solution:
Balance sheet of Excel Books as on................
Authorized Capital Goodwill 20,000
1,000 Shares of ` 100 each 1,00,000 Plant & Machinery 1,60,000
Issued & Subscribed & paid up Building 1,45,000
1,000 Shares of ` 100 each 80,000 Investments —
` 80 per share called up & paid up – Current Assets, loans & Advances
Reserve & Surplus Current Assets
Secured loans 8% debentures 2,50,000 Cash in hand 10,000
Unsecured loans – Stock in Trade 70,000
Current liabilities & Provision
Current Liabilities
Dividend payable 25,000 Loan & Advances —
Creditors 55,000 Miscellaneous Expenses
Provisions Preliminary Expenses 5,000
Profit & Loss A/c —
4,10,000 4,10,000
Illustration 4:
The following ledger balances were extracted from the goods of Varun Ltd. as on 31 st March
2006. Land and building ` 2,00,000, 12 % debentures ` 2,00,000, share capital ` 10,00,000 (equity
shares of ` 10 each fully paid up) Plant and Machinery ` 8,00,000, Goodwill ` 2,00,000, Investments
in shares of Raja Ltd. ` 2,00,000, General Reserve ` 2,00,000, Stock in trade ` 1,00,000, Bill receivable
` 1,00,000, Debtors ` 1,50,000, Creditors ` 1,00,000, Bank loans (Unsecured) ` 1,00,000, Provision
for taxation ` 55,000, Discount on issue 12% debentures ` 5,000, Proposed dividends ` 1,00,000.
You are required to prepare the balance sheet of company as per Schedule-VI Part-I of the
Companies Act 1956.

Solution: Notes
Balance Sheet of Varun Ltd. 31st March, 2006
Authorized Share Capital 1,00,000 equity Fixed Assets
shares of ` 10 each 10,00,000 Goodwill 2,00,000
Issued Share Capital 1,00,000 equity 10,00,000 Land & Building 2,00,000
shares of `10 each. Plant & Machinery 8,00,000
Subscribed Share Capital 1,00,000 equity 10,00,000 Investments
shares of ` 10 each fully Paid up
in shares of Raja Ltd. 2,00,000
Reserves and surplus 2,00,000 Current Assets, Loans and
General Reserves Advances
Secured Loans 2,00,000 (a) Current Assets 1,00,000
12% Debentures Stock in Trade 1,50,000
Unsecured Loans 1,00,000 Debtors
Bank Loan (a) Loans & Advances 1,00,000
Current Liabilities and Provision 1,00,000 Bill Receivable
(A) Current liabilities creditors
Miscellaneous Expenditure
(B) Provision 55,000 Discount on Issue
Provision for taxation
1,00,000 of 12% debentures 5,000
Proposed Dividends
17,55,000 17,55,000
Illustration 5:
The following is the Profit and Loss Account of ABC Limited for the year ended 31 st December,
2006, before providing for the following:
1. Directors’ Commission of 1 per cent on the Net Profit.
2. Managerial Commission of 10 per cent on Net Profit.
Particulars ` Particulars `
To Depreciation 30,000 By Gross Profit 5,00,000
To Compensatuion (Voluntary) 5,000 By Profit on Investment Sold
To Other Expenses 3,40,000 (Non-Trading) 20,000
5,20,000 5,20,000
Notes Depreciation allowable as per rules amount to ` 25,000.
Redraft the profit and loss account after providing for the amounts of Managerial Commission
on net profit due in accordance with provisions of the Companies Act and show the Computation
of such amount of commission.
Solution:
1. Calculation of commission ` `
Net Profit as per profit & Loss Account 1,45,000
(+) Expenses not allowed

Notes (i) Excess depreciation 5,000
(ii) Compensation value 5,000 10,000
1,55,000
(–) Income other than business income 20,000
Net profit before charging commission 1,35,000
2. Commission of 1% + 10% on net profit comes to , 13,378 calculated below:
11
 135,000  13, 348
111
If segregated then for Director’s Remuneration is , 1,216 and
For managerial commission is 12,162.
Notes Profit on sale of investment is excluded for calculation of commission as per

Companies Act.
Redrafted Profit and Loss A/c

(For the year ended on 31st Dec. 2006)
To Depreciation 30,000 By Gross Profit b/d 5,00,000
To Compensation 5,000 By Profit on sale of Investment 20,000
To Other Expenses 3,40,000
To Director’s commission 1% of Net Profit 1,216
To Managerial Commission 10% of Net Profit 12,162
5,20,000 5,20,000
Illustration 6:
E.H. Ltd. carried forward a balance of 4,25,000 in the profit and loss a/c from the year ended 31st
March, 2006. During the year ending 31 March 2007 the company made a profit of 15,75,000
before charging Income Tax. Prepare the Profit and Loss Appropriation a/c taking into
consideration the following:
1. Provide 8,00,000 for Income Tax.
2. Transfer 1,00,000 to Dividend Equalization Account
3. Provide for dividend on 10% Preference Shares of 25,00,000.
4. Provide for dividend at 12.5% on 4,00,000 Equity Shares of 10 each.
5. Transfer 1,00,000 to Development Rebate Reserve.
6. Transfer 50,000 to General Reserve.

Solution: Notes
Profit & Loss Appropriation Account
(For the year ended on 31st March 2007)
To Income Tax 8,00,000 By Balance b/f 4,25,000
To Dividend Equalization Fund 1,00,000 By net profit as per
To Dividend on Preference shares 2,50,000 Profit & loss a/c 15,75,000
To Dividend on Equity Shares 5,00,000
To Development Rebate Reserve 1,00,000
To Transfer to General reserve 50,000
To Balance c/d 2,00,000
20,00,000 20,00,000
Notes
(a) Dividend on preference shares 10% on 25,00,000 = 2,50,000
(b) Dividend on equity shares 12.5% on 40,00,000 = 5,00,000
Illustration 7:
The Balance sheet of P. Ltd. as on 31 st March 07 is given below:
Liabilities (in lacs) Assets (in lacs)

Issued and Paid up Capital 20 lacs 200 Freehold Property 200
equity shares of 10 each
Profit and Loss a/c 180 Stock in Trade 120
12% Debentures 120 Sundry Debtors 100
Sundry Creditors 100 Cash and Bank 180
600 600
It was resolved in the Annual General Meeting:
1. to pay a dividend of 10% and corporate dividend tax @ 10%.
2. to issue one bonus share for every four shares held.
3. to give existing shareholders the option to buy one 10 shares @ 14 for every four shares
held prior to the bonus distribution.
4. to repay the debentures at a premium of 4%
All the shareholders who took up the option in (iii) above pass Journal entries and draw up the
Balance sheet after the above transactions have been given effect to (Ignore tax on income), also
prepare Profit and Loss Appropriation Account.

Notes Solution:
Journal Entries in the books of P Ltd.
Dr. Cr.
S. No. Particulars LF.
1. Profit and loss Appropriation a/c Dr. 22,00,000
To Dividend Payable a/c 20,00,000
“ Corporate Tax on Dividend payable a/c 2,00,000
Appropriation of profits
2. Dividend Bank a/c Dr. 20,00,000
To Bank a/c 20,00,000
Transfer of dividend to a separate dividend Bank a/c
3. Dividend Payable a/c Dr. 20,00,000
To Dividend Bank a/c 20,00.000
Dividend from a separate bank a/c
4. Corporate dividend Tax Payable Dr. 2,00,000
To Bank a/c 2,00,000
Payment of corporate dividend tax
5. Profit and Loss a/c Dr. 50,00,000
To Bonus Issue a/c 50,00,000
Bonus declared
6. Bonus Issue a/c Dr. 50,00,000
To equity share capital a/c 50,00,000
Bonus shares issued
7. Bank a/c Dr. 70,00,000
To Equity Share Application & Allotment a/c 70,00,000
Right shares issued @ 14 per share
8. Equity share Application & Allotment a/c Dr. 70,00,000
To Equity share capital a/c 50,00,000
“ Securities Premium a/c 20,00,000
Balance Transferred
9. 12% Debentures a/c Dr. 1,20,00,000
Premium on Redemption a/c Dr. 4,80,000
To Debenture holders a/c 1,24,80,000
Amount payable to debenture holders
10. Debenture holders a/c Dr. 1,24,80,000
To Bank a/c 1,24,80,000
Paid off
11. Securities Premium a/c Dr. 4,80,000
To Premium of Redemption of debentures a/c 480,000
Balance Transferred

Profit and Loss Appropriation Account Notes
To Dividend Payable a/c 20,00,000 By Balance b/d 1,80,00,000
“ Corporate Dividend Tax a/c 2,00,000
“ Bonus Issue a/c 50,00,000
“ Balance c/d 1,08,00,000
(To be shown in Balance Sheet)
1,80,00,000 1,80,00,000
Balance Sheet of P Ltd. after

Bonus and Repayment of debentures
Liabilities (in lacs) Assets (in lacs)
Issued & Paid up Cap. Freehold Property 200

30 lacs equity shares 300 Stock in trade 120
of 10 each Sundry Debtors 100
Profit & Loss a/c 108 Cash in hand (1) 103.2
Securities Premium a/c 15.2
Sundry creditors 100
523.2 523.2
Working Notes:
(1) Cash and Bank A/C
To Balance b/d 1,80,00,000 By Dividend Bank a/c 20,00,000
” Corporate Dividend Tax a/c 2,00,000
“ Share Application &
Allotment a/c 70,00,000 ” Debenture holders a/c 1,24,80,000
” Balance c/d 1,03,20,000
2,50,00,000 2,50,00,000
Illustration 8:
The following are the extracts from the trial balance of a Neha Beauty Products Limited on 31 st
March 2007:
Particulars Debit ( ) Credit ( )

Provision for tax 2005-06 20,000
Advance Tax paid for 2005-06 18,000
Advance Tax paid for 2006-07 10,000
Tax deducted at source 06-07 1,000
Profit and loss Account
Balance 2005-06 – 20,000
Assessment for the year 2005-06 was finalized during the year 2006-07. The total tax liability for
that year was fixed at 22,000. The net profit earned by the company during 2006-07 before tax
amounts to 40,000. The company is in 35% tax bracket.
Pass Journal Entries and show how the various items will appear in the Company’s Balance sheet.

Notes Solution:
Journal Entries
Dr. Cr.
S. No. Particulars LF.
1. Profit and loss Appropriation a/c Dr. 2,000
To Provision for tax a/c 2,000
Additional provision made
2. Provision for tax a/c Dr. 22,000
To Advance Tax paid a/c 2005-06 18,000
“ Bank a/c 4,000
Balance Tax paid
3. Profit and Loss a/c Dr. 14,000
To Provision for tax a/c 14,000
Additional provision for tax @ 35% on 40,000 = 14,000
Balance Sheet as on 31.03.2007
Liabilities Assets
Reserves & Surplus Loan & Advances
Profit & Loss a/c 20,000 Advance Tax Paid 10,000
– Prov. for Tax 2,000 Tax deducted at source 1,000
+ Current year’s Profit 18,000
40,000
– Provision for tax 14,000 26,000
Current Liabilities & Provision
Provision for Tax 14,000
Illustration 9:
The following are the balances of Modern Dress Bhandar Ltd. as on 31st March, 2007.
Credit Debit
Share Capital 40,00,000 Premises 30,72,000
12% Debentures 30,00,000 Plant 33,00,000
Profit and Loss a/c 2,62,500 Stock 7,50,000
Bills Payable 3,70,000 Debtors 8,70,000
Creditors 4,00,000 Goodwill 2,50,000
Sales 41,50,000 Cash and Bank 4,06,500
General Reserve 2,50,000 Calls in Arrear 75,000
Provision for Bad debt 35,000 Interim Dividend paid 3,92,500
as on 1.4.06 Purchases 18,50,000
Preliminary Expenses 50,000
Wages 9,79,800
General Expenses 68,350
Salaries 2,02,250
Bad debts 21,100
Debenture Interest paid 1,80,000
1,24,67,500 1,24,67,500

Additional Information: Notes
1. Depreciate plant by 15%
2. Write off 5,000 from Preliminary Expenses.
3. Half year’s Debenture Interest Due.
4. Create 5% Provision on Debtors for doubtful debts.
5. Provide for income tax @ 50%.
6. Stock on 31st March, 07 was 9,50,000.
Prepare Final Accounts of the company.
Solution:
for the year ended on 31st March, 07
To Stock 7,50,000 By Sales 41,50,000
“ Purchases 18,50,000 “ Stock 950,000
“ Wages 9,79,800
“ Preliminary Expenses 5,000
“ General Expenses 68,350
“ Salaries 2,02,250
Paid 1,80,000
+ due 1,80,000 3,60,000
“ Bad debts 21,100
“ Provision for doubtful debts 8,500
“ Depreciation on plant 4,95,000
“ Provision for tax 180,000
“ Profit & Loss Appropriation a/c
(Net profit) 1,80,000
51,00,000 51,00,000
Profit and Loss Appropriation Account
To Interim Dividend 3,92,500 By Balance b/d 2,62,500
“ Balance c/d 50,000 “ Profit & Loss a/c 1,80,000
(Net profit)
4,42,500 4,42,500
Balance Sheet
as on 31.3.2007
Liabilities Assets
Called up Capital Goodwill 2,50,000
40,00,000 Premises 30,72,000
Less calls in arrear 75,000 39,25,000 Plant 33,00,000
Reserves & Surplus Less: Provision 4,95,000 28,05,000
General Reserve 2,50,000 Current Assets, Loans and Advances Contd...
Profit & Loss a/c 50,000

Secured Loans Current Assets:
12% Debentures 30,00,000 LOVELY PROFESSIONAL UNIVERSITY
Stock 9,50,000 351
O/s Interest 1,80,000 31,80,000 Debtors 8,70,000
Current liabilities and Provisions Provision 43,500 8,26,500
Cash & Bank 4,06,500
Current Liabilities Miscellaneous Expenditure:
Liabilities Assets
Called up Capital Goodwill 2,50,000
40,00,000 Premises 30,72,000
Less calls in arrear 75,000 39,25,000 Plant 33,00,000
Reserves & Surplus Less: Provision 4,95,000 28,05,000
Notes General Reserve 2,50,000 Current Assets, Loans and Advances
Profit & Loss a/c 50,000
Secured Loans Current Assets:
12% Debentures 30,00,000 Stock 9,50,000
O/s Interest 1,80,000 31,80,000 Debtors 8,70,000
Current liabilities and Provisions Provision 43,500 8,26,500
Cash & Bank 4,06,500
Current Liabilities Miscellaneous Expenditure:
Creditors 4,00,000 Preliminary Expenses 45,000
Bills Payable 3,70,000
Provision
Provision for tax 1,80,000
83,55,000 83,55,000
Illustration 10:
From the under mentioned Trial Balance of Gopal Oil Co. Limited, prepare a Trading and profit
and loss account for the year ended December 31, 2006 and the Balance sheet as on that date:
Opening Stock 30,000 Equity share capital 1,00,000
Rates and Taxes 6,000 (1,000 shares of 100 each)
Purchases 60,900 5% debentures 25,000
Wages 55,200 Sales 1,75,000
Discount 1,500 Creditors 8,000
Fuel 2,570 Bank overdraft 12,000
Building 70,000 Discount 2,200
Carriage Inward 1,175 Transfer fee 100
Sundry Debtors 20,000 Returns outward 100
Goodwill 28,000
Plant & Machinery 25,000
Loose Tools 6,000
Advertisement 3,000
General Expenses 4,400
Bad Debts 1,030
Debenture Interest 625
(Half year upto 30.06.2006)
Insurance 3,000
Miscellaneous Expenses 1,000
Cash & Bank Balances 3,000
3,22,400 3,22,400
1. The Authorized Capital of the company is 2,00,000.
2. Stock on December 31, 2006 is 35,000.
3. Depreciate Plant & Machinery @9% and revalue loose tools at 4,100.
4. Allow 2.5% discount on Debtors and 2% as bad debt reserve.

Solution: Notes
Trading and Profit & Loss Account of Gopal Oil Company
(For the year ending December 31, 2006)
To Opening Stock 30,000 By Sales 1,75,000
To Purchases 60,900 By Closing Stock 35,000
(–) Returns Outward 100
60,800 By Discount 2,200
To Wages 55,200 By Transfer Fee 100
To Fuel 2,570
To Carriage Inwards 1,175
To Rent and Rates 6,000
To Debenture Interest 625
(+) Outstanding 625
1,250
To Discount 1,500
To General Expenses 4,400
To Bad Debts 1,030
To Provision for Bad Debts 400
To Provision for Discount on Debtors 490
To Miscellaneous Expenses 3,000
To Insurance 1,000
To Depreciation on Plant & Machinery 2,250
To Loose Tools 1,900
To Net Profit 36,335
2,12,300 2,12,300
Balance Sheet of Gopal Oil Co. Ltd.

As on December 31, 2006
Liabilities Assets
Authorized Capital Goodwill 28,000
2000 Shares of 100 each 2,00,000 Building at Cost 70,000
Issued and Subscribed Capital Plant & Machinery 25,000
1000 equity shares of Less: Depreciation 2,250 22,750
100 each fully paid up 1,00,000 Investments
Reserves and Surplus: Current Assets and Loans Advances:
Profit and Loss Account 36,335 Current Assets:
Secured Loans
5% Debentures 25,000 Loose Tools 4,100
Outstanding Interest: 625 Stock in Trade 35,000
Unsecured Loans: Sundry Debtors 20,000
Current Liabilities and Provisions: Less: Provision for debts 400
Creditors 8,000 19,600
Bank Overdraft 12,000 Less: Provision for 19,110
Discount on Debtors 490
Cash in hand and Bank 3,000
1,81,960 1,81,960

11. Section ................... of the Companies Act governs the preparation of final account of a
company.
12. Interim dividend is declared between two...................
13. The difference between dividend received and dividend receivable is debited...................
14. 30 days after the declaration of dividend the amount of unpaid dividend is deposited in
a...................
15. Interest out of ................... may be paid u/s 208 of the Companies Act.
Task Discuss the importance of profit and loss A/c and explain the terms Gross Profit
and Net Profit.
14.3 Summary
 Final accounts include the Trading and Profit & Loss Account and Balance Sheet. Trading
and Profit and Loss Account is prepared to calculate the net profit earned by business
during a period. Balance Sheet of a business is prepared to disclose the financial picture of
the business.
 The Trading Account shows the gross profit difference of sales receipts and cost of sales.
Profit & Loss Account shows the net profit which is computed by matching the total
revenues and expenses of the business. Balance Sheet is a statement which has two sides –
Liability side and Assets side.
 According to Section 209 of the Indian Companies Act, 1956, it is compulsory for each and
every company to prepare its profit and loss account as well as Balance Sheet.
 It is also essential to maintain both the accounts in a proper form which is given in the
Schedule VI Parts (I and II) of the Companies Act.
 Final accounts of a business comprise of trading account, which shows gross profit.
 It includes profit and loss account which shows net profit.
 Then further it includes balance sheet which shows the assets and liabilities of the business
at the year end.
 The starting point for the preparation of final accounts is the summary of the information
from the accounting records contained in the book keepers trial balance.
14.4 Keywords
Gross Profit: It is calculated by comparing the sales and cost of sales. It is the excess of sales over
cost of sales.
Net Profit: It is the excess of revenues over expenses. It is depicted by P. & L. A/c.
Net Loss: Excess of expenditures over revenues is called net loss.
Trial Balance: It is the list of accounts taken from the ledger.

1. Explain the key books of accounts of a company.
2. State the preparation of profit and loss account.
3. What are the key requirements of Schedule VI of Companies Act concerning the profit and
loss account?
4. Prepare Profit and Loss Account as per Companies Act (take imaginary figures).
5. Explain the contingent liabilities. Give three examples of it.
6. What are the different provisions regarding depreciation?
7. Classify the following items under different heading of the balance sheet:
(a) Share Premium Account (b) Bank Overdraft
(c) Unclaimed Dividend (d) Proposed Dividend
8. Give the different forms of the balance sheet
9. Prepare the vertical form of balance sheet.
10. Give the items of Profit & Loss Appropriation A/c.
11. Give a specimen form of Balance Sheet and Profit and Loss A/c as per Companies Act.
12. Prepare Profit and Loss A/c and Profit and Loss Appropriation Account of a company with
loss Appropriation Account of a company with imaginary figures.
13. What are the rules regarding the preparation and presentation of the final account of a
company under the Companies Act? Explain.
14. Prepare a Proforma of Balance Sheet in horizontal form as per requirement of the Schedule
VI of the Companies Act, 1956.
15. Mention the requirement of Schedule VI (Parts I and II) of the Companies Act, 1956 in
respect of-
(i) Fixed Assets
(ii) Investments
(iii) Turnover
(iv) Contingent Liabilities
(v) Debtors
16. What do you mean by ‘Divisible profit’? How are they calculated? Explain.
17. Explain the term ‘Dividend’. Give the various provisions of Indian Companies Act
governing the declaration and payment of dividend.
18. What is interim dividend? Under what circumstances will it be given?
1. Calculate the maximum account that can be distributed as dividend for the year 2005
according to Companies (Declaration of Dividend out of Reserve) Rules, 1975 from the
following data:

Notes `
Paid up Capital 45 lakhs
Free Reserve 22.5 lakhs
Loss in 2005 2.25 lakhs
Dividend declared in 2000, 2001, 2002, 2003 and 2004 are 13.5%, 12.5%, 16%, 15 & 13%.
Ans: Maximum amount can be distributed as dividend ` 450,000 and the maximum rate of
dividend, 10%).
2. Calculate the amount of divisible profits for year 2005 from the information given below:
2003 2004 2005

` in lakhs ` in lakhs ` in lakhs
I Profit or Loss before depreciation -60 -30 +50
II Depreciation provided in the book. 6 6 9
III Depreciation as prescribed under Section 205 48 42 36
Ans: Divisible profits are ` 24,00,000(150-48-42-36)
3. On 31st December, 2005 the paid up capital of XYZ Company Limited was as under:
(a) 2,500 8% Tax Free Preference Shares ` 100 each issued before
1st April, 1960 2,50,000
(b) 2,500 9% Tax Free Preference Shares of ` 100 each issued after
1st April, 1960 2,50,000
(c) 5,000 10% Taxable Preference Shares of ` 100 each issued before
1st April, 1960 5,00,000
(d) 5,000 10% Taxable Preference Shares ` 100 each issued after
1st April, 1960 5,00,000
(e) 12,500 Equity Share of ` 100 each issued before 1 st April, 1960 12,50,000
(f) 12,500 Equity Shares of ` 100 each issued, as right shares on 1 st April,
2005 to rank for dividend from 1st May, 2005 fully paid up less ` 50,000
call in arrears. 12,00,000
Calculate the amount of profits that should be available so that directors may (i) transfer
` 2,50,000 to General Reserve, (ii) recommend the dividend due to preference shares and a
dividend of 10% equity shares for the year 2005, any carry forward 20% of profits.
Ans: Profit should be available ` 7,61,250
1. Trading 2. Profit & Loss
3. Debit, Trading 4. Debit, Profit & Loss
5. Trading 6. Trading, P & L A/c
7. False 8. True
9. True 10. True

11. 210, 12. Annual General Meetings, Notes
13. T.D.S A/c, 14. Unpaid Dividend A/c,
15. Capital,




Book Group, 1996.

Publishing, 1998.



Case Study Trial Balance of Alfa Limited
The following is the trial balance of Alfa Ltd. for the year ended 30 th June, 2006.
Particulars
Stock 1st July 2005 85,000
Land & Buildings 3,00,000 –
Plant & Machinery 4,50,000 –
Furniture & Fittings 40,000 –
Goodwill 60,000 –
Sundry Debtors 60,000 –
Bills Receivable 26,000 Contd...
–
Investments (5% Govt. Securities) 30,000 –
Cash in hand 2,000 –
Cash at Bank 55,000 –
Sundry Creditors – 40,000
Preliminary Expenses 29,000 –
Bills Payable – 20,000
General Reserves – 2.00,000

Dcom201 Accounting For Companies I

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ACCOUNTING FOR COMPANIES - I

Sr. No. Topics

Unit 1: Share Capital – Issue of Shares 1

Unit 2: Forfeiture of Shares 44

Unit 3: Reissue of Forfeited Shares and Bonus Issue 54

Unit 5: Redemption of Preference Shares 103

Unit 6: Debentures: Concept, Types, Issue 130

Unit 7: Debentures: Conditions of Issue of Debentures from Redemption Point of 152

Unit 8; Methods of Redemption-I 170

Unit 9: Methods of Redemption-II 200

Unit 10: Underwriting of Shares 221

Unit 11: Profit and Loss Prior to Incorporation 255

Unit 12: Divisible Profits and Managerial Remuneration 281

Unit 13: Final Accounts for Companies 307

Unit 14: Preparation of Final Accounts 330

Unit 1: Share Capital – Issue of Shares Notes

After studying this unit, you should be able to:

 Understand meaning of Share Capital

 Know classes of shares

 Explain under and Over Subscription

 Understand issue of shares for consideration other than cash

LOVELY PROFESSIONAL UNIVERSITY 1

1.1 Meaning and Categories of Share Capital

1.2 Classes of Shares

2 LOVELY PROFESSIONAL UNIVERSITY

(i) Cumulative vs. Non-Cumulative Preference Share: There is however, no obligation to

(ii) Redeemable vs Irredeemable Preference Share: Redeemable Preference Share is that

(iii) Participating vs Non-participating Preference Share: Participating preference shares

(iv) Convertible vs Non-convertible Preference Shares: Convertible preference shares are

Did u know? Cumulative preference shareholders are entitled to a dividend at a stipulated

LOVELY PROFESSIONAL UNIVERSITY 3

Notes Convertible Cumulative Preference Shares

1.3 Issue of Shares

First Instalment : Application Money

Second Instalment : Allotment Money

Third Instalment : First Call Money

Fourth Instalment : Second Call Money

Last Instalment : Final Call Money

4 LOVELY PROFESSIONAL UNIVERSITY

Procedure for Receipt of Application Money

(iv) working capital, and

LOVELY PROFESSIONAL UNIVERSITY 5

Books of Account of a Public Company

(b) all sales and purchases of goods of company.

(c) all assets and liabilities of the company.

6 LOVELY PROFESSIONAL UNIVERSITY

Accounting Treatment Regarding Issue of Shares Notes

1. On receipt of application money:

Bank Account Dr. (with the total application money)

To Share Application Account

(Being the receipt of application money on ——shares @————per share)

2. On the acceptance of applications for share:

To Share Capital Account

(Being the transfer of application money to share capital account.)

3. On making the allotment money due:

Share Allotment Account Dr. (With allotment money due)

To Share Capital Account

(Being share allotment money due on _______ shares @_______per share.)

4. On receipt of allotment money:

Bank Account Dr. (with actual allotment money received)

To Share Allotment Account

(Being the receipt of allotment money)

5. On making the first call due:

(Being share allotment money due on _ shares @_per share.)

(Being first call money due __shares @_per share)