Accounting for Share Capital

Accounting for Share Capital

Introduction to a Company

Meaning, Characteristics and Kinds of Company:

• Meaning of a Company:
i. As per section 2(20) of the Companies Act, 2013, “Company means a company
incorporated under this Act or any previous Company Law.”
ii. A company (or a joint stock company) is an entity incorporated by a group of persons
through the process of law in order to undertake a business.
iii. A company is divided into units called shares, the owners of which are known as members
or shareholders.
iv. A company is an artificial person which is separate from its members (shareholders).
Therefore, insolvency or death of a member does not affect the company, i.e., the company
continues even if a member becomes insolvent or dies.
v. A company is an artificial person, created by law having separate legal entity with perpetual
succession and a common seal.

• Characteristics (features) of a Company:

i. Incorporation: A company is created through the process of incorporation under the the
Companies Act, 2013 or any other previous Companies Act.
ii. Separate Legal Entity: It is an artificial person which is separate legal entity from its
members (shareholders).
iii. Artificial Person: It is an artificial person which is separate from its members
(shareholders) and therefore, can own property, enter into contracts, conduct business on
its own, sue or be sued for any of its debts or acts.
vi. Perpetual Existence: Since, it is an artificial person which is separate from its members
(shareholders), insolvency or death of a member does not affect the company, i.e., the
company continues even if a member becomes insolvent or dies. Life of the company
comes to an end only by winding up through the process of law.
iv. Limited Liability: The members of a company are liable only to the extent of value of
shares subscribed by them or amount guaranteed to be paid at the time of winding up in
case of companies limited by guarantee. However, the liability of the members is unlimited,
in case if the company that is incorporated with unlimited liabilities, liability of members is
unlimited.
v. Transferability of Shares: Shares of a company other than a private company are freely
transferable. For a private company, transfer of shares is regulated by its Articles of
Association.
vi. Management and Ownership: Shareholders of the company are known as owners of the
company and therefore, ownership of a company remains with the shareholders. To
manage the business activities of a company, representatives are chosen who are known
as Directors. Therefore, management and ownership are separate.
vii. Common Seal: A cannot sign or enter into any contract on its own by signing the
documents. Therefore, a common seal is maintained by many companies to affix it on all
important documents of the company.

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 Accounting for Share Capital
• Difference between Partnership and a Company (Joint Stock Company):

Sr. Basis Partnership Company (Joint Stock Company)

no.
1 Formation It is formed by an agreement among It is formed/set up by registration under
the partners irrespective of whether it the Companies Act, 2013 or under any
is registered under the Indian previous Companies Acts.
Partnership Act, 1932.
2 Governing It is governed by the provisions of It is governed by the Companies Act,
Act Indian Partnership Act, 1932. 2013.
3 Members It should have a minimum of 2 and It should have a minimum of 7
maximum of 50 members as per the members without a maximum limit if it
rules and provisions of the is a public company. In case of a
Companies Act, 2013. private company, there should be at
least 2 members but not more than 200
members excluding its present or past
employee members. In case of a One
Person Company, there is only 1
member.
4 Liability In this case, liability of the partners is In case of companies with unlimited
unlimited. liability, liabilities of members is
unlimited, however, in case of other
companies liability of members is
limited to amount of shares held.
5 Profit In this case, profits are distributed as In this case, distribution of profits
Distribution per the terms of the Partnership Deed depends upon the Articles of
or equally if there is no agreement. Association or its directors as to what
share of profits should be distributed to
the shareholders in the form of
dividend.
6 Existence Stability or survival of a partnership is Stability and survival of a company is
affected by death, retirement or not affected by the shareholder’s
insolvency of partners. death, insolvency or transfer of shares.
7 Audit Audit is not mandatory. Audit is mandatory.
8 Management Operations and transactions are Operations and transactions are
managed by all the partners or any of managed by all the directors who are
them acting for all. elected by the shareholders.
9 Transfer of It is not possible for the partners to Transfer of shares is not restricted
Shares transfer the shares to any other except in case of a private company.
person without the consent of all the
partners.
10 Business If all the partners agree, a partnership The business specified in the Object
can carry on any business. Clause of the Memorandum of
Association is the only business the
company can carry on.
11 Winding Up A partnership may be wound up by an A company can be wound up only by
agreement or by an order of the court. carrying out the winding up process
If the firm is unable to pay its debts, prescribed in the Companies Act,
the Insolvency Act will apply. 2013.

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 Accounting for Share Capital

• Kinds of Companies: There are 3 kinds of companies as follows:

i. One Person Company (OPC): As per Section 2(62) of the Companies Act, 2013, ‘One
Person Company means a company which has only one person as member’. It is governed
by Rule 3 of the Companies (Incorporation) Rules, 2014. Such company should have at
least 1 director but not more than 15 directors.
ii. Private Company: As per Section 2(68) of the Companies Act, 2013, it is a company which
has a minimum paid-up share capital as may be prescribed and which by its Articles of
Association:
a. restricts the right to transfer its shares, if any.
b. except in the case of one person company, limits the number of its members excluding
its present or past employee members to 200.
Where shares are held by two or more persons jointly they shall be treated as a single
member.
c. Prohibits any invitation to public to subscribe for any securities of the company.
It is a company which should have at least 2 directors but not more than 15 directors and
also the name of such company ends with the words, ‘Private Limited’.
iii. Public Company: As per Section 2(71) of the Companies Act, 2013, a Public Company is a
company which:
a. is not a private company;
b. has a minimum paid-up capital as may be prescribed; and
c. is a Private Company, being a subsidiary of a company which is not a Private Company.
Such company must have at least 7 members and there is no restriction on the
maximum number of members. Also, it should have at least 3 directors but not more
than 15 directors. The name of such company ends with the word ‘Limited’.

• Understanding Limited Liability Company, Unlimited Liability Company, and Company

Limited by Guarantee.
a. Limited Liability Company (or Company Limited by Shares): As per Section 2(22) of the
Companies Act, 2013, it is a company having the liability of its members limited by the
memorandum to the amount if any, unpaid on shares respectively held by them.
b. Unlimited Liability Company: As per Section 2(92) of the Companies Act, 2013, it is a
company where the liability of its members is unlimited. Therefore, in the event of winding
up of such company, debts of the company shall be met from private property of the
members.
c. Company Limited by Guarantee: As per Section 2(21) of the Companies Act, 2013, it is a
company having the liability of its members limited by the memorandum to such amount as
the members may respectively undertake to contribute to the assets of the company in the
event of it being wound up.

• Difference among One Person Company, Private Company and Public Company:

Sr. Basis One Person Company Private Company Public Company

no.
1 Number of It should have minimum It should have minimum It should have a
Members and maximum of 1 of 2 and maximum of minimum of 7
member. 200 members excluding members and there
its present or past is no limit as to the

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 Accounting for Share Capital
employee members, maximum number of
under the Companies members.
Act, 2013.
2 Number of It should have at least 1 It should have at least 2 It should have at
Directors director and not more directors and not more least 3 directors but
than 15 directors. than 15 directors. not more than 15.
3 Prospectus It is not required to have It is not required to issue It is required to issue
a prospectus. any prospectus. prospectus to invite
public to subscribe
for shares, and if not
a prospectus, a
Statement in Lieu of
Prospectus is filed
with the Registrar of
Companies.
4 Articles of It requires special It requires special It can adopt Table F
Association Articles of Association. Articles of Association. of the Companies
Act, 2013 or it can
have its own Articles
of Association
having clauses
different from those
given in the Table F
of the Companies
Act, 2013, which will
override Table F.
5 Name of the It uses the word ‘OPC’ It uses the words ‘Private It uses the word
Company as a part of its name. Limited’ as a part of its ‘OPC’ as a part of its
name. name.
6 Shares It cannot offer any It cannot offer any It can offer shares to
Subscription shares to public. shares to public. public.
7 Shares Not Applicable It can allot shares as the It can allot shares
Allotment Directors decide. only if Minimum
Subscription has
been received.
8 Public It cannot accept deposits It cannot accept deposits It can invite and
Deposit from public. from public. accept deposits from
public.
9 Transferability It has only 1 member It cannot transfer the It can transfer the
of shares and therefore, such shares as per the shares without any
concept of transferability restrictions specified in restrictions.
of shares is not the Articles of
applicable. Association.

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 Accounting for Share Capital

Incorporation of a Company

• Process of Incorporating a Company: Process for incorporating a company can be divided into
four stages that are as follows:
i. Promotion: A person or a group of persons who agree to start a business in the form of a
company are called Promoters. These promoters undertake the responsibility to bring the
company into existence by promoting its objects and activities which is the first stage in
incorporation of a company.
ii. Registration of a Company: In order to incorporate a company, procedure prescribed in the
Companies Act, 2013 should be followed, this includes:
• Promoters have to get the proposed company name approved from the Registrar of
Companies.
• After getting the name of the proposed company approved, the promoters have to
submit Memorandum of Association, Articles of Association, consent of first directors to
act as directors and a declaration that the requirements of the Companies Act have
been complied with.
• Thereafter, if the Registrar is satisfied that the requirements of the Companies Act, 2013
have been complied with, he shall issue the Certificate of Incorporation to the Company.
iii. Capital Subscription: Capital subscription consists of the following:
• Prospectus: It is a document in which terms and conditions of the issue are stated along
with the purpose of the proceeds of issue.
• Minimum subscription: It is the amount stated in the prospectus that must be subscribed
and the amount payable on application for the amount stated as minimum subscription
have been paid to and received by the company by cheque or other instrument.
• In case, minimum amount is not subscribed and the amount payable on application is
not received within the specified period, then the application money shall have to be
refunded within fifteen days from the closure of the issue.
iv. Commencement of Business: A company cannot commence its business or exercise
borrowing powers unless:
• the directors do not file a declaration with the Registrar of Companies to the effect that
every subscriber to the Memorandum of Association has paid the value if the shares, if
any, agreed to be taken by him.
• a verification of its registered office should be filed by the company with the Registrar of
Companies.

Share Capital of a Company

Meaning and Classes of Shares of a Company:

• Meaning: It is the amount that a company receives towards Share Capital from issue of both
Equity Share and Preference Shares. According to Section 43 of the Companies Act, 2013, Share
Capital of the Company can be broadly of two types or classes namely:
i. Preference Shares; and
ii. Equity Shares.

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 Accounting for Share Capital
• Classes or Kinds of Shares:
i. Section 43(b) of the Companies Act, 2013 on Preference Shares: These are the shares
that carry the following two preferential rights:
o Right to receive dividend before it is paid to Equity Shareholders. Such dividend is paid
as a fixed amount or an amount calculated at a fixed rate which may either be free of or
subject to income tax.
o Right to receive capital before equity shares in the event of winding up.
Preference Shares can be classified with reference to:
o Dividend: With reference to dividend, Preference shares are classified as Cumulative
and Non-Cumulative Preference Shares.
▪ Cumulative: This class carries the right to receive arrears dividend before dividend is
paid to the Equity Shareholders.
▪ Non-Cumulative: This class do not carry the right to receive arrears of dividend.
o Participation in Surplus Profit: With reference to participation, Preference shares are
classified as Participating and Non-Participating Preference Shares.
▪ Participating: This class has the right to participate in the profits remaining after the
dividend has been paid to the Equity Shareholders.
▪ Non-Participating: This class has no right to participate in the profits remaining after
the dividend has been paid to the Equity Shareholders.
o Convertibility: With reference to convertibility, Preference shares are classified as
Convertible and Non-convertible Preference Shares.
▪ Convertible: This class are those which carry a right to be converted into Equity
Shares.
▪ Non-Convertible: This class are those which do not carry a right to be converted into
Equity Shares.
o Redemption: With reference to redemption, Preference shares are classified as
Redeemable and Irredeemable:
▪ Redeemable: This class of preference shares can be redeemed by the company at
the time specified for their repayment or earlier.
▪ Irredeemable: This class of preference shares are those the amount of which can be
returned by the company to the holders of such shares when the company is wound
up.

ii. Section 43(1) of the Companies Act, 2013 on Equity Shares:

o These are those shares which are not Preference Shares.
o They are the most issued class of shares.
o They carry the maximum ‘risks and rewards’ of the business, where the risks are losing
part of the value of shares if the business incurs losses and the rewards are the
payment of higher dividends and appreciation in the market value.

• Difference between Preference Shares and Equity Shares:

Sr. Basis Preference Shares Equity Shares

no.
1 Right to dividend Dividend on such shares is paid Dividend on such shares is paid
before the dividend on equity shares. after the dividend is paid on the
preference shares.
2 Rate of dividend It has a fixed rate of dividend. It pays dividend at the rate that is
proposed by the board of directors

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 Accounting for Share Capital
every year.
3 Arrears of In case of cumulative Preference In case, dividend is not declared
dividend Shares, arrear of dividend is paid during the year, it is not
before dividend is paid on Equity accumulated to be paid in the
Shares. coming years.
4 Convertibility They can be converted to equity These shares are not convertible.
shares if the terms of issue so
provide.
5 Redemption They are redeemable on due date. A company may buy back its Equity
Shares.
6 Voting Rights These shareholders have voting rights These shareholders have voting
only in special circumstances. rights in all the circumstances.
7 Refund of Capital In the event of winding up, these In the event of winding up, these
shareholders are repaid before the shareholders are repaid after the
equity shareholders. preference shareholders.
8 Right to These shareholders do not have the These shareholders have the right
Participate in right to participate in the management to participate in the management of
Management of the company. the company.

• Classification of Share Capital for Accounting purpose:

For accounting purpose, provisions specified in the Companies Act, 2013 are to be followed. As
per the form prescribed for preparation of Balance Sheet in Part I of Schedule III of the Companies
Act, 2013, Share Capital of the company is to be classified and shown as follows:

i. Authorised Capital;

ii. Issued Capital;

iii. Subscribed Capital for each class of Share Capital

Understanding each of the heads:

i. Authorised Capital: It is the amount stated in the Memorandum of Association and such
amount is the maximum amount that a company can raise as share capital. It is stated
separately for each class or kind of shares. As per Section 2 (8) of the Companies Act,
2013, such capital as authorized by the memorandum of a company to be maximum
amount of share capital of the company is called as Authorised Capital or Nominal Capital.
ii. Issued Capital: It is a part of the nominal value or Authorised Share Capital which is issued
from time to time for subscription. Therefore, amount of Issued Capital cannot exceed the
company’s Authorised Share Capital. As per Section 2 (50) of the Companies Act, 2013,
such capital of the company that it issues from time to time for subscription.
iii. Subscribed Capital: It is a part of the capital which is for the time being subscribed by the
members of a company. As defined by Section 2 (86) of the Companies Act 2013, such part
of the capital which is for time being subscribed by the members of a company. This can
further be divided into:

▪ Subscribed and fully paid-up: It is a situation where the company has called-up the
total nominal value of the share and has received the same.

▪ Subscribed and not fully paid-up: It is a situation where the company has called-up the
total nominal value of the share, but has not receive it or has not called-up the total
nominal value of the share.
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 Accounting for Share Capital
Understanding the two terms, i.e., Called-up and Paid-up:
a. Called-up Capital: According to section 2(15) of the Companies Act, 2013, Called-up
Capital means such part of the capital which has been called for payment.
b. Paid-up Capital: According to section 2(64) of the Companies Act, 2013, Paid-up Share
Capital or Share Capital Paid-up means the amount that the shareholder has paid and the
company has received against the amount Called-up in respect of the shares towards share
capital or has been credited to it as paid-up.

Difference between Authorised or Nominal Capital and Issued Capital:

Sr. Basis Authorised or Nominal Capital Issued Capital

no.
It is the amount stated in the
1 Meaning Memorandum of Association which It is the nominal value of that part
a company can raise as share of Authorised Share Capital which
capital of the company. is issued for subscription.

2 Disclosure in It is stated in the Memorandum of It is not stated in the

Memorandum Association. Memorandum of Association.
of Association

3 Whether one It is always equal or more than the It is always equal or less than the
can exceed the Issued Share Capital. Authorised Share Capital.
other

• Understanding Reserve Capital and Capital Reserve:

o Reserve Capital: It is a part of Subscribed Capital remaining uncalled that a company
resolves, by a Special Resolution, not to call except in the event of winding up of the
company. Such number of shares are shown as “Subscribed but not fully paid-up”.
o Capital Reserve: It is a type of reserve which is created out of capital profits and is not free
for distribution as dividend.

o Difference between Reserve Capital and Capital Reserve:

Sr. Basis Reserve Capital Capital Reserve
no.
1 Meaning It is a part of uncalled capital which It is a part of reserves which cannot
cannot be called-up except in the be used for distribution of
event of winding up. dividends.
2 Creation It is a part of uncalled capital. It is a part of capital profits.
3 Optional/Man It is not compulsory to have Reserve It is considered appropriate to
datory Capital. transfer capital profits to capital
reserve.
4 Special Reserve Capital requires a special Capital Reserves do not require
Resolution resolution to be passed. any special resolution to be passed.
5 When can it It is a part of uncalled capital which It can be used anytime during the
be used can be called at the time of winding life of the company.
up.

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 Accounting for Share Capital
6 Writing off It cannot be used for writing off It is used to write off capital losses.
Capital capital losses.
7 Disclosure It is not disclosed in the Balance It is disclosed in the Note to
Sheet of the Company. Accounts on Shareholders’ Funds
under the head ‘Reserves and
Surplus.’

• Disclosure of Share Capital in a Company’s Balance Sheet: Share Capital is shown in the
Company’s Balance Sheet as follows:
Balance Sheet of … (Extract) as at …
Particulars Note No. `
I. EQUITY AND LIABILITIES
Shareholders’ Funds
Share Capital 1 …

Note to Accounts

1. Share Capital `
Authorised Capital
…Equity Shares of ` … each …
…Preference Shares of ` … each …
…
Issued Capital
…Equity Shares of ` … each …
…Preference Shares of ` … each …

Subscribed Capital
Subscribed and fully paid-up
…Equity Shares of ` … each …
…Preference Shares of ` … each …

Subscribed but not fully paid-up

…Equity Shares of ` … each, ` … called-up …
Less: Calls-in-Arrear … …
…Preference Shares of ` … each, ` … called-up …
Less: Calls-in-Arrears … …
Add: Forfeited Shares …
Amount to be shown in the Balance Sheet against Share Capital
…

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 Accounting for Share Capital

Process of Issue and Allotment of Shares

A Public Company can issue shares only after meeting the prescribed legal compliances. Process of
issuing and allotting the shares is explained as below with the help of a diagram:

Issue of Shares for Cash

This is the issue of shares which means the shares are issued by a company against payment received
by cheque or a banking instrument. Such issue can be made at par or premium but not at discount and
the amount received on such issue can be received either in lump sum or in installments.
Following is the accounting treatment in each of these cases:

i. If issue price received in Lump Sum: In this type of issue, total issue price of shares is payable
in one instalment.
a. To receive Shares Application Money:
Bank A/c …Dr. [amount received]
To Shares Application A/c
(Being application money received)
b. To Allot Shares:
Shares Application A/c …Dr.
To Share Capital A/c [nominal value]
To Securities Premium Reserve A/c [premium amount, when issued at premium]
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 Accounting for Share Capital
(Being shares allotted and application money transferred to Share Capital Account and
Securities Premium Reserve Account)
Instead of Share Application Account, Share Application and Allotment Account may be used
in the above entries.

ii. If issue price received in Instalments: In this type of issue, total issue price of shares is payable
in instalments.
I. For receipt of Application money:
Bank A/c ...Dr. [amount received with application]
To Shares Application A/c
II. For Allotment of Shares:
Shares Application A/c …Dr. [application money on shares allotted]
To Share Capital A/c
III. For Amount due on Allotment:
Shares Allotment A/c …Dr. [Money due on shares allotted]
To Share Capital A/c
IV. For receipt of Allotment money:
Bank A/c …Dr. [amount received on shares allotted]
To Shares Allotment A/c
V. For first call being due:
Shares First Call A/c …Dr. [amount payable on first call]
To Share Capital A/c
VI. For receipt of first call:
Bank A/c …Dr. [amount received on first call]
To Shares First Call A/c

• Points to remember when shares are issued to public for subscription: The important points
to follow as mentioned below:
I. Calls are made as provided in the Articles of Association of the company.

II. If the company does not have its own Articles of Association or Articles of Association does
not have a clause to this effect, Table F of the Companies Act, 2013 will apply.
Table F has the following provisions:

i. Period of one month must elapse between two calls.

ii. The amount of one call should not be less than 25% of the face value of the share.

iii. Notice of 14days period should be given to the shareholders to pay the amount.

iv. Calls should be made on uniform basis on all shares within the same class.

• Terms of Issue of Shares: A company may issue shares at par or at premium as explained
below:
I. Shares are issued at Par: It means that the issue price is same as the nominal value (face
value) of the shares.
II. Shares are issued at Premium: It means that the issue price is more than the nominal value
(face value) of the shares. Amount in excess of the nominal value of the share is termed as
premium and such amount of premium is credited to Securities Premium Account or
Securities Premium Reserve Account.

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 Accounting for Share Capital
• Accounting entries for issue of Shares at Premium:
i. For receipt of Application money:
Bank A/c ...Dr. [amount received on application including premium]
To Shares Application A/c
ii. For Allotment of Shares:
Shares Application A/c …Dr. [application money on shares allotted]
To Share Capital A/c [amount paid towards share capital]
To Securities Premium Reserve A/c [amount of premium received with application
money]
iii. For Amount due on Allotment:
Shares Allotment A/c …Dr. [amount due on shares allotted]
To Share Capital A/c [amount paid towards share capital]
To Securities Premium Reserve A/c [amount due towards premium]
iv. For receipt of Allotment money:
Bank A/c …Dr. [amount received on shares allotted]
Calls-in-Arrears A/c ...Dr. [amount not received against allotment money]
To Shares Allotment A/c
v. For first call being due:
Shares First Call A/c …Dr. [amount payable on first call]
To Share Capital A/c [amount paid towards share capital]
To Securities Premium Reserve A/c [amount due to towards premium]
vi. For receipt of first call:
Bank A/c …Dr. [amount received on first call]
Calls-in-Arrears A/c …Dr. [amount not received towards first call money due]
To Shares First Call A/c

• Section 52(2) of the Companies Act, 2013 on use of the amount received as premium on
securities: As per section 52(2) of the Companies Act, 2013, use of the amounts received as
premium on securities is restricted to the following purposes only:
i. issuing fully paid bonus shares to the members;

ii. writing off preliminary expenses of the company;

iii. writing off the expenses of, or the commission paid or discount allowed on any issue of
securities or debentures of the company;

iv. providing for the premium payable on the redemption of any redeemable Preference Shares
of any debentures of the company;

v. in purchasing its own shares i.e., in case of buy back of shares.

Oversubscription and Undersubscription of Shares

Meaning and Accounting Treatment of Oversubscription of Shares:

• Meaning of Oversubscription:
o Oversubscription means, the number of applications received are more than the number of
shares offered.
o In such case, allotment can be done by any of the 3 alternatives available.
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 Accounting for Share Capital
i.
First Alternative: Under this alternative, some applications are accepted and excess
applications are rejected.
ii. Second Alternative: Under this alternative, all applicants are allotted shares in
proportion which is known as Partial or Pro-rata Allotment.
iii. Third Alternative: Under this alternative, a combination of the above two alternatives
may be adopted.
o If the shares are allotted against the application, then there is no adjustment required as
share capital is credited against the application money received. However, if the applications
are rejected, the application money with respect to the rejected applications can be refunded
or adjusted (in case of pro-rata allotment) against the allotment or calls on shares.

• Meaning of Pro-rata Allotment of Shares:

o This is one of the alternative available with the company for allotment of shares when the
number of shares applied for are more than the number of shares offered for subscription.

o As per this alternative, all applicants are allotted shares in proportion which is called Partial or
Pro rata Allotment.

• Treatment of Surplus Application Money on Pro-rata Allotment:

o If the question is silent or states that ‘excess application money received is to be adjusted
against allotment’, surplus application money is adjusted against allotment money due and
excess application money, if any is refunded.
o If the question requires that surplus application money is to be refunded after adjustment of
Allotment Money and Call Money, then the amount is transferred to Shares Allotment Account
and Calls-in Advance Account. The balance, if still left, is refunded.

• Computation of Amount not Received on Allotment in Case of Pro-rata: In case where the
shares are allotted on pro-rata basis and one or some of the shareholders of pro-rata category fail
to pay the allotment money, then it is necessary to compute the amount not received on allotment
as per the following steps:
i. Step 1: Compute the number of shares applied or allotted using the following
formulae:
I. When the shares allotted are given:
Number of Shares Applied are:
(Total Shares Applied  Total Shares Allotted )  Number of Shares Allotted
II. When the shares applied are given:
Number of Shares Allotted are:
(Total Shares Allotted  Total Shares Applied ) Number of Shares Applied
ii. Step 2: Calculate the Allotment Amount not paid by defaulting shareholders:
`
Amount due on Allotment (Shares Allotted x Allotment Money per Share) …
Less: Excess Application Money Adjusted on Allotment …
(Shares Applied – Shares Allotted) x Application Money per share
Allotment Amount due but not paid …

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 Accounting for Share Capital

• Journal entries for the following in the event of Oversubscription of Shares are as follows:

a. For application money received:

Bank A/c …Dr.
To Shares Application A/c

b. For application money for allotted shares:

Shares Application A/c ….Dr.
To Share Capital A/c

c. For excess application money refunded:

Shares Application A/c …Dr.
To Bank A/c

d. For excess application money adjusted with allotment and calls:

Share Application A/c …Dr.
To Shares Allotment A/c
To Calls in Advance A/c

e. A combined entry can be passed to give effect to refund and adjustment of excess
application money at the same time as follows:
Shares Application A/c …Dr.
To Share Capital A/c
To Bank A/c
To Shares Allotment A/c
To Calls-in-Advance A/c

Meaning of Undersubscription of Shares and Difference between

Oversubscription and Undersubscription:
• Undersubscription: It is a situation when the number of shares applied are less than the number
of shares issued for subscription.

• Minimum Subscription: As per SEBI Guidelines, minimum subscription is to receive subscription

for at least 90% of the shares issued. If the company does not receive minimum subscription, it
cannot allot the shares and therefore, it will have to refund the application money to the
subscribers.

• Difference between Oversubscription and Undersubscription of Shares:

Sr. Basis Oversubscription of Shares Undersubscription of Shares

no.

1 Shares Applied Number of shares applied are Number of shares applied are less
to Offered more than the shares offered for than the shares offered for
subscription. subscription.

2 Acceptance In this situation, all applications In this situation, all the applications
are not accepted, some are for shares are accepted, i.e., full
rejected or applications are allotment is made.

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 Accounting for Share Capital
allotted on pro rata basis.

3 Minimum Such problem of minimum The problem of minimum

Subscription subscription is not faced when subscription may arise in case of
there is over subscription of under subscription.
shares.

4 Refund In this case, excess application In this situation, all the applications
money is refunded or adjusted are accepted, therefore, there is no
towards allotment and calls. excess money to be refunded.

Calls-in-Arrears and Calls-in-Advance

Meaning and Accounting Treatment of Calls-in-Arrears:

• Meaning of Calls-in-Arrears and Interest on Calls-in-Arrears:
i. Calls-in-Arrears: If the shareholder does not pay the call amount due on allotment or on
any subsequent calls according to the terms, the amount not received is called Calls-in-
Arrears.

ii. Interest on Calls-in-Arrears: If the company is authorized by the Articles of Association, it

may charge an interest at the specified rate on Calls-in-Arrears from the due date to the
date of payment. In case Articles of Association is silent, Table F of the Companies Act,
2013 shall apply which provides for interest on Calls-in-Arrears at the rate of 10% p.a.
However, directors have the right to waive such interest.

• Accounting Treatment of Calls-in-Arrears: This can be done in 2 ways as follows:

i. Accounting treatment without opening Calls-in-Arrears Account: In this method,

amount Sreceived from the shareholders is credited to the relevant call account. The
respective call accounts (first, second, etc.) will continue showing debit balance equal to the
total amount unpaid on those calls. On a subsequent date, when the amount of Calls-in-
Arrears is received, Bank Account is debited and relevant call account is credited.

Call Money Due:

Share First Call A/c …Dr. [with actual amount due on say, 100 shares @ 3 each]

To Share Capital A/c

Call Money Received:

Bank A/c …Dr. [with actual amount received, say 90 shares @ 3 each]

To Share First Call A/c

ii. Accounting treatment by opening Calls-in-Arrears Account: In this method, unlike the
first method, the unpaid amount is transferred to Calls-in-Arrears Account. On account of
this, Share Allotment Account and Shares Call Accounts will not show any balance. The
Calls-in-Arrears Account will show a debit balance equal to the total unpaid amount on
allotment or the calls. At a later date, on receipt of arrear amount, it is credited to the Calls-
in-Arrears Account and same is closed with a corresponding debit to Bank A/c.

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 Accounting for Share Capital
Call Money Due:

Share First Call A/c …Dr. [with actual amount due on say, 100 shares @ 3 each]

To Share Capital A/c

Call Money Received:

Bank A/c …Dr. [with actual amount received, say 90 shares @ 3 each]

Calls-in-Arrears A/c … Dr. [with amount not received, 10 shares @ 3each]

To Share First Call A/c

iii. Disclosure in Balance Sheet: Calls-in-Arrears Account is shown in the Notes to Accounts
on ‘Share Capital’. This is shown as a deduction from the amount of ‘Subscribed but not
fully paid-up’ under ‘Subscribed Capital’.

Meaning and Accounting Treatment of Calls-in-Advance:

• Meaning of Calls-in-Advance and Interest on Calls-in-Advance:
i. Calls-in-Advance: An amount which is accepted by the company against the call or calls
not yet made is termed as Calls-in-Advance. A company may accept such calls-in-advance
amount only if it is allowed by the Articles of Association of the Company.
ii. Interest on Calls-in-Advance: If the Articles of Association provides for any interest on
Calls-in-Advance, then interest can be paid by the company. In case when the Articles of
Association is silent, Table F of the Companies Act, 2013 shall apply where company is
liable to pay interest at the rate of 12% p.a.

• Accounting Treatment of Calls-in-Advance: Journal Entry passed:

i. To record calls-in-advances:

Bank A/c …Dr. [amount of calls money received in advance]

To Calls-in-Advance A/c

ii. To adjust when the respective call is made due:

Calls-in-Advance A/c …Dr.

To Respective Call A/c

• Difference between Calls-in-Arrears and Calls-in-Advance:

Sr. Basis Calls-in-Arrears Calls-in-Advance

no.

1 Meaning Amount which is called-up by the Amount which is not called-up by

company but not paid by the the company, but paid by the
shareholders. shareholders.

2 Interest Interest is charged on such Calls-in- Interest is allowed on Calls-in-

Arrears. Advance.

3 Rate of Interest Rate of interest is charged as per Table Rate of interest is paid as per
F of the Companies Act, 2013 which Table F of the Companies Act,

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 Accounting for Share Capital
@10% p.a. 2013 which @12% p.a.

4 Authority under No Such clause in the AoA as non- Such Calls-in-Advance can be
Articles of payment is beyond the company’s accepted by the company only if it
Association control. is authorised by its Articles of
Association to do so.

5 Disclosure It is shown in the Note to Accounts on It is shown as a separate item as

Share Capital in the Balance Sheet by Other Current Liability under
way of deduction from the Subscribed Current Liabilities.
but not fully paid-up Capital.

Shares Issued for Consideration Other Than Cash

Such issue is possible under the following circumstances where Shares are issued to:

• Vendors against purchase of assets or business: Entry to be passed is as follows:

a. if shares are issued for purchase of assets:
Sundry Assets A/c (individually) …Dr. (with the amount of purchase price)
To Vendor’s A/c (with purchase consideration)

b. if shares are issued for purchase of business: When a business is purchased, both assets
and liabilities are taken over for a consideration which can be equal to, more than or less than
the difference between values of assets and liabilities. Entry to be passed in each of these
cases is as follows:
I. if consideration is equal to the difference between the value of assets and liabilities:
Sundry Assets A/c (individually) …Dr. (agreed value)
To Sundry Liabilities (individually) (agreed value)
To Vendor’s A/c (purchase consideration)
II. if consideration is more than the difference between the value of assets and liabilities,
such excess is debited to Goodwill Account:
Sundry Assets A/c (individually) …Dr. (agreed value)
Goodwill A/c …Dr. (excess consideration over net assets)
To Sundry Liabilities (individually) (agreed value)
To Vendor’s A/c (purchase consideration)

III. if consideration is less than the difference between the value of assets and liabilities,
such shortfall is credited to Capital Reserve Account:
Sundry Assets A/c (individually) …Dr. (agreed value)
To Sundry Liabilities (individually) (agreed value)
To Vendor’s A/c (purchase consideration)
To Capital Reserve A/c (excess of net assets over consideration)

• Accounting Entries for issue of Shares to Vendors when Shares are:

i. Issued at par:
Vendor’s A/c …Dr. (nominal value of shares allotted)
To Share Capital A/c

ii. Issued at premium:

Vendor’s A/c …Dr. (purchase consideration)
To Shares A/c (nominal value of shares allotted)

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 Accounting for Share Capital
To Securities Premium Reserve A/c (premium amount)

• Calculation of Number of Shares: When a business is purchased and consideration is paid in the
form of issue of shares, number of shares is to be calculated as follows:
Number of Shares Issued = Purchase Consideration  Issue Price of Share

• Issue of Shares to Promoters: Such issue is made for services rendered by promoters for
incorporating the company. Entry to be passed is as follows:
Amount due to Promoters
Incorporating Expenses or Formation Expenses A/c …Dr.
To Promoter’s A/c

Issue of shares to Promoters

Promoter’s A/c …Dr.
To Share Capital A/c

• Issue of Shares to Underwriters: Such issue is made for services rendered by the underwriters
where the underwriter agrees to take shares instead of charging commission in cash for his
services rendered. Entry to be passed is as follows:
Amount due as Underwriting Commission
Underwriting Commission A/c …Dr.
To Underwriters’ A/c

Issue of shares to Underwriters

Underwriters’ A/c …Dr.
To Share Capital A/c

• Disclosure in the Balance Sheet:

Shares issued for consideration other than cash are disclosed in the Balance Sheet under
‘Subscribed Capital’. This may be further subscribed and fully paid or subscribed but not fully paid
as the case may be and shown in Notes to Accounts under Share Capital.

Forfeiture of Shares and Reissue of Forfeited Shares

Meaning and Accounting Entries for Forfeiture of Shares:

• Meaning:
i. It means cancellation of shares for non-payment of calls due.

ii. It can be done by the company only if it is allowed by its Articles of Association.

iii. If any of the shareholders of the company does not pay the amount of call, the company
may exercise this power to forfeit the shares held by the shareholder on which amount of
call is not paid.

iv. In case of such forfeiture, the company must first give a clear 14days’ notice to the
defaulting shareholder to pay the amount due on call and interest thereon if any.

v. If the shareholder does not pay, the company may forfeit the shares by passing an
appropriate resolution.

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 Accounting for Share Capital
vi. In the event of such forfeiture, forfeited shares are cancelled and Share Capital is reduced
to that extent.

• Accounting Entries for forfeiture of Shares:

i. Forfeiture of Shares issued at Par: Following entry is passed for forfeiture of shares:
Share Capital A/c Dr. (Shares forfeited x Called up value per share)
To Forfeited Shares A/c (Amount received on forfeited shares)
To Share Allotment A/c (Amount due but not paid on allotment)
To Shares Call A/c (Amount due but not paid on call)
Where Calls in Arrears Account is maintained, Calls in Arrears Account will be credited
instead of Shares Allotment A/c and Shares Calls Account.

ii. Forfeiture of Shares issued at Premium: In this case, there are 2 possibilities:
a. Securities Premium Amount has been received: Following entry is passed for
forfeiture of shares:
Share Capital A/c Dr. (Called up value less Premium)
To Share Allotment A/c (Amount not received on allotment)
To Shares Call A/c (Amount not received on calls)
To Forfeited Shares A/c (Amount received less premium)
b. Securities Premium Amount has not been received: Following entry is passed for
forfeiture of shares:
Share Capital A/c Dr. (Called up value less premium)
Securities Premium Reserve A/c Dr. (Premium amount called-up but not received)
To Share Allotment A/c (Amount not received on allotment)
To Shares Call A/c (Amount not received on calls)
To Forfeited Shares A/c (Amount received less premium)
Where Calls in Arrears Account is maintained, Calls in Arrears Account will be credited
instead of Shares Allotment A/c and Shares Calls Account.

Meaning and Accounting Entries for Reissue of Forfeited Shares:

• Meaning: It is the selling of shares that were cancelled by the company in the event of forfeiture.
Such forfeited shares can reissued by the company at par, premium or discount. If issued at
discount, the amount of discount should be within the maximum permissible limits. Accounting
entry passed in each case is as follows:
i. When reissue is at par, i.e., nominal value of share:
Bank A/c …Dr. (amount received on reissue)
To Share Capital A/c (amount credited as paid-up)

ii. When reissue is at discount:

Bank A/c …Dr. (amount received on reissue)
Forfeited Shares A/c …Dr. (discount allowed on reissue i.e., paid up value less reissue
price)
To Share Capital A/c (amount credited as paid-up)

iii. When reissue is at premium:

Bank A/c …Dr. (amount received on reissue)
To Share Capital A/c (amount credited as paid up)
To Securities Premium Reserve A/c (excess amount received on reissue)

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 Accounting for Share Capital
• Maximum Permissible Discount: At the time of reissue of the forfeited shares, care has to be
taken with respect to the maximum permissible discount on the shares reissued. The maximum
permissible discount that can be allowed on reissue of forfeited shares is the amount forfeited, i.e.,
the amount credited to the forfeited shares. In simple terms, the reissue price cannot be less than
the amount unpaid on the forfeited shares.

• Accounting treatment of Balance in Forfeited Shares Account: When a company has to

reissue the forfeited shares there are 2 options for which different accounting entries are required
to be passed as follows:
a. All forfeited shares are reissued: In this case, the balance left in Forfeited Shares Account is
transferred to Capital Reserve as follows:
Forfeited Shares A/c …Dr.
To Capital Reserve A/c

(Being the gain on reissue transferred to Capital Reserve)

b. All forfeited shares are not reissued: In this case, the amount of discount allowed on reissue
of forfeited shares is a Capital gain (Profit) and therefore, transferred to Capital Reserve.
The amount of forfeited shares not reissued will remain in the Forfeited Shares Account till
the time these shares are reissued.

Gain on reissue is calculated as follows:

 Amount with which Forfeited Shares 
 Total Amount Forfeited  – Account was debited at the time of reissue
 No. of shares Forfeited  No. of shares reissued   
of such shares Or the Reissue Discount
 

• Forfeiture of Shares Under Pro-Rata Category: Following process is required to be followed

when shares belonging to pro rata category are forfeited:
i. Calculate number of shares applied (if not given) by the shareholder whose shares are
being forfeited:
Shares Applied under Pro-rata Category
( )  Number of shares Allotted to shareholder
Shares Allotted under Pro-rata Category
Or
Calculate total number of shares allotted (if not given):
Shares Allotted under Pro-rata Category
( )  Number of shares Applied to shareholder
Shares Applied under Pro-rata Category

ii. Compute the total application money received on shares applied by defaulting shareholder
as under:
Number of shares Applied by shareholder  Application money per share
iii. Compute Application money due on shares allotted to defaulting shareholder as under:
Number of shares Allotted to shareholder  Application money per share
iv. Determine the excess application money received:
Application Money received (step 2) − Application Money required (step 3)
v. Determine the amount due on allotment (by multiplying number of shares allotted by the
amount of allotment money per share) and deduct from it the excess application money
(step 4).
vi. The resultant amount is arrears on allotment.

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 Accounting for Share Capital
• Concept of Preferential Allotment:
i. It is the allotment of shares at a predetermined price to the pre-identified people who are
interested in taking a strategic stake in the company.
ii. Requires special resolution for the same has been passed in the shareholder’s meeting.
iii. Such interested people includes promoters, venture capitalists, financial institutions, people
who buy company’s products or any other party related.

• Concept of Private Placement of Shares as per Section 42 of the Companies Act, 2013:
i. As per Section 42 of the Companies Act, 2013, Private Placement means any offer of the
securities or invitation to subscribe securities to a select group of persons by a company
(other than by way of public offer) through issue of private placement offer letter and which
satisfies the conditions specified in this section.
ii. In simple terms, securities offered to the selective group of persons by issuing private
placement offer is known as the Private Placement of Shares. There are conditions
specified by Companies Act, 2013 that are to be fulfilled for offering such private placement
of shares.

• Conditions to be fulfilled for offering Private Placement of Shares: Conditions have been
prescribed for the following points:
i. Limit on offers:
• Invitation to subscribe securities shall be made in a financial year to persons not
exceeding 50 in number or such higher number as may be prescribed.
• Also, the maximum number of persons to whom offer of Private Placement can be
made is prescribed as 200.
• For this purpose, Qualified Institutional buyers and employees of the company offered
securities under a scheme of employees stock option is excluded.
ii. Previous/Earlier offers: Such offer or invitation shall not be made unless the allotments
with respect to any offer or invitation made earlier have been completed or that offer or
invitation has been withdrawn or abandoned by the company.
iii. Subscription Amount: Amount of subscription should not be less than ` 20, 000. Any
amount payable towards subscription of securities shall be paid through cheque or bank
draft or any other banking instrument but not by cash.
iv. Allotment: Condition with respect to allotment prescribes that the company shall allot its
securities within 60 days from the date of receipt of application money. In case the company
is not able to allot securities within 60 days, it shall refund the application money within 15
days from the day of completion of 60 days.
v. Application money received: Any amount received towards application of securities shall
be kept in a separate bank account and shall be utilised for:
a. adjustment against allotment of securities; or
b. repayment of money against which the company is not able to allot securities.
vi. Offers: Offer for such securities shall be made only to such persons whose names are
recorded by the company before the invitation to subscribe.
vii. Filing with Registrar of Companies: It is necessary to file complete information with the
Registrar of Companies within 30 days of the circulation of offer for private placement.
viii. Public Advertisement: No public advertisement or use of any media, marketing or
distribution channels or agents to inform the public at large about the offer.

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 Accounting for Share Capital
• Concept of Employees Stock Option Plan (ESOP):
i. It is a category of Sweat Equity which is a wider term than ESOP and includes issue of
shares to promoters as remuneration for their contribution towards incorporating the
company and other related services.
ii. It is an option granted to the employees and employee directors of a Company to subscribe
the company’s shares at a price that is lower than the market price (fair value) of the share.
iii. It is an option and not an obligation for the employees and employee directors. Therefore,
they may or may not exercise the option.
iv. It is necessary to fulfil the prescribed conditions to issue such stock options.

• Terms associated with Employees Stock Option Plan (ESOP):

i. Grant: It is the option given to the Employees to subscribe to the share of the company.
ii. Grant Date: It is the date at which the enterprise and its employees agree to the terms of
Employees Stock Option Plan (ESOP).
iii. Vesting: It is the process by which the employee is given the right to apply for shares of the
company against ESOP.
iv. Vesting Date: It is date when all the specified vesting conditions are satisfied by the
employee and therefore, becomes entitled to receive the shares.
v. Vesting Period: It is the period between the grant date and the date on which all the
specified vesting conditions of an Employee Stock Option Plan are to be satisfied.
vi. Exercise: It is an application by the employee for issue of shares against the option vested
in him in pursuance of the Employees Stock Option Plan (ESOP).
vii. Exercise Period: It is the period after vesting within which the employee should exercise
the right to apply for shares against the option vested in him in pursuance of the Employees
Stock Option Plan (ESOP).
viii. Exercise Price: It is the price payable by the employee for exercising the option granted in
pursuance of the Employees Stock Option Plan.
ix. Value of Option: It is the difference between the market price and the issue price of the
security.

• Conditions to issue stock options:

i. shares issued are of the same class of shares already issued;
ii. such issue is authorized by a special resolution passed by the company;
iii. such resolution specifies all possible details of the number of shares, consideration, market
price, and class or classed of employees or directors to whom such shares are to be issued;
iv. at the date of issue, not less than 1 year has been elapsed since the date on which the
company had commenced business; and
v. all the regulations prescribed by SEBI with respect to such issue have been duly complied
with.

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Acquisition of business:
Sometimes, the company may decide to purchase another business for various reasons,
such as acquiring the supplier, eliminating the competitor, or simply trying to expand the
scope of its business, etc. Likewise, when the company acquires another company to
become its subsidiary, it can make the journal entry for goodwill on acquisition in order to
present such goodwill as an intangible asset on the consolidated financial statements.

In accounting, goodwill on acquisition is the difference between the amount the company
pays to acquire the subsidiary company and the fair value of net assets that it receives from
the acquired company.

In business, goodwill is generally known as a company’s good reputation. In this case, it can
represent many positive attributes that the company has, including good location, good
management, good customer relations, good employees relationship with excellent skills,
good product name and quality, and probably many other good things.

That is why the company usually needs to pay more than the fair value of the net assets in
acquiring another company as it will also acquire those positive attributes attached with the
acquired company in the purchase as well. This is also why the goodwill that is shown on the
balance sheet of the group consolidated financial statements is usually positive goodwill. Of
course, there is also a case of negative goodwill but it tends to be very rare.

Journal entry for goodwill on acquisition

The company can make the journal entry for the goodwill on acquisition by debiting the
assets at the fair value and the goodwill account and crediting the liabilities at the fair value
and the cash account.

Account Debit Credit

Assets 000

Goodwill 000

Liabilities 000

Cash 000
In this journal entry, the amount of goodwill is the excess amount that the company pays for
the acquired net assets (assets – liabilities) of the purchased company which are measured
in fair value.
Assets and liabilities in this journal entry are the assets and the liabilities of the subsidiary
company, in which they are measured at fair value. As a company purchases another
company, it does not only acquire assets but also liabilities. That’s why this journal entry
includes both assets and liabilities of another company.

It may be useful to mention that goodwill should only be recognized and recorded when one
company purchases another company to become its subsidiary. In accounting, internally
generated goodwill is not allowed.

It doesn’t matter how good the reputation the company has, packaging its own goodwill and
put it on the balance sheet will go against the accounting rule. One reason may be due to
the subjectivity of the dollar value that the company may put on its good reputation. In
short, how anyone can reliably measure the reputation in dollar value would be a big
question.

Goodwill on acquisition example

For example, on December 31, the company ABC pays Rs.7,000,000 to purchase 100%
shares in the XYZ company, which was originally its supplier to become its subsidiary. The
net assets of the XYZ are valued fairly at Rs.4,000,000 which comes from the total assets of
Rs.15,000,000 and total liabilities of Rs.11,000,000 measured at fair value as listed in the
table below:

Amount measured at
Assets
fair value in Rs.

Cash 1,000,000

Inventory 6,000,000

Accounts receivable 2,500,000

Equipment 3,500,000

Other assets 2,000,000

Total assets 15,000,000

Liabilities

Accounts payable 3,000,000

Note payable 7,000,000

Other liabilities 1,000,000

 Total liabilities 11,000,000

Net assets 4,000,000

What is the journal entry for goodwill on acquisition on December 31?

Solution:
With the information in the example, the company ABC can determine the goodwill on
acquisition to be Rs.3,000,000 as it pays Rs.7,000,000 for the Rs.4,000,000 net assets.

In this case, the company ABC can make the journal entry for goodwill on acquisition when
it purchases the XYZ company on December 31, as below:

Account Debit Credit

Cash 1,000,000

Inventory 6,000,000

Accounts receivable 2,500,000

Equipment 3,500,000

Other assets 2,000,000

Goodwill 3,000,000

Accounts payable 3,000,000

Note payable 7,000,000

Other liabilities 1,000,000

Cash 7,000,000
In this journal entry, the debit cash of Rs.1,000,000 is the existing cash that the acquired
company, which is the XYZ company, has as of the purchasing date while the credit of cash
of Rs.7,000,000 is the purchasing price that the company ABC pays for acquiring XYZ.
Although this debit and credit of cash will be offset on the balance sheet of the consolidated
financial statements, it should not be offset in this journal entry as keeping it this way will
make it easier for review and audit of accounting transactions.

No goodwill in the individual company

In accounting, there is no goodwill recorded in the company as the individual. In other
words, goodwill will only show up in the group company’s consolidated financial statements
that include all the subsidiaries of the company.

In this case, when the company purchases another company to be its subsidiary, it will
recognize and record the amount it pays for in account of the investment in subsidiary as an
individual company.
For instance, in the example above, if the company ABC’s accountant prepares the financial
statement of ABC as an individual company, there won’t be any goodwill shown up on the
balance sheet. And the journal entry for the individual company of ABC will not have the
debit of goodwill, but the debit of investment in subsidiary account for the amount it pays
instead.

In this case, the journal entry for purchase of XYZ in the ABC’s record as an individual
company will look like below:

Account Debit Credit

Investment in subsidiary 7,000,000

Cash 7,000,000
This Rs.7,000,000 of investment in subsidiary account will be eliminated in the consolidated
financial statements of the group company. Hence, while there is no goodwill on acquisition
in the individual company, there is no investment in subsidiary in the group’s consolidated
financial statements.

It is useful to note that if the company does not pay the full amount immediately at the
purchasing date when acquiring another company, but there is a portion of cash payable in
the purchase agreement, the journal entry will include the payables account on the credit
side together with the cash account. However, the amount needed to be discounted to the
purchasing date using an appropriate discount rate.
For example, if there is an agreement to the remaining amount of Rs.1,000,000 to be paid at
the end of the next two years and the appropriate discount rate is 6% per annum, the
payable amount should be recorded as Rs.889,996.44 (1,000,000 x (1/(1+6%)^2)) instead of
Rs.1,000,000.

Rs. 1,000,000 x 1/(1+6%)^2 = Rs. 889,996.44

ALTERATION OF SHARE CAPITAL
Alteration of Share Capital refers to the changes in the existing capital structure
of the firm. A company can alter its share capital only if it is authorized by its
Articles of Association. An article of association is the document framed at the
time of incorporation of the company to govern its internal affairs.
In case of public company, the shares are being subscribed from the public. So
the limited company has to make alteration of the memorandum of association
clause also. There is a capital clause in the memorandum of association that
contains the details regarding the amount of share capital that can be raised by
the company during its lifetime. The capital clause has to be get altered by the
registrar appointed under Companies Act 2013.
PROVISIONS REGARDING ALTERATION OF SHARE CAPITAL
The following are the provisions regarding the alteration of share capital of the
company:
SECTION: 61- WAY TO ALTER SHARE CAPITAL
Section 61 of the Companies Act, 2013 states the five different ways to alter the
share capital which are as follows:
Increase in Authorized Capital: Authorized Capital is also known as Registered or
Nominal Capital. This is the capital with which company gets incorporated. The
company can increase its share capital by altering its capital clause mentioned
in the Memorandum of Association.
Consolidation of Shares: The Company can also alter its share capital by
consolidating the smaller denominations shares into larger denominations. In
case there is any change regarding voting rights of shareholders results out of
the consolidation, the permission of the tribunal or court is compulsory. In case
of consolidation of shares, the following journal entry is passed:
Share Capital (Old) A/c Dr.
To Share Capital (New) A/c
EXAMPLE: A company has 50,000 equity shares of Rs. 10 each fully paid up. A
resolution was passed to consolidate the shares into shares of Rs. 100 each. The
journal entry to be passed is as follows:
Equity share capital A/c (Rs. 10) Dr. 5,00,000
To Equity Share Capital A/c (Rs. 100) 5,00,000
(Being the consolidation of 50,000 equity shares of Rs. 100 each into 5,000
shares of Rs. 100 each fully paid up.)
Sub-Division of Shares: A company can also alter its share capital by sub dividing
the value of the shares held by the shareholders. Section 61 allows the company
to sub-divide its shares of higher denominations into smaller denominations.
The company can do so only if it is authorized by the memorandum of
association. In case there is sub-division of partly paid-up shares, the condition
to be fulfilled is that the difference between the paid-up amount and unpaid
amount continues to be the same. This way of alteration of share capital results
in the holding of more number of shares in the hands of the shareholders with
low denomination. The journal entry to be passed in this method is as follows:
Share Capital (Old) A/c Dr.
To Share Capital (New) A/c
EXAMPLE: A company has passed the resolution for conversion of 4,000 equity
shares of Rs. 10 each and Rs. 80 paid up into 10,000 equity shares of Rs. 40 each
and Rs. 32 paid up.
The journal entry will be:
Equity shares capital A/c (Rs. 100) Dr. 3,20,000
To Equity Share Capital A/c (Rs. 40) 3,20,000
(Being the sub-division of 4,000 equity shares of Rs. 100 each Rs. 80 paid up into
10,000 equity shares of Rs. 40 each Rs. 32 paid up)
Cancel the unissued shares: the company can also cancel its unissued capital.
But this does not leads to alteration of share capital. In this method, no journal
entry is passed and no treatment is done in the books of the accounts.
Conversion of shares into stock: The Company can also alter its shares capital by
converting the fully paid up shares into the stock. Stock is the aggregate of fully
paid-up shares. The company can do so only if it is authorized by its articles of
association. Also, the company can re convert its stock into shares.
The journal entries to be passed are as follows:
A) Conversion of shares into stock
Equity share capital A/c Dr.
To Equity Capital Stock A/c
B) Conversion of stock into shares
Equity Capital Stock A/c Dr.
To Equity Share Capital A/c
EXAMPLE: A company passed the resolution for conversion of 8,000 shares of
Rs. 50 each fully paid into the stock.
The journal entry to be passed is as follows:
Equity shares capital A/c Dr. 4,00,000
To equity stock A/c 4,00,000
SECTION 64- PASSING OF SPECIAL RESOLUTION
The company must pass a special resolution in the general meeting to take the
consent of the shareholders in the presence of board of directors regarding the
alteration of share capital. The special resolution must contain the details
regarding the method to be followed for the alteration of share capital along
with the value of shares to be altered.
SECTION 64- NOTICE TO REGISTRAR
The company can never alter its capital without providing the details of
alteration to the Registrar appointed under the Companies Act, 2013. The
company must furnish all the details by filing the e-Form SH-7. The notice must
be given to the registrar within 30 days of passing of the resolution.
SECTION 99- RESERVE CAPITAL
The uncalled capital of the company is known as the reserve capital or reserve
liability. This capital can be called upon only in the case of company being wound
up. So while making alteration of share capital, this capital should remain
untouched
BUY BACK OF
SHARES
CLASS 1
BUY-BACK OF SHARES

• The provisions of buy-back of shares were introduced w.e.f 31-10-1998 in the Companies Act,
1956, SEBI regulations 1999.
• Section 68 of the Companies Act, 2013 gives power to company to purchase its own shares
and other specified securities.
• Buy-back means the purchase by the buyer of something already sold by the said buyer.
• Buy-back of shares means the purchase of its own shares already issued by the company.
• It is a process by which a cash-rich company purchases and cancels some of its outstanding
equity shares
OBJECTIVES OF BUY-BACK

Increase
promoters
holding.

To improve
company P/E Increase EPS
ratio.

Pay surplus
To thwart cash not
takeover bid. required by
the business.
LEGAL PROVISIONS OF BUY-BACK

By a private
company and an
unlisted public
company :
Listed Company:
Section 67-70 of the SEBI Regulations,
Act and Rule 17 of 1998.
the Companies (
Share Capital &
Debentures) Rules,
2014.
SOURCES OF BUY-BACK • Capital Redemption Reserve
• Debenture Redemption
Reserve
• Share Forfeited Account
• Revaluation Reserve
• Profit Prior to incorporation
Free • Statutory Reserve created
under Income Tax Act
reserves
(Not available for buy
back)
Includes
premium on
Securities
issue of shares,
Premium
deb, bonds or
other financial
instrument.
Proceeds of
issue of any
shares/specified
securities Note – Buy back of
shares is not
allowed out of
proceeds of an
earlier issue of same
kind of equity
PROVISIONS
where buy back is done out of free
reserves or securities premium, then an
amount equal to the nominal value of
shares bought back must be transferred
to ‘Capital Redemption Reserve
Account’[Sec 69]

CRR can be used only for issue of fully

paid bonus shares

for purpose of Sec 68 free reserves

means reserves available for distribution
as dividend and includes balance of
securities premium account.
 Authorized
by Articles
Special
Conditions resolution
for buy
back
#Outstanding
[Section Three test share test
68]
conditions #Resource
to be test
satisfied #Debt Equity
Shares for Ratio test
buy back
must be fully
paid up
OTHER PROVISONS

• Notice of the meeting to be accompanied by explanatory statement of full disclosure of material

facts.
• Buy-back to be completed within 12 months from passing of SR.
• Methods of buy-back.
• Declaration of insolvency with SEBI
• Destroy/Extinguish securities within 7 days of last date of completion of buyback
• Must not take further issue of same kind of sec within a period of 6 months except by way of bonus
issue or in discharge of subsisting obligations.
• Maintain a register of bought back sec.
• Filing of return of buyback.
 Buy-back Methods

Open Market Purchase Tender Method

Through Book-building * Co fixes a price for buy

Through Stock Exchange process back
(at the prevailing market (buy back at a specified * Shares bought back
price) proportionately (if shares
range say, ` 40 to ` 45 per
offered for BB>shares to
share) be bought back)
PROHIBITION OF BUY-BACK (
SECTION 70)
No company shall directly or indirectly purchase its own shares
• through any subsidiary company including its own subsidiary companies; or
• Through any investment company or group of inv companies.
• If a default is subsisting in repayment of deposits or interest due thereon , redemption of deb
or pref shares, payment of div, repayment of loan etc.
If a company has not complied with section 92 ( filing of annual return), Section 123( payt of div
within 30 days of declaration), section 127 ( Failure to distribute div), section 129 ( Preparation
of BS & P & L)- prohibited from buy-back
 BUY BACK

• Three Test conditions

Resource test
• No of shares to be bought back
• = 25% of [ paid up capital + free reserves]
• Buy back price per share
 BUY BACK

• Three Test conditions

share Outstanding test
• Buy back of equity shares in any financial year must not
exceed 25% of total outstanding shares [25% of total paid up
equity capital]
BUY BACK

• Three Test conditions

Debt Equity Ratio test
• Must not be more than 2:1 after buy back
• Debt not defined in
the Act.
• Debt means something
‘owed’ so it should
include both long term
and short term debt

The number of shares which can be bought back will be minimum

of the above three figures. ( from 3 tests)
MAXIMUM NUMBER OF SHARES TO BE
BOUGHT BACK
ACCOUNTING ENTRIES
ACCOUNTING ENTRIES
ACCOUNTING ENTRIES
 CHAPTER 5

PROFIT OR LOSS PRE AND

POST INCORPORATION

LEARNING OUTCOMES
 After studying this unit, you will be able to–
 Understand the meaning of pre-incorporation profit or loss;

 Account for pre-incorporation profit or loss;

 Learn methods for computing profit or loss prior to incorporation.

© The Institute of Chartered Accountants of India

 5.2 ACCOUNTING

CHAPTER OVERVIEW
• Profit or loss of a business for the period prior to the
Pre and Post date the company came into existence is referred to as
Incorporation Pre-Incorporation Profits or Losses. The chapter deal
Profits/ Losses with the computation of such profits or losses and
treatment thereof.

1. INTRODUCTION
When a running business is taken over by the promoters of a company, as at a
date prior to the date of incorporation of company, the amount of profit or loss
of such a business for the period prior to the date the company came into
existence is referred to as pre-incorporation profits or losses. Such profits or
losses, though belonging to the company or payable by it, are of capital nature; it
is necessary to disclose them separately from trading profits or losses.
The general practice in this regard is that:
i. If there is a loss,
(a) it is either written off by debit to the Profit and Loss Account or to a
special account described as “Loss Prior to Incorporation” and show as
an “asset” in the Balance Sheet,
(b) Alternatively, it may be debited to the Goodwill Account.
ii. On the other hand, if a profit has been earned by business prior to the same
being taken over and the same is not fully absorbed by any interest payable
for the period, it is credited to Capital Reserve Account or to the Goodwill
Account, if any goodwill has been adjusted as an asset. The profit will not be
available for distribution as a dividend among the members of the
company.

2. COMPUTING PROFIT OR LOSS PRIOR TO

INCORPORATION
The determination of such profit or loss would be a simple matter if it is possible
to close the books and take the stock held by the business before the company
came into existence. In such a case, the trial balance will be abstracted from the

© The Institute of Chartered Accountants of India

 PROFIT OR LOSS PRE AND POST INCORPORATION 5.3

books and the profit or loss computed. Thereafter, the books will be either closed
off or the balance allowed continuing undistributed; only the amount of profit or
loss so determined being adjusted in the manner described above. The simplest,
though not always the most expedient method is to close off old books and open
new books with the assets and liabilities as they existed at the date of
incorporation. In this way, automatically the result to that date will be adjusted,
the difference between the values of assets and liabilities acquired and the
purchase consideration being accounted for either as goodwill or as reserve. The
accounts, therefore, would relate exclusively to the post-incorporation period and
any adjustment for the pre-incorporation period, whether an adjustment of profit
or loss, would not be required.
Since the decision to take over a business is usually takes time from the date
when it is agreed to be taken over it is normally not possible to follow any of the
method aforementioned. The only alternative left, in the circumstances, is to split
up the profit of the year of the transfer of the business to the company between
‘pre’ and ‘post’ incorporation periods. This is done either on the time basis or on
the turnover basis or by a method which combines the two.

3. BASIS OF APPORTIONMENT
Item Basis of Apportionment between pre
and Post incorporation period
Gross Profit or Gross Loss Sales Ratio-On the basis of turnover in
the respective periods (first preference)
Or
On the basis of cost of goods sold in
the respective periods in the absence
of any information regarding turnover
(second preference)
Or
Time Ratio-On the basis of time in the
respective periods in the absence of
any information regarding turnover
and cost of goods sold (third
preference)
Variable expenses linked with Sales Ratio
Turnover [e.g. Carriage/Cartage

© The Institute of Chartered Accountants of India

 5.4 ACCOUNTING

outward, Selling and distribution

expenses, Commission to selling
agents/travelling agents,
advertisement expenses, Bad debts,
Brokerage, Sales Promotion]
Fixed Common charges [e.g., Salaries, Time Ratio
Office and Administration Expenses,
Rent, Rates and Taxes, Printing and
Stationery, Telephone, Telegram and
Postage, Depreciation, Miscellaneous
Expenses]
Expenses exclusively relating to pre- Charge to pre-incorporation period
Incorporation period [e.g. Interest on (but if the purchase consideration is
Vendor’s Capital] not paid on taking over of business,
interest for the subsequent period is
charged to post incorporation period)
Expenses exclusively relating to post- Charge to Post-incorporation period
incorporation period [e.g. Formation
expenses, interest on debentures,
director’s fees, Directors’
remuneration, Preliminary Expenses,
Share issue Expenses, Underwriting
commission, Discount on issue of
securities.
Audit Fees
(i) For Company’s Audit under the Charge to Post-incorporation period
Companies Act.
(ii) For Tax Audit under section On the basis of turnover in the
44AB of the Income tax Act, respective periods
1961
Interest on purchase consideration to
vendor:
(i) For the period from the date of Charge to Pre-incorporation period
acquisition of business to date
of incorporation.
(ii) From the date of incorporation Charge to Post-incorporation period

© The Institute of Chartered Accountants of India

 PROFIT OR LOSS PRE AND POST INCORPORATION 5.5

Calculation of time ratio and sales ratio

Example
Lion Ltd. was incorporated on 1.8.20X1 to take over the running business of M/s
Happy with assets from 1.4.20X1. The accounts of the company were closed on
31.3.20X2.
The average monthly sales during the first four months of the year (20X1-X2) was
twice the average monthly sales during each of the remaining eight months.
Calculate time ratio and sales ratio for pre and post incorporation periods.
Solution
Time ratio:
Pre-incorporation period (1.4.20X1 to 1.8.20X1) = 4 months
Post incorporation period (1.8.20X1 to 31.3.20X2) = 8 months
Time ratio = 4 : 8 or 1 : 2
Sales ratio:
Average monthly sale before incorporation was twice the average sale per month
of the post incorporation period. If weightage for each post-incorporation month
is x, then
Weighted sales ratio = 4 × 2x : 8 × 1x = 8x : 8x or 1 : 1

4. PRE-INCORPORATION PROFITS & LOSSES

S. Pre-incorporation Profits Pre-incorporation Losses
No
1. It is transferred to Capital Reserve It is treated as a part of business
Account (i.e. capitalised). acquisition cost (Goodwill).
2. It can be used for : It can be used for :
• writing off Goodwill on • setting off against Post-
acquisition incorporation Profit
• writing off Preliminary Expenses • addition to Goodwill on
• writing down over-valued assets acquisition
• issuing of bonus shares • writing off Capital Profit
• paying up partly paid shares

© The Institute of Chartered Accountants of India

 5.6 ACCOUNTING

Illustration 1
Rama Udyog Limited was incorporated on August 1, 20X1. It had acquired a
running business of Rama & Co. with effect from April 1, 20X1. During the year
20X1-X2, the total sales were ` 36,00,000. The sales per month in the first half year
were half of what they were in the later half year. The net profit of the company,
` 2,00,000 was worked out after charging the following expenses:
(i) Depreciation ` 1,23,000, (ii) Directors’ fees ` 50,000, (iii) Preliminary expenses
` 12,000, (iv) Office expenses ` 78,000, (v) Selling expenses ` 72,000 and
(vi) Interest to vendors upto August 31, 20 X1 ` 5,000.
Please ascertain pre-incorporation and post-incorporation profit for the year ended
31st March, 20X2.
Solution
Statement showing pre and post incorporation profit
for the year ended 31st March, 20X2

Particulars Total Basis of Pre- Post-

Amount Allocation incorporation Incorporation
` ` `
Gross Profit (W.N.3) 5,40,000 2:7 1,20,000 4,20,000
Less: Depreciation 1,23,000 1:2 41,000 82,000
Director’s Fees 50,000 Post - 50,000
Preliminary 12,000 Post - 12,000
Expenses
Office Expenses 78,000 1:2 26,000 52,000
Selling Expenses 72,000 2:7 16,000 56,000
Interest to 5,000 Actual 4,000 1,000
vendors
Net Profit (` 33,000
being pre-
incorporation profit is 2,00,000 33,000 1,67,000
transferred to capital
reserve Account)

© The Institute of Chartered Accountants of India

 PROFIT OR LOSS PRE AND POST INCORPORATION 5.7

Working Notes:
1. Sales ratio
The sales per month in the first half year were half of what they were in the
later half year. If in the later half year, sales per month is x then it should be
.5 x per month in the first half year. So sales for the first four months (i.e.
from 1st April, 20X1 to 31st July, 20X1) will be 4 × .50 = ` 2 and for the last
eight months (i.e. from 1st August, 20 X1 to 31st March, 20X2) will be (2 × .50
+ 6 × 1) = ` 7. Thus sales ratio is 2:7.
2. Time ratio
1st April, 20X1 to 31st July, 20X1 : 1st August, 20X1 to 31st March, 20X2
= 4 months: 8 months = 1:2
Thus, time ratio is 1:2.
3. Gross profit
Gross profit = Net profit + All expenses
= ` 2,00,000 + ` (1,23,000+50,000+12,000+78,000+72,000+5,000)
= ` 2,00,000 +` 3,40,000 = ` 5,40,000.
Illustration 2
The promoters of Glorious Ltd. took over on behalf of the company a running
business with effect from 1st April, 20X1. The company got incorporated on 1st
August, 20X1. The annual accounts were made up to 31st March, 20X2 which
revealed that the sales for the whole year totalled ` 1,600 lakhs out of which sales
till 31st July, 20X1 were for ` 400 lakhs. Gross profit ratio was 25%.
The expenses from 1st April 20X1, till 31st March, 20X2 were as follows:

(` in lakhs)
Salaries 69
Rent, Rates and Insurance 24
Sundry Office Expenses 66
Travellers' Commission 16
Discount Allowed 12

© The Institute of Chartered Accountants of India

 5.8 ACCOUNTING

Bad Debts 4
Directors' Fee 25
Tax Audit Fee 9
Depreciation on Tangible Assets 12
Debenture Interest 11

Prepare a statement showing the calculation of Profits for the pre-incorporation

and post-incorporation periods.

Solution
Statement showing the calculation of Profits for the pre-incorporation and
post-incorporation periods

Particulars Total Basis of Pre- Post-

Amount Allocation incorporation incorporation
(` in lakhs) (` in lakhs) (` in lakhs)
Gross Profit (25% of 400 Sales 100 300
` 1,600)
Less: Salaries 69 Time 23 46
Rent, rates and 24 Time 8 16
Insurance
Sundry office 66 Time 22 44
expenses
Travellers’ 16 Sales 4 12
commission
Discount allowed 12 Sales 3 9
Bad debts 4 Sales 1 3
Directors’ fee 25 Post - 25
Tax Audit Fees 9 Sales 2.25 6.75
Depreciation on 12 Time 4 8
tangible assets
Debenture interest 11 Post - 11
Net profit 152 32.75 119.25

© The Institute of Chartered Accountants of India

 PROFIT OR LOSS PRE AND POST INCORPORATION 5.9

Working Notes:
1. Sales ratio

(` in lakh)
Sales for the whole year 1,600
Sales up to 31st July, 20X1 400
Therefore, sales for the period from 1 August, 20X1 to 31
st st
1,200
March, 20X2

Thus, sale ratio = 400:1200 = 1:3

2. Time ratio
1st April, 20X1 to 31st July, 20X1 : 1st August, 20X1 to 31st March, 20X2
= 4 months: 8 months = 1:2
Thus, time ratio is 1:2.
Illustration 3
Inder and Vishnu, working in partnership registered a joint stock company under
the name of Fellow Travellers Ltd. on May 31, 20X1 to take over their existing
business. It was agreed that they would take over the assets of the partnership from
January 1st, 20X1 for a sum of ` 3,00,000 and that until the amount was discharged
they would pay interest on the amount at the rate of 6% per annum. The amount
was paid on June 30, 20X1. To discharge the purchase consideration, the company
issued 20,000 equity shares of ` 10 each at a premium of ` 1 each and allotted 7%
Debentures of the face value of ` 1,50,000 to the vendors at par.
The summarised Profit and Loss Account of the “Fellow Travellers Ltd.” for the year
ended 31st December, 20X1 was as follows:
` `
To Purchase, including 1,40,000 By Sales:
Inventory
To Freight and carriage 5,000 1st January to 31st May 60,000
20X1
To Gross Profit c/d 60,000 1st June to 31st Dec., 1,20,000
20X1
By Inventory in hand 25,000
2,05,000 2,05,000

© The Institute of Chartered Accountants of India

 5.10 ACCOUNTING

To Salaries and Wages 10,000 By Gross profit b/d 60,000

To Debenture Interest 5,250
To Depreciation 1,000
To Interest on purchase
Consideration (up to 30-6- 9,000
20X1)
To Selling commission 9,000
To Directors’ Fee 600
To Preliminary expenses 900
To Provision for taxes 6,000
(entirely related with
company)
To Dividend paid on equity 5,000
shares @ 5%
To Balance c/d 13,250
60,000 60,000

Prepare statement apportioning the expenses and calculate profits/losses for the
‘post’ and ‘pre-incorporation’ periods and also show how these figures would
appear in the Balance Sheet of the company.
Solution
Fellow Travellers Ltd.
Statement showing calculation of profit /losses for pre and post
incorporation periods
Pre- Post-
Ratio incorporation incorporation
Gross profit allocated on the basis of 1:2 20,000 40,000
sale
Less: Administrative Expenses
allocated
On time basis:
(i) Salaries and wages 10,000
(ii) Depreciation 1,000
11,000 5:7 4,583 6,417

© The Institute of Chartered Accountants of India

 PROFIT OR LOSS PRE AND POST INCORPORATION 5.11

Selling Commission on the basis 1:2 3,000 6,000

of sales
Interest on Purchase
Consideration (Time basis) 5:1 7,500 1,500
Expenses applicable wholly to the
Post-incorporation period:
Debenture Interest 5,250
(1,50,000 x 7% x 6/12)
Director’s Fee 600 5,850
Preliminary expenses 900
Provision for taxes 6,000
Balance c/d to Balance Sheet 4,917 13,333
Time Ratio
Pre incorporation period = 1 January 20X1 to 31 May 20X1 = 5 months
Post incorporation period = 1 June 20X1 to 31 December 20X1 = 7 months
Time ratio = 5: 7
Sales Ratio
Sales in pre incorporation period (1 January 20X1 to 31 May 20X1) = ` 60,000
Sales in post incorporation period (1 June 20X1 to 31 December 20X1) = ` 1,20,000
Sales ratio = 1:2
Fellow Travellers Ltd.
Extract from the Balance Sheet as on 31st Dec., 20X1

Particulars Notes `
Equity and Liabilities
1 Shareholders' funds
a Share capital 1 2,00,000
b Reserves and Surplus 2 33,250
2 Non-current liabilities
a Long-term borrowings 3 1,50,000

© The Institute of Chartered Accountants of India

 5.12 ACCOUNTING

3 Current liabilities
a Short term provisions 4 6,000
Total 3,89,250

Notes to accounts

`
1. Share Capital
20,000 equity shares of ` 10 each fully paid 2,00,000
2. Reserves and Surplus
Profit Prior to Incorporation 4,917
Securities Premium Account 20,000
Profit and loss Account 13,333
Less: Dividend on equity share (5,000) 8,333
Total 33,250
3. Long term borrowings
Secured
7% Debentures 1,50,000
4. Other Current liabilities
Provision for Taxes 6,000

Illustration 4
The partners of Maitri Agencies decided to convert the partnership into a private
limited company called MA (P) Ltd. with effect from 1st January, 20X2. The
consideration was agreed at ` 1,17,00,000 based on the firm’s Balance Sheet as at
31st December, 20X1. However, due to some procedural difficulties, the company
could be incorporated only on 1st April, 20X2. Meanwhile the business was
continued on behalf of the company and the consideration was settled on that day
with interest at 12% per annum. The same books of account were continued by the
company which closed its account for the first time on 31st March, 20X3 and
prepared the following summarised profit and loss account.

`
Sales 2,34,00,000
Less: Cost of goods sold 1,63,80,000
Salaries 11,70,000

© The Institute of Chartered Accountants of India

 PROFIT OR LOSS PRE AND POST INCORPORATION 5.13

Depreciation 1,80,000
Advertisement 7,02,000
Discounts 11,70,000
Managing Director’s remuneration 90,000
Miscellaneous office expenses 1,20,000
Office-cum-show room rent 7,20,000
Interest 9,51,000 2,14,83,000
Profit 19,17,000

The company’s only borrowing was a loan of ` 50,00,000 at 12% p.a. to pay the
purchase consideration due to the firm and for working capital requirements.
The company was able to double the average monthly sales of the firm, from 1st
April, 20X2 but the salaries tripled from that date. It had to occupy additional space
from 1st July, 20X2 for which rent was ` 30,000 per month.
Prepare statement of apportioning cost and revenue between pre-incorporation and
post-incorporation periods and calculation of profits/losses for such periods
Solution
MA (P) Ltd.
Statement showing calculation of profit/losses for pre and post
incorporation periods

Basis of Pre-inc. Post-inc.

allocation
` `
Sales Sales ratio 26,00,000 2,08,00,000
Less: Cost of goods sold Sales ratio 18,20,000 1,45,60,000
Salaries W.N.4 90,000 10,80,000
Depreciation Time ratio 36,000 1,44,000
Advertisement Sales ratio 78,000 6,24,000
Discounts Sales ratio 1,30,000 10,40,000
M.D.’s remuneration Post-inc — 90,000
Misc. Office Expenses Time ratio 24,000 96,000

© The Institute of Chartered Accountants of India

 5.14 ACCOUNTING

Rent W.N.5 90,000 6,30,000

Interest Time ratio 3,51,000 6,00,000
Net Profit/(Loss) (19,000) 19,36,000

Working Notes:
(1) Calculation of Sales ratio:
Let the average sales per month in pre-incorporation period be x. Then the
average sales in post-incorporation period are 2x. Thus total sales are (3 ×
x) + (12 × 2x) or 27x. Ratio of sales will be 3x : 24x or 1:8.
Time ratio is 3 months: 12 months or 1:4
(2) Expenses apportioned on turnover ratio basis are cost of goods sold,
advertisement, discounts.
(3) Expenses apportioned on time ratio basis are Depreciation, and misc. office
expenses.
(4) Ratio for apportionment of Salaries:
If pre-incorporation monthly average is x, for 3 months 3x.
Average for balance 12 months 3x, for 12 months 36x.
Hence ratio for division, 1:12.
(5) Apportionment of Rent:
`
Total Rent 7,20,000
Additional rent for 9 months (From 1st July 20X2 to (2,70,000)
31st March, 20X3)
Rent for old premises for 15 months at ` 30,000 4,50,000
p.m.
Pre-inc. Post-inc.
Old Premises 90,000 3,60,000
Additional rent — 2,70,000
90,000 6,30,000

© The Institute of Chartered Accountants of India

 PROFIT OR LOSS PRE AND POST INCORPORATION 5.15

Illustration 6
ABC Ltd. took over a running business with effect from 1st April, 20X1. The
company was incorporated on 1 st August, 20X1. The following summarised Profit
and Loss Account has been prepared for the year ended 31.3.20X2:
` `
To Salaries 48,000 By Gross profit 3,20,000
To Stationery 4,800
To Travelling expenses 16,800
To Advertisement 16,000
To Miscellaneous trade 37,800
expenses
To Rent (office buildings) 26,400
To Electricity charges 4,200
To Director’s fee 11,200
To Bad debts 3,200
To Commission to selling 16,000
agents
To Tax Audit fee 6,000
To Debenture interest 3,000
To Interest paid to vendor 4,200
To Selling expenses 25,200
To Depreciation on fixed assets 9,600
To Net profit 87,600
3,20,000 3,20,000

Additional information:
(a) Total sales for the year, which amounted to ` 19,20,000 arose evenly up to
the date of 30.9.20X1. Thereafter they recorded an increase of two-third
during the rest of the year.
(b) Rent of office building was paid @ ` 2,000 per month up to September, 20X1
and thereafter it was increased by ` 400 per month.
(c) Travelling expenses include ` 4,800 towards sales promotion.

© The Institute of Chartered Accountants of India

 5.16 ACCOUNTING

(d) Depreciation include ` 600 for assets acquired in the post incorporation
period.
(e) Purchase consideration was discharged by the company on 30 th September,
20X1 by issuing equity shares of ` 10 each.
Prepare Statement showing calculation of profits and allocation of expenses
between pre and post incorporation periods.
Solution
Statement showing calculation of profits for pre and post incorporation
periods for the year ended 31.3.20X2

Particulars Pre-incorpo- Post- incorpo-

ration period ration period
` `
Gross profit (1:3) 80,000 2,40,000
Less: Salaries (1:2) 16,000 32,000
Stationery (1:2) 1,600 3,200
Advertisement (1:3) 4,000 12,000
Travelling expenses (W.N.4) 4,000 8,000
Sales promotion expenses (W.N.4) 1,200 3,600
Misc. trade expenses (1:2) 12,600 25,200
Rent (office building) (W.N.3) 8,000 18,400
Electricity charges (1:2) 1,400 2,800
Director’s fee (post-incorporation) - 11,200
Bad debts (1:3) 800 2,400
Selling agents commission (1:3) 4,000 12,000
Audit fee (1:3) 1,500 4,500
Debenture interest (post-incorporation) - 3,000
Interest paid to vendor (2:1) (W.N.5) 2,800 1,400
Selling expenses (1:3) 6,300 18,900
Depreciation on fixed assets (W.N.6) 3,000 6,600
Capital reserve (Bal.Fig.) 12,800 -
Net profit (Bal.Fig.) - 74,800

© The Institute of Chartered Accountants of India

 PROFIT OR LOSS PRE AND POST INCORPORATION 5.17

Working Notes:
1. Time Ratio
Pre incorporation period = 1st April, 20X1 to 31st July, 20X1
i.e. 4 months
Post incorporation period is 8 months
Time ratio is 1: 2.
2. Sales ratio
Let the monthly sales for first 6 months (i.e. from 1.4.20X1 to 30.09. 20X1)
be x
Then, sales for 6 months = 6x
2 5
Monthly sales for next 6 months (i.e. from 1.10.X1 to 31.3.20X2) = x + x= x
3 3
5
Then, sales for next 6 months = x X 6 = 10x
3
Total sales for the year = 6x + 10x = 16x
Monthly sales in the pre incorporation period = ` 19,20,000/16 = ` 1,20,000
Total sales for pre-incorporation period = ` 1,20,000 x 4 = ` 4,80,000
Total sales for post incorporation period = ` 19,20,000 – ` 4,80,000 =
` 14,40,000
Sales Ratio = 4,80,000 : 14,40,000 = 1 : 3
3. Rent

`
Rent for pre-incorporation period (` 2,000 x 4) 8,000 (pre)
Rent for post incorporation period
August,20X1 & September, 20X1 (` 2,000 x 2) 4,000
October,20X1 to March,20X2 (` 2,400 x 6) 14,400 18,400 (post)

4. Travelling expenses and sales promotion expenses

Pre Post
` `
Traveling expenses ` 12,000 (i.e. ` 16,800-

© The Institute of Chartered Accountants of India

 5.18 ACCOUNTING

` 4,800) distributed in Time ratio (1:2) 4,000 8,000

Sales promotion expenses ` 4,800 distributed 1,200 3,600
in Sales ratio (1:3)

5. Interest paid to vendor till 30th September, 20X1

Pre Post
` `
 ` 4,200  2,800
Interest for pre-incorporation period  ×4
 6 
Interest for post incorporation period i.e. for
 ` 4,200  1,400
August, 20X1 & September, 20X1 =  ×2
 6 
6. Depreciation

Pre Post
` `
Total depreciation 9,600
Less: Depreciation exclusively for post 600
incorporation period 600
Remaining (for pre and post incorporation
period) 9,000
Depreciation for pre-incorporation period
 4 3,000
9,000 × 12  *
 
Depreciation for post incorporation period
 8 6,000
9,000 × 12  *
 
* Time ratio = 1 : 2 3,000 6,600

Illustration 7
ABC Ltd. was incorporated on 1.5.20X1 to take over the business of DEF and Co.
from 1.1.20X1. The summarised Profit and Loss Account as given by ABC Ltd. for
the year ending 31.12.20X1 is as under:

© The Institute of Chartered Accountants of India

 PROFIT OR LOSS PRE AND POST INCORPORATION 5.19

Summarised Profit and Loss Account

` `
To Rent and Taxes 90,000 By Gross Profit 10,64,000
To Salaries including By Interest on 36,000
manager’s salary of 3,31,000 Investments
` 85,000
To Carriage Outwards 14,000
To Printing and Stationery 18,000
To Interest on Debentures 25,000
To Sales Commission 30,800
To Bad Debts (related to sales) 91,000
To Underwriting Commission 26,000
To Preliminary Expenses 28,000
To Audit Fees 45,000
To Loss on Sale of Investments 11,200
To Net Profit 3,90,000
11,00,000 11,00,000

Prepare a Statement showing allocation of expenses and calculations of pre-

incorporation and post-incorporation profits after considering the following
information:
(i) G.P. ratio was constant throughout the year.
(ii) Sales for January and October were 1½ times the average monthly sales
while sales for December were twice the average monthly sales.
(iii) Bad Debts are shown after adjusting a recovery of ` 7,000 of Bad Debt for a
sale made in July, 20X0.
(iv) Manager’s salary was increased by ` 2,000 p.m. from 1.5.20X1.
(v) All investments were sold in April, 20X1.
(vi) The entire audit fees relates to the company.

© The Institute of Chartered Accountants of India

 5.20 ACCOUNTING

Solution
Pre-incorporation period is for four months, from 1st January, 20X1 to 30th April,
20X1. 8 months’ period (from 1st May, 20X1 to 31st December, 20X1) is post-
incorporation period.
Statement showing calculation of profit/losses for pre and post
incorporation periods
Pre-Inc Post inc
` `
Gross Profit 3,42,000 7,22,000
Interest on Investments 36,000 −
Bad debts Recovery 7,000 −
3,85,000 7,22,000
Less : Rent and Taxes 30,000 60,000
Salaries
Manager’s salary (85,000- refer note below) 23,000 62,000
Other salaries (3,31,000 – 85,000) 82,000 1,64,000
Printing and stationery 6,000 12,000
Audit fees - 45,000
Carriage outwards 4,500 9,500
Sales commission 9,900 20,900
Bad Debts (91,000 + 7,000) 31,500 66,500
Interest on Debentures − 25,000
Underwriting Commission − 26,000
Preliminary expenses − 28,000
Loss on sale of investments 11,200 −
Net Profit 1,86,900 2,03,100

Working Notes:
(i) Calculation of Sales ratio
Let average monthly sales be x.
Thus Sales from January to April are 4½ x (i.e., 1.5x + x + x + x) and sales
from May to December are 9½ x (x + x + x + x + x + 1.5x + x + 2x).
Sales are in the ratio of 9/2x : 19/2x or 9 : 19.

© The Institute of Chartered Accountants of India

 PROFIT OR LOSS PRE AND POST INCORPORATION 5.21

Calculation of Time Ratio

Pre-incorporation period = 1.1.20X1 to 30.4.20X1 = 4 months
Post-incorporation period = 1.5.20X1 to 31.12.20X1 = 8 months
Time ratio = 1:2
(ii) Gross profit, carriage outwards, sales commission and bad debts written off
(after adjustment for bad debt recovery) have been allocated in pre and
post incorporation periods in the ratio of Sales i.e. 9 : 19.
(iii) Rent, salaries (subject to increase in manager’s salary), printing and
stationery are allocated on time basis.
(iv) Interest on debentures, underwriting commission and preliminary expenses
are allocated in post incorporation period.
(v) Interest on investments, loss on sale of investments and bad debt recovery
are allocated in pre-incorporation period.
Note
Let Pre-incorporation period manager’s monthly salary be x
Total pre-incorporation period manager’s monthly salary = 4x
Post-incorporation period manager’s monthly salary = x + 2,000
Total pre-incorporation period manager’s monthly salary = 8(x+2,000)
Total manager’s salary (pre and post) = ` 85,000
Thus, 4x + 8(x+2,000) = 85,000
x = 5,750
Total pre-incorporation period manager’s monthly salary = 4 x 5,750 = ` 23,000
Total pre-incorporation period manager’s monthly salary = 8(5,750 + 2,000) =
` 62,000

SUMMARY
♦ Profit or loss of a business for the period prior to the date the company
came into existence is referred to as Pre-Incorporation Profit or Loss.
♦ such profit/ loss is disclosed separately from normal trading profits/losses
of the business in the financial statements of the business entity.

© The Institute of Chartered Accountants of India

 5.22 ACCOUNTING

TEST YOUR KNOWLEDGE

MCQ
1. Profit prior to incorporation is transferred to
(a) General reserve.
(b) Capital reserve.
(c) Profit and loss account.
2. The profit earned by the company from the date of purchase to the date of
incorporation is
(a) Pre- incorporation profit.
(b) Post- incorporation profit.
(c) Notional profit.
3. Loss prior to incorporation is debited to which account?
(a) Goodwill account
(b) Loss prior to incorporation account
(c) Either (a) or (b)
4. Profit prior to incorporation is
(a) Available for distribution as dividend among the members of the
company.
(b) Not available for distribution as dividend among the members of the
company.
(c) Depends upon the Memorandum of Association.
5. Profit or loss prior to incorporation is of
(a) Revenue nature.
(b) Capital nature.
(c) Nominal nature.
6. Which of the following expenditure is allocated on the basis of time?
(a) Insurance.
(b) Bad debts.

© The Institute of Chartered Accountants of India

 PROFIT OR LOSS PRE AND POST INCORPORATION 5.23

(c) Discount allowed.

7. Which of the following is allocated on the basis of turnover?
(a) Salaries.
(b) Depreciation.
(c) Gross profit.
8. Preliminary expenses on the formation of the company are charged against
(a) Pre-incorporation profit.
(b) Post- incorporation profit.
(c) Not calculated because of bifurcation of profit into pre and post.
9. Which of the following expense is not allocated on time basis?
(a) Rent
(b) Salaries
(c) Discounts.
THEORETICAL QUESTIONS

1. Define Pre–incorporation profit/loss in brief.

PRACTICAL QUESTIONS
Question 1
Sneha Ltd. was incorporated on 1st July, 20X1 to acquire a running business of
Atul Sons with effect from 1st April, 20X1. During the year 20X1-X2, the total sales
were ` 24,00,000 of which ` 4,80,000 were for the first six months. The Gross
profit of the company ` 3,90,800. The expenses debited to the Profit & Loss
Account included:
(i) Director's fees ` 30,000
(ii) Bad debts ` 7,200
(iii) Advertising ` 24,000 (under a contract amounting to ` 2,000 per month)
(iv) Salaries and General Expenses ` 1,28,000
(v) Preliminary Expenses written off ` 10,000
(vi) Donation to a political party given by the company ` 10,000.

© The Institute of Chartered Accountants of India

 5.24 ACCOUNTING

Prepare a statement showing pre-incorporation and post-incorporation profit for

the year ended 31st March, 20X2.
Question 2
The partners Kamal and Vimal decided to convert their existing partnership
business into a Private Limited Company called M/s. KV Trading Private Ltd. with
effect from 1-7-20X2.
The same books of accounts were continued by the company which closed its
account for first term on 31-3-20X3.
The summarised Profit and Loss Account for the year ended 31-3-20X3 is below:

(`) in lakhs (`) in lakhs

Turnover 240.00
Interest on investments 6.00
246.00
Less: Cost of goods sold 102.00
Advertisement 3.00
Sales Commission 6.00
Salary 18.00
Managing director’s remuneration 6.00
Interest on Debentures 2.00
Rent 5.50
Bad Debts 1.00
Underwriting Commission 2.00
Audit fees 2.00
Loss on sale of investment 1.00
Depreciation 4.00 152.50
93.50

The following additional information was provided:

(i) The average monthly sales doubled from 1-7-20X2. GP ratio was constant.
(ii) All investments were sold on 31-5-20X2.

© The Institute of Chartered Accountants of India

 PROFIT OR LOSS PRE AND POST INCORPORATION 5.25

(iii) Average monthly salary doubled from 1-10-20X2.

(iv) The company occupied additional space from 1-7-20X2 for which rent of `
20,000 per month was incurred.
(v) Bad debts recovered amounting to ` 50,000 for a sale made in 20X0, has
been deducted from bad debts mentioned above.
(vi) Audit fees pertains to the company.
Prepare a statement apportioning the expenses between pre and post
incorporation periods and calculate the Profit/Loss for such periods.
Question 3
SALE Limited was incorporated on 01.08.20X1 to take-over the business of a
partnership firm w.e.f. 01.04.20X1. The following is the extract of Profit and Loss
Account for the year ended 31.03.20X2:

Particulars Amount (`) Particulars Amount (`)

To Salaries 1,20,000 By Gross Profit 6,00,000
To Rent, Rates & Taxes 80,000
To Commission on Sales 21,000
To Depreciation 25,000

To Director Fees 12,000

To Advertisement 36,000
To Net Profit for the Year 2,74,000
6,00,000 6,00,000

(i) SALE Limited initiated an advertising campaign which resulted increase in

monthly average sales by 25% post incorporation.
(ii) The Gross profit ratio post incorporation increased to 30% from 25%.
You are required to apportion the profit for the year between pre-incorporation
and post-incorporation, also explain how pre-incorporation profit is treated in the
accounts.

© The Institute of Chartered Accountants of India

 5.26 ACCOUNTING

ANSWERS/ HINTS
MCQ
[1. (b), 2. (a), 3. (c), 4. (b), 5. (b),6. (a), 7. (c),8. (b),9.(c)]

THEORETICAL QUESTIONS
1. Refer para 1 of the chapter.

PRACTICAL QUESTIONS
Answer 1
Statement showing the calculation of Profits for the pre-incorporation and
post-incorporation periods
For the year ended 31st March, 20X2
Particulars Total Basis of Pre- Post-
Amount Allocation incorporat incorporat
ion ion
Gross Profit 3,90,800 Sales 39,080 3,51,720
Less: Directors’ fee 30,000 Post - 30,000
Bad debts 7,200 Sales 720 6,480
Advertising 24,000 Time 6,000 18,000
Salaries & general 1,28,000 Time 32,000 96,000
expenses
Preliminary expenses 10,000 Post 10,000
Donation to Political 10,000 Post 10,000
Party
Net Profit 1,81,600 1,81,240
Pre-incorporation profit 360
transfer to Capital Reserve
Working Notes:
1. Sales ratio

Particulars `
Sales for period up to 30.06.20X1 (4,80,000 x 3/6) 2,40,000
Sales for period from 01.07.20X1 to 31.03.20X2 (24,00,000 – 2,40,000) 21,60,000

Thus, Sales Ratio = 1 : 9

© The Institute of Chartered Accountants of India

 PROFIT OR LOSS PRE AND POST INCORPORATION 5.27

2. Time ratio
1st April, 20X1 to 30 June, 20X1: 1st July, 20X1 to 31st March, 20X2
= 3 months: 9 months = 1: 3
Thus, Time Ratio is 1: 3
Answer 2
K V Trading Private Limited
Statement showing calculation of profit/loss for pre and post incorporation
periods
` in lakhs
Ratio Total Pre Post
Incorporation Incorporation
Sales 1:6 240.00 34.29 205.71
Interest on Investments Pre 6.00 6.00 -
Bad debts recovered Pre 0.50 0.50 -
(i) 246.50 40.79 205.71
Cost of goods sold 1:6 102.00 14.57 87.43
Advertisement 1:6 3.00 0.43 2.57
Sales commission 1:6 6.00 0.86 5.14
Salary (W.N.3) 1:5 18.00 3.00 15.00
Managing directors Post 6.00 - 6.00
remuneration Post 2.00 - 2.00
Interest on Debentures 5.50 0.93 4.57
Rent (W.N.4) 1:6 1.50 0.21 1.29
Bad debts (1 + 0.5) Post 2.00 - 2.00
Underwriting commission Post 2.00 - 2.00
Audit fees Pre 1.00 1.00 -
Loss on sale of Investment 1:3 4.00 1.00 3.00
Depreciation
(ii) 153.00 22.00 131.00
Net Profit [(i) – (ii)] 93.50 18.79 74.71
Working Notes:
1. Calculation of Sales Ratio
Let the average sales per month be x

© The Institute of Chartered Accountants of India

 5.28 ACCOUNTING

Total sales from 01.04.20X2 to 30.06.20X2 will be 3x

Average sales per month from 01.07.20X2 to 31.03.20X3 will be 2x
Total sales from 01.07.20X2 to 31.03.20X3 will be 2x X 9 =18x
Ratio of Sales will be 3x: 18x i.e. 3:18 or 1:6
2. Calculation of time Ratio
3 Months: 9 Months i.e. 1:3
3. Apportionment of Salary
Let the salary per month from 01.04.20X2to 30.09.20X2 is x
Salary per month from 01.10.20X2 to 31.03.20X3 will be 2x
Hence, pre incorporation salary (01.04.20X2 to 30.06.20X2) = 3x
Post incorporation salary from 01.07.20X2 to 31.03.20X3 = (3x + 12x) i.e.15x
Ratio for division 3x: 15x or 1: 5
4. Apportionment of Rent ` Lakhs
Total Rent 5.5
Less: additional rent from 1.7.20X2 to 31.3.20X3 1.8
Rent of old premises for 12 months 3.7
Pre Post
Apportionment in time ratio 0.925 2.775
Add: Rent for new space - 1.80
Total 0.925 4.575
Answer 3
Statement showing the calculation of Profits for the pre-incorporation and
post-incorporation periods
Particulars Total Basis of Pre- Post-
Amount Allocation incorporation incorporation
` ` `
Gross Profit (W.N.2) 6,00,000 1:3 1,50,000 4,50,000
Less: Salaries 1,20,000 Time 40,000 80,000
Rent, rates and taxes 80,000 Time 26,667 53,333
Sales’ commission 21,000 Sales (2:5) 6,000 15,000

© The Institute of Chartered Accountants of India

 PROFIT OR LOSS PRE AND POST INCORPORATION 5.29

Depreciation 25,000 Time 8,333 16,667

Interest on debentures 32,000 Post 32,000
Directors’ fee 12,000 Post 12,000
Advertisement 36,000 post 36,000
Net profit 2,74,000 69,000 2,05,000
Working Notes:
1. Sales ratio
Let the monthly sales for first 4 months (i.e. from 1.4.20X1 to 31.7.20X1) be
=x
Then, sales for 4 months = 4x
Monthly sales for next 8 months (i.e. from 1.8.X1 to 31.3.20X2) = x + 25% of
x= 1.25x
Then, sales for next 6 months = 1.25x X 8 = 10x
Total sales for the year = 4x + 10x = 14x
Sales Ratio = 4 x :10x i.e. 2:5
2. Gross profit ratio
From 1.4.20X1 to 31.7.20X1 gross profit is 25% of sales
Then, 25% of 4x= 1x
gross profit for next 8 months (i.e. from 1.8.X1 to 31.3.20X2) is 30%
Then, 30% of 10x = 3x
Therefore gross profit ratio will be 1:3
3. Time ratio
1st April, 20X1 to 31st July, 20X1 : 1st August, 20X1 to 31st March, 20X2
= 4 months: 8 months = 1:2
Thus, time ratio is 1:2.

© The Institute of Chartered Accountants of India