Tag: Consolidated Balance Sheet

Management Notes

Fresh Issue of Shares, Reasons, Types, Challenges

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Fresh Issue of Shares refers to the process by which a company issues new shares to raise additional capital for its business needs. This capital can be used for expansion, repayment of debt, modernization, or meeting working capital requirements. A fresh issue increases the company’s share capital and may dilute the ownership percentage of existing shareholders. It is generally offered to the public through an Initial Public Offering (IPO) if the company is going public, or through a Follow-on Public Offering (FPO) if already listed. The issue must comply with the provisions of the Companies Act, 2013, and guidelines of the Securities and Exchange Board of India (SEBI), ensuring transparency, fairness, and protection of investors’ interests in the capital-raising process.

Reasons of Fresh Issue of Shares:

  • Business Expansion

A primary reason for issuing fresh shares is to raise funds for expanding business operations. Companies often need significant capital to enter new markets, open additional branches, increase production capacity, or launch new products. Fresh equity financing helps achieve these objectives without increasing the company’s debt burden. The raised funds can be invested in infrastructure, technology, or workforce development. By issuing new shares, companies can also attract strategic investors who bring expertise and resources. Expansion through fresh share issues supports long-term growth, enhances competitiveness, and may lead to higher profitability and shareholder value over time.

  • Repayment of Debt

Companies may issue fresh shares to raise funds for repaying existing loans or debentures. High debt levels increase financial risk due to interest obligations and potential cash flow strain. By replacing debt with equity through fresh share issues, companies can improve their debt-to-equity ratio, reduce interest expenses, and strengthen their financial position. This approach also enhances creditworthiness, making it easier to secure favorable borrowing terms in the future. Moreover, eliminating or reducing debt can free up cash for reinvestment in operations. While existing shareholders may face dilution, the reduction in financial risk often benefits the company’s long-term stability.

  • Working Capital Requirements

Working capital is essential for meeting day-to-day business expenses such as paying suppliers, salaries, utilities, and maintaining inventory. Companies sometimes face cash flow shortages due to seasonal fluctuations, increased operational costs, or growth demands. Issuing fresh shares provides an infusion of permanent capital that can be used to cover these short-term financial needs without creating repayment obligations. Adequate working capital ensures smooth operations, avoids disruptions, and enables the company to take advantage of business opportunities quickly. This method of financing is especially beneficial for companies that want to maintain liquidity without relying heavily on short-term borrowings.

  • Funding for Acquisitions or Mergers

Fresh issue of shares is often used to finance acquisitions or mergers, allowing a company to acquire another business without taking on excessive debt. The funds raised can be used to purchase assets, pay for goodwill, or meet integration expenses. In some cases, shares are directly issued to the shareholders of the acquired company as part of the purchase consideration. This equity-based financing method preserves cash reserves and aligns the interests of new and existing shareholders. By funding acquisitions through fresh share issues, companies can expand their market presence, diversify product offerings, and achieve economies of scale effectively.

  • Compliance with Regulatory Capital Requirements

Certain industries, particularly banking, insurance, and financial services, are required by law to maintain a minimum level of capital adequacy to safeguard stakeholders’ interests. If a company’s capital falls below the required level, it may issue fresh shares to meet these regulatory norms. This not only ensures legal compliance but also enhances investor confidence and market credibility. Raising capital through fresh issue strengthens the company’s balance sheet, supports its ability to absorb potential losses, and ensures continued operation under regulatory frameworks. Failure to meet these requirements can result in penalties, restrictions, or loss of operating licenses.

Types of Fresh Issue of Shares:

  • Initial Public Offering (IPO)

An Initial Public Offering is the first sale of shares by a company to the public to raise capital. Through an IPO, a private company becomes a publicly listed entity, allowing its shares to be traded on stock exchanges. It enables the company to access a large pool of investors, raise substantial funds, and enhance its visibility and credibility in the market. IPO proceeds are often used for expansion, debt repayment, or working capital. The process involves meeting SEBI regulations, issuing a prospectus, and following strict disclosure norms to protect investor interests and ensure transparency in the capital-raising process.

  • Follow-on Public Offering (FPO)

Follow-on Public Offering refers to the issuance of additional shares by a company that is already listed on a stock exchange. Unlike an IPO, which is for new listings, an FPO is conducted to raise further capital from the public. Companies opt for FPOs to fund expansion, reduce debt, or meet other financial needs. The offering can be dilutive, where new shares are issued, or non-dilutive, where existing shareholders sell their holdings. FPOs are regulated by SEBI and require disclosures similar to IPOs, ensuring investors are informed about the company’s performance and the purpose of raising additional funds.

  • Rights Issue

Rights Issue allows existing shareholders to purchase additional shares in proportion to their current holdings, usually at a price lower than the market value. This method gives priority to current investors before offering shares to outsiders. The main advantage is that it maintains the control and voting power of existing shareholders while raising capital without increasing debt. Rights Issues are often used to fund expansion, acquisitions, or repay liabilities. Shareholders can either subscribe to their rights, sell them to others, or let them lapse. This type of fresh issue is cost-effective as it avoids extensive marketing expenses.

  • Private Placement

Private Placement involves selling shares directly to a select group of investors, such as institutional investors, banks, mutual funds, or high-net-worth individuals, rather than the general public. This method is quicker and less expensive compared to a public issue, as it avoids extensive regulatory requirements and marketing costs. Private placements are often used when companies require funds urgently or want to bring in strategic investors who can offer expertise and resources. While it limits the investor base, it provides flexibility in negotiation and pricing. SEBI regulations govern such issues to ensure fairness and prevent misuse of the capital-raising process.

  • Preferential Allotment

Preferential Allotment refers to the issuance of shares to a specific group of investors at a predetermined price, often lower than the market rate, subject to SEBI guidelines. This method is used to quickly raise capital, reward promoters, bring in strategic partners, or convert loans into equity. It provides flexibility in choosing investors and customizing terms. Unlike public issues, preferential allotment is less time-consuming and involves fewer formalities. However, it requires shareholder approval through a special resolution. By selectively allotting shares, companies can strengthen control structures, attract experienced investors, and raise funds for specific business purposes efficiently.

  • Bonus issue

Bonus Issue involves issuing additional shares to existing shareholders free of cost, in proportion to their current holdings. Instead of distributing profits as cash dividends, the company capitalizes its reserves and issues bonus shares. For example, a 1:2 bonus means one additional share for every two shares held. Bonus issues do not bring in new funds but increase the number of outstanding shares, thereby reducing the market price per share and improving liquidity. They reward shareholders, signal financial strength, and can make shares more affordable to small investors, enhancing trading activity in the stock market.

  • Employee Stock Option Plan (ESOP) Issue

An ESOP Issue involves granting employees the right to purchase company shares at a predetermined price, often below the market rate, after a certain vesting period. This method is used to reward and retain talented employees, align their interests with company performance, and foster a sense of ownership. While it does not raise immediate capital, when employees exercise their options, the company receives funds, effectively making it a fresh issue. ESOPs also serve as a non-cash incentive, reducing the need for high salaries while motivating employees to contribute to long-term growth and increasing shareholder value.

Challenges of Fresh Issue of Shares:

  • Dilution of Ownership

When a company issues fresh shares, the ownership percentage of existing shareholders decreases unless they purchase additional shares to maintain their stake. This dilution can lead to reduced control over decision-making, especially for promoters or major shareholders. In public companies, significant dilution may shift voting power toward new investors or institutional shareholders. This challenge often makes existing owners cautious about approving large fresh issues. Although fresh capital supports growth, the loss of influence in strategic matters can create conflicts of interest and resistance among shareholders, affecting the smooth execution of future corporate plans and decision-making processes.

  • Market Perception and Share Price Impact

The announcement of a fresh issue of shares can sometimes negatively affect market perception. Investors may interpret it as a sign that the company is facing financial pressure or that current cash flows are insufficient. A large issue can also increase the supply of shares in the market, leading to a fall in share prices. If the issue price is significantly lower than the current market price, it may cause dissatisfaction among existing shareholders. Poorly timed or inadequately justified fresh issues can therefore harm the company’s image, weaken investor confidence, and impact long-term valuation in capital markets.

  • Regulatory Compliance and Costs

Issuing fresh shares requires strict compliance with provisions of the Companies Act, 2013, SEBI guidelines, and stock exchange regulations. The process involves preparing a prospectus, obtaining approvals, and making detailed disclosures, which can be time-consuming and costly. Additional expenses include legal fees, underwriting charges, advertising, and administrative costs. Any delay or error in compliance may result in penalties, legal disputes, or rejection of the issue. For smaller companies, the regulatory burden and related expenses may outweigh the immediate financial benefits, making fresh issues less attractive compared to other financing options like loans or internal accruals.

  • Under-subscription Risk

A major challenge in fresh issue of shares is the possibility of under-subscription, where the public or targeted investors apply for fewer shares than offered. This can happen due to poor market conditions, high issue price, weak investor confidence, or inadequate promotion of the issue. Under-subscription may force the company to scale down planned projects or seek alternative funding, which could delay operations. It can also signal a lack of market trust, damaging the company’s reputation. Companies often appoint underwriters to reduce this risk, but that adds to the cost of raising capital, affecting the net proceeds from the issue.

  • Short-term Pressure on Performance

Fresh issue of shares raises expectations among investors for immediate growth and returns. This can create pressure on management to deliver quick results, sometimes at the expense of long-term strategic goals. The influx of funds may lead to hasty investments or overexpansion if not managed carefully. Moreover, the company must now generate higher profits to provide adequate dividends and sustain share value, especially after the ownership base expands. Failure to meet these expectations can result in a drop in share price, negative analyst reports, and reduced investor confidence, ultimately affecting the company’s overall market position and stability.

Bangalore North University B.Com Notes

Corporate Accounting Bangalore North University B.COM SEP 2024-25 3rd Semester Notes

indiafreenotesby indiafreenotes1
Unit 1 [Book]
Shares, Meaning, Features and Types VIEW
Issue of Shares VIEW
Fresh Issue of Shares VIEW
Issue of Rights Shares VIEW
Issue of Bonus Shares VIEW
ESOPs VIEW
Buy-Back of Shares VIEW
Subscription of Shares: Minimum Subscription, Over Subscription and Under Subscription VIEW
Pro-Rata allotment procedure for issue of shares VIEW
Book Building procedure for issue of shares VIEW
Problems related to Journal entries on Issue of Shares at Par and Premium – Special cases, where Shares can be issued at a Discount VIEW
Unit 2 [Book]
Underwriting, Introduction, Meaning and Definition, Advantages, Types VIEW
Underwriting Commission VIEW
Underwriting Guidelines under Company’s Act VIEW
Underwriting Guidelines under SEBI VIEW
Underwriting: Types of Applications, Calculation of Underwriters’ Liability: Firm and Pure Underwriting; Full & Partial Underwriting VIEW
Calculation of Underwriting commission (excluding Journal entries) VIEW
Unit 3 [Book]
Financial Statements VIEW
Statutory Provisions regarding preparation of Financial Statements of Companies as per Schedule III of Companies Act, 2013 VIEW
Statutory Provisions regarding Preparation of Financial Statements of Companies as per IND AS-1 VIEW
Treatment of Special Items:
TDS VIEW
Advance Payment of Tax VIEW
Provision for Tax VIEW
Depreciation VIEW
Amortization VIEW
Interest on Debentures VIEW
Dividends VIEW
Rules regarding Payment of Dividends VIEW
Transfer to Reserves VIEW
Preparation of Statement of Profit and Loss and Balance Sheet VIEW
Unit 4 [Book]
Redemption of Preference Shares: Meaning and Legal Provisions VIEW
Treatment regarding Premium on Redemption VIEW
Creation of Capital Redemption Reserve Account VIEW
Fresh issue of Shares for the purpose of Redemption VIEW
Arranging for Cash Balance for the Purpose of Redemption VIEW
Minimum Number of Shares to be issued for Redemption VIEW
Issue of Bonus Shares VIEW
Preparation of Balance sheet after Redemption as per Schedule III of Companies Act 2013 VIEW
Unit 5 [Book]
Internal Reconstruction, Introduction, Meaning, Definition, Objectives VIEW
Capital Reduction, Meaning, Modes and Objectives VIEW
Provisions for Reduction of Share Capital under Companies Act, 2013 VIEW
Accounting for Capital Reduction VIEW
Reorganization through Sub Division and Consolidation of Shares VIEW
Preparation of Capital Reduction Account after Reduction as per Schedule III of Companies Act 2013 VIEW
Preparation of Balance Sheet after Reduction as per Schedule III of Companies Act 2013 VIEW
Management Notes

Determination of Liability in respect of Underwriting contract when fully Underwritten and Partially Underwritten with and without firm Underwriting

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Underwriting agreements in securities issuance can vary depending on the level of commitment made by the underwriter. The liability of underwriters in such contracts differs when the issue is fully underwritten versus partially underwritten, and further varies with or without firm underwriting.

Fully Underwritten Contract

In a fully underwritten contract, the underwriter or group of underwriters guarantees the entire issue. This means that regardless of how much of the issue is subscribed to by the public, the underwriter is liable to purchase the unsold portion of the securities at the agreed-upon issue price.

  • Liability of Underwriters: The underwriter assumes full liability, meaning they are legally bound to purchase any remaining shares that investors do not subscribe to. The underwriter’s risk is significant, as they are committed to taking on the entire offering if necessary. This type of underwriting provides a capital guarantee to the issuer, ensuring they will raise the full desired amount of funds.

  • Example: Suppose a company is issuing 1,000,000 shares, and the public subscribes to only 600,000. In a fully underwritten agreement, the underwriter would be responsible for purchasing the remaining 400,000 shares. If the shares are issued at a premium, the underwriter must pay the agreed price, regardless of how the market reacts.

Partially Underwritten Contract

In a partially underwritten contract, the underwriter agrees to guarantee only a portion of the securities being offered. The liability is therefore limited to the agreed-upon amount. The issuer may attempt to sell the remaining shares to the public or through other means, but if the public does not fully subscribe, the underwriter is only required to purchase their part of the issue.

  • Liability of Underwriters: Underwriters are only liable for their specific portion of the offering. This means that if, for example, the underwriter has agreed to purchase 60% of the shares and the public subscribes to 40%, the underwriter will be liable for the 60% they committed to, and the remaining 40% will need to be managed through other channels.

  • Example: In an offering of 1,000,000 shares, if the underwriter has agreed to underwrite 600,000 shares, and the public subscribes to 300,000, the underwriter’s liability would be limited to the 600,000 shares, even if the full offering isn’t subscribed.

Firm Underwriting

Firm underwriting involves the underwriter agreeing to buy a fixed number of shares from the issuer, even if the public does not fully subscribe. This type of underwriting involves a higher level of commitment than regular underwriting, and it’s typically used in situations where there is a need to ensure that the issuer raises the required capital.

  • Liability of Underwriters: In firm underwriting, the underwriter is committed to buying a specific number of shares regardless of public subscription. This differs from non-firm underwriting where the underwriter may back out if the subscription level is too low. The underwriter thus takes on more risk, especially if market conditions are unfavorable.

  • Example: If a company issues 1,000,000 shares and the underwriter commits to purchasing 500,000 shares on a firm basis, the underwriter must buy these 500,000 shares, even if the public subscribes to only 300,000 shares. This ensures that the issuer raises at least the required capital.

Non-Firm Underwriting:

Non-firm underwriting occurs when the underwriter agrees to purchase securities only if they are not subscribed to by the public. In this case, the underwriter has no obligation to buy the unsold portion if there is sufficient public subscription. Non-firm underwriting carries less risk for the underwriter as their liability is contingent upon the public’s interest in the offering.

  • Liability of Underwriters: The liability for the underwriter is contingent on the amount of the offering that remains unsold. If there is over-subscription by the public, the underwriter has no responsibility to purchase additional shares. However, if the offering is undersubscribed, they may be required to step in and buy the unsold shares.

  • Example: In an offering of 1,000,000 shares, if the underwriter agrees to underwrite 500,000 shares on a non-firm basis, and the public subscribes to 700,000 shares, the underwriter would have no further obligation to purchase any unsold shares.

Liability in Case of Over-Subscription and Under-Subscription

  • Over-Subscription: When the offering is over-subscribed, meaning the public subscribes for more shares than are available, the underwriter may reduce their liability proportionally. In a firm underwriting, the underwriter still needs to buy the agreed-upon amount, but in a non-firm underwriting, they may reduce their commitment.

  • Under-Subscription: In the case of under-subscription, the underwriter assumes liability for the unsold portion. In fully underwritten contracts, the underwriter is obligated to purchase all the unsold shares. However, in partially underwritten contracts, the underwriter only needs to buy their portion of the unsold shares, and the remaining unsold shares may be dealt with by other means, such as extending the issue period or reducing the offering.

Management Notes

Accounting for Issue of Shares at Par, Premium, Discount

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When a company issues shares, the accounting treatment varies depending on whether the shares are issued at par, premium, or discount. Let’s explore each of these methods in detail, including examples and accounting entries.

1. Issue of Shares at Par

When shares are issued at par, the nominal value (face value) of the share is the same as the price at which the shares are issued. For example, if a company issues 1,000 shares with a face value of ₹10 each, they will be sold to investors at ₹10 per share, meaning no premium or discount is applied.

Example:

  • Number of Shares Issued: 1,000

  • Face Value: ₹10 per share

  • Issue Price: ₹10 per share

  • Total Capital Raised: 1,000 shares × ₹10 = ₹10,000

Accounting Entry:

  • Bank Account Debit ₹10,000

  • Share Capital Account Credit ₹10,000

This reflects the cash received in exchange for shares issued at par.

2. Issue of Shares at Premium

When shares are issued at a premium, the price at which shares are sold is higher than their nominal (face) value. The excess amount received over the face value is known as the securities premium and is credited to a separate account called the Securities Premium Account.

Example:

  • Number of Shares Issued: 1,000

  • Face Value: ₹10 per share

  • Issue Price: ₹15 per share (₹10 face value + ₹5 premium)

  • Total Capital Raised: 1,000 shares × ₹15 = ₹15,000

  • Premium Received: 1,000 shares × ₹5 = ₹5,000

Accounting Entry:

  • Bank Account Debit ₹15,000

  • Share Capital Account Credit ₹10,000

  • Securities Premium Account Credit ₹5,000

The above entry records the receipt of cash from investors for both the face value and the premium.

3. Issue of Shares at Discount

When shares are issued at a discount, the price at which shares are sold is lower than their nominal (face) value. This results in the company receiving less money than the nominal value of the shares. In most jurisdictions, issuing shares at a discount is restricted and often requires specific approvals from regulatory authorities.

Example:

  • Number of Shares Issued: 1,000

  • Face Value: ₹10 per share

  • Issue Price: ₹8 per share (₹10 face value – ₹2 discount)

  • Total Capital Raised: 1,000 shares × ₹8 = ₹8,000

  • Discount Given: 1,000 shares × ₹2 = ₹2,000

Accounting Entry:

  • Bank Account Debit ₹8,000

  • Share Capital Account Credit ₹10,000

  • Discount on Issue of Shares Account Credit ₹2,000

The Discount on Issue of Shares account is a contra-equity account that reflects the reduction in the total capital raised from the issue of shares at a discount.

Summary of Accounting Entries for Share Issues

Issue Type Bank Account Share Capital Account Securities Premium Account Discount on Issue of Shares Account
At Par ₹10,000 ₹10,000 – –
At Premium ₹15,000 ₹10,000 ₹5,000 –
At Discount ₹8,000 ₹10,000 – ₹2,000
Management Notes

Calls in Arrears and Calls in Advance

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Calls in Advance refers to the amount paid by shareholders on their shares before it is officially called or due by the company. This payment is made by shareholders in advance of the scheduled installment or call. The company records this amount as a liability until the call is formally made, at which point it is adjusted against the amount due. Calls in Advance do not carry voting rights until the actual call is due, and the company may pay interest on these amounts at a predetermined rate as compensation to the shareholders for their early payment.

Characteristics of Calls in Advance:

  1. Prepayment by Shareholders

The fundamental characteristic of Calls in Advance is that shareholders voluntarily pay part or all of their outstanding share capital before the company makes an official call for the payment. This prepayment is often done to secure an investment or ensure prompt fulfillment of financial obligations related to their shares.

  1. Recorded as a Liability

When a company receives Calls in Advance, it records this amount as a liability on its balance sheet. This is because the payment is considered unearned revenue until the company officially calls for the payment. The liability remains until the call is made, at which point the amount is adjusted against the due call.

  1. Interest Payment

Companies may pay interest on Calls in Advance as a form of compensation to shareholders for providing funds earlier than required. The rate of interest is usually predetermined and is stipulated in the company’s Articles of Association. However, the company is not obligated to pay interest if it chooses not to, depending on its policies.

  1. No Voting Rights

One significant characteristic of Calls in Advance is that shareholders who have paid in advance do not receive any additional voting rights based on their early payment. Voting rights are only granted based on the paid-up share capital when the call is actually due.

  1. Adjustment Against Future Calls

The amount paid in advance is adjusted against the future calls made by the company. When the call is due, the company will deduct the amount already paid in advance from the total amount payable by the shareholder, reducing their financial obligation at the time of the call.

  1. Temporary Use of Funds

The company can temporarily use the funds received as Calls in Advance for its operational or capital needs. However, this use is limited by the fact that the company must treat these funds as a liability, meaning they must be available when the call is officially made.

  1. No Dividend Entitlement

Shareholders who pay Calls in Advance are not entitled to dividends on the amount paid in advance until it is officially called. Dividends are typically declared only on paid-up capital, which includes only those amounts that are due and payable.

  1. Flexibility for the Company

Calls in Advance provide the company with flexibility in managing its cash flow. The early receipt of funds can help the company meet its immediate financial needs or invest in short-term opportunities. However, this flexibility comes with the responsibility of managing these funds carefully, as they are liabilities that must be settled when the official call is made.

Calls in Arrears

Calls in Arrears refers to the amount that shareholders have not paid by the due date on their shares, despite a formal request or “call” from the company. When a company issues shares, it may request payment in installments. If a shareholder fails to pay any installment by the due date, the unpaid amount is considered a call in arrears. The company records this as a receivable on its balance sheet. Interest may be charged on calls in arrears, and in severe cases, the company may forfeit the shares if the arrears are not cleared within a specified period.

Characteristics of Calls in Arrears:

  1. Unpaid Amount

The primary characteristic of Calls in Arrears is that it represents an amount that shareholders owe to the company but have not yet paid by the deadline specified. This occurs when shareholders do not fulfill their financial obligation to pay the call on the due date as required by the company.

  1. Recorded as an Asset

In the company’s financial records, Calls in Arrears are recorded as an asset. Specifically, it is shown as a receivable on the balance sheet, reflecting the amount that the company expects to collect from shareholders. This receivable remains on the books until the amount is fully paid by the shareholders.

  1. Interest Charges

Companies often charge interest on Calls in Arrears as a penalty for late payment. The interest rate and terms are usually specified in the company’s Articles of Association. This serves as a deterrent to shareholders against delaying payment and compensates the company for the delay in receiving funds.

  1. No Voting Rights

Shareholders with Calls in Arrears do not enjoy voting rights for the unpaid shares. Voting rights are typically granted based on the paid-up share capital. As a result, shareholders who fail to pay on time may temporarily lose their influence in company decisions until they settle their dues.

  1. Possible Forfeiture of Shares

If the Calls in Arrears remain unpaid for an extended period, the company may initiate the process of forfeiting the shares. Forfeiture involves canceling the shareholder’s ownership of the shares, and the company may reissue or sell the shares to recover the unpaid amount.

  1. Impact on Dividend

Shareholders with Calls in Arrears are not entitled to receive dividends on the unpaid shares. Dividends are typically declared on fully paid-up shares, so until the arrears are cleared, the shareholder forfeits any right to dividends on those shares.

  1. Negative Impact on Shareholder Reputation

Calls in Arrears can negatively affect a shareholder’s reputation within the company and among other investors. Persistent arrears may lead to a loss of trust and potential exclusion from future investment opportunities within the company.

  1. Legal Implications

If the arrears are significant and remain unresolved, the company may take legal action to recover the outstanding amount. This could involve court proceedings or other legal remedies to enforce payment, depending on the jurisdiction and the company’s policies.

Key differences between Calls in Advance and Calls in Arrears

Aspect Calls in Advance Calls in Arrears
Payment Timing Before due date After due date
Balance Sheet Status Liability Asset
Interest May be paid to shareholders Charged to shareholders
Voting Rights No additional rights Suspended until paid
Dividend Rights Not entitled Not entitled
Company Benefit Early cash inflow Receivable expected
Shareholder Initiative Voluntary Obligatory
Financial Flexibility Increases for company Decreases for shareholder
Impact on Reputation Positive Negative
Legal Action None Possible if unpaid
Forfeiture Risk None High if unpaid
Impact on Share Price Neutral Negative
Accounting Treatment Deferred liability Accounts receivable
Disclosure Requirement In notes to accounts Directly shown in balance sheet
Management Control Easier More complex

Bangalore University BBA Notes

Corporate Accounting 3rd Semester BU BBA SEP 2024-25 Notes

indiafreenotesby indiafreenotes1
Unit 1 [Book]
Issue of Shares VIEW
Initial Subscription of Shares VIEW
Right Issue of Shares VIEW
Private Placement of Shares VIEW
IPO VIEW
FPO VIEW
Book Building VIEW
Prospectus VIEW
Red herring Prospectus VIEW
Issue of Bonus Shares, Reasons for issuing Bonus Shares, Legal Framework VIEW
Relevant Provisions of the Companies Act, 2013 for issuing Bonus Shares VIEW
Students are advised to go through some of the IPO documents which is available in the Public Domain) VIEW
Buyback of Shares Meaning, Objectives, Legal framework for Buyback under the Companies Act, 2013 VIEW
Unit 2 [Book]
Introduction, Meaning and Definition of Underwriting, Importance of Underwriting in Raising Capital VIEW
Types of Underwriting: Firm Underwriting, Conditional Underwriting, and Sub-Underwriting VIEW
Calculation of Liabilities and Commission: Gross Liability and Net Liability VIEW
Marked Applications and Unmarked Applications VIEW
Proportionate Liability in Syndicated Underwriting VIEW
Accounting for Underwriting: Treatment of Underwriting Commission in the Company’s Book and Settlement between Parties VIEW
Preparation of Statement of Underwriters Liability VIEW
** ****
Role of Underwriters in Capital Markets VIEW
Ethical Practices in Underwriting VIEW
Key Clauses in Underwriting Agreements VIEW
SEBI Guidelines on Commission Rates and Responsibilities VIEW
Unit 3 [Book]
Introduction Meaning and Need for Valuation of Shares VIEW
Factors affecting Value of Shares VIEW
Methods of Share Valuation illustration on:
Intrinsic Value Method VIEW
Yield Method VIEW
Earning Capacity Method VIEW
Fair Value Method VIEW
Rights Issue VIEW
Valuation of Rights Issue VIEW
Valuation of Warrants: Australian Model, Shivaraman-Krishnan Model VIEW
Unit 4 [Book]
Introduction, Meaning Concept of Profit (or Loss) Prior to the date of Incorporation VIEW
Pre-incorporation vs. Post-incorporation Periods VIEW
Calculation of Apportionment Ratios:
Sales Ratio VIEW
Time Ratio VIEW
Weighted Ratio VIEW
Treatment of Capital and Revenue Incomes and Expenditures VIEW
Ascertainment of pre-incorporation and post- incorporation profits by preparing statement of Profit and Loss (Vertical Format) as per schedule III of Companies Act, 2013 VIEW
Unit 5 [Book]
Statutory Provisions regarding Maintenance of Accounts by Company Section 128, 129, 134 VIEW
Fundamental Accounting assumption:  Going Concern, Accrual, Consistency VIEW
Annual Returns under Section 92, (Form AOC-4 & MGT-7A) VIEW
Preparation of Financial Statements of Companies as per schedule III to companies act, 2013 VIEW
Schedule 7 to Companies Act of 2013 for understanding the Rate of Depreciation on Key assets such as Plant and Machinery, Furniture and Fixtures, Office equipment, Vehicle, buildings, Intellectual Properties and Intangible Assets VIEW

>>Old Syllabus for 2024-25 Notes<<

Unit 1 [Book]
Introduction, Meaning of Shares VIEW
Types of Shares (Equity Shares and Preference Shares), Features of Equity & Preference Shares VIEW
Issue of Shares, Procedure for Issue of Shares, Kinds of Share Issues VIEW
Types of Share Issues, Issue of Shares at Par, at Premium and at Discount VIEW
Subscription of Shares, Minimum Subscription, Over-Subscription VIEW
Pro- Rata Allotment of Shares VIEW
Accounting for Issue of Shares at Par, Premium, Discount VIEW
Calls in Arrears and Calls in Advance VIEW
Unit 2 [Book]
Introduction, Overview of Redemption of Debentures Meaning, Importance and Objectives of Redemption VIEW
Methods of Redemptions:
Redemption Out of Profit VIEW
Redemption Out of Capital VIEW
Redemption by Payment in Lump Sum VIEW
Redemption by Instalments VIEW
Redemption by Purchase in the Open Market VIEW
Key Financial Adjustments in Redemption of Debentures VIEW
Provision for Premium on Redemption of Debentures VIEW
Treatment of Unamortized Debenture Discount or Premium VIEW
Accounting for Redemption of Debentures under Sinking Fund method VIEW
Journal Entries VIEW
Ledger Accounts VIEW
Preparation of Financial Statements VIEW
Post- Redemption as per Schedule III to Companies Act 2013 VIEW
Unit 3 [Book]
Introduction, Meaning of Underwriting VIEW
SEBI regulations regarding Underwriting VIEW
Underwriting Commission VIEW
Underwriter, Functions, Advantages of Underwriting VIEW
Types of Underwriting VIEW
Marked and Unmarked Applications VIEW
Determination of Liability in respect of Underwriting Contract when fully Underwritten and Partially Underwritten with and without firm Underwriting VIEW
Unit 4 [Book]
Introduction Meaning and Need for Valuation of Shares VIEW
Factors affecting Value of Shares VIEW
Methods of Share Valuation illustration on:
Intrinsic Value Method VIEW
Yield Method VIEW
Earning Capacity Method VIEW
Fair Value Method VIEW
Rights Issue VIEW
Valuation of Rights Issue VIEW
Valuation of Warrants: Australian Model, Shivaraman-Krishnan Model VIEW
Unit 5 [Book]
Statutory Provisions regarding Preparation of Financial Statements of Companies as per schedule III of Companies act. 2013 VIEW
List of the Companies follow Schedule III of companies Act 2013 VIEW
Preparation of Statement of Profit and Loss VIEW
Preparation of Statement of Balance Sheet VIEW
Management Notes

SEBI regulations regarding Underwriting

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Underwriting is a crucial aspect of the capital market, especially during public offerings like Initial Public Offerings (IPOs), Follow-on Public Offerings (FPOs), and Rights Issues. In the context of securities markets in India, underwriting refers to an arrangement in which a designated underwriter agrees to purchase shares from a company in case the public offering is not fully subscribed. The Securities and Exchange Board of India (SEBI), as the regulatory authority for the Indian securities market, has laid down certain guidelines and regulations for underwriting in order to ensure transparency, protect investor interests, and maintain market integrity.

Regulations on Underwriting by SEBI:

SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018 (ICDR Regulations)

Under the SEBI ICDR Regulations, which governs the process of public offerings in India, specific rules apply to underwriting arrangements:

  • Appointment of Underwriters: Companies issuing securities must appoint one or more underwriters to ensure that they can raise sufficient capital even if the issue does not receive full subscription from the public. These underwriters may be financial institutions, banks, or other recognized entities with the necessary expertise and financial backing.

  • Underwriting Agreements: An underwriting agreement is a formal contract between the issuer and the underwriter. The agreement must clearly specify the number of securities being underwritten, the terms of underwriting (including commission), and the conditions under which the underwriting agreement becomes effective.

  • Underwriting Commitment: The underwriter commits to purchasing any unsubscribed shares, thereby assuming the risk of the offering’s under-subscription. They will purchase the unsold shares at the issue price. If the issue is fully subscribed, the underwriter does not need to purchase any shares. If the issue is not fully subscribed, the underwriter buys the remaining shares and may later resell them in the secondary market or hold them as an investment.

Minimum Underwriting Requirement:

Under the SEBI regulations, for a public issue to proceed, there is a minimum underwriting requirement, ensuring that the issuer will not be left with an unsubscribed portion that cannot be filled. The minimum requirement depends on the type of issue and its structure.

  • Public Issues: If a company is making a public offering of equity shares, the minimum underwriting requirement is set at 100% of the portion of the issue that is to be underwritten. This means that underwriters must commit to purchase shares that are not subscribed by the public, ensuring that the company raises the necessary capital.

  • Rights Issues: Under the SEBI regulations, rights issues (where existing shareholders are offered new shares) also require underwriting, especially when the company anticipates that not all shareholders will subscribe to the offer. In such cases, the company is expected to make underwriting arrangements to cover any unsold shares.

Role and Responsibilities of Underwriters:

  • Due Diligence: Underwriters must conduct due diligence before agreeing to underwrite an issue. This includes evaluating the financial stability and business model of the issuing company to assess the risks involved in underwriting the issue.

  • Subscription of Shares: If there is an under-subscription in the public issue, the underwriter must step in and subscribe to the remaining shares as per the underwriting agreement.

  • Compliance with Disclosure Requirements: Underwriters must ensure that all necessary disclosures are made in the prospectus or offer document related to underwriting. They need to disclose the underwriting commitment, the percentage of the issue that is being underwritten, and any conflicts of interest.

  • Handling of Underwritten Shares: If the issue is undersubscribed and the underwriter has to purchase the remaining shares, they can either hold or sell the shares in the secondary market. The underwriter has to disclose how these shares will be dealt with.

SEBI Guidelines on Underwriting Commission:

Under SEBI regulations, the underwriting commission is allowed, but it is capped to prevent excessive charges that may harm investors. The commission is typically paid by the issuer to the underwriter in return for taking on the underwriting risk.

  • The maximum underwriting commission is determined based on the type and size of the issue. For example, for equity issues, the commission can range from 1% to 2% of the issue size, depending on the total amount being raised.

  • The underwriting commission is generally lower for large offerings as the risk is spread across a larger number of shares.

SEBI Guidelines on Underwriter’s Liability:

Underwriters must ensure that they are financially capable of fulfilling their commitments. They are held responsible for purchasing the unsubscribed shares if necessary, and their ability to meet this responsibility is a critical factor in maintaining market stability.

  • If the underwriter fails to fulfill its underwriting commitments, they may face penalties and enforcement actions from SEBI.

  • The underwriter’s liability is typically limited to the agreed-upon underwriting portion of the issue and does not extend beyond this.

SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011:

Underwriting in cases of public takeovers is also governed by the Takeover Regulations, which ensure that any underwriting agreements in takeover bids comply with the broader framework of the takeover law. These regulations specify how underwriters may participate in or affect the offer.

Management Notes

Amortization, Characteristics, Entries

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Amortization refers to the systematic allocation of the cost of an intangible asset (e.g., patents, copyrights, goodwill) or the repayment of a loan principal over its useful life or loan term. For intangible assets, it follows the matching principle in accounting, spreading the expense to align with the revenue it generates. Unlike depreciation (for tangible assets), amortization typically uses the straight-line method, assuming equal expense distribution each period. For loans, amortization involves gradual principal repayment through periodic installments, reducing the outstanding balance over time. It impacts financial statements by lowering asset book value (balance sheet) and recording periodic expenses (income statement). Under IFRS and GAAP, amortization stops if the asset’s residual value is reassessed or impaired. Proper amortization ensures accurate profit measurement and compliance with accounting standards.

Characteristics of Amortization:

  • Gradual Allocation of Cost

Amortization involves systematically allocating the cost of an intangible asset over its useful life. Instead of recording the full expense at once, the cost is divided into equal or appropriate portions for each accounting period. This gradual recognition ensures that the expense matches the periods in which the asset contributes to revenue generation. By spreading the cost, amortization prevents sudden impacts on profits and provides a more accurate picture of an entity’s financial performance, aligning with the matching principle in accounting.

  • Applicable to Intangible Assets

Amortization is specifically applied to intangible assets such as patents, trademarks, copyrights, franchises, goodwill, and software. These assets lack physical substance but provide long-term benefits to a business. The process helps in systematically reducing their book value until it reaches zero or their residual value, whichever is applicable. Unlike depreciation (for tangible assets), amortization only applies to non-physical assets and usually uses the straight-line method unless otherwise specified. It reflects the consumption or expiration of the economic benefits embedded in intangible assets.

  • Non-Cash Expense

Amortization is a non-cash expense, meaning it does not involve any actual cash outflow during the accounting period. The cash payment for acquiring the intangible asset is made upfront or in installments, but amortization simply spreads that cost in the books over time. This characteristic makes it important in financial analysis because it reduces reported profits without affecting cash flows. It helps stakeholders distinguish between accounting expenses and actual cash expenditures, thus aiding in more accurate cash flow management and analysis.

  • Based on Useful Life

The amount of amortization depends on the useful life of the intangible asset, which is the period over which it is expected to generate economic benefits. This useful life is estimated based on legal, contractual, or economic factors. For example, a patent might have a legal life of 20 years but could be amortized over 10 years if the company expects to benefit from it only during that period. Amortization stops when the asset is fully amortized or disposed of.

  • Matches Expenses with Revenue

Amortization follows the matching principle in accounting, which requires expenses to be recorded in the same period as the revenues they help generate. By allocating the cost of intangible assets over their useful lives, amortization ensures that financial statements accurately reflect the cost of using these assets in generating income. This leads to fairer and more consistent profit measurement across accounting periods, preventing overstatement of income in earlier years and understatement in later years when benefits are still being received.

  • Straight-Line Method Preference

In most cases, amortization is calculated using the straight-line method, which allocates an equal amount of expense in each period of the asset’s useful life. This approach is preferred because intangible assets often provide consistent benefits over time. However, other methods can be used if the asset’s benefits are consumed unevenly. The choice of method should reflect the pattern in which economic benefits are derived. The straight-line method’s simplicity, predictability, and ease of calculation make it the most widely adopted practice.

Entries of Amortization:

S. No. Situation Journal Entry Explanation

1

Recording amortization expense

Amortization Expense A/c Dr.

  To Accumulated Amortization A/c

Records the amortization amount for the period, reducing the value of the intangible asset over time.

2

Directly reducing asset value

Amortization Expense A/c Dr.

  To Intangible Asset A/c

Used when amortization is directly deducted from the asset account rather than accumulated separately.

3

At year-end transfer of expense to Profit & Loss

Profit & Loss A/c Dr.

  To Amortization Expense A/c

Transfers amortization expense to P&L, reducing net profit for the period.

4

Fully amortizing an asset

Accumulated Amortization A/c Dr.

  To Intangible Asset A/c

Removes the asset’s cost and related accumulated amortization upon completion of its useful life.

5

Amortization in case of disposal of asset

 Bank A/c Dr.

Accumulated Amortization A/c Dr.

  To Intangible Asset A/c

  To Gain on Disposal A/c (if any)

Records disposal, removes asset’s cost, accumulated amortization, and recognizes any gain.

6

Loss on disposal

 Bank A/c Dr.

Accumulated Amortization A/c Dr.

Loss on Disposal A/c Dr.

  To Intangible Asset A/c

Records loss when sale proceeds are less than the net book value.
Management Notes

Minimum number of Shares to be issued for Redemption

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The minimum number of shares to be issued for redemption refers to the smallest quantity of new equity shares a company must issue to fund the redemption of preference shares when adequate distributable profits are unavailable. According to Section 55 of the Companies Act, 2013, the amount equal to the nominal value of preference shares redeemed must be replaced either from profits (transferred to the Capital Redemption Reserve) or through the issue of new shares. The calculation ensures the company’s capital remains intact, thereby safeguarding creditors’ interests and maintaining financial stability after redemption.

When a company decides to redeem preference shares, it must comply with the provisions of the Companies Act, 2013. If the redemption is not made entirely out of distributable profits, the company must issue fresh equity shares to raise funds for the redemption.

The minimum number of shares to be issued is calculated as:

Minimum Shares to Issue = [Nominal Value of Preference Shares to be Redeemed − Available Profits for Transfer to CRR] / Nominal Value per Equity Share

This ensures that the capital base is maintained and creditors’ interests are protected.

The objective is to determine the least number of shares that must be issued so the company complies with legal provisions while minimizing dilution of ownership.

1. Basic Principle

The nominal value of shares redeemed must be replaced either by:

  • Profits transferred to CRR, or

  • Proceeds from fresh issue of shares

Therefore,

Face Value of Shares Redeemed = Fresh Issue of Shares (Nominal Value) + Transfer to CRR

The company will try to issue the minimum shares possible so that CRR requirement becomes minimum.

2. When Shares are Issued at Par

If new shares are issued at face value (par), the entire amount received is treated as share capital.

Formula:

Minimum Fresh Issue (Nominal Value) = Face Value of Preference Shares Redeemed − Available Profits for CRR

After determining the total amount of fresh issue, number of shares is calculated:

Number of Shares = Amount of Fresh Issue ÷ Face Value per Share

3. When Shares are Issued at Premium

If shares are issued at a premium, the premium portion goes to Securities Premium Account and cannot be used to replace share capital. Only the face value portion of the fresh issue is considered for calculating minimum shares.

However, securities premium can be used to pay premium on redemption of preference shares.

Thus,

CRR requirement is reduced only by the nominal value of shares issued, not by the premium collected.

4. Adjustment for Premium on Redemption

If preference shares are redeemed at a premium:

  • Premium payable must be provided from securities premium or profits

  • It does not affect the calculation of minimum number of shares, which is based only on nominal capital.

5. Step-by-Step Calculation Procedure

  • Find the face value of preference shares to be redeemed.

  • Determine profits available for CRR (free reserves).

  • Deduct available profits from nominal value of shares redeemed.

  • Balance amount = minimum nominal value of fresh issue required.

  • Divide by face value per share to find minimum number of shares.

6. Illustration (Conceptual)

Suppose a company redeems preference shares worth ₹1,00,000 and has profits available ₹40,000.

Required fresh issue (nominal value):

₹1,00,000 − ₹40,000 = ₹60,000

If face value per share = ₹10

Number of shares to be issued:

₹60,000 ÷ 10 = 6,000 shares

Thus, the company must issue at least 6,000 equity shares to legally redeem the preference shares.

Minimum number of Shares to be issued for Redemption:

Date Particulars Debit (₹) Credit (₹)
1 Bank A/c Dr. xxx
    To Share Application & Allotment A/c xxx
(Being application money received on fresh issue of shares for redemption purposes)
2 Share Application & Allotment A/c Dr. xxx
    To Share Capital A/c xxx
(Being allotment of new shares made for redemption)
3 Preference Share Capital A/c Dr. xxx
Premium on Redemption of Preference Shares A/c Dr. (if any) xxx
    To Preference Shareholders A/c xxx
(Being amount payable on redemption transferred to shareholders’ account)
4 Preference Shareholders A/c Dr. xxx
    To Bank A/c xxx
(Being payment made to preference shareholders on redemption)
5 Profit & Loss A/c / General Reserve A/c Dr. (for balance portion not covered by fresh issue) xxx
    To Capital Redemption Reserve A/c xxx
(Being transfer of profits to CRR for nominal value of redeemed shares not covered by fresh issue)

Management Notes

Underwriting Commission

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Underwriting commission is a fee paid by a company to underwriters for their role in guaranteeing the successful completion of a public offering, such as an Initial Public Offering (IPO) or a Rights Issue. The underwriters are financial intermediaries who commit to purchasing the shares in case the public does not fully subscribe to them. This commission compensates the underwriter for taking on the risk of underwriting the issue and for their involvement in ensuring that the offering is fully subscribed.

Role of Underwriters in Public Offers:

In the capital markets, underwriting is a critical function. Underwriters perform due diligence, evaluate the financial health of the issuing company, and determine the pricing and risk associated with the offer. They then agree to purchase any unsold shares from the issue if the public subscription falls short of the total number of shares offered. By guaranteeing the issue’s success, underwriters ensure that the company can raise the desired capital even if public interest is insufficient.

Understanding Underwriting Commission

The underwriting commission is the fee paid to the underwriters for assuming the risk of purchasing unsubscribed shares. This commission is typically expressed as a percentage of the total capital raised from the issue and varies depending on the size of the issue, the risk involved, and the market conditions.

How Underwriting Commission Works:

  1. Risk Compensation: The primary purpose of the underwriting commission is to compensate the underwriter for taking on the risk of purchasing any unsubscribed shares. If the public subscription is insufficient, the underwriter must buy the remaining shares at the offer price.

  2. Cost of Services: Besides taking on risk, underwriters also incur costs related to the due diligence process, market analysis, pricing strategy, and preparing the necessary documentation, all of which contribute to the overall commission.

  3. Market Conditions: In times of high demand for securities (bull market), the underwriting commission tends to be lower because the issue is likely to be fully subscribed by the public. In contrast, in bearish market conditions, when investor sentiment is lower, underwriting commissions may be higher due to the increased risk of an under-subscribed offering.

Regulations on Underwriting Commission in India:

In India, the Securities and Exchange Board of India (SEBI) regulates the underwriting commission, ensuring fairness and preventing excessive fees. The underwriting commission is capped under SEBI’s guidelines to protect investors and maintain transparency in the capital market.

SEBI Guidelines:

  1. Maximum Commission: SEBI specifies the maximum underwriting commission based on the size of the issue. For example, the maximum commission for a public issue of equity shares is generally in the range of 1% to 2% of the total issue size. For smaller issues, the commission might be slightly higher.

  2. Equity Issues: For equity-based public offerings, underwriters typically receive a commission of around 1% to 1.5% of the issue size, although this can vary depending on the complexity of the offer, the financial strength of the issuing company, and market conditions.

  3. Debt Issues: For debt securities or debentures, the underwriting commission is usually lower than for equity issues. This is because the risk involved in debt underwriting is typically considered to be lower, as bondholders have a fixed claim on the company’s assets in case of liquidation.

  4. Non-Equity Issues: Underwriting commissions for non-equity issues, such as preference shares or debentures, also fall under SEBI’s purview but tend to be lower than for equity issues due to their lower risk and fixed income nature.

  5. Payment and Terms: The underwriting commission is usually payable by the issuer after the offer is completed. The terms and conditions of the commission payment, including the percentage and any performance-related clauses, must be disclosed in the prospectus or the offer document.

Factors Influencing Underwriting Commission:

Several factors determine the amount of the underwriting commission that the issuer and underwriter agree upon:

  1. Issue Size: Larger offerings generally involve lower underwriting commissions because the risk is spread across a larger number of shares. In contrast, smaller offerings tend to carry higher commissions due to the higher relative risk for underwriters.

  2. Risk Profile: The perceived risk of the offering affects the underwriting commission. If the issuing company is perceived to have higher risk or there is a general lack of investor confidence in the market, underwriters may demand a higher commission to compensate for the increased risk of undersubscription.

  3. Market Conditions: During a bullish market, when investor sentiment is strong, underwriting commissions are often lower because public demand for shares is more predictable. Conversely, in bearish markets, where investor appetite is lower, underwriting commissions may rise as compensation for the potential risk of an under-subscribed issue.

  4. Issuer’s Reputation: The financial health and reputation of the issuing company can also influence the underwriting commission. If the company is financially stable and has a good market reputation, the underwriting commission will likely be on the lower end of the scale.

Benefits of Underwriting Commission:

The underwriting commission is an essential mechanism in public offerings, benefiting both the issuer and the underwriter:

  1. Issuer’s Perspective: The issuer benefits from a guaranteed capital raise, even in the event of an under-subscribed issue. They also receive the expert services of the underwriters, who manage the pricing and marketing of the offer.

  2. Underwriter’s Perspective: The underwriter assumes the risk of buying unsold shares in exchange for the underwriting commission. This compensation reflects the expertise and financial backing needed to ensure the success of the offering.

  3. Investor Protection: The regulatory cap on underwriting commissions ensures that the issuer is not paying excessive fees, thus protecting investors from higher issue costs that may be passed on to them through inflated prices.

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