Corporate Accounting Notes

Company: A company, abbreviated as co., is a legal entity representing an association of people,

whether natural, legal or a mixture of both, with a specific objective. Company members share a common
purpose and unite to achieve specific, declared goals

Accounting: The American Institute of Certified Public Accountants (AICPA) defines accounting as: "the art
of recording, classifying, and summarizing in a significant manner and in terms of money,
transactions and events which are, in part at least of financial character, and interpreting the results
thereof."

Corporate Accounting: Corporate accounting deals with processes such as the preparation
of cash flow statements, financial records, balance sheets and more. It can be used to handle
unique corporate business processes such as absorption, amalgamation and the creation of
consolidated documents.
Share: A share is the interest of a member in a company. Section 2(84) of the Companies Act, 2013
(hereinafter referred to as Act) “share” means a share in the share capital of a company and includes stock.
It represents the interest of a shareholder in the company, measured for the purposes of liability and
dividend.

Equity Shares:
Equity shares are long-term financing sources for any company. These shares are issued to the
general public and are non-redeemable in nature. Investors in such shares hold the right to vote, share
profits and claim assets of a company

Types of Equity Shares:. There are following types of Equity shares:

 Bonus shares

As the name might suggest, bonus shares are those stocks that companies issue to the existing

shareholders sans any additional charge. Through the issuance of bonus shares, companies

can convert their retained earnings into stocks. Usually, companies provide these bonus shares

to shareholders instead of paying out dividends.

Furthermore, organisations issue bonus shares on a pro-rata basis. So, if Mr. Amit holds 200

shares of Hindustan Unilever Ltd and the company announces its decision to issue 1:4 as a

bonus, then he will receive 50 additional shares for free.

 Right shares

Right shares refer to the offerings that a company makes to its existing shareholders to

purchase new shares at a specific price within a particular period. In other words, the right

shares are those new stocks on which existing stakeholders can lay claim before such issuing

company opens them up to public trading.

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Similar to bonus shares, companies issue the right shares on a pro-rata basis as well.

Therefore, if a company is offering 2000 new shares, and a shareholder possesses 2% of its

existing lot, then he/she is entitled to 40 of those new offerings.

 Sweat equity shares

Organisations often compensate employees or directors on a job well done by issuing sweat

equity shares. Sweat equity literally refers to an individual’s contribution – typically not

monetary – to an organisation.

Thus, sweat equity shares denote stocks that companies issue to reward such contributions.

Several companies use this compensation method to enhance employee retention by endowing

them with a stake in that organisation’s assets and ownership.

 Voting and non-voting shares

Typically, most types of equity shares carry voting rights because of the stake in ownership it

entails. However, in some cases, companies can issue shares with the condition that it will

confer differential or no voting right at all to such shareholders.

For instance, in 2008, Tata Motors issued ‘A’ shares with the condition that 10 such shares will

equate to one vote. That’s the differential voting right. However, it perked up share in profit by

5% for such stocks compared to its ordinary counterpart.

Types of Share capital:

Authorised/Nominal/Registered Capital:
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At the time of registration of a company, the Memorandum of Association
mentions the amount of capital a company is authorised to raise from the
public by selling shares which is known as Authorised Capital or Normal
Capital or Registered Capital.

It is the maximum amount of share capital that a company can issue. In the
case of a limited company, the Memorandum shall contain the amount of
Capital by which a company is proposed to be registered and the division
thereof into shares of fixed amount. In short, it is the maximum amount of
capital which a company will have during its lifetime—unless it is increased.

Issued Capital:
Generally, a part of the authorised capital is issued to the public for
subscription which is known as issued capital, i.e., it is the nominal value of the
shares which are offered to the public for subscription. Usually, a company
does not issue all its capital at a time, i.e., issued capital is less than the
authorised capital. If all shares are issued, issued capital and authorised capital
will be the same.

Subscribed Capital: A part of the issued capital which is subscribed by the

public is known as subscribed capital. It does not necessarily mean that all the
shares which have been issued will be taken over by the public.

In other words, the share capital of the number of shares which are taken over
by the public is called subscribed capital, i.e., the portion of issued share
capital which is paid/subscribed by the shareholder is known as subscribed
capital.

Called-Up Capital:
Generally, the shareholders pay the price of the shares by installments, viz.,
application, allotment, First call, Final call etc. Therefore, the portion of the
face value of the shares which the shareholders are called upon to pay or the
company has demanded to pay is called Called-up capital.
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Uncalled Capital:
The unpaid portion of the subscribed capital is called Uncalled Capital. In
other words, it is the remainder of the issued Capital which has not been
called. However, the company may call this amount at any time but that must
be subject to the terms of issue of shares.

Paid Up Capital:
The amount actually paid by the shareholders is known as Paid-up Capital

Reserve Capital:
According to Sec. 99 of the Companies Act, 1956, Reserve Capital is that part of
uncalled capital of a company which can be called only in the event of its
winding-up. A limited company may, by special resolution, determine that any
portion of its share capital which has not been called-up, shall be called up,
except in the event of the company being wound-up, such capital is known as
Reserve Capital.

It is available only for the creditors on the winding-up of the company.

Preference Shares :
As per explanation given in the Section 42 of the Companies Act, 2013, the
term preference shares includes the part of share capital to which the holders
have a preferential right during payment of dividend and repayment of share
capital in the event of company liquidation.
Types of Preference: 1. Cumulative preference shares
These shares come with a provision that entitles shareholders to receive dividends in arrears.

So, when a company does not make enough profits in a year to pay dividends, they pay

cumulative dividends in the following year.

2. Non-cumulative preference shares

These shares do not accumulate dividends. It is mostly because non-cumulative preference

shareholders are paid from the current year’s net profits. So, if a company is met with loss in a
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particular year, the outstanding dividends cannot be claimed by shareholders from future

profits.

3. Redeemable preference shares

These preference shares are also known as callable preferred stock and serve as one of the

most effective ways to finance big companies. These shares come with a blend of equity and

debt financing and are readily traded on stock exchanges.

Typically, a company has the right to repurchase the shares it had issued to satiate its own

purpose. Consequently, the redeemable preference shares are repurchased at a fixed rate on a

fixed date or by announcing the same in advance. Notably, redeemable preference shares

come in handy for cushioning the impact of inflation and the decline of monetary rate.

4. Irredeemable preference shares

This particular share cannot be redeemed or repaid during the active lifetime of a company. To

elaborate, shareholders will have to wait until the company decides to wind up its current

operations or liquidate the venture altogether to initiate the same. It makes the shares a

perpetual liability for the company.

5. Participating preference shares

The said shares extend the right to partake in surplus profit during liquidation once the company

in question has paid its other shareholders. So, to elaborate, the participating preference

shareholders receive a fixed rate of dividend and also have a share in the company’s extra

earnings. Most individuals invest in participating preference shares of those companies which

are more likely to generate robust profits.

An agreement pertaining to this preference share may include these following features –

 When the company generates profit, a certain share of profits along with the pre -fixed dividend will be

paid to the participating preference shareholders.

 In the event of the company winding up, shareholders will be entitled to receive a certain share of the

net sale generated.

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 Participating preference shareholders may have voting rights or authority over certain decisions

pertaining to the sale of the business venture or crucial assets.

 The shares may be cumulative, which means shareholders will receive the unpaid dividends before it

is paid to the equity stockholders.

6. Non-participating preference shares

As the name suggests, non-participating preference shareholders do not have a share in the

extra earnings or surplus assets during the liquidation of a company. This type of share entitles

its shareholders to receive only the pre-fixed dividends.

7. Convertible preference shares

Convertible shares are fundamentally those shares which enable holders to get them converted
into equity shares at a fixed rate. Notably, these shares can only be converted after the expiry

of a specified time and within a given period, as stated in the memorandum.

Ideally, these shares are considered to be beneficial for those investors who intend to receive

preferred share dividends. It also proves rewarding for those who wish to partake in the change

in the price of equity shares. Thus, such shares help investors generate fixed earnings along

with the opportunity to accrue higher returns frequently.

8. Non-convertible preference shares

Non-convertible shareholders cannot convert their shares into equity shares. Regardless, they

enjoy the preferential benefit when it comes to accruing dividends or during company’s

dissolution.

9. Adjustable-rate preference shares

The rate of dividend paid on this share is floating in nature and is heavily dependent on the

prevailing market rates. It directly influences the amount of dividend received by the

shareholders throughout the investment.

The table below shows the classification of preference shares in a nutshell.

 Corporate Accounting Notes
Types of
Preference Description
Shares

Convertible These shares can be readily converted into equity shares.

Though these types of preference shares cannot be converted into

Non-convertible
common stock, they are still prioritised over them.

Typically, these shares come with a maturity date. On maturity, the

Redeemable company repurchases its shares from the investors at a fixed rate and
ceases their dividend.

These shares cannot be redeemed in the lifetime of the company.

Non-redeemable
Notably, they come with a fixed rate of dividend.

Besides extending dividends, participating preference shareholders are

Participating
also entitled to surplus profits of the company.

These shares do not entitle shareholders to any surplus profit but offer
Non-participating
them the promised dividends.

In the event of loss, a company is liable to pay the shareholders’

Cumulative
outstanding dividends.

The non-cumulative shareholders are not entitled to receive dividends in

Non-cumulative
arrears.

In case of this share, the rate of dividend is not fixed and gets influenced
Adjustable
by prevailing market rates.

Difference Between Equity Shares and Preference Shares

Some of the features of the various types of preference shares are similar to equity shares in

general; they are two distinct entities. This table highlights the basic differences between equity
shares and preference shares.
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Parameter Preference Share Equity Share

It offers preferential rights in terms of It represents shareholders’

Definition
receiving dividend or capital amount. ownership in a company.

Dividend payout’s rate

Rate of dividend Dividend payout’s rate is fixed. fluctuates with more
earnings.

Preferred stockholders are given more Shareholders avail dividend

Dividend payout priority over common stockholders during only after other liabilities
dividend payment. have been paid.

Shareholders may receive

Shareholders may receive bonus shares
Bonus shares bonus shares against their
against current shareholdings.
shareholdings.

Capital Capital repayment is made before equity

Capital is repaid at the end.
repayment shares.

Shareholders avail voting

Voting rights Shareholders do not enjoy voting rights.
rights.

Equity share allows

Participation in Shares do not come with management
shareholders to partake in
management rights.
company management.

Equity stocks cannot be

Convertibility Preferred stocks can be converted.
converted.

Shareholders are not

Arrears of Shareholders may receive a cumulative
entitled to avail cumulative
dividend dividend.
dividends.

They are simply classified as

Types Preference shares and its types include, ordinary or common stock of
convertible, non-convertible, participatory, a company.
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non-participatory, cumulative, non-
cumulative, etc.

It is not mandatory to issue preference Companies must issue

Issuance
shares. equity shares.

It is considered suitable for investors with It is considered for investors

Suitability
low risk-taking capacity. who can take risks.

Methods of Valuation of Goodwill

The choice of the method of goodwill valuation depends entirely on the partners
or the partnership deed when they have made it.

1. Average Profits Method

i] Simple Average: Under this method, the goodwill is valued at the agreed
number of year’s of purchase of the average profits of the past years.

Goodwill = Average Profit x No. of years’ of purchase

ii] Weighted Average: Under this method, the goodwill is valued at an agreed
number of years’ of purchase of the weighted average profits of the past years.
We use the weighted average when there exists an increasing or decreasing trend
in the profits giving the highest weight to the current year’s profit.

 Goodwill = Weighted Average Profit x No. of years’ of purchase

 Weighted Average Profit = Sum of Profits multiplied by weights/ Sum of
weights

2. Super Profits Method

(i) The Number of Years Purchase Method: Under this method, the goodwill is
valued at the agreed number of years’ of purchase of the super profits of the
firm.
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 Goodwill = Super Profit x No. of years’ of purchase
 # Super Profit = Actual or Average profit – Normal Profit
 # Normal Profit = Capital Employed x (Normal Rate of Return/100)
(ii) Annuity Method: This method considers the time value of money. Here, we
consider the discounted value of the super profit.

 Goodwill = Super Profit x Discounting Factor

3. Capitalization Method

(i) Capitalization of Average Profits: Under this method, the value of goodwill is
calculated by deducting the actual capital employed from the capitalized value
of the average profits on the basis of the normal rate of return.

 Goodwill = Normal Capital – Actual Capital Employed

 # Normal Capital or Capitalized Average profits = Average Profits x
(100/Normal Rate of Return)
 # Actual Capital Employed = Total Assets (excluding goodwill) – Outside
Liabilities
(ii) Capitalization of Super Profits: Under this method, Goodwill is calculated by
capitalizing the super profits directly.

 Goodwill = Super Profits x (100/ Normal Rate of Return)

Valuation of shares: Valuation of shares is the process of knowing the value of a

company's shares. Share valuation is done based on quantitative techniques and
share value will vary depending on the market demand and supply. The share
price of the listed companies which are traded publicly can be known easily.

Methods of Valuation of Shares

Valuation of shares is the process of determining the fair value of the company
shares. The methods of valuation depend on the purpose for which valuation is
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required. Share valuation is done based on quantitative techniques and share value
will vary depending on the market demand and supply. Generally, there are three
methods of valuation of shares:

(1) Net Assets Method of Valuation of Shares

Under this method, the net value of assets of the company is divided by the
number of shares to arrive at the value of each share. Since the valuation is made
on the basis of the assets of the company, it is known as Asset-Basis or Asset-
Backing Method. For the determination of the net value of assets, it is necessary
to estimate the worth of the assets and liabilities. The goodwill, as well as non-
trading assets, should also be included in total assets. Under this method, the value
of the net assets of the company is to be determined first. The following points
should be considered while valuing of shares according to this method:

 Goodwill must be properly valued

 The fictitious assets such as preliminary expenses, discount on issue of
shares and debentures, accumulated losses, etc. should be eliminated.
 The fixed assets should be taken at their realizable value.
 Provision for bad debts, depreciation, etc. must be considered.
 All unrecorded assets and liabilities ( if any) should be considered.
 Floating assets should be taken at market value.
The external liabilities such as sundry creditors, bills payable, loan, debentures,
etc. should be deducted from the value of assets for the determination of net value.
The net value of assets, determined so has to be divided by a number of equity
shares for finding out the value of the share. Thus the value per share can be
determined by using the following formula:
Value Per Share=(Net Assets-Preference Share Capital)/Number Of Equity
Shares

(2) Yield or Market Value Method of Valuation of Shares

Yield is the effective rate of return on investments that is invested by the investors.
The expected rate of return in investment is denoted by yield. The term “rate of
return” refers to the return which a shareholder earns on his investment. Since the
valuation of shares is made on the basis of Yield, it is called Yield-Basis Method.
Further, it can be classified as (a) Rate of earning and (b) Rate of dividend. In
other words, yield may be earning yield and dividend yield.
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Value of Right Shares:

According to Sec. 81 of the Company Act, 1956, a company, if it so desires, can
increase its share capital by issuing new shares. In that case, the existing
shareholders must be given the priority of purchasing those shares according
to their paid-up value. Since the existing shareholders have got such right to
purchase the newly issued shares, they are called Right Shares.

In order to make a proper valuation of right relating to Right Shares, the

market value of the old holdings and the total issue price of the new holdings
must be added and the same must be divided by the total number of new and
old holdings. Value of right will be the difference between the result that is
obtained and market value of shares

Hence:
Value of Right = Number of Right Shares/Total Holdings (i.e. holdings = Old +
New) x (Market Value – Issue Price)

Method # 3. Earning Capacity:

When someone is interested to have majority of shares of a company in order
to have controlling interest in it, he makes use of earning capacity method for
the purpose of valuation of shares.

He is interested to know the disposable profits of the company. The profit is

found out by deducting reserves and taxes from the net profit of the company.

Thus profits earned by the company are compared with the amount
of capital employed in the business and rate of earning is found out
in the following manner:
Profit earned/Capital Employed x 100 = Rate of earning
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Fair Value Method: There are some accountants who do not prefer to use
Intrinsic Value or Yield Value for ascertaining the correct value of shares. They
however, prescribe the Fair Value Method which is the mean of Intrinsic value
and Yield Value method and the same provides a better indication about the
value of shares than the other methods.

Fair Value = (Intrinsic Value + Yield Value)/2

Redemption of Debenture: Redemption of Debentures means repayment of the

amount of. debentures to the debenture holders. It implies of the principle
amount as well as interest due on. debentures to the debenture holders. In
other words, it refers to the discharge of liability on debentures.

Methods of Redemption of Debentures:

Various companies may opt for different methods of redemption of
debentures. These following are some popular ways of doing so –
1. Lump-sum payment on a prefixed date
This one-time method is considered to be among the simplest redeeming
options. As per this method, debenture holders receive the promised sum on
the prefixed date.
If the debentures are not redeemed at discount or premium, the lump sum
amount, calculated by the summation of the principal value of all debentures,
is paid out on the prefixed or maturity date that is mentioned on debenture
agreement. The issuing company may decide to pay off the debenture amount
before its maturity. Since companies know in advance, when they have to pay
off for debenture, they are better positioned to streamline it.
2. Payment in annual instalment
This method is considered similar to the redeeming process of a term loan. As
per this method, companies pay a portion of a debenture’s principal each year
to holders until its maturity date. The total liability is divided by the number of
investment years, and the outcome is paid off each year.
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3. Debenture redemption reserve
This is also known as the sinking fund. Essentially, it is a reserve that is built
by accumulating at least 25% of the face value of debenture every year until its
maturity. The main objective of this reserve is to protect the interest of
debenture holders. According to the Indian Companies Act, 1956, companies
that issue debentures need to create this reserve before the maturity date of a
specific debenture.
4. Call and put option
Some companies issue debentures with both calls and put options for
redemption. Typically, the call option enables companies to purchase their
debenture either before or on the maturity date at a predetermined price. On
the other hand, in the put option, debenture holders avail the right to sell the
debenture back to the company at an agreed price, either before or on the
maturity date.
5. Conversion into shares
This particular method is directed towards convertible debentures. Such
debentures come with a clause that enables holders to convert their units into
company’s ordinary equity shares. It is at that point of conversion that the total
liability of debentures is discharged.
6. Buy from the open market
Companies can also purchase debentures from an open market if their units
are being traded on a regulated exchange. It will save them from the hassle of
being subject to administrative documentation. Furthermore, often debentures
are traded at a discount in the market. In turn, it allows individuals to lower
redemption payout and helps retain more revenue.

Compiled & Created by

Ashish Kumar Mishra
Corporate Accounting Notes