UNIT 3

Module 3

COMPANY ACCOUNTS

Introduction to Company
Accounts

The word company is derived from the Latin word, companies, ‗ come‘

meaning together and ‗panis‘ meaning bread. So, companies means earning

bread together. This word came to be substituted to company which means

carrying on a enterprise together.

A company is a voluntary association of persons formed for some common

purpose, with capital divisible into parts, known as shares and with limited liability.

It exists only in the eye of law and it may also be described as an artificial person

created by law, having perpetual succession and a common seal.

On basis of the definitions, it becomes clear that a company is an association of

persons which has a name of its own, a Joint capital and as a separate legal

personality.

Features of a company

1. Separate legal assistance

2. Limited liability
3. Transfer of shares
4. Separate property
5. Perpetual succession
6. Ownership divorced from

management. Differences between

Basis of Partnership Company
Partnership
Distinction and a company

Law It is regulated by the It is regulated by the

IndianPartnership Act IndianCompanies Act 1956
1932

Number of Minimum number is two In the case of public company, the

members Maximum is 20 but in the case of a minimum number is 7 without any
banking business it is 10 maximum limit. A private company
1 must have atleast two members
but not more than 50
Transfer A partner cannot transfer his The shares of a public
of shares interest in the firm without the company are freely
consent of all other partners transferable.
Audit A partnership firm is under no Books of accounts of companies
obligation to get its annual must be audited by qualified
accounts audited by qualified persons.
auditors
Book It is not compulsory to maintain A company must maintain
any books of account though proper books of account and
normally they are maintained other books required under
the law, called statutory
books
Registration Law provides for registration of Every company is to be
partnership but it is not compulsorily registered either
compulsory under the companies act or
under the special act which has
created it.
Duration Death, Insolvency of a partner A company is independent of
has the effect of dissolving the lives of its members. The
the partnership company continuous its affairs
unaffected even if there is a
total change in its membership

Kinds of companies

(i) Chartered companies

The earliest companies to be established in Great

Britain were granted royal charters by the King or

Queen of England. The charters granted the

companies certain specified rights and privileges

of trade.

(ii) Statutory companies

Such companies are established by a special Act

of the Central or State legislatures they are

governed by the Special Act as well as the

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 company law.

(iii) Registered companies

A company which is established and registered

under the Companies Act 1956 or any preceding

companies act is known as a registered company.

Registered companies account for the largest

number of companies in India.

(iv) Limited companies

Such companies are registered under the

Companies Act and have an authorized capital

divided into a specified number of shares. The liability

of each shareholder is limited to the extent of the

amount of shares held by him and on which he has

paid full amount.

(v) Guarantee companies

Like members of a company limited by shares, the

members of a company limited by guarantee also

have limited liability. But their liability is limited by the

Memorandum to the amount which they had

guaranteed to pay in the event of winding up of the

company. Companies limited by guarantee are not

formed for the purpose of profit but for the promotion

of Art, Science, Culture, Religion, Charity, Literature,

Sport, Commerce or for any other similar purpose. A

company limited by guarantee may also have share

capital. But the amount guaranteed to be paid by

each member on its winding up is in the nature of its

reserve capital.

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(vi) Unlimited companies

Liability of shareholders of such companies is

unlimited similar to that of partners in a partnership

organization. Such companies do not exist in India.

They may or may not have share capital.

(vii) Private companies

A private company is a company which by its articles.

It restricts the right of its members to transfer shares.

It limits the numbers of its members to fifty excluding

the present and past employee members of the

company and prohibits any invitation to the public to

subscribe for any shares in or debentures of the

company. A private company must use the words

‗Private Limited‘ after its name.

(viii) Public companies

Such companies are registered under the Companies

Act. They invite subscriptions from public in the form

of shares and debentures which can be freely

transferred to others through an open sale at the

stock exchanges. The size of members here is not

limited to fifty, through its Articles of Association.

Unlike a sole proprietorship or partnership, company

accounts have a different format. Here we have to account for

the different ownership structure (shares, debentures).

Company Law also has a definite format for the final accounts

of a company. Let us study company accounts and their

format.

Basic Concepts of Company Accounts

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A company is a voluntary association of people who contribute

money for a common purpose. A company is an artificial

person and a separate legal entity. Let us now understand the

basic concepts of company accounts. The contribution of

money by people forms the capital of the company and the

contributors are its members. Hence, the capital of a company

is known as share capital and the contributors as shareholders.

Indian Companies Act, 2013 governs all companies and

provides guidelines for them to adhere to.

Basic Concepts of Company Accounts

Meaning of Shares

Section 2(84) of the Companies Act, 2013 defines share

as a share in the share capital of a company and it includes

stock. The share capital of a company is divided into units of

smaller denominations. Each such unit is called a Share. It

entitles the holder to ownership in the company.

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 Types of share capital

As per Section 43 of the Companies Act, 2013 Share Capital of a

company can be of two types:

1. Equity Share Capital

2. Preference Share Capital

Equity Share Capital

It consists of equity shares. Equity Shares are shares

which are not Preference Shares. These carry maximum ‗risks

and rewards‘ of the business. In the case of high profits, they

receive a payment of higher dividends and appreciation in the

market value of the shares. While, in the case of loss, there

exists a higher risk of losing part or all the shares. Equity Share

Capital may be with the voting rights or with the differential

rights related to dividend, voting or any other right.

Preference Share Capital

Preference Share Capital consists of preference shares. As

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 per Section 43(b) of the Companies Act, 2013, preference

shares are shares which carry preferential rights. The

preferential rights of preference shares are:

1. Preferential right to receive dividend: This implies that the

company will first make payment to a person holding

preference shares at fixed rate or amount and then to the

equity shareholders. Thus, they receive dividend before

Equity Shareholders.

2. Preferential right to repayment of capital: On the winding

up of the company they receive the repayment of capital

before paying the equity shareholders.

Deemed Preference Share Capital

The capital will be deemed to be preference share capital

when it has either or both of the following rights:

1. In addition to the preferential right to payment of dividend,

it possesses a right to participate. However, the right to

participate may be fully or to a limited extent.

2. In addition to the preferential right to repayment of capital,

it possesses a right to participate. However, the right to

participate may be fully or to a limited extent.

Types of Share Capital Shown in The Balance Sheet

Authorized or Nominal Capital

It is the amount of capital with which a company registers itself and also states
this

amount in the Memorandum of Association. It is the maximum amount

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of capital beyond which a company cannot issue shares to the public.

However, a company may issue shares of an amount more than the

Nominal Capital, if it increases the Nominal Capital by altering the

Capital clause in the Memorandum of Association.

Issued Capital

It is the amount of capital which a company offers to the public for

subscription. Also, it includes the shares that a company allotted to the

vendors or promoters of the company for consideration other than cash.

In the Balance Sheet, under the head Issued Capital, a company needs

to state the different classes of share capital including the sub-classes

of the preference shares, the date and the terms of the redemption or

conversion of redeemable preference shares and any option on un-

issued share capital.

Subscribed Capital

It is the amount of capital for which the company receives the

subscription from the public and makes the allotment to them. It can be

equal to or less than the Issued Capital.

Called-up Capital

It is the amount which the company calls from the shareholders to pay on the
shares.

Usually, a company does not call the full amount at once from the shareholders.

Hence, the portion that the company calls is called-up capital and the

remaining portion is un-called capital.

Paid-up Capital

It is the amount that is paid by the shareholders. This is the amount that

we include in the Balance Sheet total. It may be less than or equal to the

paid-up capital.

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 The various classes of Preference shares are:

1. Cumulative Preference Shares:

These are Preference Shares which carry right to receive arrears of

dividend before the company makes payment to Equity Shareholders.

2. Non- Cumulative Preference Shares:

These are Preference Shares which do not carry the right to receive arrears of
dividend.

3. Participating Preference Shares:

The Articles of Association may provide that after paying the dividend to

the Equity Shareholders, the Preference shareholders will also have a right

to participate in the remaining profits. Thus, the Preference Shares

carrying this right are Participating Preference Shares.

4. Non-Participating Preference Shares:

These are Preference Shares which do not carry the right to participate in

the profits remaining after paying the Equity Shareholders.

5. Convertible Preference Shares:

These Preference Shares have a right to conversion into Equity Shares.

6. Non-Convertible Preference Shares:

These Preference Shares do have a right to conversion into Equity Shares.

7. Redeemable Preference Shares:

These Preference Shares are redeemable by the company at a specific

time (not exceeding 20 years from the date of issue) for the repayment.

8. Irredeemable Preference Shares:

These are not redeemable and thus, the company pays the amount only

at the time of the winding up of the company.

Under and Over Subscription

A company issues shares to the general public for subscription. It receives

the applications along with the application money so that it can allot the

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shares to the applicants. It may hardly happen that it receives the

applications equal to the number of shares issued. Thus, there may be

either under subscription or oversubscription.

Under Subscription of shares

A company offers shares to the public inviting applications for their

subscription. When the number of shares applied for by the public is less

than the number of shares issued by the company, it is a situation of

under-subscription. Generally, a company that is newly set up or does not

have a good reputation in the market receives under-subscription.

Usually, such companies opt for underwriting of the shares. However, if a

company receiving under- subscription receives the minimum

subscription, it can allot the shares for which it receives the application.

Oversubscription of shares

When a company receives applications for shares more than the number

of shares it has offered to the public, it is known as over-subscription of

shares. Usually, the companies with strong financial background or good

reputation in the market or profitable future prospects receive over-

subscription of shares. According to the guidelines of SEBI, a company

cannot out- rightly reject any application. However, it can do so where the

information is incomplete, the signature is not there or the application

money is insufficient.

In this case, it is not possible for the company to allot shares to every

applicant in the number that he desires. Thus, the company needs to allot

the shares in a proper manner. The company has the following three

alternatives:

1. Reject some applications totally.

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 2. Accept some applications in full.
3. Make Pro-Rata Allotment to the remaining applicants.

Pro-rata allotment implies the allotment of shares in proportion of the

shares applied for. In the case of pro-rata allotment, the company

adjusts the excess money received at the time of application towards

the allotment and refund the excess.

However, it can transfer the excess amount to Calls-in Advance A/c if

its articles of association permit and takes the consent of the

applicant by a separate letter or by inserting a clause in the

Prospectus.

Issues shares at discount:

The issue of shares at a discount means the issue of the shares at a

price less than the face value of the share. For example, if a company
issues share of Rs.100 at Rs.90, then Rs.10 (i.e. Rs 100—90) is the amount
of discount.

It is nothing but a loss to the company. One must remember that the
issue of share below the Market Price (MP) but above the Face Value
(FV) is not termed as ‗Issue of Share at Discount.

The issue of Share at Discount is always below the Nominal Value

(NV) of the shares. The company debits it to a separate account
called ‗Discount on Issue of Share Account.

Conditions for Issue of Shares at Discount

1. In order to issue the shares at a price less than the face

value, the company has to get permission from the
relevant authority. For seeking permission, they should call
and upon a general meeting and discuss and authorize
the matter in that meeting.

2. There is a cap on the rate of discount. A company

cannot issue any shares at more than 10% discount.

3. The company should issue the shares within 60 days of

receiving permission from the relevant authority. In

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 certain cases, the company can extend this time frame
after getting permission in the permission.

4. The company cannot issue these shares before

passing of 1 year from the date of commencement
of business.

5. The shares must belong to the same class of shares

which are already available in the market. For example,
if the has previously issued Equity shares then this time
also, the company has to issue Equity shares only.

6. Also, the company has to acquire the sanction by the

Central Government after getting approval from the
general meeting.

Issue of Shares at Premium

The issue of shares at premium refers to the issue of shares at a price

higher than the face value of the share. In other words, the premium is
the amount over and above the face value of a share.
Usually, the companies that are financially strong, well- managed and
have a good reputation in the market issue their shares at a premium. For
example, if a company issues a share of nominal or face value of ` 10 at `
11, it issues it at 10% premium.

A company may call the amount of premium from the applicants or

shareholders at any stage, i.e. at the time of application, allotment or calls.
However, a company generally calls the amount of Premium at the time
of allotment.

Accounting treatment of Securities Premium

The company needs to credit the amount of Premium in a separate

account i.e. Securities Premium A/c, as it is not a part of the Share Capital.
It is actually a gain for the company. As per the Companies Act, 2013 the
company shows the credit balance of the Securities Premium A/c under
the heading ‗Reserves and Surplus‘ on the liabilities side of the Balance
Sheet.

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Also, section 52 of the Companies Act, 2013 states how a company can
use the Securities Premium. The following are the provisions regarding
this:

1. The company can use the amount towards the issue of un-
issued shares to the shareholders or members of the
company as fully paid bonus shares.

2. It can use this amount to write off the preliminary expenses.

3. The company may use it to pay the premium on

the redemption of debentures or redeemable
preference shares.

4. It can also use this amount to write off the expenses

incurred, commission paid or discount allowed on
the issue of any securities or debentures.

5. It can also use it for buy-back of own shares or any other securities.

For example, X Ltd. offers 20000 shares to the public. It receives

applications for 40000 shares. When the company decides to allot the

shares at pro-rata basis, then it has to allot 20000 shares to the

applicants of 40000 shares. Thus, the ratio will be 40000:20000. Hence,

each applicant for 2 shares will receive 1 share. This is Pro-rata

allotment.

Journal Entries

Dat Particulars Amoun Amoun

e t (Dr.) t (Cr.)

1. On receipt of Bank A/c Dr.

Application money (Total application amount)

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 To Share Application A/c
(Being application money
received)

Share Application A/c Dr.

2. Transfer of application money

to Share Capital A/c and refund
of excess

To Share Capital A/c

(Application amount)

To Share Allotment A/c

(excess)

To Calls-in-advance A/c
(balance, if any)

To Bank A/c (refund)

Share Allotment A/c Dr.

(Amount due on allotment)

3. On Share Allotment due

To Share Capital A/c

(Being share allotment due

on
…..shares)

Bank A/c Dr.

(Actual amount received)
4. Share Allotment money
received

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 To Share Allotment A/c

(Being share allotment

money received)

5. On Share call due Share Call A/c Dr.

To Share Capital A/c

(Being money on share call

due on shares)

Bank A/c Dr.

6. Share call amount received

Calls-in-advance A/c Dr.

To Share Call A/c

(Being share call amount

received and calls-in-
advance adjusted)

Forfeiture of Shares

Forfeiture of shares signifies cancellation of shares and the company

seizes the amount of the shares. The shareholder, who applies for the

purchase of shares, makes an offer on the one hand. On the other hand,

the company by accepting or allotting shares shows acceptance. Hence,

offer and acceptance with the lawful consideration create a valid

15
contract between the shareholder and the company. In this article, we

will look at the aspects of forfeited shares.

As we know, a company can forfeit shares on non-payment of the

number of calls. The company before forfeiture must first give clear 14

days‘ notice to the defaulting shareholder that he shall pay the due

amount along with the interest.

If not paid by the specified date, the shares shall be forfeited. If the

shareholder still does not pay, the company may forfeit the shares by

passing an appropriate resolution.

Accounting Entries on Forfeiture of Share

The company may issue the forfeited shares at par or at a premium.

Accounting entry for forfeiture will vary according to the situation.

1. When Forfeiture of shares Issued at Par

In this case,

1. The company debits the Share Capital Account with the

amount called-up up to the date of forfeiture on shares.
2. It credits the Shares Allotment Amount or Shares Call
Account with amount called-up on forfeited shares but
due from the shareholders. If we are maintaining Calls-in-
Arrears Account then we credit Calls-in-Arrears Account.

The company credits the Forfeited Shares Account by the receipt of the
amount on the shares forfeited.

Notice before Forfeiture

There are instances when a member who is liable to pay any call money

on his shares, fails to pay the amount. In such cases, the directors may

either by the implementation of Table A or express provision on the articles

16
proceed to forfeit the shares of such a defaulting member. Before the

actual forfeiture of the shares, the company may send a notice to the

defaulting member asking payment of the call.

The notice must give not less than 14 days time from the date of service of

notice for the payment of the amount of the call. The notice must also

state the consequences of not fulfilling the requirements of the notice. It

generally states that if the shareholder fails to pay the amount within a

time which the notice mentions then his shares will be liable for forfeiture.

Accounting Treatment

In the case of Share Forfeiture (Par)

Date Particulars L.F. Amoun Amoun

t (Dr.) t (Cr.)

Share Capital A/c Dr. XXX

To Forfeited Shares Account A/c XXX

To Shares Allotment A/c XXX

To Shares Call A/c XXX

If, we maintain Calls-in-Arrears Account we will credit Calls-in-Arrears Account

instead of

―Shares Allotment Amount‖ and ―Shares Call Account‖.

Journal entry for this will be:

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Date Particulars L.F. Amou Amou
nt nt
(Dr.) (Cr.)

Equity Share Capital A/c Dr. XXX

To Forfeited Shares Account A/c XXX

To Calls-in-Arrears A/c XXX

In the case of Share Forfeiture (Premium)

Date Particulars L.F. Amoun Amoun

t (Dr.) t (Cr.)

Share Capital A/c Dr. XXX

To Shares Allotment A/c XXX

To Forfeited Shares A/c XXX

To First Call A/c XXX

Date Particulars L. Amou Amou

F. nt nt
(Dr.) (Cr.)

Share Capital A/c Dr. XXX

Securities Premium A/c Dr. XXX

XXX
To Shares Allotment A/c

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 XXX
To Forfeited Shares A/c

XXX
To First Call A/c

Calls-in-Advance

Excess Money received by the company which has been called up

isknown as calls in advance. If authorized by its Articles, A Company may

accept call in advance from its shareholders. When a company receives

such an amount, it needs to credit it to the calls-in- advance account.

Calls in Advance

The company treats calls-in-advance as a debt of until it makes the calls.

The amount already paid is adjusted. Calls-in-advance may also arise

when the number of shares allotted to a person is much smaller than the

number applied by him for and the terms of issue allow the company to

retain the amount received in excess of application and allotment money.

The company can retain only such amount as is required to make the

allotted shares fully paid. After transferring the amount to the relevant call

accounts, the company closes the calls-in- advance account. It shows

this amount under a separate heading, namely ‗calls-in-advance‘ on the

liabilities side. A company may pay interest on such amount received in

advance at the rate of 12% p.a. No dividend is payable on this amount. It

adjusts the amount of calls-in-advance for the payment of calls when

they become due. Interest payable on Calls-in- Advance is a liability

against the profits of the company. A company has to pay Interest on

Calls-in-Advance even when there is no profit.

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 Journal Entries

Dat Particula Amount(Dr. Amount(Cr

e rs ) .)

Bank A/c Dr. XXXX

(i) On receipt
of call money To Call-in-Advance A/c
XXXX
(Being receipt of calls in advance)

(ii) On making Calls-in-Advance A/c Dr. XXXX

calls
To Relevant Call A/c
XXXX
(Being transfer of the calls-in-
advance)

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 Interest on Calls-in-Advance A/c XXXX
(iii) When
Dr.
Interest on
Calls-in-
To Bank
Advance is XXXX
(Being payment of Interest on
paid in cash
Calls-in- Advance)

(iv) When Interest on Calls-in-Advance A/c XXXX

Dr.
interest on
Calls-in-
To Sundry Shareholders A/c
Advance is XXXX
(Being Interest on Calls-in-
not paid in
Advance due)
cash

Sundry Shareholders A/c Dr. XXXX

(v) For
payment to To Bank
shareholders XXXX
(being interest paid)

Profit and Loss A/c Dr. XXXX

(vi) On
transfer of
interest on To Interest on Calls-in-Advance
Calls-in- A/c (Being the transfer of interest XXXX
Advance to P expenses to profit and loss A/c)
& L A/c

Issue of Shares for Cash

Joint stock companies carry their business on a large scale. Hence, these

companies require a huge amount of capital. They fulfill their requirement

by issuing shares and debentures to the public. Moreover, after receiving

the certificate of incorporation, they can offer shares to the public under

different methods. In this article, we will discuss the issue of share for cash.

Methods of Issue

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Mostly, a company issues equity shares to the general public. When the

capital raised through ordinary shares is not enough, the company can

also go for preference shares. They can issue it either by collecting the full

par value of shares at the time of issue or collecting the face value in

different calls. It includes application, allotment, first call, etc.

Issue of share at Par

Par value is the value given or mentioned on the certificate of share. Each
company can mention its own par value like Rs.10, Rs.20, etc. When the
company asks the total par value of at the time of application; it is called
the issue of shares on a lump sum basis.

The following entries are made for issuing shares.

Date Particulars Amount Amount

(Dr.) (Cr.)

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 Bank A/c (actual amount received) Dr.
1.
Applicatio To Share Application A/c
n money (Being application money received on
shares)

Share Application A/c Dr.

2.
Applicatio To Share Capital A/c
n Money (Being share application money
transfer transferred to share capital)

Share Allotment A/c (amount due

on allotment) Dr
3. Share
Allotment
To Share Capital A/c
(Being share allotment
due)

Bank A/c (actual amount

received) Dr.
4. Money
received
To Share Allotment A/c
(Being share allotment money received)

Share Call A/c Dr.

5. Share
call due To Share Capital A/c
(Being money on share call due)

Bank A/c Dr.

6. Call
amount
To Share Call A/c
receive
(Being share call amount received)
d

Issue of share at Premium

When a share is issued at a price which is more than the par value, it is

called the issue of share at a premium. For example, if a share of Rs.10 is

23
issued t Rs. 12, then it is called the issue of share at a premium. Here Rs. 2

is the premium amount per share.

Journal entries for the issue of shares at Premium

1. Premium is due at the time of application.

Date Particulars Amount Amount

(Dr.) (Cr.)

1. On receipt of Bank A/c (application and premium

Application money amount)
Dr.

To Share Application
A/c Cr.
(Being application money received
on shares)

2. Transfer of Share Application A/c

application money to Dr.
Share Capital A/c and To Securities Premium A/c Cr.
Securities Premium A/c
To Share Capital A/c Cr.

(Being share application money

transferred to share capital)

3. On Share Allotment Share Allotment A/c (amount due

due on allotment) Dr.

To Share Capital A/c Cr.

(Being share allotment due)

4. Share Allotment Bank A/c (actual amount received)

money received Dr.

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 To Share Allotment A/c Cr.

(Being share allotment money

received)

5. On Share call due Share Call A/c

Dr.

To Share Capital A/c Cr.

(Being money on share call due)

6. Share call amount Bank A/c Dr.

received
To Share Call A/c
Cr.
(Being share call amount received)

2. Premium is due at the time of allotment.

Date Particulars Amount Amount

(Dr.) (Cr.)

1. On receipt of Bank A/c (actual amount received)

Application money Dr.
To Share Application A/c
Cr.
(Being application money received on
shares)

2. Transfer of Share Application A/c Dr.

application money

25
to Share Capital To Share Capital A/c Cr.
A/c
(Being share application money
transferred to share capital)

3. On Share Share Allotment A/c (amount due on

Allotment and allotment including premium) Dr.
Premium due
To Securities Premium A/c Cr.

To Share Capital A/c Cr.

(Being share allotment money and

premium due)

4. Share Allotment Bank A/c (allotment and premium

money received amount received)
Dr.
To Share Allotment A/c Cr.

(Being share allotment money

received)

5. On Share call Share Call A/c

due Dr.
To Share Capital A/c Cr.

(Being money on share call due)

6. Share call Bank A/c Dr.

amount received
To Share Call A/c
Cr.
(Being share call amount received)

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 Issue of Debentures

The issue of Debentures is very similar to the issue of shares by a company. Here
to the money can be collected lump sum or in installments. The accounting
treatment of the two is also quite similar. Now debentures can be issued for cash
or some other consideration. At times issue of debentures is also done as a
collateral security.

Issue of Debentures for Cash

Debentures in the general course of business are issued for cash. This issue
of debentures that happens can be of three kinds, just like an issue of shares, at
par, at a discount, and at a premium.

Issue at Par

Here the debentures will be issued exactly at their nominal price, i.e. not
above or below the face value of the debentures. Now the company can decide
to collect the cash all at once, in a lump sum. Or the money will be collected in
installments, like with allotment, first call, second call, last call etc.

(A) Money Received in One Installment

Particulars Amount
Amount
Bank A/c Dr xxx
To Debenture Application & Allotment A/c
xxx
(Being amount received in one installment)

Particulars Amount Amount

Debenture Application & Allotment A/c Dr xxx
To Debenture A/c xxx
(Being allotment being done)

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(B) Being Money Received in Two or More Installments

Particulars Amount Amount

Bank A/c Dr xxx
To Debenture Application A/c xxx
(Being amount received on application)

Particulars Amount Amount

Debenture Application A/c Dr xxx
To Debenture A/c xxx
(Being allotment being done)

Particulars Amount Amount

Debenture Allotment A/c Dr xxx
To Debenture A/c xxx
(Being allotment money becoming due)

Particulars Amount Amount

Bank A/c Dr xxx
To Debenture Allotment A/c xxx
(Being allotment money received)\

Issue at Discount

When the debentures are issued at below face value, such issue of debentures is
known as a discount issue.

Discount on issue of debentures is treated as a capital loss and put under

“Miscellaneous Expenses” on the asset side of the balance sheet until it can be
written off. Then during the life of the debentures, such discount amount is written
off by debiting it to the Profit and Loss A/c. It can also be charged against the
Capital Profits of the company. The accounting entries for the issue of debentures
on discount and the writing off the expense are as below,

Particulars Amount Amount

Debenture Allotment A/c Dr xxx
Discount on Debenture A/c Dr xxx

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To Debenture A/c xxx
(Being allotment money becoming due)

Particulars Amount Amount

Bank A/c Dr xxx
To Debenture Allotment A/c xxx
(Being allotment money received)
Particulars Amount Amount
Profit and Loss A/c Dr xxx
To Discount on Debenture A/c xxx
(Being discount written off)

Issue at Premium
Now we come to the issue of debentures at a premium, that is when more money
than the nominal value is charged. So if a debenture with a face value of 100/- is
sold at 110/- then it is issued at a premium. The amount of the premium is
charged to a special account known as Securities Premium Reserve Account. This
account will be shown on the liabilities side of the Balance Sheet under the
heading of Reserves and Surplus.

The accounting entries for the issue of debentures at a premium will be as below,

Particulars Amount Amount

Debenture Allotment/Call A/c Dr xxx
To Debenture A/c xxx
To Securities Premium A/c xxx
(Being allotment/call money becoming due)

Particulars Amount Amount

Bank A/c Dr xxx
To Debenture Allotment/Call A/c xxx
(Being allotment/call money received)

Issue of Debentures for Consideration other than Cash

Debentures can be issued for non-cash considerations. The company may have
purchased assets from some vendors or acquired some other business. Then
instead of paying cash, the company may issue debentures to such vendors.
Such an issue for debentures can be at par, or for a discount or at a premium.

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Accounting entries for all these possibilities.

Particulars Amount Amount

Asset A/c Dr xxx
To Vendors A/c xxx
(Being asset purchased from vendor)

Vendors A/c Dr xxx

To Debentures A/c xxx
(Being debentures issued at par against the
purchase of asset)

Vendors A/c Dr xxx

To Debentures A/c xxx
To Securities Premium A/c xxx
(Being debentures issued at a premium against
the purchase of asset)

Vendors A/c Dr xxx

Discount on Debentures A/c Dr xxx
To Debentures A/c xxx
(Being debentures issued at a discount against
the purchase of asset)

Issue of Debentures as Collateral Security

Debentures can also be issued by a company as collateral security against a

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

Generally, because it is a contingent liability no entry is passed in the books of the

company against such an issue of debentures. However, if some companies opt
to pass an entry to record such a transaction, the following entries may be
passed

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

Particulars Amount Amount

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

VALUATION OF GOODWILL AND SHARES

Good Will

Goodwill is an intangible asset that is associated with the purchase of one

company by another. Specifically, goodwill is the portion of the purchase price
that is higher than the sum of the net fair value of all of the assets purchased in
the acquisition and the liabilities assumed in the process. The value of a
company’s brand name, solid customer base, good customer relations, good
employee relations, and proprietary technology represent some reasons why
goodwill exists.

Concept of Goodwill

When one company buys another company, the purchasing company may pay
more for the
acquired company than the fair market value of its net identifiable assets
(tangible assets plus
identifiable intangibles, net of any liabilities assumed by the purchaser). The
amount by which the purchase price exceeds the fair value of the net identifiable
assets is recorded as an asset of the acquiring company. Although sometimes
reported on the balance sheet with a descriptive title such as “excess of
acquisition cost over net assets acquired”, the amount is customarily called
goodwill.
Goodwill arises only part of a purchase transaction. In most cases, this is a
transaction in which
one company acquires all the assets of another company for some consideration
other than an
exchange of common stock. The buying company is willing to pay more than the
fair value of the identifiable assets because the acquired company has a strong
management team, a favourable reputation in the marketplace, superior

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production methods, or other unidentifiable intangibles. The acquisition cost of
the identifiable assets acquired is their fair market value at the time of acquisition.
Usually, these values are determined by appraisal, but in some cases, the net
book value of these assets is accepted as being their fair value. If there is
evidence that the fair market value differs from net book value, either higher or
lower, the market value governs.

Methods of Valuation of Goodwill

Various ways are used in the valuation of goodwill. However, the valuation
methods are based on the situation of an individual company and different
practices of the trade. The top three processes of valuation of goodwill are
mentioned below.

⇨ Average Profits Method – This method is divided into two sub-division.

Simple Average – In this process, goodwill evaluation is done by calculating the

average profit by the number of years it is called years purchase. It can be
calculated by using the formula. Goodwill = Average Profit x No. of years’ of
purchase.
Weighted Average – Here, last year’s profit is calculated by a specific number of
weights. It is used to obtain the value of goods, which is divided by the total
number of weights for determining the average weight profit. This technique is
used when there is a change in profits and giving high importance to the present
year’s profit. It is evaluated by using the formula.
Goodwill = Weighted Average Profit x No. of years’ of purchase, where Weighted
Average Profit = Sum of Profits multiplied by weights/ Sum of weights

⇨ Super Profits Method – It is a surplus of expected future maintainable profits

over normal profits. The two methods of these methods are.

The Purchase Method by Number of Years – The goodwill is established by

evaluating super-profits by a specific number of the purchase year. It can be
estimated by applying the below formula. Super Profit = Actual or Average profit –
Normal Profit
Annuity Method –Here, the average super profit is taken as an annuity value over
a definite number of years. A discounted amount of super profit calculates the
current value of an annuity at the given rate of interest. The formula to be used
here is.
Goodwill = Super Profit x Discounting Factor

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⇨ Capitalisation Method – Under this method, goodwill can be evaluated by two
methods.

Average Profits Method – In this process, goodwill is measured by subtracting the

original capital applied from the capitalised amount of the average profits based
on the average return rate. The formula used is mentioned below.

Capitalised Average profits = Average Profits x (100/average return rate)

Super Profits Method- Here, the super profit is capitalised, and the goodwill is
calculated.
The formula applied is. Goodwill = Super Profits x (100/ Normal Rate of Return)

Methods of Valuation of Shares

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

Net Assets Method of Valuation of Shares

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

Goodwill must be properly valued

The fictitious assets such as preliminary expenses, discount on issue of shares
and debentures, accumulated losses, etc. should be eliminated.
The fixed assets should be taken at their realizable value.
Provision for bad debts, depreciation, etc. must be considered.
All unrecorded assets and liabilities ( if any) should be considered.
Floating assets should be taken at market value.

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The external liabilities such as sundry creditors, bills payable, loan, debentures,
etc. should be deducted from the value of assets for the determination of net
value.

The net value of assets, determined so has to be divided by a number of equity

shares for finding out the value of the share. Thus the value per share can be
determined by using the following formula:

Value Per Share=(Net Assets-Preference Share Capital)/Number Of Equity Shares

Yield or Market Value Method of Valuation of Shares

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

Earnings Yield
Under this method, shares are valued on the basis of expected earning and a
normal rate of return. The value per share is calculated by applying the following
formula:

Value Per Share = (Expected rate of earning/Normal rate of return) X Paid-up

value of equity share

Expected rate of earning = (Profit after tax/paid-up value of equity share) X 100

Dividend Yield
Under this method, shares are valued on the basis of expected dividend and
normal rate of return. The value per share is calculated by applying following
formula:

Expected rate of dividend = (profit available for dividend/paid up equity share

capital) X 100

Value per share = (Expected rate of dividend/normal rate of return) X 100

Earning Capacity Method Of Valuation Of Shares

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Under this method, the value per share is calculated on the basis of disposable
profit of the company. The disposable profit is found out by deducting reserves
and taxes from net profit. The following steps are applied for the determination of
value per share under earning capacity:

Step 1: To find out the profit available for dividend

Step 2: To find out the capitalized value

Capitalized Value =( Profit available for equity dividend/Normal rate of return) X

100

Step 3: To find out value per share

Value per share = Capitalized Value/Number of Shares.

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