Tag: Financial Statements

Management Notes

Debentures in Subsidiary Companies

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Debenture is a long-term financial instrument that represents a loan made by an investor to a borrower, typically a corporate entity. It is issued under a formal agreement, which stipulates the terms of the loan, including the interest rate, repayment schedule, and the rights and obligations of both the issuer and the debenture holder.

Debentures are usually Secured or Unsecured:

  • Secured Debentures:

These are backed by specific assets of the company, providing assurance to debenture holders that they can claim these assets in the event of default.

  • Unsecured Debentures:

These are not backed by any specific assets, making them riskier for investors.

Importance of Debentures in Subsidiary Companies:

Subsidiary companies are entities that are controlled by a parent company, typically holding a majority of shares.

  1. Capital Raising

Subsidiary companies often require funds for various purposes, such as expansion, acquisition of assets, or working capital. Issuing debentures provides a means of raising capital without diluting the ownership of the parent company. This is particularly advantageous for subsidiaries that may not have easy access to equity markets.

  1. Fixed Cost of Financing

Debentures typically carry a fixed interest rate, which allows subsidiary companies to predict their financing costs accurately. This predictability aids in financial planning and budgeting, enabling the subsidiary to manage its cash flows effectively.

  1. Flexibility in Financing

Debentures offer flexibility regarding maturity periods and repayment schedules. Subsidiary companies can structure their debenture issues to align with their cash flow needs, allowing for better financial management.

  1. Tax Benefits

Interest payments on debentures are tax-deductible, which can enhance the financial efficiency of subsidiary companies. This tax advantage makes debt financing more attractive compared to equity financing.

  1. Attraction of Diverse Investors

Issuing debentures can attract a wide range of investors, including institutional investors who prefer fixed-income securities. This diversification of the investor base can enhance the subsidiary’s financial stability and reputation in the market.

Regulatory Framework Governing Debentures in Subsidiary Companies:

In India, the issuance and management of debentures by subsidiary companies are regulated under the Companies Act, 2013, as well as the Securities and Exchange Board of India (SEBI) regulations. Key provisions are:

  1. Issuance of Debentures

Section 71 of the Companies Act governs the issue of debentures, stipulating that a company may issue debentures subject to the conditions specified in the act. Companies must pass a resolution to approve the issue of debentures, which may require obtaining consent from the shareholders in certain cases.

  1. Debenture Trust Deed

Debenture trust deed is a legal document that outlines the terms and conditions of the debenture issue, including the rights of debenture holders and the obligations of the issuing company. It must be executed in favor of a trustee representing the debenture holders to safeguard their interests.

  1. Redemption of Debentures

Companies are required to outline a clear redemption plan for debentures in their issuance documents, specifying the maturity period and repayment terms. Provisions for the creation of a debenture redemption reserve may also apply, which is a fund set aside for the repayment of debentures upon maturity.

  1. Interest Payments

Subsidiary companies must ensure timely payment of interest to debenture holders as stipulated in the debenture agreement. Failure to do so can lead to legal consequences and impact the company’s creditworthiness.

  1. Filing Requirements

Subsidiary companies must comply with filing requirements under the Companies Act, including submitting necessary forms to the Registrar of Companies (ROC) concerning the issuance of debentures.

  1. Regulations by SEBI

If the debentures are listed on stock exchanges, the subsidiary company must also comply with SEBI regulations, which impose additional disclosure and reporting requirements to protect investors’ interests.

Types of Debentures Suitable for Subsidiary Companies:

  1. Convertible Debentures

These debentures give holders the right to convert their debentures into equity shares of the company after a specified period. This option can be attractive to investors, as it allows them to participate in the company’s equity upside.

  1. Non-Convertible Debentures

These debentures cannot be converted into equity shares and typically offer higher interest rates compared to convertible debentures, compensating investors for the lack of conversion rights.

  1. Redeemable Debentures

These debentures are issued with a specified maturity date, at which point the company must repay the principal amount to the debenture holders. This type allows for better cash flow management.

  1. Irredeemable Debentures

Irredeemable debentures do not have a fixed redemption date and may remain outstanding indefinitely. They can provide a steady income stream for the issuing subsidiary but may be less attractive to investors due to their uncertain repayment timeline.

Management Notes

Forensic Accounting, Features, Example

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Forensic Accounting is a specialized field of accounting that involves investigating financial records to detect fraud, embezzlement, or other financial misconduct. Forensic accountants analyze, interpret, and summarize complex financial data to provide evidence in legal cases, such as fraud investigations, litigation support, or disputes. They often work with law enforcement agencies, attorneys, and organizations to uncover financial irregularities, assess damages, or trace illicit activities. Forensic accounting combines accounting knowledge with investigative techniques and legal understanding, playing a crucial role in identifying and preventing financial crimes, as well as supporting legal proceedings.

Features of Forensic Accounting:

  1. Investigative Skills

Forensic accountants are skilled investigators who examine financial records to uncover fraud, embezzlement, or misconduct. They go beyond standard accounting practices, using investigative techniques to identify anomalies and trace suspicious transactions.

  1. Litigation Support

One of the primary features of forensic accounting is its role in legal cases. Forensic accountants provide expert witness testimony, prepare detailed reports, and offer evidence in court to support legal proceedings. Their analysis helps attorneys and law enforcement understand complex financial issues and resolve disputes.

  1. Fraud Detection

Forensic accounting is heavily focused on detecting fraud within financial statements, organizations, or individuals. Forensic accountants identify patterns of misappropriation, fraudulent reporting, or manipulation of financial data by thoroughly examining transactions, records, and systems.

  1. Use of Data Analysis Tools

Forensic accountants often utilize advanced data analysis tools and techniques to process large volumes of financial data. These tools help identify unusual patterns, correlations, or inconsistencies that may indicate fraudulent activity or accounting errors.

  1. Detailed Financial Analysis

Forensic accounting involves deep analysis of financial statements, transactions, and documents to assess the accuracy and reliability of the information. This in-depth analysis is used to detect hidden assets, trace financial flows, and identify discrepancies.

  1. Expert Testimony

In cases of fraud or financial disputes, forensic accountants often serve as expert witnesses in court. Their testimony is critical in explaining complex financial data in a clear and concise manner to judges, juries, or arbitrators.

  1. Prevention and Risk Management

In addition to investigating financial misconduct, forensic accountants assist organizations in developing risk management strategies. They help implement internal controls, perform audits, and provide recommendations to prevent future fraud or financial crimes.

Example of Forensic Accounting:

Here is an example of forensic accounting presented in a table format:

Case Component Description
Scenario A company suspects an employee of embezzling funds over several years through fraudulent invoices.
Trigger for Investigation Unusual discrepancies in financial statements, such as increased expenses without corresponding output.
Forensic Accountant’s Role Investigate financial records, track suspicious transactions, and analyze bank statements.
Key Focus Areas Examining invoices, payment records, and vendor accounts to identify irregularities.
Data Analysis Tools Used Specialized software to track invoice history, cross-checking vendor details with internal records.
Findings Discovery of fabricated invoices and payments routed to the employee’s personal account.
Legal Action The forensic accountant provides an expert report and testimony to support legal proceedings.
Outcome The employee is found guilty of embezzling funds, and the company recovers some losses through restitution.
Risk Management Recommendations Implement stronger internal controls, segregation of duties, and regular audits to prevent future fraud.

Management Notes

Social Responsibility Accounting, Need, Issues, Journal entry

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Social Responsibility Accounting is an approach that integrates social and environmental concerns into the traditional financial accounting framework. It goes beyond merely reporting on financial performance to include the impact of a company’s activities on society and the environment. This type of accounting tracks and reports on areas such as environmental sustainability, employee welfare, community engagement, and ethical practices. The goal is to provide stakeholders with a comprehensive view of the company’s overall impact, thereby promoting transparency, accountability, and sustainable business practices. Social Responsibility Accounting helps businesses align their operations with broader social and ethical standards.

Need of Social Responsibility Accounting:

  • Transparency and Accountability

SRA promotes transparency by providing detailed information on a company’s social and environmental impact. It holds businesses accountable for their actions, ensuring that stakeholders are aware of how the company contributes to or detracts from societal and environmental well-being.

  • Meeting Stakeholder Expectations

In today’s socially conscious environment, stakeholders, including customers, investors, and employees, expect businesses to act responsibly. SRA helps companies demonstrate their commitment to social and environmental issues, meeting these expectations and building trust.

  • Enhanced Corporate Reputation

Companies that actively engage in SRA can enhance their reputation. By publicly disclosing their social and environmental efforts, businesses can differentiate themselves from competitors, attract socially conscious consumers, and foster a positive brand image.

  • Risk Management

SRA helps businesses identify and manage risks associated with social and environmental issues. By tracking their impact, companies can mitigate potential legal, financial, and reputational risks, ensuring long-term sustainability.

  • Improving Decision-Making

SRA provides valuable data that can inform strategic decision-making. Understanding the social and environmental impacts of various business activities allows companies to make more informed decisions that align with their long-term goals and values.

  • Compliance with Regulations

Increasingly, governments and regulatory bodies are mandating social and environmental reporting. SRA ensures that companies comply with these regulations, avoiding penalties and aligning with legal requirements.

  • Attracting Investment

Investors are increasingly considering environmental, social, and governance (ESG) factors when making investment decisions. SRA provides the necessary data to attract and retain investment from socially responsible investors, who prioritize sustainable and ethical business practices.

  • Promoting Long-Term Sustainability

SRA encourages businesses to focus on long-term sustainability rather than short-term profits. By accounting for social and environmental impacts, companies are more likely to adopt practices that ensure their operations are sustainable over the long term, benefiting both the company and society at large.

Issues of Social Responsibility Accounting:

  1. Lack of Standardization

One of the major challenges in SRA is the absence of universally accepted standards and frameworks. Different organizations may use various methods and metrics to report their social and environmental impacts, leading to inconsistencies and making it difficult to compare the performance of different companies.

  1. Subjectivity in Measurement

Measuring social and environmental impacts often involves subjective judgments. Unlike financial metrics, which are quantifiable, social responsibility metrics can be harder to define and measure accurately. This subjectivity can result in biased or incomplete reporting, reducing the reliability of the information provided.

  1. High Costs of Implementation

Implementing SRA can be costly, particularly for small and medium-sized enterprises (SMEs). The process requires significant resources, including time, money, and expertise, to gather and report data. These costs may deter some businesses from fully adopting SRA practices.

  1. Complexity and Data Collection Challenges

Collecting and analyzing data on social and environmental impacts can be complex. Businesses often struggle to gather relevant data, especially if they operate in multiple regions or industries with varying regulations and standards. This complexity can hinder the accuracy and completeness of SRA reports.

  1. Potential for Greenwashing

There is a risk that companies may engage in “greenwashing,” where they present an overly positive image of their social and environmental efforts without making significant changes to their practices. SRA can be misused to create a misleading impression of a company’s commitment to social responsibility.

  1. Difficulty in Quantifying Impact

Quantifying the impact of social responsibility initiatives can be challenging. For example, the effects of a company’s community engagement or environmental conservation efforts may not be immediately apparent or easily measurable, making it difficult to accurately assess the true impact of these activities.

  1. Balancing Multiple Stakeholder Interests

Companies face the challenge of balancing the sometimes conflicting interests of various stakeholders, such as shareholders, employees, customers, and communities. Prioritizing one group’s interests over another’s can lead to criticism and undermine the perceived effectiveness of SRA.

  1. Regulatory and Compliance issues

With varying regulations across different regions and industries, companies may struggle to meet all compliance requirements related to SRA. The evolving nature of these regulations adds to the complexity, making it difficult for businesses to keep up with and adhere to all necessary standards.

Journal entry of Social Responsibility Accounting:

Date Particulars

Debit (₹)

Credit (₹)

 Explanation
DD/MM/20XX Social Responsibility Expense A/c Dr 1,00,000 Recording expenses related to social responsibility activities, such as community service.
To Cash/Bank A/c 1,00,000 Payment made for social responsibility activities.
DD/MM/20XX Provision for Social Responsibility A/c Dr 50,000 Setting aside a provision for future social responsibility costs.
To Provision for Liability A/c 50,000 Credit to recognize the liability for future social responsibility activities.
DD/MM/20XX Social Responsibility Asset A/c Dr 2,00,000 Recording investments in social assets, such as donations or community infrastructure.
To Cash/Bank A/c 2,00,000 Payment made for acquiring social responsibility assets.
DD/MM/20XX Depreciation on Social Responsibility Asset A/c Dr 20,000 Depreciation on assets related to social responsibility, such as community infrastructure.
To Accumulated Depreciation A/c 20,000 Credit to recognize accumulated depreciation on social responsibility assets.
DD/MM/20XX Social Responsibility Income A/c Dr 30,000 Recording income from grants or contributions received for social responsibility initiatives.
To Government Grants A/c 30,000 Recognizing government grants received for social responsibility activities.

Explanation:

  • Social Responsibility Expense A/c:

Captures costs associated with social responsibility efforts, such as charitable donations or community programs.

  • Provision for Social Responsibility A/c:

Sets aside funds for anticipated future social responsibility expenditures.

  • Social Responsibility Asset A/c:

Records investments in assets dedicated to social responsibility, such as community facilities.

  • Depreciation on Social Responsibility Asset A/c:

Reflects depreciation on social responsibility-related assets over time.

  • Social Responsibility Income A/c:

Records income or grants received for supporting social responsibility initiatives.

Management Notes

Preparation of Reconstruction accounts

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(a) Increase in share capital: A company can increase its share capital by issue of new shares by an ordinary resolution in the general meeting if the increase is within the authorised capital. But for increase beyond the authorised capital, the company is required to alter the capital clause of its Memorandum of Association by special resolution and to give its notice to the Registrar within 30 days of resolution.

No accounting entry is required to be passed in the books of the company for the increase in its authorized share capital. But when new shares are offered for subscription, accounting entries will be very much the same as has been explained in an earlier chapter.

(b) Decrease in share capital by cancelling the unissued shares: A company can cancel the shares which have not been subscribed or agreed to be subscribed by any person and this diminishes the amount of share capital. But no company can cancel the unpaid amount on shares already issued or agreed to be subscribed without the sanction of the Court as the same leads to reduction of capital. As the cancellation of unissued shares does not affect the issued share capital of a company, no accounting entry is required. Only the details of authorized share capital are to be changed in the Balance Sheet

(c) Consolidation of share capital: A company may consolidate any of its shares of smaller denomination (value) into shares of higher denomination. To make this change effective, share capital account with old denomination is closed and share capital account with new denomination is created. The accounting entry is:

Share Capital (Old denomination) Account                                Dr.

To Share Capital (New denomination) Account

(d) Sub-division of share capital: This implies converting shares of higher denomination into shares of smaller denomination. The entry is:

Share Capital (Old denomination) Account                                 Dr.

To Share Capital (New denomination) Account

(e) Conversion of shares into stock and reconversion of stock into shares: A company, if so authorised by its Articles, may convert any of its, fully paid shares into stock. The stock can be reconverted into fully paid up shares of any denomination. When shares are converted into stock, the share capital account will be closed by transfer to stock account by means of the following journal entry:

(Say) Equity Share Capital Account                                           Dr.

To Equity Stock Account

Conversely if stocks are reconverted into shares, stock account will be closed by transfer to share capital account.

(f) Reserve Capital: Section 99 of Companies Act provides that a company may by special resolution decide that any portion of uncalled amount on shares issued will be called up only on its liquidation. Such portion of share capital is known as reserve capital. No accounting entry is required to give effect to it.

(2) Reduction of Share Capital: Usually internal reconstruction involves reduction of share capital. Section 100 to 105 of Companies Act deal with it. Accordingly, it can be carried out by a company only It is authorised by its Articles, and a special resolution is passed to that effect. It also requires confirmation of the Court.

Capital reduction can take any of the following three forms:

  • Extinguishing or reducing the liability on shares held by shareholders in respect of uncalled or unpaid amount : This does not affect the paid-up value of shares; only partly paid shares become fully paid by reducing the face value of the shares to the level of their paid-up value. No journal entry is necessary to record this event. However, some accountants prefer to pass the following entry to record this fact:

Share Capital (partly paid-up) Account                      Dr

To Share Capital (fully paid-up) Account

  • Paying off the surplus paid-up capital: The share capital may be reduced by paying off the paid-up capital which is in excess of the needs of the company. This can be done with or without reducing the liability on the shares. Thus, surplus capital can be paid off in the following two ways: (a) Paying off surplus paid-up capital without reducing the face value of shares: In such a case, the following entries are passed:

(i) Share Capital Account                               Dr.                 with the amount to be paid off

To Sundry Shareholders Account

(ii) Sundry Shareholders Account                  Dr.                  with the amount paid off

To Bank Account In this case, the company shall have the right to call up in future the amount paid off on the shares.

(b) Paying off surplus paid-up capital by reducing the face value of shares: For example, for a fully paid share of Rs. 10, paying off Rs. 5 and reducing the face value of share from Rs. 10 to Rs. 5. The following entries are passed in such a case. () Share Capital (Old Face Value) Account Dr. (with total amount of old capital) To Share Capital (New Face Value) Account (with the amount to be kept as new capital)

To Sundry Shareholders Account                   Dr             (with amount to be paid oft)

(ii) Sundry Shareholders Account                  Dr. with the amount paid off To Bank Account

In this case, the company shall not have any right to call up in future the amount paid off on these shares.

(c) Cancelling the paid-up capital: Where existing capital of the company is not represented by available assets, cancellation of paid-up capital to that extent is the most common method adopted by a company in such a case. The purpose is to improve the profitability of the existing company in tune with the real values of assets as against the given book values which do not represent the actual financial position of the enterprise. Under it, a meeting of different classes of shareholders is called-up and where borrowed capital is also lost, the debenture holders and creditors are also invited in the meeting and they are made to agree to sacrifice their claims to certain extent and their sacrifices are utilized to write off the accumulated losses and fictitious assets and to adjust the over-valuation of assets. For this purpose, a new according called Capital Reduction Account (or Reconstruction Account or Reorganisation Account) is opened to which sacrifices of different parties are credited and through which accumulated losses and fictitious assets are written off and over-valuations of assets adjusted. The preparation of Reconstruction Account is preferred when debenture holders and creditors too have to accept some reduction in their claims in addition to the shareholders and/or where there is appreciation in the value of any asset. The scheme of entries is as follows:

  • On reduction of paid-up capital:

Share Capital Account                                  Dr. with the amount of reduction

To Capital Reduction Account                      or To Reconstruction Account

If the denomination or description of capital is changed (e.g. the face value of shares is changed or rate of dividend is changed in case of preference shares), the old Capital Account is closed and new capital account is created with the new amount and the difference is transferred to Capital Reduction Account

Notes: (i) If any reserve appears in the books of the company, the same should be transferred to Capital Reduction Account so that no such reserve could be utilized for payment of dividend in future.

(ii) The Capital Redemption Reserve Account and Securities Premium Account can also be reduced in the same manner as the share capital account.

(iii) After granting the scheme of capital reduction, the Court may order the use of words “and reduced” after the name of the company for such period as it deems fit.

  • If debenture holders and creditors too make some sacrifice:

Debentures Account                  with the amount of sacrifice Sundry Creditors Account

To Capital Reduction Account

  1. If there is appreciation in the value of an asset:

Respective Asset Account                                Dr. with the amount of appreciation

To Capital Reduction Account

  1. On utilizing Capital Reduction Account for writing off accumulated losses, fictitious assets, and over-valuations of assets:

Capital Reduction Account                                  Dr

To Profit & Loss Account

To Goodwill Account

To Patent Account

To Trade Marks Account

To Preliminary Expenses Account

To Discount on Shares and Debentures Account

To Unrecorded Liability Account (if any) To Asset Account

To Capital Reserve Account (with the balance left, if any)

Management Notes

Debentures Legal Provisions

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Companies generally raise funds by issuing as share capital or through borrowing from lenders. A debenture is one of ways of company borrowing where the company agrees to repay the debt where may also be a charge over the company’s assets to ensure the repayment of this debt. Debenture is an alternative form of investment in a company that is more secured than investment in shares because company must pay interest and it will be paid before the dividend payment. Debenture holders also get privilege, if the company which issued the debentures becomes bankrupt. A disadvantage is that debenture holders have no share in the company and therefore have no control over it.

Following provisions of the Companies Act, 2013 governs the floatation, issue and allotment with regards to the debentures:

  • Section 2(30): Definition;
  • Section 44: Nature of debentures;
  • Section 71: Provisions relating to issue and allotment of debentures;
  • Rule 18 of the Companies (Share Capital and Debenture) Rules, 2014: Rules pertaining to issue and allotment of debentures.

Governing Sections:

Section 2(30): Definition of Deposit: “debenture” includes debenture stock, bonds or any other instrument of a company evidencing a debt, whether constituting a charge on the assets of the company or not.

Section 44: Nature of Share and Debenture.

Section 71: Provision relating to Debentures.

Section 117(3) (a)A copy of every resolution or any agreement, in respect of the matters specified in sub-section [1](3) of section 17 together with the explanatory statement under section 102, if any, annexed to the notice calling the general meeting in which the resolution is proposed, shall be filed with the Registrar within thirty days of the passing of resolution.

Section 179 (3) (c,d): (c) to issue securities, including debentures, whether in or outside India;

*(d) to borrow monies;

Section 180(1) (c): The Board of Directors of a company shall exercise the powers “borrow money”, where the money to be borrowed, together with the money already borrowed by the company will exceed aggregate of its paid-up share capital and free reserves, only with the consent of the company by a special resolution, namely.

Section 56(4) (d): Within a period of six months from the date of allotment in the case of any allotment of debenture.

Section 42: Offer or invitation for subscription of securities on Private Placement.

Governing Rules:

  • Rule 18 of the Companies (Share Capital and Debentures) Rules, 2014:
  • Rule 24 The Companies (Management and Administration) Rules, 2014: Resolutions and agreements to be filed.
  • Rule 1(c) of The Companies (Acceptance of Deposits) Rules, 2014: “Deposit” does not include

“Any amount raised by the issue of debentures secured by a first charge or a charge ranking paripassu with the first charge on any assets referred 73 Proviso to in Schedule III of the Act excluding intangible assets of the company or debentures compulsorily convertible into shares of the company within five years.”

Rule 14 of the Companies (Prospectus and Allotment of Securities) Rules, 2014: Process of Issue and allotment of Securities (Debentures).

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

Need for Reconciliation

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Reconciliation of Cost and Financial Accounts is process to find all the reasons behind disagreement in profit which is calculated as per cost accounts and as per financial accounts. There are lots of items which are shown in the profit and loss account only when we make it as per financial accounting rules. There are lots of items which are shown in costing profit and loss account only when we calculate profit as per cost accounting.

Suppose, we have taken the profit or loss as per financial accounts, we adjust it as per cost accounts. In the end of adjustments, we see same profit as per cost accounts. If we have taken profit as per cost account, we have to adjust items as per financial accounts. For this purpose, we make reconciliation Statement.

(a) Items included only in financial accounts

There are number of items which appear only in financial accounts, and not in cost accounts, since they neither do nor relate to the manufacturing activities, such as, Purely financial charges, reducing financial profit

  • Losses on capital assets
  • Stamp duty and expenses on issue and transfer of stock, shares and bonds
  • Loss on investments.
  • Discount on debentures, bonds, etc.
  • Fines and penalties,
  • Interest on bank loans.
  • Purely financial income, increasing financial profit
  • Rent received
  • Profit on sale of assets
  • Share transfer fee
  • Share premium
  • Interest on investment, bank deposits.
  • Dividends received.
  • Appropriation of profit donations and charities.

(b) Items included only in the cost accounts

There are very few items which appear in cost accounts, but not in financial accounts. Because, all expenditure incurred, whether for cash or credit, passes though the financial accounts, and only relevant expenses are incorporated in cost accounts. Hence, only item which can appear in cost accounts but not in financial accounts is a notional charge, such as:

(i) Interest on capital, which is not paid but included in cost accounts to show the notional cost of employing capital

(ii) Rent i.e. charging a notional rent of premises owned by the proprietor.

In those concerns where there are no separate cost and financial accounts, the problem of reconciliation does not arise. But where cost and financial accounts are maintained independent of each other, it is imperative that periodically two accounts are reconciled. Though both sets of books are concerned with the same basic transactions but the figure of profit disclosed by the former does not agree with that disclosed by the latter.

Thus, reconciliation between the results of the two sets of books is necessary due to the following reasons:

  1. To find out the reasons for the difference in the profit or loss in cost and financial accounts and to indicate the position clearly and to be sure that no mistakes pertaining to accounts have been committed.
  2. To ensure the mathematical accuracy and reliability of cost accounts in order to have cost ascertainment, cost control and to have a check on the financial accounts.
  3. To contribute to the standardisation of policies regarding stock valuation, depreciation and overheads.
  4. To facilitate coordination and promote better cooperation between the activities of financial and cost sections of the accounting department.
  5. To place management in better position to acquaint itself with the reasons for the variation in profits paving the way to more effective internal control.

Methods of Reconciliation:

Reconciliation of costing and financial profits can be attempted either:

(a) By preparing a Reconciliation Statement or

(b) By preparation a Memorandum Reconciliation Account.

Management Notes

Distinction between Shares and Debentures

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Stocks/Shares

Stocks or shares are popular investment tools, issued by corporate entities through which they sell a portion of their proprietorship to general investors and raise funds through it. These are also known as scrips or owned capital.  As an owner of stocks, you are holding a part of the company’s financial capital. It entitles you to receive a portion of the company’s profit in return.

Types of stocks are

  • Equity shares
  • Preference shares

The price that you pay to buy shares is called share price. In return, you qualify to receive dividends as decided by the company. Profit is announced during the end of a financial year, which means, the longer you stay invested, higher will be your gain from the share.

Share prices depend on various factors, including market performance, macroeconomic parameters, sectoral performance, and individual company performance. As investment instruments, share are highly liquid and traded in the exchanges.

Debentures

Debentures are debt tools; issued by companies to raise funds as loans from the public. It is an acknowledgement from a corporate entity that it has taken a loan from you. However, a debenture isn’t a secured loan. It is backed solely by the creditworthiness of the issuing firm. But it carries some amount of assurance. It is why, in India, if a company declares bankruptcy, debenture holders have the first claim over the company’s assets.

Categories of debentures

Debentures also have different types, based on their intrinsic characters.

  • Perpetual Debentures: Perpetual debentures don’t have a maturity value and treated much like equities. These bonds create a lifelong stream of income for the investors, and they can trade those the market like equities.
  • Convertible Debentures: Some corporate give the offer to receive maturity value on debenture or get it converted to equity. This allows investors to alleviate some of the uncertainties associated with investing in unsecured bonds.
  • Non-convertible Debentures: It is a traditional type of bond that pays out the maturity and accrued interest at the end of the tenure without giving any opportunities to convert to equity.

Debentures can be either floating or fixed in nature. The payout on floating rate debenture varies with the market movement. But, for fixed-rate debentures, final payout remains assured.

Shares

Debentures
Meaning The shares are the owned funds of the company. The debentures are the borrowed funds of the company.
What is it? Shares represent the capital of the company. Debentures represent the debt of the company.
Holder The holder of shares is known as shareholder. The holder of debentures is known as debenture holder.
Status of Holders Owners Creditors
Form of Return Shareholders get the dividend. Debenture holders get the interest.
Payment of return Dividend can be paid to shareholders only out of profits. Interest can be paid to debenture holders even if there is no profit.
Allowable deduction Dividend is an appropriation of profit and so it is not allowed as deduction. Interest is a business expense and so it is allowed as deduction from profit.
Security for payment No Yes
Voting Rights The holders of shares have voting rights. The holders of debentures do not have any voting rights.
Conversion Shares can never be converted into debentures. Debentures can be converted into shares.
Repayment in the event of winding up Shares are repaid after the payment of all the liabilities. Debentures get priority over shares, and so they are repaid before shares.
Quantum Dividend on shares is an appropriation of profit. Interest on debentures is a charge against profit.
Trust Deed No trust deed is executed in case of shares. When the debentures are issued to the public, trust deed must be executed.

Management Notes

Issue of Debentures as a Collateral Security

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The term ‘collateral security’ implies additional security given for a loan. Where a company obtains a loan from a bank or insurance company and the security offered to the company is not sufficient, the company may issue its own debentures to the lender as collateral security against the loan. In such a case, the lender has the absolute right over the debentures until and unless the loan is repaid.

Debentures can also be issued by a company as collateral security against a bank loan or any such borrowings. A collateral security is like a parallel security which is provided along with the actual security against the loan taken. Debentures issued as such a collateral liability are a contingent liability for the company, i.e. the liability may or may not arise. Only when the company defaults on such a loan will this liability arise.

On repayment of the loan, however, the lender is legally bound to release the debentures forthwith. But in case the loan is not repaid by the company on the due date or in the event of any other breach of agreement, the lender has the right to retain these debentures and to realize them. The lender is entitled to interest only on the amount of loan, but not on the debentures issued as collateral security.

Generally, because it is a contingent liability no entry is passed in the books of the company against such an issue of debentures. However, if some companies opt to pass an entry to record such a transaction, the following entries may be passed

Particulars Amount Amount
Debentures Suspense A/c Dr xxx
To Debentures  A/c xxx
(Being debentures issued as a collateral security)

Particulars Amount Amount
Debentures  A/c Dr xxx
To Debenture Suspense A/c xxx
(Being debentures cancelled on repayment of the loan)

 

Accounting Treatment:

When debentures are issued as a collateral security there are two treatments in the accounting books.

First Method:

(i) No journal entry is made in the account books at the time of issue of such debentures. A note is appended below the loan on the liabilities side of the balance sheet to the fact that they have been secured by the issue of debentures.

This will be shown in the balance sheet as follows:

 

Balance Sheet
Equity and Liabilities Note No. Current Year Previous Year
Non-Current Liabilities      
Long Term Borrowings      
Debentures      
Loan      

Second Method:

(ii) Sometimes issue of debentures as collateral security is recorded by making journal entry as follows:

Debentures Suspense a/c Dr.

To Debentures a/c

(With nominal value of debentures)

The Debentures Suspense Account will appear on the assets side of the balance sheet and Debentures on the liabilities side. When the loan is re-paid the entry is reversed in order to cancel it.

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