Tag: Financial Statements

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

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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

Issue of Rights and Bonus Shares

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The issuance of shares by a company is one of the most common ways of raising capital. Companies can issue shares in different ways, such as initial public offerings (IPOs), private placements, and rights issues. Two other types of share issuance are bonus issues and bonus shares. Rights issue and bonus issue are two different ways of issuing shares by a company. A rights issue is a way for a company to raise additional capital by offering existing shareholders the right to buy new shares at a discounted price, while a bonus issue is a way to reward existing shareholders by issuing additional shares without raising any new capital. Both types of issues have their own advantages and disadvantages and should be carefully evaluated by the company before making a decision. It is important for investors to understand the implications of these issues before making any investment decisions.

Rights Issue of Shares:

A rights issue is a way for a company to raise additional capital by offering existing shareholders the right to buy new shares in proportion to their current holdings. The company offers the new shares at a discount to the current market price, making it an attractive option for existing shareholders. The rights issue is a type of public offering, but only existing shareholders can participate.

For example, if a company has 10 million shares outstanding and decides to issue 1 million new shares through a rights issue, it will offer one right to every ten shares held by existing shareholders. If a shareholder holds 1,000 shares, he or she will be offered 100 rights to purchase 100 new shares at a discounted price. The rights issue is usually offered for a limited period of time, and shareholders can choose to exercise their rights or sell them to other investors in the market.

Process of Rights Issue of Shares

  • Announcement:

The first step in a rights issue is the announcement by the company to its shareholders and the general public. The announcement includes details about the number of shares to be issued, the price at which they will be offered, and the time period during which shareholders can exercise their rights.

  • Record Date:

The company then fixes a record date, which is the date on which shareholders must hold the shares to be eligible for the rights issue. Shareholders who purchase shares after the record date are not eligible for the rights issue.

  • Issue of Rights:

Once the record date is fixed, the company issues the rights to existing shareholders based on the number of shares they hold. The rights are issued in proportion to the existing shareholding, and each right gives the shareholder the option to purchase a specified number of new shares at a discounted price.

  • Trading of Rights:

Shareholders can either exercise their rights or sell them in the market. The rights can be traded like regular shares, and their value is determined by the difference between the market price and the discounted price of the new shares.

  • Exercise of Rights:

Shareholders who wish to exercise their rights must submit an application and payment for the new shares before the expiration of the rights issue period. The payment must be made at the discounted price specified in the rights issue announcement.

  • Allotment of Shares:

After the expiration of the rights issue period, the company determines the total number of shares applied for and allot the new shares to the applicants. If there is an oversubscription, the company may allocate the shares on a pro-rata basis.

  • Listing:

The new shares issued through the rights issue are listed on the stock exchange, and existing shareholders who have exercised their rights can trade them in the market.

Benefits of Rights Issue of Shares

  • Capital Raising:

Rights issue is a quick and cost-effective way for a company to raise additional capital from its existing shareholders without incurring any underwriting or brokerage fees.

  • Dilution:

Rights issue does not result in dilution of ownership for existing shareholders since they have the option to purchase new shares in proportion to their current holdings.

  • Support:

Rights issue is usually offered at a discount to the market price, making it an attractive option for existing shareholders. It also shows the company’s commitment to its existing shareholders and provides a way for them to support the company’s growth plans.

Bonus Issue of Shares

Bonus issue is a way for a company to reward its existing shareholders by issuing additional shares without raising any new capital. The bonus shares are issued to existing shareholders in proportion to their current holdings. For example, if a company issues a 1:1 bonus issue, each shareholder will receive one additional share for every share they hold.

Process of Bonus Issue of Shares

  • Announcement:

The first step in a bonus issue is the announcement by the company to its shareholders and the general public. The announcement includes details about the number of shares to be issued, the ratio of the bonus issue, and the time period during which the bonus shares will be credited to shareholders’ accounts.

  • Record Date:

The company then fixes a record date, which is the date on which shareholders must hold the shares to be eligible for the bonus issue. Shareholders who purchase shares after the record date are not eligible for the bonus issue.

  • Allotment of Shares:

After the record date, the company credits the bonus shares to the eligible shareholders’ accounts in proportion to their current holdings. The bonus shares are usually credited within a few weeks after the record date.

  • Listing:

The bonus shares are listed on the stock exchange, and existing shareholders can trade them in the market.

Benefits of Bonus Issue of Shares

  • Rewarding Shareholders:

Bonus issue is a way for a company to reward its existing shareholders without raising any new capital. It shows the company’s commitment to its shareholders and provides a way to retain them.

  • Increase in Liquidity:

Bonus issue increases the liquidity of the company’s shares as the number of shares outstanding increases. This can result in higher trading volumes and better price discovery in the market.

  • Positive Signal:

Bonus issue is usually viewed as a positive signal by the market as it indicates that the company is in a strong financial position and expects to continue to perform well in the future.

Key differences between Rights Issue and Bonus Issue:

Feature Rights issue Bonus issue
Purpose To raise additional capital To reward existing shareholders
Eligibility Only existing shareholders are eligible Only existing shareholders are eligible
Discounted Price Offered at a discounted price No discounted price
Capital Raised Raises additional capital for the company No additional capital raised
Dilution of Ownership May result in dilution of ownership for shareholders No dilution of ownership
Listing of New Shares New shares are listed on the stock exchange New shares are listed on the stock exchange
Market Perception May be viewed as a negative signal by the market Usually viewed as a positive signal by the market

Bangalore University B.com Notes

Corporate Accounting 3rd Semester BU B.Com SEP 2024-25 Notes

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Unit 1 [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 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
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
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
Underwriter’s Account 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]
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
Unit 5 [Book]
Buyback of Shares Meaning, Objectives and Legal framework for buyback under the Companies Act, 2013 VIEW
Methods of Buyback:
Open Market Purchase VIEW
Tender offer of Buyback of Shares VIEW
Direct Negotiation / Targeted Buyback of Shares VIEW
Buyback through Book-building process VIEW
Accounting Treatment of Buyback in the Company’s Book VIEW
Bonus Issue Meaning, Definitions VIEW
Difference between Bonus Issue and Rights Issue VIEW
Reasons for issuing Bonus Shares VIEW
Advantages and Disadvantages for the Company and Shareholders for issuing Bonus Shares VIEW
Legal Framework, Relevant Provisions of the Companies Act, 2013 VIEW
SEBI Guidelines on Bonus Issues VIEW
Types of Bonus Issues (Capitalization of Reserves & Bonus Issues out of Free Reserves vs. Capital Reserves) VIEW
Sources of Financing Bonus Issues (Accumulated profits, Free reserves, or Securities premium account) VIEW
Management Notes

Sources of Financing Bonus Issues (Accumulated Profits, Free Reserves, or Securities Premium Account)

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Bonus issues are funded through a company’s internal reserves rather than fresh capital. The primary sources include Accumulated profits, Free reserves, and the Securities premium account. Accumulated profits represent retained earnings available for capitalization. Free reserves consist of surplus funds not earmarked for liabilities, ensuring financial stability. The securities premium account includes excess amounts received from share issuances, which can be used under Section 52 of the Companies Act, 2013. These sources enable companies to issue bonus shares without affecting cash flow while enhancing shareholder value and market liquidity.

Sources of Financing Bonus Issues:

1. Accumulated Profits

Accumulated profits refer to the retained earnings that a company has generated over time after paying dividends and other obligations. These profits are reinvested into the business and can be capitalized to issue bonus shares. Using accumulated profits for a bonus issue allows a company to reward shareholders without impacting cash reserves. It enhances investor confidence and portrays financial stability. However, since these profits are already accounted for within the equity section, issuing bonus shares does not provide additional funds but improves share liquidity. The Companies Act, 2013, allows companies to capitalize a portion of their accumulated profits to issue bonus shares, subject to regulatory approvals and compliance with financial norms.

2. Free Reserves

Free reserves consist of the profits available for distribution, which are not earmarked for specific liabilities. These reserves arise from a company’s surplus earnings and are often allocated toward growth, dividend payouts, or bonus issues. Capitalizing free reserves for bonus issues increases share capital while maintaining overall equity. It benefits shareholders by enhancing their investment value without diluting ownership. Companies must ensure that the reserves used for the bonus issue are truly free and not encumbered by liabilities. SEBI and the Companies Act, 2013, regulate the usage of free reserves for issuing bonus shares, ensuring transparency and financial prudence.

3. Securities Premium Account

The securities premium account consists of the extra amount received over the nominal value of shares issued at a premium. Companies can use this premium to finance bonus issues, as per Section 52 of the Companies Act, 2013. Utilizing the securities premium for a bonus issue helps capitalize on excess funds received from shareholders, enhancing the company’s shareholding structure without impacting its operational liquidity. This method reduces the per-share value, making shares more affordable to investors while increasing market activity. However, companies must follow SEBI guidelines and legal provisions ensuring fair utilization.

Management Notes

Types of Bonus Issues (Capitalization of Reserves & Bonus Issues out of Free Reserves vs. Capital Reserves)

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Bonus issues refer to the distribution of additional shares to existing shareholders at no extra cost, based on their current holdings. These shares are issued from a company’s free reserves or securities premium, converting retained earnings into share capital. Bonus issues increase the total number of shares while keeping the proportionate ownership unchanged. They enhance market liquidity, investor confidence, and perceived financial strength without affecting the company’s cash reserves. However, the market price per share adjusts downward post-issue. Bonus issues are governed by SEBI guidelines and the Companies Act, 2013 in India.

Types of Bonus Issues:

1. Capitalization of Reserves (Bonus Shares from Reserves)

Capitalization of reserves refers to the process where a company converts its accumulated reserves into share capital and issues bonus shares to existing shareholders. Instead of distributing cash dividends, the company allocates additional shares to shareholders in proportion to their existing holdings. These reserves may include free reserves, securities premium reserves, or capital redemption reserves, but not revaluation reserves.

The advantage of this approach is that it enhances investor confidence while maintaining liquidity within the company. By issuing bonus shares, the company increases its share capital without affecting cash flow. However, since bonus shares do not bring additional funds into the company, they do not improve financial strength directly. The market price of shares generally adjusts downward after a bonus issue, ensuring that shareholders’ wealth remains unchanged.

Companies opt for capitalization of reserves when they wish to reward shareholders, improve liquidity, or maintain an investor-friendly image while retaining earnings for future expansion.

2. Bonus Issues out of Free Reserves vs. Capital Reserves

Bonus shares can be issued from free reserves or capital reserves, each having distinct characteristics.

  • Bonus from Free Reserves: Companies commonly issue bonus shares from free reserves, retained earnings, or securities premium. These reserves represent accumulated profits, making them ideal for rewarding shareholders. Since these are earned profits, SEBI permits issuing bonus shares from them. It reflects a company’s strong financial performance and long-term stability.

  • Bonus from Capital Reserves: Capital reserves arise from non-operating profits, such as asset revaluation or government grants. SEBI restricts issuing bonus shares from revaluation reserves, as they do not represent real earnings. Companies can issue from capital redemption reserves, which arise when preference shares are redeemed.

Management Notes

SEBI Guidelines on Bonus Issues

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Securities and Exchange Board of India (SEBI) regulates the issuance of bonus shares to ensure fair practices, protect investors’ interests, and maintain market stability. SEBI has established guidelines for companies issuing bonus shares under the SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018 (ICDR Regulations). These guidelines ensure transparency, fair treatment of shareholders, and prevent price manipulation.

Eligibility Criteria for Issuing Bonus Shares

SEBI mandates that companies must meet certain eligibility criteria before issuing bonus shares.

  • The company must ensure that its reserves are sufficient for the bonus issue without affecting its financial stability.

  • The company must not have defaulted on any statutory payments, including loans, deposits, or interest on outstanding debt.

  • It must not have defaulted in the payment of dues to employees, statutory bodies, or financial institutions.

  • The bonus issue must be authorized by the company’s Articles of Association (AOA).

These criteria ensure that only financially stable companies issue bonus shares.

Conditions for Issuing Bonus Shares

SEBI has set specific conditions that companies must comply with while issuing bonus shares.

  • The issue must be fully paid-up shares and not convertible into any other form of security.

  • The company must ensure that bonus shares are issued out of free reserves, capital redemption reserves, or securities premium accounts.

  • The company should not have any outstanding convertible debt instruments at the time of issuing bonus shares.

  • The company must ensure that the bonus issue does not dilute its financial position or create undue price fluctuations.

These conditions ensure the fairness and authenticity of bonus share issuance.

Approval Process for Bonus Issues

The issuance of bonus shares requires approval from the company’s board and shareholders.

  • The company’s board of directors must first approve the bonus issue in a meeting.

  • After board approval, the company must obtain shareholder approval in a general meeting through an ordinary resolution.

  • If the Articles of Association (AOA) do not permit bonus issues, the company must amend the AOA before proceeding.

  • The company must inform stock exchanges about the approval and proposed record date for the bonus issue.

This process ensures transparency and compliance with legal formalities.

Record Date and Trading Restrictions

SEBI mandates that companies must set a record date for determining eligible shareholders.

  • The record date is the cut-off date on which shareholders must hold shares to be eligible for the bonus issue.

  • The company must notify stock exchanges at least two working days before the record date.

  • After the record date, the shares are traded ex-bonus, meaning new buyers will not receive the bonus shares.

  • The bonus shares must be credited to eligible shareholders within 15 days from the record date.

This ensures clarity for investors and prevents market manipulation.

Disclosure and Regulatory Filings:

SEBI requires companies to make necessary disclosures and filings related to bonus issues.

  • Companies must file an intimation to stock exchanges about the proposed bonus issue and record date.

  • The company must disclose the rationale, impact on financials, and details of the reserves utilized.

  • Any material changes or delays in the bonus issue must be promptly reported to SEBI and stock exchanges.

  • Companies must publish press releases and investor notifications about the bonus issue.

These disclosures maintain transparency and ensure that investors have accurate information.

Restrictions on Bonus Issues:

SEBI imposes certain restrictions to prevent the misuse of bonus issues.

  • Companies cannot withdraw or modify a bonus issue after it is announced.

  • Bonus shares must be issued only from free reserves and not from revaluation reserves.

  • If the company has defaulted on loans or interest payments, it cannot issue bonus shares.

  • Companies must not issue bonus shares to promoters selectively; all shareholders must be treated equally.

These restrictions prevent misuse of bonus issues and ensure fair treatment for all shareholders.

Listing and Trading of Bonus Shares:

Bonus shares must be listed and made tradable as per SEBI regulations.

  • The company must list the bonus shares on stock exchanges within two months from the date of approval.

  • The shares must be credited to shareholders’ demat accounts before trading begins.

  • Companies must ensure that the bonus shares carry the same rights as the original shares.

  • The trading price adjusts automatically to reflect the increased number of shares in the market.

This ensures smooth market operations and liquidity for investors.

Impact of Bonus Issues on Stock Prices:

SEBI ensures that bonus issues do not lead to artificial price manipulation in the stock market.

  • Stock prices typically adjust after a bonus issue due to increased supply.

  • SEBI monitors price movements to prevent suspicious trading activities before or after the bonus announcement.

  • Companies must disclose the bonus issue plan in advance to prevent insider trading.

  • The impact of bonus issues on a company’s financial performance must be explained in investor reports.

This ensures that bonus issues do not cause unnecessary volatility in the stock market.

Tax Implications of Bonus Issues:

SEBI does not directly regulate taxation, but companies must consider tax implications while issuing bonus shares.

  • Bonus shares are not taxable at the time of issuance in the hands of shareholders.

  • However, when sold, capital gains tax applies on the selling price minus the original purchase price.

  • SEBI requires companies to disclose any tax implications in their investor communications.

  • Shareholders must maintain proper records to calculate capital gains tax on future sales.

Understanding tax implications helps investors make informed financial decisions.

Penalties for Non-Compliance with SEBI Guidelines:

SEBI imposes strict penalties for companies that violate bonus issue regulations.

  • Companies failing to comply with SEBI guidelines may face fines, trading suspensions, or legal actions.

  • If companies delay the issuance of bonus shares beyond the prescribed time, SEBI can impose penalties.

  • Shareholders can file complaints with SEBI if they face unfair practices related to bonus issues.

  • Stock exchanges monitor compliance and report any violations to SEBI for further action.

These penalties ensure that companies follow fair and ethical practices in issuing bonus shares.

Management Notes

Legal Framework, Relevant Provisions of the Companies Act, 2013

indiafreenotesby indiafreenotes0

The Companies Act, 2013 governs corporate regulations in India and establishes the legal framework for the incorporation, management, and operations of companies. It aims to enhance corporate governance, transparency, and compliance while protecting stakeholders’ interests. Below are key legal provisions under the Act, categorized by their relevance.

Incorporation and Registration of Companies (Sections 3 to 22):

The Companies Act, 2013 provides the legal foundation for the formation and registration of companies.

  • Types of Companies: The Act recognizes public, private, and one-person companies (Section 2).

  • Memorandum & Articles of Association (MOA & AOA): Companies must draft and file these documents during incorporation.

  • Certificate of Incorporation: Issued by the Registrar of Companies (RoC) as proof of existence.

  • Corporate Identity Number (CIN): Every registered company receives a unique CIN.

These provisions ensure that companies operate with a clear legal identity and defined structure.

Corporate Governance and Board of Directors (Sections 149 to 178)

The Act emphasizes strong corporate governance to ensure ethical and efficient business operations.

  • Board Composition (Section 149):

    • A listed company must have at least one-third independent directors.

    • At least one woman director is required in certain companies.

  • Duties of Directors (Section 166):

Directors must act in good faith and in the best interest of the company and stakeholders.

  • Audit Committee (Section 177):

Mandatory for large companies to oversee financial reporting and compliance.

These provisions safeguard transparency and accountability in corporate decision-making.

Share Capital and Securities (Sections 43 to 72)

The Act defines regulations for issuing shares and securities to protect investors.

  • Types of Share Capital (Section 43):

Equity shares and preference shares are the primary categories.

  • Issue of Shares (Section 62):

Companies can issue rights shares, bonus shares, and preferential allotments.

  • Buyback of Shares (Section 68):

A company may repurchase its shares under specific conditions, subject to a 25% limit of its paid-up capital.

  • Transfer and Transmission of Shares (Section 56):

The process must be documented and comply with statutory requirements.

These provisions regulate capital structure and protect shareholders’ rights.

Financial Statements, Audit, and Disclosures (Sections 128 to 138):

To ensure financial transparency, companies must maintain proper accounting records and undergo regular audits.

  • Books of Accounts (Section 128):

Companies must maintain books at their registered office.

  • Statutory Audit (Section 139):

Every company, except a few small firms, must appoint an independent auditor.

  • Board’s Report (Section 134):

Includes financial performance, corporate social responsibility (CSR), and risk management details.

  • Internal Audit (Section 138):

Required for large and listed companies to strengthen financial control mechanisms.

These provisions ensure accurate financial reporting and prevent fraudulent activities.

Mergers, Acquisitions, and Corporate Restructuring (Sections 230 to 240)

The Act provides a structured framework for corporate restructuring, ensuring legal compliance.

  • Compromise and Arrangements (Section 230):

Companies can enter into agreements with creditors and shareholders for restructuring.

  • Mergers and Amalgamations (Section 232):

Court or tribunal approval is required for mergers.

  • Takeovers and Oppression (Section 241):

Shareholders can seek legal remedies against oppressive management practices.

These provisions facilitate smooth business restructuring while protecting stakeholders’ rights.

Corporate Social Responsibility (CSR) (Section 135)

CSR is a mandatory provision under the Companies Act, 2013, ensuring that businesses contribute to societal development.

  • Applicability:

Companies with a net worth of ₹500 crores, a turnover of ₹1000 crores, or a net profit of ₹5 crores must spend 2% of their average net profits on CSR activities.

  • CSR Committee:

Companies must form a CSR Committee to oversee and implement projects in education, healthcare, and environmental sustainability.

This provision encourages ethical corporate practices and social welfare initiatives.

Investor Protection and Shareholder Rights (Sections 91 to 127)

To ensure fairness in corporate dealings, the Act provides multiple safeguards for shareholders.

  • Annual General Meeting (AGM) (Section 96):

Every company, except one-person companies, must hold an AGM annually.

  • Voting Rights (Section 47):

Shareholders have proportional voting rights based on their equity holdings.

  • Declaration of Dividends (Section 123):

Dividends must be declared from company profits and transferred to shareholders.

  • Unpaid Dividend (Section 124):

Unclaimed dividends must be transferred to the Investor Education and Protection Fund (IEPF).

These provisions ensure transparency and safeguard shareholders’ interests.

Winding Up and Liquidation of Companies (Sections 270 to 365)

The Act defines the legal process for closing a company.

  • Voluntary Winding Up (Section 304):

Companies can dissolve voluntarily if shareholders approve.

  • Compulsory Winding Up (Section 271):

Ordered by the tribunal due to insolvency, fraud, or non-compliance with regulations.

  • Insolvency and Bankruptcy Code (IBC):

The IBC governs financial distress resolution for companies.

These provisions ensure a structured and fair exit strategy for failing businesses.

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