Tag: Amalgamation

Internal Reconstruction refers to the process of reorganizing the financial structure of a financially troubled company without dissolving the existing entity or forming a new one. It involves restructuring the company’s capital, liabilities, and assets to improve its financial stability and operational efficiency. This may include reducing share capital, settling debts at a compromise, revaluing assets and liabilities, or altering shareholder rights. The objective is to revive the company by eliminating accumulated losses, reducing debt burden, and strengthening the balance sheet. Internal reconstruction requires approval from shareholders, creditors, and sometimes the National Company Law Tribunal (NCLT) under the Companies Act, 2013. Unlike amalgamation or external reconstruction, the company continues its operations under the same legal identity but with a restructured financial framework.

Objectives of Internal Reconstruction

• To Wipe Out Accumulated Losses

One of the primary objectives of internal reconstruction is to eliminate accumulated losses from the company’s balance sheet. These losses often prevent a company from declaring dividends and reflect poor financial health. By reducing share capital or adjusting reserves, the losses are written off, making the balance sheet cleaner and more attractive to investors. This process gives the company a fresh start financially, improving its credibility in the eyes of stakeholders and potential financiers.

• To Reorganize Share Capital

Over time, a company may have an overcapitalized or undercapitalized structure. Internal reconstruction helps reorganize this by reducing or consolidating shares, converting preference shares into equity, or altering share values. This adjustment aligns the capital structure with the company’s present financial position. It also ensures better utilization of funds, more realistic share values, and improved returns for shareholders. This ultimately enhances the company’s ability to raise capital and sustain operations more efficiently.

• To Eliminate Fictitious or Overvalued Assets

Companies may carry fictitious or overvalued assets like preliminary expenses, goodwill, or inflated investments on their balance sheets. These non-productive assets distort the true financial position. Internal reconstruction aims to eliminate or adjust the values of such assets, ensuring the balance sheet reflects accurate values. This transparency is crucial for stakeholder trust, effective decision-making, and compliance with accounting standards. Correct asset valuation also improves ratios and financial health indicators used by investors and lenders.

• To Reduce the Burden of Debt and Liabilities

Excessive or unmanageable liabilities can hinder a company’s ability to operate and grow. Internal reconstruction allows the company to renegotiate or restructure its obligations. It can include converting debt into equity, reducing interest rates, or seeking concessions from creditors. These measures help reduce the debt burden, lower interest outflows, and improve liquidity. A leaner liability structure strengthens the company’s long-term viability and provides better cash flow management for future development.

• To Improve Financial Position and Creditworthiness

A company with a weak financial position may struggle to gain credit or attract investment. Internal reconstruction helps improve its balance sheet by eliminating losses, adjusting capital, and removing fictitious assets. This results in a more accurate representation of the company’s net worth. A stronger balance sheet enhances the company’s image in the financial market, increases investor confidence, and makes it easier to raise funds or get better credit terms from banks and institutions.

• To Avoid Liquidation and Continue Business

When a company faces financial distress, liquidation may seem inevitable. However, internal reconstruction provides an alternative that allows the company to continue operating. Through reorganization and adjustments, the company can become viable again without being dissolved. This saves jobs, preserves business relationships, and retains the company’s market presence. It also gives the business a chance to revive, recover from losses, and potentially return to profitability, which benefits all stakeholders in the long run.

• To Protect the Interests of Stakeholders

Internal reconstruction is designed to protect the interests of various stakeholders, including shareholders, creditors, employees, and customers. By restructuring debt and capital, the company becomes more stable and sustainable. Creditors may receive partial payments or equity in exchange for their claims, and shareholders may retain value in their investments. Employees benefit from continued employment, and customers from uninterrupted services. A successful internal reconstruction creates a win-win situation that balances losses while promoting long-term recovery.

Types of Internal Reconstruction

• Reduction of Share Capital

This involves decreasing the paid-up value or number of shares issued by the company to write off accumulated losses or overvalued assets. It can take forms like reducing the face value of shares, cancelling unpaid share capital, or returning excess capital to shareholders. This process requires approval from shareholders, creditors, and the tribunal as per legal provisions. The goal is to align the capital with the company’s actual financial position and make the balance sheet healthier, paving the way for future profitability and investor confidence.

• Reorganization of Share Capital

Reorganization refers to altering the structure of a company’s existing share capital without reducing its total value. It may involve converting one class of shares into another (e.g., preference to equity), subdividing shares into smaller units, or consolidating them into larger units. This type of reconstruction improves the flexibility and attractiveness of the company’s shareholding pattern. It helps cater to investor preferences, improve market perception, and better reflect the company’s operational scale and prospects.

• Revaluation of Assets and Liabilities

In this type, the company reassesses the book value of its assets and liabilities to reflect their actual market values. Overvalued assets like goodwill or obsolete machinery are written down, while undervalued ones like land may be increased. Liabilities may also be restated, such as provisioning for doubtful debts. This brings transparency, accuracy, and credibility to the balance sheet, making financial statements more reliable for investors, auditors, and lenders. It supports better decision-making and financial planning.

• Alteration of Rights of Stakeholders

Here, the company may alter the rights attached to different classes of shares or renegotiate terms with creditors. For example, preference shareholders may agree to a lower dividend or delayed payment. Creditors may agree to partial settlements or convert their dues into equity. These adjustments require consent and legal approval but help reduce financial stress on the company. It balances the expectations of stakeholders while improving the company’s survival chances and long-term sustainability.

Conditions/Provisions regarding Internal Reconstruction:

• Approval by Shareholders and Creditors

Internal reconstruction requires the formal approval of shareholders through a special resolution passed in a general meeting. In addition, the consent of creditors, debenture holders, and other affected parties is essential, especially when their rights are altered or reduced. This ensures transparency and fairness in the reconstruction process. Without stakeholder consent, the plan cannot proceed legally, as it may negatively impact their financial interests. This step reflects democratic decision-making and protects the rights of those involved in the company’s capital structure.

• Compliance with Section 66 of the Companies Act, 2013

Section 66 of the Companies Act, 2013 governs the reduction of share capital, a key element of internal reconstruction. It mandates that the company must apply to the National Company Law Tribunal (NCLT) for confirmation of the reduction. A detailed scheme, statement of assets and liabilities, and auditor’s certificate must accompany the application. The Tribunal will approve the plan only after ensuring that the interests of creditors and shareholders are safeguarded. Compliance ensures legal validity and protects against future legal disputes or financial misstatements.

• Tribunal’s Sanction and Public Notice

Before implementing internal reconstruction, especially involving capital reduction, companies must obtain the sanction of the National Company Law Tribunal (NCLT). The Tribunal may direct the company to notify the public and creditors through advertisements in newspapers and seek objections. This transparency protects public interest and allows concerned parties to express their views. Only after hearing objections and verifying fairness does the Tribunal approve the scheme. This provision ensures accountability and protects the rights of both existing investors and the public.

• Filing with Registrar of Companies (RoC)

After obtaining Tribunal approval, the company must file the sanctioned reconstruction scheme and any altered documents with the Registrar of Companies (RoC). This includes submitting revised copies of the Memorandum of Association and Articles of Association if they are modified. Filing ensures that the changes become part of the company’s legal records and are accessible to stakeholders and regulatory authorities. It completes the legal formalities and provides legitimacy and transparency to the restructuring process, keeping the company compliant with statutory requirements.

Steps in Internal Reconstruction

Internal reconstruction is a method used by companies to reorganize their financial structure and restore solvency without winding up the company. The process involves several steps, each aimed at strengthening the company’s capital base, eliminating losses, and improving financial stability. The key steps are explained below.

Step 1. Surrender of Shares by Shareholders

The first step in internal reconstruction often involves the voluntary surrender of shares by shareholders. Shareholders may agree to surrender a portion of their shares to reduce the company’s capital. This reduces the paid-up share capital and helps the company eliminate excess or overcapitalization. The surrendered shares are either cancelled or reduced in nominal value. This step is crucial to provide financial relief to the company and forms the foundation for the reconstruction process.

Step 2. Reduction of Share Capital

Once shares are surrendered, the company may proceed with a formal reduction of share capital. This requires approval from the court or shareholders as per the Companies Act, 2013. The nominal value of shares may be reduced to a more realistic level that aligns with the company’s actual assets. Capital reduction helps the company balance its capital with its true financial position, avoids excessive dividend obligations, and restores solvency.

Step 3. Writing Off Accumulated Losses

A major step in internal reconstruction is the writing off of accumulated losses. Losses, if carried forward, reduce the company’s net worth and affect its ability to attract investment. These losses can be written off against capital reduction account, share premium, or revaluation reserves. This step improves the financial position of the company, increases shareholder confidence, and ensures that the balance sheet reflects a true and fair view of assets and liabilities.

Step 4. Revaluation of Assets and Liabilities

Internal reconstruction often requires the revaluation of assets and liabilities. Fixed assets, investments, and other resources may be revalued to reflect their true market value. Similarly, liabilities may be reassessed to ensure proper provisions are made. Revaluation ensures that the company’s balance sheet presents a realistic picture of its financial health. It also helps in adjusting capital and reserves to cover losses and maintain solvency.

Step 5. Adjustment of Capital and Reserves

After revaluation, the company needs to adjust its capital and reserves to bring them in line with the revised financial structure. Capital reduction, reissue of shares, and utilization of reserves help eliminate discrepancies caused by losses or overvaluation. Reserves may be utilized to absorb losses or fund new capital requirements. This step ensures that the financial structure of the company is balanced and sustainable.

Step 6. Reissue of Shares

If required, the company may reissue shares at a revised value after surrender and reduction. This allows the company to raise new funds from shareholders and improve liquidity. Reissued shares help in strengthening capital base, attracting investors, and enhancing market confidence. The reissue may include shares at a discount, par value, or premium, depending on the financial requirement and investor willingness.

Step 7. Preparation of Revised Balance Sheet

The final step is the preparation of a revised balance sheet that reflects the effects of internal reconstruction. This includes adjusted share capital, revalued assets, written-off losses, and restructured reserves. The revised balance sheet shows the true financial position of the company after reconstruction. It provides a clear picture to shareholders, creditors, and investors regarding the solvency, stability, and operational efficiency of the company.

Accounting Treatment of Internal Reconstruction:

Amalgamation is a strategic process in corporate restructuring where two or more companies combine to form a new entity or where one company is absorbed by another. The primary motive behind amalgamation is to achieve synergy, expand operations, eliminate competition, and enhance market reach. In accounting and legal terms, amalgamation is governed by the Companies Act, 2013, and is treated as per the accounting standard AS 14 – Accounting for Amalgamations.

AS 14 classifies amalgamation into two broad categories:

1. Amalgamation in the Nature of Merger

2. Amalgamation in the Nature of Purchase

Each type has distinct accounting treatments, legal conditions, and strategic implications, which are discussed in detail below.

Amalgamation in the Nature of Merger

Amalgamation in the nature of merger refers to a form of business combination in which two or more companies combine to form one single company and the business of the transferor company (selling company) is taken over by the transferee company (purchasing company). In this type of amalgamation, the companies are integrated in such a way that the identity of the transferor company is not treated as sold but as continued in the new or existing company. It is treated as a unification of business rather than a purchase.

Essential Conditions

For an amalgamation to be considered in the nature of merger, certain conditions must be satisfied:

• All the assets and liabilities of the transferor company become the assets and liabilities of the transferee company.

• Shareholders holding at least 90% of the equity shares of the transferor company become equity shareholders of the transferee company.

• Consideration is discharged only by issue of equity shares (except for fractional cash adjustments).

• The business of the transferor company is continued by the transferee company.

• No adjustment is made to the book values of assets and liabilities except to bring uniformity in accounting policies.

Characteristics of Amalgamation in the Nature of Merger

Accounting Treatment of Pooling of Interests Method

Amalgamation in the nature of merger is accounted for by the Pooling of Interest Method. Under this method, the assets, liabilities, and reserves of the transferor company are recorded by the transferee company at their existing book values. No revaluation of assets or liabilities is done because the business is treated as a continuation.

All reserves such as General Reserve, Profit and Loss Account, and other accumulated balances of the transferor company are carried forward and appear in the books of the transferee company. This preserves the financial position and past records of the business.

Under the Pooling of Interests Method, the books of the transferee company reflect:

• Assets and liabilities of the transferor company at existing book values.

• Reserves of the transferor company as they are, and not transferred to the Profit & Loss account.

• No goodwill or capital reserve is recorded.

• The difference in share capital is adjusted against reserves.

This method ensures continuity in financial reporting and is often preferred for strategic mergers between equals.

Example

Let’s consider two companies – A Ltd. and B Ltd.

• A Ltd. and B Ltd. decide to merge and form a single company, A Ltd. (B Ltd. is absorbed).

• All assets and liabilities of B Ltd. are taken over by A Ltd.

• 95% of the shareholders of B Ltd. are issued equity shares in A Ltd.

• No purchase consideration is paid in cash.

• Business of B Ltd. is continued by A Ltd.

Since all five conditions are satisfied, this amalgamation is in the nature of merger.

Accounting Treatment of Goodwill or Capital Reserve

In this type of amalgamation, goodwill or capital reserve normally does not arise because the purchase consideration is equal to the share capital of the transferor company. If any difference occurs, it is adjusted in reserves rather than treated as goodwill. The objective is to maintain continuity of business and not to show acquisition profit or loss.

Journal Entries in the Books of Transferee Company

1. For recording assets and liabilities taken over

Business Purchase A/c Dr.
  To Liquidator of Transferor Company A/c

2. For incorporating assets and liabilities at book value

Assets A/c Dr.
  To Liabilities A/c

3. For payment of purchase consideration (issue of shares)

Liquidator of Transferor Company A/c Dr.
  To Equity Share Capital A/c

Features

• It represents a genuine combination of companies.

• Shareholders of transferor company become shareholders of transferee company.

• Business operations continue without interruption.

• Book values are maintained and reserves are preserved.

• No gain or loss on acquisition is recognized.

Amalgamation in the Nature of Purchase

Amalgamation in the nature of purchase refers to a type of business combination in which one company acquires another company and takes over its business. In this case, the transferor company (selling company) is treated as being purchased by the transferee company (purchasing company). The transaction is similar to buying a business, and the shareholders of the transferor company generally do not continue as owners in the same proportion. Therefore, it is considered an acquisition and not a true merger.

Characteristics of Nature of Purchase

• Acquisition of Business

In this type of amalgamation, the transferee company acquires the business of the transferor company just like a buyer purchases a running business. The relationship between the two companies is that of purchaser and vendor. The transferor company does not continue as a partner in the combined entity. The purpose is expansion, control, or gaining market advantage. Therefore, the transaction is treated as a purchase and not as a unification of equal companies.

• Transfer of Selected Assets and Liabilities

The transferee company is not required to take over all assets and liabilities of the transferor company. It may choose only specific assets and certain liabilities according to the agreement. Unwanted or risky obligations can be left behind in the transferor company. This flexibility is an important feature because it allows the purchasing company to acquire only profitable parts of the business and avoid unnecessary risks or losses.

• Shareholders Do Not Continue Ownership

Shareholders of the transferor company generally do not become equity shareholders of the transferee company in the same proportion. They are paid purchase consideration in cash, shares, debentures, or a combination of these. Because ownership is not continued, the transferor company loses its identity and is liquidated. This absence of continuity of ownership clearly distinguishes purchase from merger.

• Consideration Paid in Various Forms

Purchase consideration may be paid in equity shares, preference shares, debentures, cash, or other securities. There is no restriction that payment must be only in equity shares. The purchasing company may even pay entirely in cash. This flexibility confirms that the transaction is an acquisition rather than a partnership arrangement and allows the transferee company to design payment according to its financial position.

• Revaluation of Assets and Liabilities

In amalgamation in the nature of purchase, assets and liabilities of the transferor company are recorded at agreed or revised values. They are not necessarily recorded at book value. The transferee company may increase or decrease values to reflect fair market price. This revaluation ensures that the assets are recorded at realistic amounts in the new books of accounts.

• Application of Purchase Method

Accounting treatment follows the Purchase Method. The transferee company records only the assets and liabilities taken over and ignores those not acquired. Financial statements are not combined as in merger. Instead, the acquisition is treated like buying a separate business. This method clearly recognizes the difference between old and new entity.

• Reserves Not Carried Forward

Reserves such as general reserve, profit and loss balance, and other accumulated profits of the transferor company are not transferred to the books of the transferee company. Only statutory reserves may be recorded if required by law. Since the business is considered purchased, the past financial history of the transferor company is not continued.

• Recognition of Goodwill or Capital Reserve

Difference between purchase consideration and net assets taken over results in goodwill or capital reserve. If consideration exceeds net assets, goodwill arises representing reputation and future earning capacity. If net assets exceed consideration, capital reserve arises showing a gain on purchase. This is a typical feature of acquisition accounting.

• Discontinuance of Transferor Company

After completion of the transaction, the transferor company is liquidated and dissolved. Its legal existence comes to an end because its business has been sold. The transferee company becomes the sole owner of the acquired business and operates it under its own name and policies.

• Independent Management Control

Management and control remain entirely with the transferee company. The purchasing company makes all decisions regarding operations, policies, and administration. Directors or managers of the transferor company may or may not be retained. The combined business operates under a single authority, showing clear acquisition rather than cooperation.

Accounting Treatment – Purchase Method

Under the Purchase Method, the transferee company:

• Records assets and liabilities at fair market value (not book value).

• Does not carry over reserves of the transferor company (except statutory reserves).

• Recognizes the difference between the purchase consideration and net assets taken over as goodwill (if consideration > net assets) or capital reserve (if consideration < net assets).

This method reflects a new ownership and often results in changes in financial position due to revaluation.

Example:

Consider another case:

• X Ltd. acquires Y Ltd. by paying ₹50 lakh in cash and taking over only selected assets.

• Only 60% of Y Ltd.’s equity shareholders become shareholders of X Ltd.

• Y Ltd.’s business is discontinued after acquisition.

• Asset values are revalued at the time of acquisition.

This transaction fails to meet the conditions of merger and hence qualifies as an amalgamation in the nature of purchase.

Comparison Between Merger and Purchase

Remuneration of a Liquidator refers to the compensation or fee payable to a liquidator for carrying out the process of winding up a company. This process includes selling the company’s assets, settling liabilities, distributing the surplus (if any) among shareholders, and ensuring all statutory and regulatory obligations are fulfilled. The liquidator plays a critical fiduciary role, and the remuneration structure is designed to reflect the complexity, responsibility, and time involved in managing the liquidation process.

Legal Framework

The remuneration of the liquidator is governed by:

• Companies Act, 2013 (especially Sections 275–365 on winding up),

• Insolvency and Bankruptcy Code (IBC), 2016, and

• Companies (Winding-Up) Rules, 2020.

Under these laws, the amount and manner of payment of remuneration vary depending on whether the liquidation is:

1. Voluntary,

2. Compulsory (by order of NCLT), or

3. Under the IBC (corporate liquidation process).

Who Fixes the Remuneration?

The remuneration is fixed based on the mode of winding up:

1. In Compulsory Winding-Up:

• The National Company Law Tribunal (NCLT) appoints an official liquidator and fixes their remuneration.

• The fee may be fixed as a percentage of the assets realized and distributed or as a fixed sum depending on the complexity and scale of the process.

2. In Voluntary Winding-Up:

• The company in general meeting appoints the liquidator and fixes the remuneration through a special resolution.

• The appointed liquidator cannot change the remuneration unless approved by shareholders.

3. In Liquidation under IBC:

• The Committee of Creditors (CoC) fixes the fee of the liquidator (Resolution Professional acting as liquidator) under Regulation 4 of the IBBI (Liquidation Process) Regulations, 2016.

• The fees may be a fixed monthly remuneration or based on asset realization and distribution.

Modes of Remuneration:

Remuneration may be paid in the following ways:

1. Percentage Basis:

• A percentage of the assets realized or distributed to creditors and shareholders.

• For example, 2% of assets realized and 3% of assets distributed.

2. Fixed Monthly Fee:

Especially under IBC, where CoC fixes a monthly fee for the duration of the liquidation.

3. Success-Based Fee:

In some cases, liquidators may be offered an incentive for completing the process efficiently or achieving higher recoveries.

Remuneration is a Priority Cost:

• Under both the Companies Act and IBC, the liquidator’s remuneration is treated as part of the insolvency resolution and liquidation process costs.

• These costs are accorded highest priority in the waterfall mechanism for distribution (Section 53 of IBC and Rule 190 of Companies Rules).

Reimbursement of Expenses:

In addition to remuneration, a liquidator is entitled to reimbursement of actual expenses incurred during the winding-up, such as:

• Legal and professional fees,

• Advertising costs for notices or auctions,

• Costs of maintaining records and conducting meetings,

• Travel and administrative expenses.

All such expenses must be properly accounted for and supported with evidence.

Remuneration Restrictions:

Certain restrictions and rules ensure fairness and prevent abuse:

• Liquidators cannot increase their own fee or receive additional benefits without approval.

• They cannot accept commissions or gifts from stakeholders.

• Double remuneration for the same work is prohibited.

• The remuneration must be approved and disclosed in the final accounts.

Remuneration Upon Resignation or Removal:

If a liquidator resigns or is removed before the completion of liquidation:

• They are entitled to remuneration only for the period of service.

• Prorated fees may be calculated based on work done and approvals obtained.

The Liquidator’s Statement of Account is a comprehensive financial report prepared by the liquidator during the winding-up process of a company. It captures all financial transactions from the commencement of liquidation to its completion. This statement ensures accountability, transparency, and statutory compliance, especially under the Companies Act, 2013 and the Insolvency and Bankruptcy Code (IBC), 2016.

Purpose and Importance:

The primary objective of preparing a Liquidator’s Statement of Account is to:

1. Disclose the financial position of the company under liquidation.

2. Track the realization and distribution of assets.

3. Provide transparency to stakeholders including creditors, shareholders, and regulatory authorities.

4. Ensure compliance with the legal and procedural norms under the Companies Act, IBC, and SEBI guidelines (where applicable).

It acts as a key document submitted to the Tribunal (NCLT), Registrar of Companies, and the Insolvency and Bankruptcy Board of India (IBBI) as part of the final reporting in the liquidation process.

Legal Provisions:

Under the Companies (Winding-Up) Rules, 2020, Rule 185 and 186 outline the format and frequency of the Liquidator’s Account.

Under the Insolvency and Bankruptcy Code, 2016, the Liquidator must file periodic and final reports, including statements of receipts and payments, with the Adjudicating Authority (NCLT) and IBBI.

Contents of the Liquidator’s Statement of Account:

A standard Liquidator’s Statement of Account includes the following components:

1. Receipts Section

This section details the total cash and assets received during liquidation, including:

• Opening cash and bank balances.

• Sale proceeds from fixed assets.

• Realization from current assets (stock, receivables, etc.).

• Income from investments.

• Refunds or recoveries from tax authorities.

• Other income (interest, rent, etc.).

2. Payments Section

This section records all expenditures and distributions, such as:

• Insolvency resolution and liquidation process costs.

• Legal and professional fees.

• Payments to secured creditors.

• Workmen’s dues and employee salaries.

• Government dues (taxes, duties, etc.).

• Payments to unsecured creditors.

• Interim dividend or final dividend to shareholders.

• Miscellaneous expenses (postage, printing, rent, utilities).

3. Summary of Assets Realized and Disposed

• Details of each asset realized (description, book value, sale value).

• Details of assets yet to be realized or written off.

• Any shortfall or surplus generated.

4. Statement of Distribution

• Date and amount paid to each category of stakeholder.

• Particulars of dividends declared and paid.

• Unclaimed amounts and transfer to the Corporate Liquidation Account (as mandated by IBBI).

5. Bank Reconciliation Statement

• Cash at bank and on hand.

• Bank account statement attached to ensure reconciliation with liquidation records.

6. Notes and Observations

• Notes regarding any legal proceedings, disputes, or liabilities.

• Explanation for delays or outstanding recoveries.

• Remarks on books and records maintained during liquidation.

Format and Frequency

Frequency of Submission:

• Half-yearly (for voluntary winding-up) or

• Quarterly (as per IBBI regulations for corporate persons)

• Final Statement at the end of the liquidation process

Format:

The format of the statement is prescribed under Form No. 11 and Form No. 12 of the Companies (Winding-Up) Rules and under Form H of IBBI (Liquidation Process) Regulations, 2016.

Audit and Certification

• The statement must be audited by a Chartered Accountant, especially if the liquidation period exceeds one year.

• Certified true copies are submitted to:

  • NCLT (for compulsory winding-up)

  • Registrar of Companies

  • IBBI (for cases under IBC)

Closing the Liquidation Process:

Once the statement is prepared and submitted, and all obligations are met:

1. Final meeting of stakeholders is held (in case of voluntary winding-up).

2. A final report and accounts are submitted to the NCLT/Registrar.

3. On approval, the company is dissolved and struck off from the records.

If unclaimed funds remain, they are deposited into the Corporate Liquidation Account, managed by IBBI, and reported in the Statement.

Participants

Loan Takers: A huge number of organizations want to take a loan from the capital market. Among them, the following are prominent as Govt. organizations, Corporate bodies, Non-profit organizations, Small business, and Local authorities.

Loan Providers: These types of organizations provide loans to my capital market. Others can take the loan from the loan providers such as savings organizations, insurance organizations etc.

Service organizations: Service organizations help to run capital market perfectly. These firms, on one hand, help issuers or underwriters to sell their instruments with high value and in other hand help sellers and buyers to transact easily. These are mainly service organization – invests banks, Brokers, Dealers, Jobbers, Security Exchange Commission, Rating service, Underwriters etc.

Financial intermediaries: Financial intermediaries are media between loan providers and takers. The financial intermediaries are Insurance organizations, Pension funds, Commercial banks, financing companies, Savings organizations, Dealers, Brokers, Jobbers, Non-profit organizations etc.

Regulatory organizations: Regulatory organizations are mainly govt. the authority that monitors and controls this market. It secures both the investors and corporations. It strongly protects forgery in stock market Regulatory organization controls the margin also. The Central bank, on behalf of govt. generally controls the financial activities in a country.

Instruments

Government Securities:

Securities issued by the central government or state governments are referred to as government securities (G-Secs).

A Government security may be issued in one of the following forms, namely:

1. A Government promissory note payable to or to the order of a certain person,
2. A bearer bond payable to bearer
3. A stock
4. A bond held in a ‘bond ledger account,

Bonds:

Bonds are debt instruments that are issued by companies/governments to raise funds for financing their capital requirements. By purchasing a bond, an investor lends money for a fixed period of time at a predetermined interest (coupon) rate. Bonds have a fixed face value, which is the amount to be returned to the investor upon maturity of the bond.

During this period, the investors receive a regular payment of interest, semi-annually or annually, which is calculated as a certain percentage of the face value and known as a ‘coupon payment.’ Bonds can be issued at par, at discount or at premium. A bond, whether issued by a government or a corporation, has a specific maturity date, which can range from a few days to 20-30 years or even more.

Both debentures and bonds mean the same. In Indian parlance, debentures are issued by corporates and bonds by government or semi-government bodies. But now, corporates are also issuing bonds which carry comparatively lower interest rates and preference in repayment at the time of winding up, comparing to debentures.

The government, public sector units and corporates are the dominant issuers in the bond market. Bonds issued by corporates and the Government of India can be traded in the secondary market.

Basically, there are two types of bonds viz.:

1. Government Bonds: Are fixed income debt instruments issued by the government to finance their capital requirements (fiscal deficit) or development projects.
2. Corporate Bonds: Are debt securities issued by public or private corporations that need to raise money for working capital or for capital expenditure needs.

Types of Government Securities:

Following are the types of Government Securities:

1. Promissory Notes:

Promissory Notes are instruments containing the promises of the Government to pay interest at a specified rate. Interests are usually paid half yearly. Interest is payable to the holder only on presentation of the promissory notes. They are transferable by endorsement and delivery.

2. Stock Certificates (Inscribed Stock):

Stock certificate, also known as Inscribed Stock, is a debt held in the form of stock. The owner is given a certificate inserting his name after registering in the books of PDO of RBI. The execution of transfer deed is necessary for its transfer. Since liquidity is affected, these are not much favoured by investors. One will have to wait till maturity to get it encashed.

3. Bearer Bonds:

A bearer bond is an instrument issued by government, certifying that the bearer is entitled to a specified amount on the specified date. Bearer bonds are transferable by mere delivery. Interest Coupons are attached to these bonds. When the periodical interest falls due, the holder clips off the relevant coupon and presents it to the concerned authority for payment of interest.

4. Dated Securities:

They are long term Government securities or bonds with fixed maturity and fixed coupon rates paid on the face value. These are called dated securities because these are identified by their date of maturity and the coupon, e.g., 12.60% GOI BOND 2018 is a Central Government security maturing in 2018, which was issued on 23.11.1998 bearing security coupon 400095 with a coupon of 12.06 % payable half yearly. At present, there are Central Government dated securities with tenure up to 30 years in the market. Dated securities are sold through auctions. They are issued and redeemed at par.

5. Zero Coupon Bonds:

These bonds are issued at discount to face value and to be redeemed at par. As the name suggests there is no coupon/interest payments. These bonds were first issued by the GOI in 1994 and were followed by two subsequent issues in 1995 and 1996 respectively.

6. Partly Paid Stock:

This is a stock where payment of principal amount is made in installments over a given time frame. It meets the needs of investors with regular flow of funds and the needs of Government when it does not need funds immediately. The first issue of such stock of eight year maturity was made on November 15, 1994 for Rs. 2000 crore. Such stocks have been issued a few more times thereafter.

7. Floating Rate Bonds:

These are bonds with variable interest rate, which will be reset at regular intervals (six months). There may be a cap and a floor rate attached, thereby fixing a maximum and minimum interest rate payable on it. Floating rate bonds of four year maturity were first issued on September 29, 1995.

8. Bonds with Call/Put Option:

These are Govt. bonds with the features of options where the Govt. (issuer) has the option to call (buy) back or the investor can have the option to sell the bond (Put option) to the issuer. First time in the history of Government Securities market RBI issued a bond with call and put option in 2001-02. This bond was due for redemption in 2012 and carried a coupon of 6.72%. However the bond had call and put option after five years i.e. in the year 2007. In other words, it means that holder of bond could sell back (put option) bond to Government in 2007 or Government could buy back (call option) bond from holder in 2007.

9. Capital Indexed Bonds:

These are bonds where interest rate is a fixed percentage over the wholesale price index. The principal redemption is linked to an index of inflation (here wholesale price index). These provide investors with an effective hedge against inflation. These bonds were floated on December, 1997 on an on tap basis. They were of five-year maturity with a coupon rate of 6 per cent over the wholesale price index.

10. Fixed Rate Bond:

Normally government securities are issued as fixed rate bonds. In this type of bonds the coupon rate is fixed at the time of issue and remains fixed till redemption.

Gold bonds, National Defence bonds, Special Purpose Securities, Rural Development bonds, Relief bonds, Treasury bill etc. are other types of Government securities.

The major investors in G-Secs are banks, life insurance companies, general insurance companies, pension funds and EPFO. Other investors include primary dealer’s mutual funds, foreign institutional investors, high net-worth individuals and retail individual investors.

Most of the secondary market trading in government bonds happens on OTC (Over the Counter), the Negotiated Dealing System and the wholesale debt-market (WDM) segment of the National Stock Exchange.

Debentures:

Debenture is an instrument under seal evidencing debt. The essence of debenture is admission of indebtedness. It is a debt instrument issued by a company with a promise to pay interest and repay the principal on maturity. Debenture holders are creditors of the company. Sec 2 (12) of the Companies Act, 1956 states that debenture includes debenture stock, bonds and other securities of a company. It is customary to appoint a trustee, usually an investment bank- to protect the interests of the debenture holders. This is necessary as debenture deed would specify the rights of the debenture holders and the obligations of the company.

Types of Debentures:

1. Secured Debentures:

Debentures which create a charge on the property of the company is a secured debenture. The charge may be floating or fixed. The floating charge is not attached to any particular asset of the company. But when the company goes into liquidation the charge becomes fixed. Fixed charge debentures are those where specific asset or group of assets is pledged as security. The details of these charges are to be mentioned in the trust deed.

2. Unsecured Debentures:

These are not protected through any charge by any property or assets of the company. They are also known as naked debentures. Well established and credit worthy companies can issue such shares.

3. Bearer Debentures:

Bearer debentures are payable to bearer and are transferable by mere delivery. Interest coupons are attached to the certificate or bond. As interest date approaches, the appropriate coupon is ‘clipped off by the holder of the bond and deposited in his bank for collection. The bank may forward it to the fiscal agent of the company and proceeds are collected. Such bonds are negotiable by delivery.

4. Registered Debentures:

In the case of registered debentures the name and address of the holder and date of registration are entered in a book kept by the company. The holder of such a debenture bond has nothing to do except to wait for interest payment which is automatically sent him on every payment date.

When such debentures are registered as to principals only, coupons are attached. The holder must detach the coupons for interest payment and collect them as in the case of bearer bonds.

5. Redeemable Debentures:

When the debentures are redeemable, the company has the right to call them before maturity. The debentures can be paid off before maturity, if the company can afford to do so. Redemption can also be brought about by issuing other securities less costly to the company in the place of the old ones.

6. Convertible Debentures:

When an option is given to convert debentures in to equity shares after a specific period, they are called as convertible debentures.

7. Non-Convertible Debentures With Detachable Equity Warrants:

The holders of such debentures can buy a specified number of shares from the company at a predetermined price. The option can be exercised only after a specified period.

Preference Shares:

The Companies Act (Sec, 85), 1956 describes preference shares as those which Carry a preferential right to payment of dividend during the life time of the company and Carry a preferential right for repayment of capital in the event of winding up of the company.

Preference shares have the features of equity capital and features of fixed income like debentures. They are paid a fixed dividend before any dividend is declared to the equity holders.

Types of Preference Shares:

1. Redeemable Preference Shares:

These shares are redeemed after a given period.

Such shares can be repaid by the company on certain conditions, viz.;

1. The shares must be fully paid up.
2. It must be redeemed either out of profit or out of reserve fund for the purpose.
3. The premium must be paid if any.

A company may opt for redeemable preference shares to avoid fixed liability of payment, increase the earnings of equity shares, to make the capital structure simple or such other reasons.

2. Irredeemable Preference Shares:

These shares are not redeemable except on the liquidation of the company.

3. Convertible Preference Shares:

Such shares can be converted to equity shares at the option of the holder. Hence, these shares are also known as quasi equity shares. Conversion of preference shares in to bonds or debentures is permitted if company wishes. The conversion feature makes preference shares more acceptable to investors. Even though the market for preference shares is not good at a point of time, the convertibility will make it attractive.

4. Participating Preference Shares:

These kinds of shares are entitled to get regular dividend at fixed rate. Moreover, they have a right for surplus of the company beyond a certain limit.

5. Cumulative Preference Shares:

The dividend payable for such shares is fixed at 10%. The dividend not paid in a particular year can be cumulated for the next year in this case.

6. Preference Shares with Warrants:

This instrument has certain number of warrants. The holder of such warrants can apply for equity shares at premium. The application should be made between the third and fifth year from the date of allotment.

7. Fully Convertible Cumulative Preference Shares:

Part of such shares, are automatically converted into equity shares on the date of allotment. The rest of the shares will be redeemed at par or converted in to equity after a lock in period at the option of the investors.

Securities:

‘Securities’ is a general term for a stock exchange investment.

Securities Contract (Regulation) Act, 1956 defines securities as to include:

1. Shares, Scripts, Stocks, Bonds, Debentures.
2. Government Securities.
3. Such other instruments as may be declared by the Central government to be securities.
4. Rights or interests in securities
5. Derivatives
6. Securitized instruments

Equity Shares:

Equity Shares are the ordinary shares of a limited company. It is an instrument, a contract, which guarantees a residual interest in the assets of an enterprise after deducting all its liabilities- including dividends on preference shares. Equity shares constitute the ownership capital of a company. Equity holders are the legal owners of a company.

Capital Expenditure

Capital expenditure is the expenditure incurred to acquire fixed assets, capital leases, office equipment, computer equipment, software development, purchase of tangible and intangible assets, and such kind of any value addition in business with the purpose to enhance the income. However, to decide nature of the capital expenditure, we need to pay attention on:

• The expenditure, which benefit cannot be consumed or utilized in the same accounting period, should be treated as capital expenditure.
• Expenditure incurred to acquire Fixed Assets for the company.
• Expenditure incurred to acquire fixed assets, erection and installation charges, transportation of assets charges, and travelling expenses directly relates to the purchase fixed assets, are covered under capital expenditure.
• Capital addition to any fixed assets, which increases the life or efficiency of those assets for example, an addition to building.

Revenue Expenditure

Revenue expenditure is the expenditure incurred on the fixed assets for the ‘maintenance’ instead of increasing the earning capacity of the assets. Examples of some of the important revenue expenditures are as follows:

• Wages/Salary
• Freight inward & outward
• Administrative Expenditure
• Selling and distribution Expenditure
• Assets purchased for resale purpose
• Repairs and renewal expenditure which are necessary to keep Fixed Assets in good running and efficient conditions

Revenue Expenditure Treated as Capital Expenditure

Following are the list of important revenue expenditures, but under certain circumstances, they are treated as a capital expenditure:

• Raw Material and Consumables: If those are used in making any fixed assets.
• Cartage and Freight: If those are incurred to bring Fixed Assets.
• Repairs & Renewals: If incurred to enhance life of the assets or efficiency of the assets.
• Preliminary Expenditures: Expenditure incurred during the formation of a business should be treated as capital expenditure.
• Interest on Capital: If paid for the construction work before the commencement of production or business.
• Development Expenditure: In some businesses, long period of development and heavy amount of investment are required before starting the production especially in a Tea or Rubber plantation. Usually, these expenditures should be treated as the capital expenditure.
• Wages: If paid to build up assets or for the erection and installation of Plant and Machinery.

A transaction refers to the exchange of an asset and discharge of liabilities for consideration in terms of money. However, these transactions are of two types, viz. Capital transactions and Revenue transactions.

the accounting profit for a period the concept of capital and revenue is of utmost importance. The bifurcation of the transactions between capital and revenue is also necessary for the recognition of business assets at the end of the accounting or financial year.

Important Terms

1. Capital Transactions

Capital transactions are transactions that have a long-term effect on the business. It means that the effect of these transactions extends to a period of more than one year.

2. Revenue Transactions

Revenue transactions are transactions that have a short-term effect on the business. Usually, the effect of these transactions is only for a period of one year.

3. Capital Expenditure

Capital expenditure is the expenditure that a business incurs on the purchase, alteration or the improvement of fixed assets. For example, the purchase of furniture for office use is a capital expenditure. The following costs are included in the capital expenditure:

1. Delivery charges of fixed assets
2. Installation expenses of fixed assets
3. Alteration or improvement expenses of fixed assets
4. Legal costs of purchasing a fixed asset
5. Demolition costs of fixed assets
6. Architects fee

   4. Revenue Expenditure

The expenditure incurred in the running or the management of the business is known as the revenue expenditure. For example, the cost of the repairs of machinery is a revenue expenditure.

We need to show the Capital expenditure on the Assets side of the Balance Sheet while we show the Revenue expenditure on the debit side of the Trading and Profit and Loss Account.

5. Revenue Receipts

The revenue receipt is the amount received by a business against the revenue incomes.

6. Capital Receipts

It is the amount which is received against the capital income by a business.

7. Capital Profits

Capital profit refers to the profit that is earned on the sale of fixed assets.

8. Revenue Profits

Revenue profit is the profit which a business earns during the ordinary course of business.

9. Capital Loss

It is the amount of loss that a business incurs on the sale of fixed assets.

10. Revenue Loss

It is the amount of loss that a business incurs during the ordinary course of business.

Rules for Determination of Capital Expenditure

The following expenses are termed as Capital expenditure:

1. Any expenditure on the purchase of fixed assets or long-term assets for use in business in order to earn profits is capital expenditure. However, expenditure on fixed assets purchased for resale does not amount to capital expenditure.
2. Any expenditure on the improvement or alteration in the present condition of a fixed asset to bring it to the working condition is a capital expenditure and thus we need to add it to the cost of the asset.
3. Any expenditure of any sort which increases the earning capacity of the business is also capital expenditure.
4. Preliminary expenses incurred before the commencement of business are also capital expenditure.

Rules for Determination of Revenue Expenditure

The following expenses are termed as the revenue expenditure:

1. Any expenditure for the day-to-day conduct of the business is revenue expenditure. The benefits of these expenses last only for the period of one year.
2. Any expenditure on the consumable items and on goods and services.
3. Any expenditure on the maintenance of fixed assets such as repairs and renewals.

Deferred Revenue Expenditure

Deferred revenue expenditure refers to the expenditure which is revenue in nature but involves a lump sum amount and the benefits that extend for a period of more than one year. We need to write off these expenses over a period of 3 to 5 years. On the other hand, the balance which is not written off is carried forward and shown on the Assets side of the Balance Sheet. Heavy advertisement expenditure is a good example of such expenditure.

The following are the types of capital and revenue items in accounting:

1. Capital Receipts
2. Revenue Receipts
3. Capital Profits
4. Revenue Profits
5. Capital Losses
6. Revenue Losses

(A) Capital Receipts:

Capital Receipts is the amount received in the form of additional Capital (by issuing shares) loans or by the sale proceeds of any fixed assets. Capital Receipts are shown in Balance Sheet.

(B) Revenue Receipts:

Revenue Receipts are the amount received in the ordinary course of a business. It is the incomes earned from selling merchandise, or in the form of discount, commission, interest, transfer fees etc. Income received by selling waste paper, packing cases etc. is also a revenue receipt. Revenue Re­ceipts are shown in the Profit and Loss Account.

(C) Capital Profit:

Capital profits are earned as a result of selling some fixed assets or in connection with raising capital for the firm. For example a land purchased by a business for Rs 2, 00,000 is sold for Rs. 2, 50,000. Rs 50,000 are a profit of capital nature. Another example, suppose a company issues its shares of the face value of Rs 100 for Rs 110 each, i.e. issue of shares at premium, the premium on shares i.e. Rs 10 is capital profit. Such profits are (a) transferred to Capital Account or (b) transferred to Capital Reserve Account. This amount is utilised for meeting Capital losses. Capital Reserve ap­pears in the Balance Sheet as a liability.

(D) Revenue Profits:

evenue Profits are earned in the ordinary course of business. Revenue profits appear in the Profit and Loss Account. For example, profit from sale of goods, income from investments, discount received, Interest Earned etc.

(E) Capital Losses:

Capital losses occur when selling fixed assets or raising share capital. A building purchased for Rs 2, 00,000 is sold for Rs 1, 50,000. Rs 50,000 are a capital loss. Shares of the face value of Rs 100 issued at Rs 95, i.e. discount of Rs 5. The amount of discount is a capital loss.

Capital Loss is not shown in the Profit and Loss Account. They are shown in the asset side of Balance Sheet. When Capital Profit arises, Capital losses are gradually written off against them. If capital losses are huge, it is common to spread them over a number of years and a proportionate amount is charged to Profit and Loss Account every year.

Balance amount is shown in the Balance Sheet as an asset and it is written off in future years. If the loss is manageable, they are debited to Profit and Loss Account of the same year.

(F) Revenue Losses:

Revenue losses arise during the normal course of business. For instance, sale of goods, loss may incur. Such losses are debited in the Profit and Loss Account.