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Corporate Accounting bcom lecture notes bharatiyar

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B.com finance (Bharathiar University)

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B.Com-Corporate Accounting

B.Com.

Third Year
Core Paper No.11
CORPORATE ACCOUNTING

BHARATHIAR UNIVERSITY
SCHOOL OF DISTANCE EDUCATION

COIMBATORE – 641 046

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B.Com-Corporate Accounting

(SYLLABUS)

B.Com – III Year

CORE PAPER 15 CORPORATE ACCORDING

Objectives : To enable the students to be aware on the Corporate According in conformity

with the provision of the Companies Act.

Unit – I
Issue of shares : par, premium and Discount – Forfeiture – Reissue – Surrender of Shares–
Right Issue – Underwriting

Unit – II
Redemption of Preference Shares – Debentures – Issue – Redemption : Sinking Fund
Method.

Unit – III
Final Account of Companies.

Unit – IV
Valuation of Shares and Good will – Need – Methods of valuation of Shares and
Goodwill.

Unit – V
Liquidation of Companies – Preparation of Statement of Affairs and Deficiency Account.
NOTE Distribution of Marks : Theory 20% Problems – 80%

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CONTENT

TITLE PAGE
No.
UNIT-I

1 Issue o Shares 4

UNIT-II

2.2 Redemption of Preference Shares 40

UNIT-III

3.1 Final Accounts of Companies 88

UNIT-IV

4.3 Valuation of Goodwill 134

4.12 Valuation of Shares 149

UNIT-V

5.2 Modes of Winding up or Liquidation 175

Model Question Paper – I 201

Model Question Paper – II 204

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UNIT – I
ISSUE OF SHARES

CONTENTS
1.0 AIMS AND OBJECTIVES
1.1 Introduction
1.2 Issue of shares
1.3 Important points to be noted in connection with issue of shares
1.3.1 Issue of shares at par
1.3.2. Stock invest scheme
1.3.3 Under-subscription of shares
1.3.4 Oversubscription of shares
1.4. Issue of shares at premium
1.5 Issue of shares at discount
1.6 Forfeiture of shares
1.7 Re-issue of forfeited shares
1.7.1 Forfeited shares re-issued at a discount
1.7.2 Forfeited shares re-issued at par
1.7.3 Forfeited shares re-issued at a premium
1.8 Surrender of shares
1.9 Rights issue
1.10 Underwriting
1.10.1 Types of underwriting
1.10.2 Underwriting commission
1.10.3 Determining the liability of the underwriters
1.10.4. Accounting treatment relating to underwriting of shares or debenture
1.11. Issue of shares for consideration other than cash
1.12 Issue of shares to vendors
1.13 Issue of shares to promoters
1.14 LET US SUM UP
1.15 Lesson end activities
1.16 References

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1.0 AIMS AND OBJECTIVES

i) To know the Meaning and definition of shares.

ii) To study the different methods of issue of shares.
iii) To understand the provisions and treatment for forfeiture and surrender of shares.

1.1 INTRODUCTION

The Companies Act, 1956 deals with the organization of the company, its creation,
constitution, relationship to member and creditors, its management and winding up.
According to Section 2946) of the Companies Act, “Share” means share in the share
capital of the of the Company and includes stock except where a distinction between stock
and share is expressed or implied. A share is one unit into which the total share capital is
divided. It forms the basis of ownership in the Company and the people who contribute
the money through shares, which constitute the share capital of the Company. Thus for
example, when a company has a share capital of Rs.1,00,000 divided into 10,000 shares
of Rs.10/- each and a person who has taken 50 shares of that company, is said to have a
share in the share capital of the company to the tune of Rs.500/-.

1.2 ISSUE OF SHARES

There are two basic types of share capital based on the types of shares, which can be
issued by a company under the companies Act, 1956 i.e.
a) Preference shares and
b) Equity shares.

Preference shares are those which carry the following preferential rights as to :
i) The payment of dividend at a fixed rate before anything could be paid to equity
shares.
ii) The return of capital on winding up of the Company.
The above rights are conferred by the Articles of Association.
An Equity share is one which is not a Preference share. These are normally risk bearing
shares.
The dividend and repayment will be done after the preference shares.

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1.3 IMPORTANT POINTS TO BE NOTED IN CONNECTION WITH ISSUE OF

SHARES

1. When a public company desires to raise capital by issuing its shares to the public, it
invites the public to subscribe for its shares. The invitation is made through a
document called the “Prospectus”.
2. An application for shares is an offer made by the applicant while the allotment in
pursuance thereof by the company is its acceptance. In other words, allotment
means the appropriation of a certain number of shares to an applicant in response to
the application, by a resolution of the directors.
3. As per the guidelines issued by the SEBI, the minimum subscription has been fixed
at 90% of the issued amount. Such subscription must be received within 60 days of
the close of the issue.

4. If the number of shares applied for is less than the number of shares offered, the
allotment can be only for the shares applied for provided the minimum subscription
is raised. Minimum subscription refers to the number of shares which, in the opinion
of the directors, should be subscribed for, by payment in cash in order to enable the
company to function smoothly.
5. The primary issuances are governed by SEBI in terms of SEBI (Disclosures and
Investor protection) guidelines. SEBI framed its DIP guidelines in 1992. Many
amendments have been carried out in the same in line with the market dynamics and
requirements.
6. Offer document” means Prospectus in case of a public issue or offer for sale and
Letter of Offer in case of a rights issue which is filed Registrar of Companies (ROC)
and Stock Exchanges. An offer document covers all the relevant information to help
an investor to make his/her investment decision.
7. “Red Herring Prospectus” is a prospectus which does not have details of either price
or number of shares being offered or the amount of issue.
8. The form for applying/bidding of shares is available with all syndicate members,
collection centers, the brokers to the issue and the bankers to the issue.
9. As per the requirement, all the public issues of size in excess of Rs.10 crore are to
made in Demat mode.
10. The amount payable on applications is fixed by the Directors but it cannot be less
than 5% of the nominal value of shares. As per SEBI guidelines the minimum
application money to be paid shall not be less than 25%of the issue price.
11. The amount received on applications for shares has to be kept in a Scheduled Bank
till the minimum subscription is raised and the certificate of commencement of
business is obtained in case of a new company and till the minimum subscription is
raised in case of existing companies.

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12. If the company fails to raise the minimum subscription within 120days of the issue of
prospectus, no shares can be allotted and the application moneys received have to
be returned to the applicants within the next ten days.
13. If listed, approval from the stock exchanges is a must before allotment.
14. If the number of shares applied for is more than the number of shares offered the
Board of directors must set a criteria for allotment.
15. In case of oversubscription, SEBI has laid the guidelines as follows
a) applicants will be categorized according to the number of shares applied for and
b) the total number of shares to be allotted to each category as a whole shall be
arrived at on a proportionate basis.(Pro rata basis)
16. Where both the equity and preference shares are issued, separate application,
allotment, calls and capital accounts should be maintained in respect of the two
classes of shares.

1.3.1 ISSUE OF SHARES AT PAR

Shares of the company may be issued in any of the following 3 ways
a) At par
b) At premium
c) At discount

Shares are said to be issued at par when the issue price is equal to the face value or
nominal value of the shares i.e. issue price is Rs.10/- and the face value is also Rs.10/-
When the shares are issued at par, the company may ask the payment of the face value of
the shares either payable in one lump sum or in installments.

a) WHEN SHARES ARE ISSUED AT PAR AND ARE PAYABLE IN FULL IN

A LUMP SUM THE ACCOUNTING ENTRY WOULD BE
i) (on receipt of application money)
Bank A/c Dr (with the amount received on
To Share application and allotment A/c Application)
ii) (on allotment of shares)
Share application and allotment a/c Dr (with the money received
To Share capital a/c on the number of shares allotted)

Note: If the company fails to raise the minimum subscription then no shares can be
allotted and the application money has to be returned to the applicants.
Then the entry will be

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Share application and allotment A/c Dr. (with the application money received
To Bank now refunded)

The following illustration will make us understand the above clearly

A Ltd. issued 10,000 equity share of Rs.10/- each payable in full on application. The
company received application for 10,000 shares. Applications were accepted in full.

The following entry will be passed

1) Bank A/c Dr. Rs.1, 00,000/- (10,000 x 10)
To Equity share application
And allotment account) Rs.1, 00,000/-
(Being amount received for 10,000 shares @10/-each)

2) Equity share application and allotment A/c Dr. 1, 00,000/-

To Equity Share capital a/c 1, 00,000/-
(Being allotment of 10,000 shares @10/- each)

b) WHEN SHARES ARE ISSUED AT PAR AND ARE PAYABLE IN

INSTALMENTS
In such a case, the various instalments are termed as follows: First instalment is called
“application money”. Second instalment is called “allotment money”. Third installment
is called “first call money” and the last installment is called “final call money”.

i) on receipt of the application money

Bank a/c Dr (with the amount received on
To Share application account application)
(Being application money received in respect of …. Shares @Rs…. Per share)

Note: Where the capital of the company consists of shares of different classes, a separate
share application account will be opened for each class of shares. i.e. equity share
application account/preference share application account etc.,

ii) on allotment of shares

Share application account Dr (with the amount of application
To Share capital account money on allotted shares)
(Being the application money on allotted shares now transferred to share capital account)
Entries at allotment stage could be
Share allotment account Dr
To Share capital Account
And

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Bank Account Dr
To Share Allotment account
iii) on call on shareholders:
After allotment, whenever, the need arises, the directors may demand further money from
the shareholders towards payment of the value of the shares taken up by them. Such
demands are termed as calls. The different calls are distinguished from each other by their
serial numbers, i.e. first call, second call, third call and so on.
When the first call is made
Share first call account Dr (with the amount due on first call
To Share Capital a/c
(being the amount due on first call @ Rs... Per share on … shares)
The amount due on particular call is to be calculated with reference to the number of
shares on which the call is made and the amount of installment for that call.
On receipt of first call money
Bank A/c Dr. (With the amount received on first call
To share first call account
(Being the amount received in respect of first call @Rs… per share on .. shares)
When second call is made
Share second call account Dr. (With the amount due on second call)
To Share capital account (Being the amount due on second call
@...per share on … shares)
On receipt of Second call money
Bank a/c Dr (with the amount received on
To second call account second call
(Being the amount received in respect of second call @ Rs... Per share on … shares)
When the final call is made
Share First call is made
Share final call Account Dr. (With the amount due on final call
To Share capital account
(Being the amount due on final call @Rs…. Per share on ….. Shares)
On receipt of final call money
Bank a/c Dr. (With the amount actually received
To share final call account on final call)
(being the amount received in respect of final call @ Rs..... Per share on …. Shares)
Note: In actual practice there may be cash transactions and the same have to be entered
into the cash book instead of bank book as shown above)

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Illustration 2
H ltd was registered with an authorized capital of Rs.10,00,000/- divided into 1,00,000
equity shares of Rs.10/- each out of which 50,000 equity shares were offered to the public
for subscription. The shares were payable as under:
Rs. 3/- per share on application
Rs.2/- per share on allotment
Rs. 2/- per share on 1st call
Rs.3/- per share on 2nd and final call
The shares were fully subscribed for and the money was duly received.
Show the journal and cash book entries

SOLUTION
JOURNAL ENTRIES
Rs. Rs.

Equity Share Application A/c Dr. 1, 50,000

To Share capital A/c 1, 50,000
(Being the application money on 50,000 equity shares
@Rs.3/-per share transferred to equity share capital account

Equity Share allotment A/c Dr. 1, 00,000

To Equity Share capital account 1, 00,000
(Being allotment money due on 50,000 equity
Shares @2/- per share)

Equity Share first call A/c Dr 1, 00,000

To Equity Share capital a/c 1, 00, 000
(Being first call money on 50,000 equity shares
@Rs.2/- per share)

Equity Share Second & Final Call A/c Dr 1, 50,000

To Equity Share Capital A/c 1, 50,000
(Being the second and final call money due
On 50,000 Equity Shares @3/- per share)

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Dr CASH BOOK (BANK COLUMN)

Rs. Rs.

To Equity share Application a/c 1, 50,000 By Balance c/d 5,00,000

(Application money@3/-per share)
To Equity share allotment a/c 1, 00,000
(Allotment money@2/-per share)
To Equity share first call a/c 1,00,000
(First call money @Rs.2/- per share
To Equity share second and
Final call a/c 1,50,000
(Second and final call @3/- per share
----------- -----------
5,00,000 5,00,000

1.3.2. STOCK INVEST SCHEME:

Stockinvest is an instrument which can be used by an applicant to tender application
money to shares or debentures applied for. In order to mitigate the difficulties caused to
the investors because of non-receipt/delay or refund of share application money from the
issuing company, the Stockinvest schemes has been introduced by the Government. The
instrument is an additional facility available to an intending investor in case he so opts.

1.3.3 UNDER-SUBSCRIPTION OF SHARES

In actual practice, it rarely happens that the number of shares applied for is exactly equal
to the number of shares offered to public for subscription. If the number of shares applied
for is less than the number of shares issued he shares are said to be undersubscribed.

1.3.4 OVERSUBSCRIPTION OF SHARES

When the number of shares applied for exceeds the number of shares issued, the shares are
said to be over-subscribed. In such a case, the directors of the company allot shares on
some reasonable basis because the company can allot only that number which is actually
offered for subscription. SEBI has issued clear guidelines for oversubscription.

1.4 ISSUE OF SHARES AT PREMIUM

When shares are issued at a price higher than the face value, they are said to be issued at a
premium. Thus, the excess of issue price over the face value is the amount of premium.
For example, if a share of Rs.10/- is issued at Rs.12/- Rs.12-10= Rs.2/- is the premium.

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According to SEBI a new company set up by entrepreneurs without a track record can
issue capital to public only at par.
The Premium on issue of shares must not be treated as revenue profits and shall be shown
in the Balance sheet, as it is treated as a capital receipt. Separate account called
“Securities Premium Account” must be credited towards the premium amount. There are
no restrictions in the Companies Act on the issue of shares at a premium, but there are
restrictions on its disposal. Under Section 78 of the Act, The Securities Premium
Account may be used wholly or in part for
i) Issuing fuly 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 the shares or debentures of the company: or
iv) Providing for the premium payable on the redemption of any redeemable preference
shares or of any debentures of the company.
It is to be noted that utilization of the amount of premium except in any of the modes
specified above, can only be done by way of reduction of capital and this will require the
compliance of the provisions laid down in Section 100 of the Companies Act.
The premium is usually payable with the instalment due on allotment. In such a case, the
amount of premium included in the allotment money should be segregated and credited
direct to the Securities Premium Account.

Accounting Entry
When shares are allotted and allotment money becomes due
Share Allotment A/c Dr. (with the money due on allotment incl. premium.
To Securities premium A/c (with the premium amount)
To Share Capital A/c ( with the share money)

ILLUSTRATION 3
A Ltd. Issued 10,000, 12% preference shares of Rs.100/- each at a premium of Rs.10/- per
share payable as follows:
i) On application Rs.30/-
ii) On Allotment Rs. 30/-(including premium)
iii) On First Call Rs.25/-
iv) On final call Rs.25/-

Applications were received for 12,000 shares and the directors allotted 10,000 shares and
rejected 2,000 shares with the money received thereon refunded.

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The allotment money was duly received while the firs call money was received on 9,000
shares and the final call money on 8,000 shares.
Show the cash book and journal entries and prepare the balance sheet of the company

Solution:
JOURNAL ENTRIES
Dr.
Cr.
12% preference share application and
Allotment A/c Dr. 6,00,000
To 12% Preference share Capital A/c 5,00,000
To Securities Premium A/c 1,00,000
(Capitalisation of application money @Rs.30- per share
And allotment of money due @Rs.30/-per share on
10,000, 12% preference shares including Rs.10/- as Premium )

12% Preference Share first call A/c Dr. 2,50,000

To 12% preference share Capital A/c 2,50,000
(First call money due @Rs.25/- per share on 10,000
12% Preference shares)
Calls-in- arrears A/c 25,000
To 12% Preference share first call A/c 25,000
(being first call money due on 1,000, 12%
Preference shares @Rs.25/-per share
Transferred to call-in-arrear a/c)
12% Preference share final call A/c 2,50,000
To 12% Preference share Capital A/c 2,50,000
(being first callmoneydue @Rs.25/- per share on 10,000
12% preference shares)
Calls-in-arrears A/c 50,000
To 12% Preference share final call A/c 50,000
(being final call money due on 2,000,12%
Preference [email protected]/ - per share
Transferred to call-in-arears A/c)

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________________________________________________________________________
Dr CASH BOOK (Bank Column) Cr

To 12% Prefence share By 12% Preference share

Application and Allotment A/c 3,00,000 Application A/c 60,000

To 12% Preference share appli

Cation and allotment A/c 3,00,000 By Balance c/d 10,25,000

To 12% preference share

First call A/c 2,25,000

To 12% Preference share

Final call A/c 2,00,000
________ _________
10,85,000 10,85,000

Note: Application money 12,000 x Rs.30/-. Allotment money Rs.30/- on 10,000 shares.
First call money Rs.25/- on 9000 shares. Final call money Rs.25/- on 8000 shares.

BALANCE SHEET OF A LTD AS AT …………

Liabilities Amount Assets Amount

Share Capital :
Authorised capital
Issued,subscribed and Current Assets :
Paid-up capital – 10000, Loans & Advances
12% preference shares of Rs.100/- a) Current Assets
Each fully called up 10,00,000 Cash at Bank 10,25,000
(-) call in arrears 75,000
------------ 9,25,000

Reserves & Surplus;

Securities premium account 1,00,000

------------ ---------------
10,25,000 10,25,000

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1.5 ISSUE OF SHARES AT DISCOUNT

When shares are issued at a price lower than the face value, they are said to be issued at
discount. Thus, the excess of the face value over the issue price is the amount of discount.
For example, if a share of Rs.10/- is issued at Rs.9/- then Rs.(10-9) = Re.1/- is the
discount.
Section 79 of the Companies Act allows a company to issue shares at a discount subject to
the following conditions:

1) The share must belong to a class already issued

2) At least one year has elapsed since the date on which the company was entitled to
commence business.
3) The issue is authorized by a resolution passed in the general meeting of the company
and the sanction of the Central Government is obtained
4) The resolution must specify the maximum rate of discount.
5) The shares must be issued within two months from the date of receiving the
sanctions from the Central Government.
There fore, shares cannot be issued at a discount
1) if it is a new company
2) if it is a new class of shares even though old company.

The discount on issue of shares must be treated as a loss of capital nature and as such
debited to a separate account called “ Discount on issue of shares account”. Until it is
written off it must be distinctly shown on the assets side of the Balance sheet under the
head “miscellaneous expenditure”. Discount on the issue of shares is generally recorded
at the time of allotment of shares.

Accounting entry will be as follows:

1. Share allotment A/c Dr. (with the amount due)

Discount on issue of shares Dr. (with the discount allowed)
To share capital account (with the total amount)

2. When some portion of discount is written off

Profit and loss A/c Dr. (with the amount written off
To discount on issue of shares A/c

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Illustration 4
Elegant Ltd, issued 25,00 equity shares of Rs.10/- each at a discount of 10% payable as follows:
On application Rs.3/- per share
On Allotment Rs.1/- per share
On first call Rs.2.50 per share
On final call Rs.2.50 per share

Applications were received for 30,000 shares and the directors allotted 25,000 shares and
refunded the excess application money for 5,000 shares

The allotment money was duly received on all the shares. One shareholder holding 1,000
shares did not pay the firs call money while another shareholder holding 200 shares paid
the final call money along with the first call money. The company did
Not make the final call.

Show the cash book, journal entries and prepare the balance sheet of the company.

Solution:
CASH BOOK (Bank column)
Dr. Cr.
To Equity Share application A/c 90,000 By Equity share application A/c 15,000

To Equity share allotment A/c 25,000 By Balance C/d 1,60,500

To Equity share first call A/c 60,000

----------- --------------
1,75,500 1,75,500

JOURNAL ENTRIES
Dr. Cr.

Equity share application A/c Dr. 75,000

Equity share allotment A/c Dr. 25,000
Discount on issue of shares A/c Dr 25,000
To equity share capital A/c 1,25,000
(being capitalization of application money @3/- per
Share and allotment money due @Re.1/- per share
Excluding discount @Re.1/- per share on allotment
Of 25,000 equity shares of Rs.10/- each at a
Discount of 10%)

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Equity share first call A/c Dr. 62,500

To Equity share capital A/c 62,500
(being first call due on 25,000 shares @Rs.2.50/-
Per share)

Calls-in-arrears A/c Dr. 2,500

To equity share first call A/c 2,500
(being first call due on 1,000 shares @$s.2.50/- per share
Transferred to calls in arrears a/c

BALANCE SHEET OF ELEGANT LTD AS AT …..

LIABILITIES AMOUNT ASSETS AMOUNT

Rs. Rs.

Shares capital: Current Assets,

Authorised Capital Loans and advances
Issued & subscribed capital A. Current assets
25,000 equity shares of Cash at bank 1,60,500
Rs.10/- each 2,50,000 …… Discount on issue of
Shares 25,000
Paid-up-capital
25,000 equity shares of
Rs.10/- each Rs.7.50 per share
Called up 1,87,500
Less: Call-in-arrears 2,500 1,85,000

Call-in-advance 500
_________ ________
1,85,500 1,85,500

1.6 FORFEITURE OF SHARES

If a shareholder fails to pay the allotment money and/or calls made on him, his shares are
liable to be forfeited. Forfeiture may be said to be the compulsory termination of
membership by way of penalty for non-payment of allotment and/or any call money.
The power to forfeit must be contained in the Articles of Association of the company.
The effect of forfeiture of shares is that the defaulting shareholder loses all the rights in

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the shares and ceases to be a member. The name of the shareholder is removed from the
Register of Members and the amount already paid by him is forfeited. No dividend is
payable to the forfeited shares. It is interesting to note that although a person ceases to be
a member on the forfeiture of the shares, he/she still continues to be liable for the unpaid
calls due on the date of forfeiture until the nominal value of the shares is fully paid-up.

1.6.1 Accounting entries on forfeiture of shares

The accounting treatment depends on the nature of issue of the shares i.e. i) at par or
iii) at premium or iii) at discount.
(a) Forfeiture of shares issued at par.

i) Where the unpaid calls have already been transferred to calls-in-arrear A/c and the
respective call accounts have been closed:

Share Capital A/c Dr. (with the amount of called up value of

Shares forfeited i.e. number of shares
Forfeited X the called up value per share)
To Shares forfeited A/c (with the amount already paid-up-by
the shareholders on the shares so
forfeited)
To Calls-in-arrear (with the amount of unpaid of calls
Alternatively
Share Capital A/c Dr.
To shares forfeited A/c
To share allotment A/c
To share first call A/c
To share final call A/c

ILLUSTRATION 5
X ltd. Forfeited 1,000 equity shares of Rs.10 each issued at par for non-payment of the
first call of Rs.2/- per share and the final call of Rs.3/- per share. Give journal for the
forfeiture.
SOLUTION

Equity Share Capital A/c Dr. 10,000

(1000 X Rs.10/-)
To Shares forfeited A/c 5,000
(1000 X Rs.5/-)*

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To calls in arrears A/c 5,000

(1000 X Rs.5/-) *

(being forfeiture of 1000 equity shares for non

Payment of the first call of Rs.2/- per share
And the final call of Rs.3/- per share)

ALTERNATIVELY

Equity Share capital A/c Dr. 10,000

To Shares forfeited A/c 5,000
To Equity share first call A/c 2,000
To Equity share final call A/c 3,000
(being forfeiture of 1000 equity shares for
Non payment of the first call of Rs.2/-
And the final call of Rs.3/-

b) Forfeiture of shares issued at Premium

i) where shares to be forfeited and are issued at a premium and the premium money remained
unpaid, the credit already given to the “Securities Premium Account will be cancelled at the time
of forfeiture of the shares by debiting “Securities Premium A/c.
The Accounting entry will be

Share Capital A/c Dr. (with the amount called up value of

Shares forfeited, i.e. Number of shares
Forfeited X called up value per share
(excluding premium)
Securities Premium A/c Dr. with the amount of premium money
Remaining unpaid on shares
Forfeited)

To shares forfeited A/c (with the amount already paid by the

Shareholders on the shares forfeited)
To calls-in-arrears A/c with the amount unpaid on calls

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ALTERNATIVELY

Share Capital A/c Dr.

Securities Premium A/c

To Shares forfeited A/c

To Share Allotment A/c
To share first call A/c
To share final call A/c

Where shares to be forfeited were issued at a premium and the premium money was duly
received on the shares to be forfeited, Securities premium Account already credited at the
time of making call will not be cancelled at the time of forfeiture of the Shares.
i.e. Share premium once received and credited cannot be cancelled.

ILLUSTRATION 6
Sri Ltd forfeited 1,500 equity shares of Rs.10/-each, issued at a premium of Rs.5/- per
share for non payment of allotment money of Rs.8/- per share (including share premium of
Rs.5/- per share), the first call of Rs.2/- per share and the final call of Rs.3/- per share.
Give journal entry for the forfeiture.

Solution
Equity share capital A/c Dr 15,000
(1500 X Rs.10)*

Securities premium A/c Dr. 7,500

(1500 X Rs.5/-)*

To shares forfeited A/c 3,000

(1500 X Rs.2/-)*
To calls-in-arrear A/c 19,500
(1500 X Rs.13/-)*

(being forfeiture of 1,500 equity shares of Rs.10 each for non payment of allotment money
of Rs.8/- per share, including a premium of Rs.5/- per share, first call money of Rs.2/- per
share and the final call money of Rs.3/- per share)

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Alternatively
Equity Share Capital A/c Dr.. 15,000
Securities Premium A/c Dr. 7,500

To Shares forfeited A/c 3,000

To Equity shares allotment A/c 12,000
To Equity share first call A/c 3,000
To Equity share final call A/c 4,500

(being forfeiture of 1,500 equity shares of Rs.10 each for non payment of allotment money
of Rs.8/- per share, including a premium of Rs.5/- per share, first call money of Rs.2/- per
share and the final call money of Rs.3/- per share).

C) Forfeiture of shares issued at discount

If shares to be forfeited were issued at discount, a proportionate amount of discount
allowed on such shares should be written off. Since discount on issue of shares, being a
loss, is debited to “Discount on issue of shares account” at the time of issue of shares, it
should be credited at the time of forfeiture of the shares. On reissue of such forfeited
shares again, Discount on issue of shares account is debited making the discount on issue
of shares proportionate to the shares actually issued. Thus, the position in respect of
discount is quite distinct from the position in respect of premium on issue of shares. The
accounting entry for forfeiture will be as follows:

Share Capital A/c Dr. (with the amount of called up value of

Shares forfeited, i.e. No.of shares
Forfeited X called up value per share
(including discount)
To Shares forfeited A/c (with the amount already paid by the
Shareholders on the shares forfeited
i.e. No.of shares forfeited X amount
paid per share.
To Discount on issue of share A/c with the amount of discount allowed
Previously on shares forefeited i.e.
No.of shares forfeited X amount paid
Per share.
To Calls-in-arrear A/c With the amount of unpaid calls i.e.
No.of shares forfeited X unpaid amount
Per share.

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ALTERNATIVELY

Share capital A/c Dr. (with the amount of called up value of shares
Forfeited i.e. No of shares forfeited X called
Up value per share.(incl discount)

To shares forfeited A/c with the amount of already paid by the

Shareholders on the shares forfeited
To Discount on issue of Shares A/c with the amount of discount allowed
Previously on shares forfeited.
To respective calls with the amount unpaid on respective
Calls. i.e. No of shares forfeited X
Amount due on respective call per share

Illustration 7
Y ltd forfeited 1,000 equity shares of Rs.10/- each, issued at a discount of 10%
For non payment of first call of Rs.2/0- and the final call of Rs.3/- per share.
Show the necessary journal entry.

SOLUTION
JOURNAL ENTRY
Dr.
Cr.
Rs.
Rs.
Equity share capital A/c 10,000
(1000 X Rs.10/-)
To Shares forfeited A/c 4,000
(1000 X 4)
To Discount on issue of share A/c 1,000
(1000 X Re.1/-)
To Calls-in-arrear a/c 5,000
(1000 x Rs.5/-)

(being forfeiture of 1,000 equity shares issued at a discount

Of 10% for non payment of first call money of Rs.2/- per
Share and final call money of Rs.3/- per share)

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Alternatively
Equity Share capital A/c Dr. 10,000
To shares forfeiture A/c 4,000
To discount on issue of shares A/c 1,000
To equity share first call A/c 2,000
To equity share final call A/c 3,000
(forfeiture of 100 equity shares issued at a discount
Of 10% fornon payment of first call money of Rs.2/-
And final call money of Rs.3/- per share respectively)

1.7 RE-ISSUE OF FORFEITED SHARES

The important point of consideration for reissue of forfeited shares is that the amount
receivable on re-issue of such shares together with the amount already received from the
defaulting member, shall not, in any case, be less than the face value of the shares. Thus,
forfeited shares may be re-issued at par, at a premium or even at a discount.

1.7.1 Forfeited shares re-issued at a discount

If a forfeited shares are re-issued at a discount, the amount of discount can, in no case,
exceed the amount credited to Shares forfeited account. Discount thus allowed on re-issue
has to be debited Shares forfeited account. If the discount allowed on re-issue is less than
the forfeited amount, there will be a surplus left in the Shares forfeited account which
shall be treated as net gain on forfeiture. This gain should be treated as capital gain and
thus transferred to Capital Reserve Account.

1.7.2 Forfeited shares re-issued at par

If forfeited shares are re-issued at par, the entire amount standing to the credit of Shares
forfeited account would be treated as net gain and transferred to Capital Reserve account.

1.7.3 Forfeited shares re-issued at a Premium

If forfeited shares are re-issued at a premium, the amount of such premium should be
credited to Securities premium Account. In such a case also, the entire amount standing to
the credit of shares forfeited account would be treated as net gain and transferred to
Capital Reserve Accountt.
Note: If only part of the forfeited shares are re-issued, only the proportionate amount
representing the net gain on the shares re-issued should be transferred to Capital reserve
account and the balance representing the amount received on the forfeited shares not yet
re-issued should be left in the Shares forfeited account itself.

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ACCOUNTING ENTRIES

i) If forfeited shares are re-issued at par

1) On re-issue of shares

Bank A/c Dr. (with the amount received on re-issue

To share capital A/c i.e.No. of shares re-issued X amount received per
Share)

2) On Transfer of Shares forfeited account to Capital Reserve Account

Shares forfeited A/c Dr. (with the forfeited amount on shares)

To Capital Reserve A/c

ii) If forfeited shares are re-issued at a premium

1. On re-issue of shares

Bank A/c Dr. (with the total amount received on re-issue)

To Share capital A/c (with nominal value or paid-paid up value

Of shares)
To Securities Premium A/c (with the premium money)

2. On transfer of Shares forfeited A/c to Capital reserve A/c

Shares forfeited A/c Dr. with the forfeited amount on shares
To Capital Reserve A/c re-issued

iii) If forfeited shares are re-issued at a discount

1. On re-issue of shares
Bank A/c Dr. (with the amount received on re-issue)
Shares forefeited A/c Dr. (with the discount allowed on re-issue)

To share capital A/c (with the total)

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2. On Transfer of balance in Shares forfeited Account, if any, to capital reserve

Shares forfeited A/c Dr.
To Capital Reserve A/c (with the net gain, if any, on shares reissued

iii) Re-issue of forfeited shares which were originally issued at a discount

1. On re-issue of shares
Bank A/c Dr. With the amount received on re-issue
Discount on reissue of shares Dr. with the amount of discount – original
discount
Shares forfeited account Dr. with the amount of short fall if any

To Share capital A/c with the total

2. On transfer of balance in Share forfeited A/c if any to Capital reserve A/c

Shares forfeited A/c Dr. with the net gain,.on re-issue

To capital Reserve

Illustration 8

Give Journal entries for the forfeiture and re-issue of shares in the following cases

(a) S.S. Ltd forfeited 300 shares of Rs.10/- each, fully called up for non payment of
final call money of Rs.4/-per share. These shares were Subsequently re-issued by
the company for Rs.10/-per share as fully Paid up.

(b) R.S. ltd forfeited 300 shares of Rs.10/- each, fully called up for non- Payment of
final call money of Rs.4/- per share. These shares were Subsequently re-issued by
the company for Rs.12/- per share as Fully paid up.

(c) S.P. ltd forfeited 200 shares of Rs.10/- each, Rs.8/- per share being Called up on
which a share holder paid application and allotment Money of Rs.5/- per share but
did not pay the first call money of Rs. 3/- per share. Of these forfeited shares, 150
shares were subsequently re-issued by the company as fully paid-up for Rs.8/- per
share

(d) R.P Ltd forfeited 100 shares of Rs.10/- each, Rs.8/- per share being Called up, which
were issued at a discount of 10% for non-payment Of first call money of Rs.3/- per
share. Of these forfeited shares, 80 shares were subsequently re-issued by the
company at Rs.5/- as Rs.8/- paid up.

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Solution
Journal entries
Dr. Cr.
Rs. Rs.

(a) 1. Share Capital A/c 3,000

(300 X Rs.10)
To Share forfeited 1,800
(300 X Rs.6/-)
To shares final call A/c 1,200
(300 X Rs.4/-)
(forfeiture of 300 shares of Rs.10/- each for
Non payment of final call money of Rs.4/- per share)
________________________________________________________________________

2. Bank A/c 3,000

To share capital A/c 3,000
(re-issue of 300 forfeited shares of Rs.10/-
Each fully paid up)

3. Shares forfeited A/c 1,800

To Capital Reserve A/c 1,800
(Transfer of profit on re-issue of forfeited shares
To Capital reserve a/c)

(b) 1. Share Capital A/c 3,000

(300 X Rs.10/-)
To shares forfeited A/c 1,800
(300 X Rs.6/-)
To Share final call A/c 1,200
(300 X Rs.4/-)
(forfeiture of 300 shares of Rs.10/- each for non
Payment of final call money of Rs.5/- per share)

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2. Bank A/c 3,600

(300 X Rs.12)
To Share Capital A/c 3,000
(300 X Rs.10/-)
To Securities premium a/c 600
(300 X Rs. 2/-)
(Re-issue of forfeited shares of Rs.10/- each at
A premium of Rs.2/- per share)

3. Shares forfeited A/c 1,800

To capital reserve A/c 1,800
(Transfer of profit on re-issue of forfeited
Shares to capital reserve A/c)

(c) 1. Share Capital A/c Dr. 1,600

(200 X Rs.8/-)
To shares forfeited A/c 1,000
(200 X Rs.5/-)
To share first call A/c 600
(forfeiture of 200 shares of Rs.10/- each Rs.8/- being
Called up for non-payment of first call money
Of Rs.3/- per share)

2. Bank A/c Dr. 1,200

(150 X Rs.8)
Shares forfeited A/c Dr. 300
(150 X Rs.3/-)
To Share Capital 1,500
(Re issue of 150 forfeited shares of Rs.10/- each
As fully paid-up for Rs.8/- per share, i.e. at a
Discount of Rs.2/-)

3. Share Forfeited A/c Dr. 450

To Capital reserve 450
(transfer of capital profit proportionate
To forfeited shares re-issued. i.e. on 150 share
To capital reserve A/c)

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(d) 1. Share Capital A/c Dr. 800

(100 x 8)
To share forfeited A/c 400
(100 X Rs.4/-)
To Discount on issue of Shares A/c 100
100 X re.1/-)
To share first call A/c 300
(100 X Rs.3/-)
(forfeiture of 100 shares of Rs.10 each, Rs.8/-
Being called up, issued at a discount of re.1/-
Per share for non-payment of first call @Rs.8/-
Per share)

2. Bank A/c Dr. 400

(80 X Rs.5/-)
Discount on issue of shares Dr. 80
Share forfeited A/c Dr. 160
(80 X Rs.2/-)
To Share Capital A/c 640
(80 X Rs. 8/-)
( Re-issue of 80 forfeited shares of Rs.10/-
Each, Rs.8/- being called up originally issued
At discount of 10% for Rs.5/- per share
Credited as Rs.8/- per share)

3. Shares forfeited A/c Dr. 160

To Capital Reserve A/c 160
(Transfer of Capital profit proportionate to
Forfeited shares re-issued i.e 80 shares)
________________________________________________________________________

1.8 SURRENDER OF SHARES

When on non payment of money called on shares, the shares of a holder are forfeited, it is
called forfeiture. This action is a penalizing action. On the other hand, when the holder
accepts inability to pay the called money and wants to give up holding, it is known as
surrender of shares. The law does not provide guidelines for this particular issue. While
Forfeiture is punitive in nature, Surrender is a voluntary action by the shareholder who is
not able to pay the amount being called on shares by the company whose shares are held

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by him. Surrender of shares means the return of shares by the shareholder to the company
for cancellation voluntarily. It is a shortcut to the long procedure of forfeiture of shares
otherwise the causes and effects are the same. A company can accept surrender of partly
paid-up shares only.

Thus surrender of shares is at the instance of the share holders while the forfeiture of
shares is at the instance of the company. Surrender will be void if it amounts to purchase
of shares by the company or it is accepted to relieve a member from his/her liabilities.

Accounting entries are the same as Forfeiture of shares

1.9 RIGHTS ISSUE

Under section 81, of the Companies Act, the existing shareholders have a right to
subscribe, in their existing proportion to the fresh issue of capital or to reject the offer or
to sell their rights. Before offering it to public a special resolution should have been
passed by the existing share holders. This rights issue can be done after the expiry of two
years of formation of the company or at any time after the expiry of one year from the date
of first allotment of shares whichever is earlier.

The value of the right is calculated with reference to the market value of the shares and the
following steps may be taken:
1. The market value of the shares held by a shareholder has to be ascertained.
2. The price of the new share which is required to be paid to the company has to be
added with the market value of the shares held to ascertain the total price of all the
shares.
3. The average price of one share has to be ascertained by dividing the total price of all
the shares by the number of shares.
4. The value of the right will be the difference between the market value and the
average price of the share.

Illustration 9
A Company has decided to increase its existing share capital by making rights issue to the
existing shareholders in the proportion of one new share for every two old shares held.
You are required to calculate the value of the right if the market value of share at the time
of announcement of right issue is Rs.240/- . The company has decided to give one share of
Rs.100/- each at a premium of Rs.20/- each

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Solution Rs.

Market value of 2 shares already held by a share holder

=2 X 240 480
Add: The price required to be paid for acquiring one
More share 120
------
Total price of 3 shares 600
-----

Average price of one share = 600/3 = 200

Value of right = market value – average value

= (Rs.240/- - Rs.200/- = Rs.40/-

An alternative formula is
( New shares/ Total shares ) X cum rights price – new issue price
Accordingly 1/3 X (240-120) = Rs.40

Proof : Suppose a person wants to hold three shares in the company, he can buy two
existing shares @Rs.240/- each and then he can get one additional share from the
company for Rs.120/- he will spend Rs.600/- in all for the three shares. i.e. Rs.200/-
Per share. Alternatively, the rights attached to each existing shares enables one to buy ½
new share: for buying one new shares, two rights are required and for buying three shares
one needs six rights which will cost Rs.240/- in all, one must pay Rs.360/- to the company
for the three additional shares making a total of Rs.600/- in all for Rs.200/- per share.

Issuing bonus shares is a way of rewarding the shareholders & creating shareholder
wealth. Only companies which have huge reserves (i.e. undistributed accumulated profits)
in comparison to its equity capital which have been accumulated over the years issue
bonus shares as bonus shares means capitalisation of reserves. The company, only when it
is confident of delivering sustained profits & would be able to maintain the dividend pay-
out ratio on diluted equity capital (i.e. after bonus shares) will reward the shareholders by
a bonus issue.

1.10 UNDERWRITING

Underwriting may be defined as a contract entered into by the company with persons or
institutions, called underwriters, who undertake to take up the whole or a portion of such
of the offered shares or debentures as may not be subscribed for by the public, in

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consideration of remuneration called underwriting commission. The name derives from

the Lloyd’s of London insurance market in London, united kingdom. Financial bankers,
who would accept some of the risk on a given venture, (historically a sea voyage with
associated risks of shipwreck) in exchange for a premium, would literally write their
names under the risk of information which was written on a Lloyd’s ship created for this
purpose. Underwriting of shares is the way business customers are assessed by
investment houses for access to either equity or debt capital. This is a way of placing a
newly issued security, such as stocks or bonds, with investors

The persons or institutions underwriting a public issue of shares or debentures are called
underwriters. The underwriters may be individuals, partnership firms or even joint stock
companies. But, an issue of shares or debentures is hardly underwritten by a single
individual as it involves more risk and attaches greater responsibility.

The leading underwriters set up by Government of India are Industrial Credit and
Investment Corporation of India, Industrial finance Corporation of India, Life insurance
corporation of India, Industrial development bank of India, Unit Trust of India etc.,
Nationalized banks do the business of underwriting shares or debentures of companies but
to a limited extent.

1.10.1 TYPES OF UNDERWRITING

An underwriting may be
(i) Complete underwriting: If the whole issue of shares or debentures of a company is
underwritten, it is said to be complete underwriting.
(ii) Partial underwriting: If only a part of the issue of shares or debentures of a company
is underwritten, it is said to be partial underwriting.
(iii) Firm Underwriting: It refers to a definite commitment by the underwriter or
underwriters to take up a specified number of shares or debentures of a company
irrespective of the number of shares or debentures subscribed for by the public. In
such a case, the underwriters are committed to take up the agreed number of shares
or debentures in addition to unsubscribed shares or debentures, if any. Even if the
issue is over-subscribed, the underwriters are liable to take up the agreed number of
shares or debentures.

1.10.2 UNDERWRITING COMMISSION:

The consideration payable to the underwriters for the underwriting the issue of shares or
debentures of a company is called underwriting commission. Such a commission is paid
at a specified rate on the issue price of the whole of the shares or debentures underwritten
whether or not the underwriters are called upon to take up any shares or debentures. Thus,
the underwriters are paid for the risk they bear in the placing of shares before the public.

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Underwriting commission may be paid in addition to brokerage. Company may pay a

commission to any person inconsideration of
i) his subscribing or agreeing to subscribe, whether absolutely or conditionally, for any
shares in or debentures of the company, or
ii) His procuring or agreeing to procure subscription whether absolute or conditional
for any shares in or debentures of the company.
iii) The commission paid or agreed to be paid does not exceed in the case of shares
@5% of the price at which the shares are issued or the amount of rate authorised by
the articles, which ever is less. In the case of debentures it is 2.5% of the price at
which the debentures are issued or the amount or rate authorised by the articles
which ever is less.
iv) The rate or amount should be mentioned in the prospectus or statement in lieu of
prospectus.

1.10.3 DETERMINING THE LIABILITY OF THE UNDERWRITERS

i) Complete underwriting.
a) If the whole of the issue of shares or debentures is underwriten only by one underwriter:
in such a case, the underwriter will be liable to take up al the shares or debentures that
have not been subscribed for by the public.
Liability = shares or debentures offered – total applications received
If the whole of the issue of shares or debentures is underwritten by a number of
underwriters in an agreed ratio: in such a case the liability of the respective underwriters
can be determined as follows:
The gross liability of each underwriter according to the agreed ratio should be reduced
first by the marked applications and then credit may be given in respect of unmarked
applications sent directly to the company by way of deduction from the balance left in the
ratio of their gross liability. Thus, the liability of each underwriter in such a case will be
as follows:
Gross liability according to the agreed ratio …….
LESS: Marked applications …….
-----------
Balance left
Less: Unmarked applications in the ratio of
Gross liability ……
------------
Net liability ……
------------

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Illustration 10

Sun limited issued 50,000 equity shares. The whole of the issue was underwritten as
follows:
Red 40% white 30% Blue 30%

Applications for 40,000 shares were received in all, out of which applications for 10,0000
shares had the stamp of Red; those for 5,000 shares that of white; and those for 10,000
shares that of Blue. The remaining applications for 15,000 shares did not bear any stamp.
Determine the liability of the underwriters.

Solution
NET LIABILITY OF UNDERWRITERS
RED WHITE BLUE
40% 30% 30%
Shares Shares Shares

Gross liability in the agreed

Ratio of 40:30:30 20,000 15,000 15,000
Less: Marked applications 10,000 5,000 10,000
______________________________________
Balance left (Resultant liability 10,000 10,000 5,000

Less: Unmarked applications

In the above ratio 6,000 4,500 4,500
_______________________________________
NET LIABILITY 4,000 5,500 500
_______________________________________

1.10.4. ACCOUNTING TREATMENT RELATING TO UNDERWRITING OF

SHARES OR DEBENTURES

a) When the shares or debentures are allotted to the underwriters in respect of their
liability:
Underwriters A/c Dr. (with the value of the shares or
To Share Capital/debentures debentures taken up by the
Underwriters)

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b) When commission becomes payable to the underwriters:

Underwriters Commission A/c Dr. (with the amount of commission
To Underwriters A/c due on the total issue price of
Shares underwritten)

c) When the net amount due from the underwriters on the shares or debentures
Taken up by them is received
Bank A/c Dr. (with the amount due
To underwriters A/c

Note: Underwriting commission is not generally paid in cash. Instead the same is adjusted
against the money due on shares or debentures taken up by the underwriters and only the
net amount (i.e. total amount due on shares or debentures taken up by the underwriters
minus the underwriting commission) is received from the underwriters.

Illustration 11

W Ltd., invited the public to subscribe to the following:

i) 10,000 equity shares of Rs.100/-each at a premium of 5% and
ii) Rs.2,50,000 in 14$ Debentures of Rs.100/- each at Rs.96/-

60% of the shares and the whole of the issue of debentures were underwritten by M/s S
and F for the commission allowable by the Government. The applications from the public
totalled 6,000 shares and 2,000 debentures. The underwriters fulfilled their obligations.
Show the journal entries that would appear in the books of the company.

Solution
JOURNAL ENTRIES Dr. Cr.
Rs. Rs.
Bank A/c 8,22,000
To Equity share application & Allotment A/c 6,30,000
To Debentures Application and Allotment A/c 1,92,000
(being receipt of application money on 6,000 equity shares
@Rs.105/- each including premium of Rs.5/- each and on
2,000 debentures @Rs.96/- each at a discount of Rs.4/- each)

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quity share application and allotment A/c 6,30,000

To Equity share capital A/c 6,00,000
To Securities Premium A/c 30,000
(being allotment of 6,000 equity shares of Rs.100/-
Each at a premium of Rs.5/- each to public)

14% Debenture application and allotment A/c 1,92,000

Discount on issue of Debenture A/c 8,000
To 14% debentures A/c 2,00,000
(being allotment of 2,000 14% debentures of Rs.100/-
Each at a discount of Rs.4/- each to public)
M/s S & F 48,000
Discount on issue of Debentures A/c 2,000
To 14% Debentures A/c 50,000
(Allotment of 500 debentures allotted to M/s S & F
Being their liability)
Underwriting commission A/c 19,830
To S & F A/c 19,830
(being underwriting commission due on issue price of
Shares @2.5% (as per Govt.rate) on Rs.6,30,000/- and on
Debentures @1.5% and 2.5% on Rs.1,92,000/-and Rs.48,000
Respectively)
Bank A/c 2,80,170
To M/s S & F A/c 2,80,170
( Receipt of the net amount due from M/s S & F
i.e. Rs. (2,52,000+48,000- 19830)

WORKING NOTES:
i) Liability of S and F Shares Debentures
60% 100%
Gross Liability 6,000 2,500
Less: Marked applications
Shares 60% of 6,000 and debentures100% of 2000 3,600 2,000
__________________
Net Liability 2,400 500
___________________
ii) Underwriting commission
Underwriting commission has been calculated as per the rates applicable in force:
Equity Shares

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2.5% on the issue price of 6,000 shares Rs.15,750

Underwritten = 6,30,000 X 2.5%

Debentures
On amounts subscribed by the public:
1.5% on issue price of 2,000 debentures
= 2,000 X 96 X 1.5% Rs.2,880
On the amounts devolved on underwriters
2.5% on issue price of 500 debentures
= 500 X 96 X 2.5% = Rs. 1,200 4,080
______
Total 19,830

1.11 ISSUE OF SHARES FOR CONSIDERATION OTHER THAN CASH

A Company may also issue shares for consideration other than cash to vendors who sell
some assets to the company or to the promoters for their services. When share are so
issued, the Companies Act, requires that the same must be clearly stated in the balance
sheet and must be distinguished from the issue made for cash

1.12 ISSUE OF SHARES TO VENDORS

A company may purchase assets from the vendors and instead of paying the vendors cash,
may settle the purchase price by issuing fully paid up shares in the company. This type of
issue of shares to the vendors is called issue of shares for consideration other than cash.
Such shares may be issued by the vendors either i) at par ii) at premium iii) at a discount.

1.13 ISSUE OF SHARES TO PROMOTERS

A Company may allot fully paid shares to promoters or any other party for the services
rendered by them by way of furnishing technical information, engineering services, plant
lay out, drawing and designing etc., without payment. This type of issue of shares to
promoters is called issue of shares for consideration other than cash. As the amount paid
to promoters for services rendered by them is supposed to be utilized by the company over
a long period of time, such expenditure should be treated as capital expenditure and
debited to Goodwill Account. The accounting entry in such a cash will be as follows

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Goodwill A/c Dr. with the nominal value of the

To share capital account shares allotted

To find out the number of shares to be issued the formula to be followed is

= Purchase consideration / Issue price

1.14 LET US SUM UP

Share, forms the basis of ownership in the Company and the people who contribute the
money through shares, which constitute the share capital of the Company. As a
accounting person one is expected to know the meaning, definition of shares, the issue of
shares and he ways of issuing the same.

1.15 LESSON-END ACTIVITIES

1 What do you mean by a ‘share’ and what are the types of shares?
2. Distinguish between a Equity share and Preference share?
3. What do you mean by a “offer document”?
4. What is “Red Herring Prospectus”?
5. What are 3 ways a company may issue its shares?
6. Explain Stock invest scheme.
7. Distinguish between oversubscription and undersubscription of shares
8. A Company issued 10,000 shares of Rs.10/- each. Total applications were
For 12,000 shares. Allotment was made pro-rata. Application money was
Rs.2/- per share and allotment money Rs.3/- per share. X failed to pay the
allotment money on his 300 shares. How much is due from X for allotment?
9. E ltd had allotted 10,000 shares to applicants for 14,000 shares on a pro rata
Basis. The amount payable was Rs.2/- on application, Rs.5/- on allotment
(including premium of Rs.2/- each), Rs.3/.- on first call and Rs.2/- on final call. V
failed to pay the first cal and final call on his 300 shares. All the shares were
forfeited and out of these 200 shares were re-issued @Rs.9/- per share. What is the
amount credited to capital reserve?
10. R Ltd forfeited 150 shares of Rs.10/- issued a premium of Rs.2/- for non
Payment of the final call of Rs.3/-. Of these 100 shares were re-issued @Rs.11/- per
share. How much is transferred to capital reserve?

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1.16 REFERENCES

1. Gupta R.L & Radhaswamy M. “Corporate Accounts” Theory method and

application- 13th revised edition 2006, Sultan chand & Co.,, New delhi.
2. S.P.Jain & K.L Narang, “ Advanced Accounting “, Kalyani publications, New
delhi.
3. Reddy & Murthy, “Financial accounting”, Margham publications, Chennai 2004

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UNIT - II
2.0 Aims and objectives
2.1 Introduction
2.2 Redemption of preference shares
2.2.1 What is special about Preference shares:
2.2.2 Redeemable preference shares - Meaning
2.2.3 Redemption out of Capital:
2.3 Accounting entries for redemption of preference shares:
2.4 Redemption of Debentures:
2.4.1 Mobilisation of funds for Redemption of Debentures:
2.4.2 Raising the capital:
2.4.3 Disposing of the assets of the company:
2.5 Methods of Redemption of debentures:
2.5.1 By annual drawings by lots:
2.5.2 By payment in one lump sum at the expiry of a specified period or at the
option of the company at a date within such specified period:
2.5.3 By purchase of debentures in the open market:
2.5.4 By conversion into shares:
2.6 Protection of the interest of the Debentureholders
2.7 Redemption of Debenture out of Profit
2.8 Reserve on redemption of all the debentures.
2.9 let us sum up
2.10 lesson-end activities

2.0 AIMS AND OBJECTIVES

i) To study the issue of Redeemable preference shares & Debentures

ii) To know the meaning of redemption of preference shares, debentures.
iii) To study the methods of redeeming preference shares
a) out of profit
b) out of capital
c) redemption of debentures by sinking fund method

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2.1 INTRODUCTION

Section 80, of the Companies act provides for the issue and redemption of preference
shares. Redemption is the process whereby a company can redeem shares through
repayment of the nominal value to the shareholder. Any Indian company that issues
debentures must create a debenture redemption service to protect investors against the
possibility of default by the company.

2.2 REDEMPTION OF PREFERENCE SHARES

2.2.1 What is special about Preference shares:

Ordinary shareholders are not automatically entitled to a dividend every year. The
dividend will be paid only if the company makes a profit and declares a dividend. This is
not the case with preference shares. A preference shareholder is entitled to a dividend
every year. If the company doesn't have the money to pay dividends on preference shares
in a particular year, the dividend is then added to the next year's dividend. If the company
can't pay it the next year as well, the dividend keeps getting added until the company can
pay. These are known as cumulative preference shares. Some preference shares are non-
cumulative -- if the company can't pay the dividend for one particular year, the dividend
for that year lapses.

Usually, preference shares are most commonly issued by companies to institutions. That
means, it is out of the reach of the retail investor. Companies, on the other hand, may need
money but are unwilling to take a loan. So they will issue preference shares. The banks
and financial institutions will buy the shares and the company gets the money it needs.
The big disadvantage of preference shares, of course, is the fact that they aren't traded on
the markets.

2.2.2 Redeemable preference shares - Meaning

Shares which, on a stated maturity date, the issuing company will buy back at a
predetermined price. Being Preference shares, they rank ahead of ordinary shares, but
behind debentures, in any claim on the assets of the company. Redeemable preference
shares have been used mostly as a form of debt financing. A conventional redeemable
preference share issue would involve the issue of shares which were redeemable for an
amount equal to the capital and premium subscribed for them, with no further right to
participate in profits on redemption or a winding up - that is, the rights to return of capital
and premium corresponded closely with a right to repayment of principal of a loan. The
redeemable preference shares would generally carry a fixed cumulative dividend.
Redeemable preference shares can be redeemed only when the company is financially
capable of doing so. Whereas, in the case of bankruptcy, issuers of debt or ECBs are ahead
of holders of preference shares."

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The other conditions are

(a) no such shares shall be redeemed except out of profits of the company which would
otherwise be available for dividend or out of the proceeds of a fresh issue of shares
made or the purposes of the redemption;
(b) no such shares shall be redeemed unless they are fully paid;
(c) the premium, if any, payable on redemption shall have been provided for out of the
profits of the company or out of the company's share premium account, before the
shares are redeemed;
(c) where any such shares are redeemed otherwise than out of the proceeds of a fresh
issue, there shall, out of profits which would otherwise have been available for
dividend, be transferred to a reserve fund, to be called 1[the capital redemption
reserve account], a sum equal to the nominal amount of the shares redeemed; and
the provisions of this Act relating to the reduction of the share capital of a company
shall, except as provided in this section, apply as if 1[the capital redemption reserve
account] were paid-up share capital of the company.

(2) Subject to the provisions of this section, the redemption of preference shares there
under may be effected on such terms and in such manner as may be provided by the
articles of the company.
(3) The redemption of preference shares under this section by a company shall not be
taken as reducing the amount of its authorised share capital.
(4) Where in pursuance of this section, a company has redeemed or is about to redeem
any preference shares, it shall have power to issue shares up to the nominal amount
of the shares redeemed or to be redeemed as if those shares had never been issued;
and accordingly the share capital of the company shall not, for the purpose of
calculating the fees payable under 2[section 611], be deemed to be increased by the
issue of shares in pursuance of this sub-section:

2.2.3 Redemption out of Capital:

i) When fresh issue of shares is made at par:
In such a case, there should not be any confusion. The nominal value of shares issued will
constitute the proceeds and the same should be considered for determining the amount to
be credited to Capital Redemption reserve.

ii) When fresh issue of shares is made at a Premium:

In such a case, the confusion may arise as to whether the nominal value of the shares
issued should constitute the “proceeds” or both the nominal value of the shares issued and
the premium money received on those shares should constitute the “proceeds”.

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iii) When fresh issue of shares is made at a discount:

In such a case, the confusion may arise as to whether the net amounts received after
deduction of discount from the nominal value of shares issued constitute the proceeds.

2.3 ACCOUNTING ENTRIES FOR REDEMPTION OF PREFERENCE SHARES

i) If the redeemable preference shares are redeemed out of the profits of the company
which would otherwise be available for dividend:-
1) When profits available for dividend are transferred to Capital
Redemption
Reserve Account:
General Reserve A/c Dr.
Profit Loss Appropriation A/c Dr.
Dividend equalization A/c Dr.
To Capital Redemption Reserve A/c With the nominal value of the
Shares to be redeemed

2) If Current Assets are realized to provide cash for redemption of preference

shares:
Bank A/c Dr. With the realized value
To Respective Asset A/c of assets

3) On transfer of redeemable preference share capital to be redeemed to Preference

Shareholders A/c
Redeemable Preference Share Capital A/c with the nominal
To Preference Shareholders A/c value of the shares to be
Redeemed
4) If Preference shares are to be redeemed at Premium:
Premium on Redemption of
Preference Shares A/c with the amount of
To Preference Shareholders A/c premium payable

NOTE: Entries 3 and 4 can be combined

5) On writing off premium on redemption of preference shares:

Securities Premium A/c Dr. With the amount of
OR Profit loss appropriation A/c Dr. Premium paid on
To Premium on redemption of redemption of
Preference share A/c preference shares

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6) On redemption of preference shares:

Preference shareholders A/c with the amount paid
To Bank

ii) If the Redeemable preference shares are redeemed out of the proceeds of
Of a fresh issue of shares made for the purpose of redemption

First all entries for fresh issue of shares will be passed. The entries
3,4,5 and 6 will be passed as given above.

NOTE: In such a case,. New share Capital account (preference/equity) replaces

The redeemable Preference Share Capital Account redeemed.

iii) If the redeemable preference shares are redeemed partly out of the profits of the
company which would otherwise be available for dividend and partly out of the
proceeds of a fresh issue of shares made for he purpose of redemption.
Here, all the entries shown under (i) and (ii) have to be passed. But there are certain
common entries which can be combined together.

NOTE; In this case, capital redemption Account and the new capital account will jointly
replace the Redeemable preference share capital account redeemed.

ILLUSTRATION 1
(WHEN PREFERENCE SHARES ARE REDEEMED OUT OF THE PROFITS OF
THE COMPANY)

Hema overseas Ltd had an issue 1,000, 12% redeemable preference shares of Rs.100/-
each, repayable at a premium of 10%. These shares are to be redeemed now out of the
accumulated reserves, which are more than the necessary sum required for redemption.
Show the necessary entries in the books of the company, assuming that the premium on
redemption of shares has to be written off against the company’s Securities Premium
Account.

Solution:
Journal Entries
Rs Rs
1. General reserve A/c Dr 100000
To Capital Redemption A/c 100000
(Transfer of Reserves to Capital
Redemption Reserve Account on
Redemption of Redeemable
Preference Shares)

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2. 12% Redeemable Preference 100000

Share Capital A/c Dr
Premium on Redemption of
Preference Shares A/c Dr 10000
To 12% Preference
Shareholders A/c 110000
(Amount Payable to 12%Prefrence
Shareholders on redemption of
12% preference Shareholders on
Redemption of 12% preference
Shares at a Premium of 10%)

3. Securities Premium A/c Dr 10000

To Premium on Redemption of 10000
Preference Share A/c
(Application of Securities Premium
Account to Write off Premium on
Redemption of Preference Shares)

4. 12% Preference Shareholders A/c Dr 110000

To Bank 110000
(Amount due to 12% preference
Shareholders on Redemption paid)

Notes: Capital Redemption Reserve Account Replaces the 12% Redeemable

Preference Shares Capital Account and the Capital Structure of the Company
Remains unchanged.

Illustration 2

(When Redeemable Preference Shares are redeemed out of the Proceeds of

Fresh issue made for the purpose)

Sure and Fast Ltd. has part of it’s share capital in 2,000, 12% Redeemable Preference
Shares of Rs.100 each, repayable at a premium of 5% . The Shares have now become
ready for redemption. It is decided that the whole amount will be redeemed out of a fresh
issue of Rs.10 each at Rs.11 each. The whole amount is received in cash and the 12%
preference shares are redeemed.

Show the necessary journal entries in the books of the company.

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Solution:
Journal entries Rs Rs

1. Bank A/c Dr 220000

To Equity Share Application
and Allotment A/c 220000

(Application money on 20000 equity

Shares @ Rs.11 per Share including
a premium of Re.1 Per Share)

2. Equity share Application and Dr 220000

Allotment A/c
To Equity Share Capital A/c 200000
To Securities Premium A/c 20000
(Allotment of 20000 equity
shares Rs.10 each issued at
a premium of Re.1 Per share
As Pet Board’s Resolution
dated….)

3. 12% Redeemable Preference Share

capital A/c Dr 200000
Premium on Redemption of
Preference share A/c Dr 10000
To 12% Preference Shareholders A/c 210000
(Amount Due to 12% preference
shareholders on redemption of
8% preference shares at a
premium of 5%)

4. Securities Premium A/c Dr 10000

To Premium on Redemption of
Preference shares A/c 10000
(Application of Securities Premium
Account to Write off Premium on
Redemption of preference share)

5. 12%Preference shareholders A/c Dr 210000

To Bank 210000
(Amount due to 12% preference
Shareholders on redemption paid)
Note: Equity Share Capital Account replaces the 12% Redeemable Preference Share
Capital Account and the Capital Structure of the Company remains unchanged)

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Illustration 3:

The Following is the Balance sheet of Oscar India Ltd. as on 31st March 2006:

Liabilities Rs Assets Rs

Preference Share Capital: Fixed Assets 600000

2500 shares of Rs.100
each fully called-up 250000 Investment 50000
less: Final call@ Rs.20 Bank 90000
Per share unpaid 2000
Equity share capital:
30000 shares of Rs.10
Each fully paid-up 300000
Profit and loss A/c 150000
Securities Premium 15000
Creditors 27000
---------- ------------
740000 740000
_______ ________

On 30th June 2006, the board of Directors decided to redeem the Preference shares at
Premium of 10% and to sell the investments at it’s market price of Rs.40000. They also
decided to issue sufficient number of equity shares of Rs.10 each at a Premium of Re.1
Per share, required after utilising the profit and loss account leaving a balance of Rs.
50000. Premium on redemption is required to be set off against Securities Premium
account.

Repayments on Redemption were made in full except to one shareholder holding 50shares
only due to his leaving India for good.

You are required to show the journal entries and the balance sheet of the company after
redemption. Assumption made should be shown in the working.

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Solutions:
Journal entries in the books of Oscar Ltd.

2006
June 30 Bank A/c Dr 40000
Profit and loss A/c Dr 10000
To Investments 50000
(Being the sale of investments
at a loss of Rs.10000)

Bank A/c Dr 1650000

To Share capital A/c 150000
To Securities premium A/c 15000
(Being the issue of required number
of equity shares at a premium of
10%)

Preference share capital A/c Dr 240000

Premium on Redemption A/c Dr 24000
To Preference shareholders A/c 264000
(Being the transfer of the amount
due to preference shareholder
on redemption)

Securities Premium A/c Dr 24000

To Premium on Redemption A/c 24000
(Being the transfer of securities
premium account to write off
premium on redemption account)

Profit and loss A/c Dr 90000

To Capital Redemption Reserve A/c 90000
(Being the transfer of profit used
for redemption of Preference Shares
transferred to capital redemption
reserve A/c)

Preference shareholders A/c Dr 258500

To Bank 258500
(Being the payment to preference
Shareholders except for 50 shares)

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Balance Sheet of Oscar India Ltd. as on 1st July 2006

(After Redemption)

Liabilities Rs Assets Rs

Pref.share Capital Fixed Assets 600000

100 shares of Bank 36500
Rs.100 each 10000
Less: Calls in arrears 2000 8000
Equity share capital
45000 shares of Rs.100 each 450000
Capital Red. Reserve 90000
Profit and loss A/c 50000
Securities Premium 6000
Current Liabilities
Creditors 27000
Pref.Shareholders 5500
________ _______
636500 636500

Working Notes:
1 .Calculation of required Number of Fresh Issue of Equity shares
Rs Rs
Profit and loss A/c balance 150000
Less: loss on sale of investment 10000
Balance Required 50000 60000
90000
Profit Available for Redemption 240000
Amount available from Profit and loss A/c 90000
New issue Required 15000 shares 150000

2. Bank Account

To Balance b/d 90000 By Preference shareholders A/c 258500

To Investment 40000 By balance b/d 36500
To Share capital A/c 150000
To Securities Premium A/c 15000
295000 295000

3. Premium on redemption of preference shares has been met out of securities

premium account.

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Illustration: 4
(When Redeemable Preference Shares are redeemed partly out of the profits of the
company and partly out of the proceeds of fresh issue of shares made for the purpose)

The Balance Sheet of Producers ltd. as at 31st march 2006 is as follows:

Liabilities Rs Assets Rs

Share Capital: Fixed Assets:

Authorised capital Plant and Machinery 190000
40000 equity shares Furniture and Fixtures 20000
of Rs.10 each 400000 Investments 60000
1000 8% Preference shares Current Assets, loans and
of Rs.100 each 100000 Advances:
500000 A. Current Assets:
Issued and subscribed Capital: Stock 130500
25000 Equity Shares of Debtors 49550
Rs.10 each fully Paid 250000 Cash at Bank 4950
1000 8% Preference shares B. Loans And Advances
Of Rs.100 each fully Paid-up Prepaid Expenses 1000
Reserves and Surplus:
Securities premium Account 9000
Profit and Loss Account
Current Liabilities and Provisions
A.Current Liabilities:
Sundry Creditors 22500
B. Provisions:
Provisions for taxation 19500
________ ________
456000 456000

In order to redeem its Preference shares, the company issued 5,000 equity shares of Rs.10
each at a premium of 10% and sold its investment of Rs.70800. Preference shares were
redeemed at a premium of 10%.

Show the necessary journal entries in the books of the company and prepare the balance
sheet of the company immediately after redemption of Preference shares.

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Solution:
Journal Entries
Dr Cr

Bank A/c 55000

To Equity share Application and 55000
AllotmentA/c
(Application money received on 5,000 equity
Shares of Rs.10 at a Premium of 10%)

Equity share Application and Allotment A/c Dr 55000

To Equity share capital A/c 50000
To Securities Premium A/c 5000
(Allotment of 5000 equity shares of Rs.10
Each issued at a premium of 10% as per
Board’s resolution Dated…)

Profit and loss A/c Dr 50000

To Capital Redemption Reserve A/c 50000
(Transfer of the balance amount of the
Nominal value Preference shares to be
redeemed not covered by fresh issue,
i.e., Rs. 100000- Rs.5000 on redemption
to Capital Redemption Reserve A/c)

Bank Dr 70800
To Investments A/c 60000
To Profit and Loss A/c 10800
(Sale on investments at a profit and transfer
Of profit on sale to Profit and loss A/c)

8% Redeemable Preference share capital A/c Dr 100000

Premium on Redemption of Preference
Shares A/c Dr 10000
To 8% Preference shareholders A/c 110000
(Amount due to 8% preference shareholders
On redemption)

Securities premium A/c Dr 10000

To Premium on redemption of
Preference shares A/c 10000
(Application of Securities premium to write off
Premium on redemption of Preference shares)

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8% Preference shareholders A/c Dr 110000

To Bank 110000
(Amount due to 8% Preference Shareholders on
Redemption paid)

Balance Sheet of Producers Ltd. as at 31st March, 2006

(After Redemption Preference Shares)
________________________________________________________________________
Liabilities Rs Assets Rs
________________________________________________________________________
Share capital: Fixed Assets:
Authorised Capital: Plant and Machinery 1,90,000
40,000 shares of Rs.10 each 4,00,000 Furniture and Fixtures 20,000
1,000, 8% Preference shares Investments Nil
of Rs.100 each 1,00,000 Current Assets, loans and
5,00,000 Advances:
A. Current Assets:
Issued and Subscribed Capital: Stock 1,30,500
30,000 Equity Shares of Debtors 49,550
Rs.10 each fully paid-up 3,00,000 Cash at bank 20,750
B. Loans and Advances
Reserves and Surplus: Prepaid Expenses 1,000
Capital Redemption
Reserve Account 50,000
Securities Premium Account 4,000
Profit and Loss Account 15,800
Current Liabilities and Provision:
A. Current Liabilities:
Sundry Creditors 22,500
B. Provisions:
Provisions for taxation 19,500
________ ________
4,11,800 4,11,800
_________ _________

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Working Notes:

(i) Dr. Bank A/c Cr

To Balance b/d 4,950 By 8% Preference Shareholders A/c 1,10,000

To Equity share Application
And Allotment A/c 55,000 By Balance C/d 20750
To Investment A/c 60,000
To Profit and Loss A/c 10,800
_______ ________
1,30,750 1,30,750
________ _________

(ii) Dr Securities premium A/c Cr

To Premium on Redemption By balance b/d 9,000

of preference shares Account 10,000 By Equity share Application
To Balance c/d 4,000 and Allotment A/c 5,000
_______ ________
14,000 14,000

(iii) Dr Profit and loss A/c Cr

To Capital Redemption By Balance b/d 55,000

Reserve A/c 50,000 By Bank (Profit on sale
To Balance c/d 15,800 of investment) 10,800
_______ _________
65,800 65,800

Note:
Equity share capital issued at Rs.50,000 and capital redemption reserve Account
Rs.50,000 jointly replace 8% redeemable Preference share capital Rs.1,00,000 . Hence
The capital Structure of the company remains unchanged.

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Illustration: 5

(When fresh issue of shares is made at a discount)

The Balance Sheet of ultra-modern Ltd. As at 31st march, 2006 is as follows:

________________________________________________________________________
Liabilities Rs Assets Rs
________________________________________________________________________
Share capital Fixed Assets:
Issued and Subscribed Capital: Land and Building 2,00,000
1,000, 9% Redeemable plant and machinery 60,000
Preference shares of Furniture and Fixtures 9,000
Rs.100 each 1, 00,000 Current Assets:
Rs.18,000 Equity Shares of Stock 60,000
Rs.10each
1,80,000 Debtors 25,000
Reserves and Surplus: Investments 54,000
Securities premium A/c 20,000 Bank 42,000
General Reserve Account 60,000
Profit and loss Account 40,000
Current Liabilities:
Sundry Creditors 50,000
_______ _________
4,50,000 4,50,000

The Company decided to redeem its preference shares at a premium shares at a Premium
of 5% on1st April, 2006.

A fresh issue of 3,000 equity shares of Rs.10 each was made at Rs.9 share, payable in full
on 1st April, 2006. These were fully subscribed and all moneys were duly collected. All
the investments were sold for Rs.50,000 to provide cash for redemption of preference
shares. The directors wish that only a minimum reduction Should be made in the revenue
reserves.
You are required to give the journal entries, including those relating to cash to record the
above transactions and to draw up the balance sheet as it would appear after redemption of
preference shares.

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Solution:
Journal Entries
Dr Cr
2006s
April 1 Bank A/c Dr 27,000
To Equity share Application and
Allotment A/c 27,000
(Receipt of Application money on
3,000 Equity shares at Rs.9 per Share)

Equity share Application and

Allotment A/c Dr 27,000
Discount on issue of shares A/c Dr 3,000
To Equity Share capital A/c 30,000
(Allotment of 3,000 shares of
Rs.10 each issued at a discount of
Re.1 per share as per Board’s
resolution dated…)

Bank A/c Dr 50,000

Profit and loss A/c Dr 4,000
To investment A/c 54,000
(Sale of investment at a loss and
transfer of loss on sale to
profit and loss Account)

Profit and loss Appropriation A/c Dr 36,000

General Reserve A/c Dr 37,000
To Capital Redemption Reserve A/c 73,000
(Transfer of the balance amount of the
nominal value of preference shares to
be redeemed not covered by fresh issue,
i.e. Rs.1,00,000- Rs.27,000 on redemption
to capital redemption reserve Account)

9% Redeemable of Preference
share capital A/c Dr 1,00,000
Premium on Redemption of
Preference Shares A/c Dr 5,000
To 9% reference shareholders A/c 1,05,000
(Amount due to 9% preference
shareholders on redemption)

Securities Premium A/c Dr 5,000

To Premium on Redemption of
preference shares A/c 5,000

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(Application of securities premium Account

to write off Premium on Redemption
Preference Shares Account)

9% Preference Shareholders A/c Dr 1,05,000

To bank 1,05,000
(Amount due to 9% preference shareholders
on redemption paid)

Balance sheet of ultra-modern ltd. As at 1st April, 2006

(After Redemption of preference shares)
________________________________________________________________________
Liabilities Rs Assets Rs
________________________________________________________________________
Share capital: Fixed Assets:
Authorised capital: Land and building 2,00,000
Issued, subscribed and paid-up Plant and machinery 60,000
Capital Furniture and Fixtures 9,000
21,000 equity shares of Current Assets, loans and
Rs.10 each fully paid-up 2,10,000 Advances:
Reserves and surplus: A. Current Assets:
Capital redemption reserve a/c 73,000 Stock 60,000
Securities premium A/c 15,000 debtors 25,000
General reserve 23,000 Bank 14,000
Current Liabilities: B.Loans and Advances Nil
Sundry Creditors 50,000 Miscellaneous Expenditure
Discount on issue of shares 3,000
________ _______
3,71,000 3,71,000

Working Notes:

(i) Dr Bank Account Cr

To Balance c/d 42,000 By 9% Preference share 1,05,000
To Equity share Application 27,000 holders A/c
And Allotment A/c By Balance c/d 14,000
To Investment A/c 50,000
_______ ________
1,19,000 1,19,000

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(ii) Profit and Loss A/c

To Investment A/c 4,000 By Balance b/d 40,000
To Capital Redemption
Reserve A/c 36,000
_______ _______
40,000 40,000

(iii) General Reserve Account

To Capital Redemption By Balance b/d 60,000
Reserve Account 37,000
To Balance c/d 23,000
________ ________
60,000 60,000
(iv) Securities premium A/c
To Premium on Redemption By Balance b/d 20,000
of Preference share A/c 5,000
To Balance c/d 15,000
_______ ________
20,000 20,000

Note:
(1) Proceeds of fresh issue of equity shares Rs.27,000 and Capital redemption Reserve
Account Rs.73,000 jointly replace 9% Redemption Preference share capital Account
Rs.1,00,000. Hence Capital Structure of the company remains unchanged.
(2) Discount on issue of shares amounting to Rs.3,000 can be written off against
Securities premium Account, in which case the balance sheet total will be
Rs.3,68,000/-

2.4 REDEMPTION OF DEBENTURES:

Redemption of debenture refers to the discharge of the liability in respect of the debenture
issued by a company. Debenture can be redeemed at any time either at par or at a premium
or at a discount without any legal formalities to be complied with. The prospectus inviting
applications for the debentures generally contains terms of redemption of the debentures.
But irredeemable debentures are perpetual in nature and cannot be redeemed expect on the
happening of a contingency.

Section 121 of the companies Act, 1956 provide that where a company has redeemed any
debentures previously issued, it has the right to re-issue them either by issuing the same
debentures or by issuing other debenture. Upon such re-issue the debenture holders will
enjoy the same rights and properties as if the debentures had never been redeemed.

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2.4.1 Mobilisation of funds for Redemption of Debentures:

If no provision is made for mobilizing additional funds required for the redemption of the
debentures, the company may find great difficulty in discharging the liability when the
debentures become due for payment. Even if it is assumed the liquid position of the
company would permit such redemption, the working capital and consequently the profits
of the company would be adversely affected if a large sum of money is withdrawn from
the business at a time.

In order to overcome the above difficulties the following courses of actions are open to the
company for mobilizing the additional funds required at the time of redemption:

2.1.1 Utilizing a part of the profits of the company:

A part of the profit may be withheld and utilized by the company for the purpose of
redemption of the debentures. Here again, the company is having the following options:

(a) The amount of profits withheld by the company may be retained in the business
itself as owned capital in the form of general reserve.
(b) The amount of the profit withheld by the company may be withdrawn from the
business and the same may be invested either
(i) in readily convertible securities or (ii) in taking out an insurance
Policy to provide funds when needed.
.

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2.4.2 Raising the capital:

In order to provide for additional funds required for the redemption of the debentures, the
company may issue new shares or debentures. For this purpose. old debentures will be
redeemed out of the proceeds of fresh issue and the new share capital or debentures will
take the place of the old debentures.

2.4.3 Disposing of the assets of the company:

Additional funds required for the redemption of debentures may also be provided by the
company by disposing of some of its fixed assets.

2.5 METHODS OF REDEMPTION OF DEBENTURES:

There are three different methods of redeeming the debentures which are follows:

2.5.1 By annual drawings by lots:

Under this method, a certain portion of the total debentures is redeemed every year over
the life-time of the debentures and thus at the end of the life time of the debentures, the
debentures are fully redeemed. Which debenture should be paid in which year usually
depends on the drawings. What is actually done in that slips bearing the number of
debentures are mixed up and put into a drum and then as many slips as the debentures to
be redeemed are taken out of the drum at random. This procedure is known as “Drawing
by lot”. The amount of debentures to be redeemed every year is generally calculated by
dividing the total amount of the debentures by the number of years for which they have
been issued. In such a case, the amount of annual drawings will be equal. But the amount
Of annual drawings will be equal. But the amount of annual drawings may also be unequal
in some cases. When debenture are redeemed by annual drawings, the amount of annual
drawings should be transferred to general Reserve account created out of the profits of the
company and the same need not be invested in any other way.

2.5.2 By payment in one lump sum at the expiry of a specified period or at the option
of the company at a date within such specified period:
Under this method the entire amount of the debenture debt is paid to the debenture holders in one
lump sum at the expiry of the specified period according to the terms of issue. As the amount
involved is large and the date of which debentures have to be redeemed is known to the company
well in advance, it is possible for the company to make necessary arrangement to provide for the
additional funds required for the debentures from the very beginning. In such a case, the best method
is to set aside every year throughout the life of the debentures a part of the profits of the company
which would otherwise be available for dividend and to invest the same in readily convertible
securities together with compound interests at a fixed rate. The investments, thus made, are sold
when the debentures become due for payment. This method ensures the availability of sufficient
cash for the redemption of debentures when they become due and is known as “Sinking Fund
method”.

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2.5.3 By purchase of debentures in the open market:

Under this method, a company may purchase its own debentures in the open market if it
seems to be convenient and profitable to the company. When the market price of the
debentures goes down below par or debentures are quoted at a discount on the stock
exchange, the company usually takes the opportunity to buy the debentures in the open
market and to cancel them. Own debentures may, also, be purchased by the company for
its own investment when it is desired to keep the debentures alive with a view to issuing
them in future. The law does not prohibit a company from purchasing its own debentures
unless the terms of issue specify otherwise. In such a case, the purchase of
debentures can be made out of the amount realized on sale of investments where sinking
funds exist. Where there is no sinking fund, the debentures can be purchased out of the
company’s cash balance.

2.5.4 By conversion into shares:

A company may issue convertible debentures by giving option to the debenture holders to
exchange their debentures for equity shares or preference shares in the company. The
debenture holders are given the right on certain number of shares for each debenture.
When the debenture-holders exercise this option and the company issues the shares, it is
referred as redemption by conversion.

2.6 PROTECTION OF THE INTEREST OF THE DEBENTUREHOLDERS

According to Section 117C of the Companies Act, where a company issues debentures, it
should create a debenture redemption reserve account for the redemption of such
debenture to which adequate amount shall be credited out of its profit every year, until
such debentures are redeemed. The amount credited to the debentures redemption reserve
account cannot be utilized by the company for any other purpose.

SEBI has made it obligatory for all companies raising resources through debentures to
create a Debenture Redemption Reserve equivalent to 50% of the amount of debenture
issued before the company intends to redeem the debentures.

When a company has created a sinking fund of the equivalent amount of debenture issue,
it means that there is no need to create Debenture Redemption Reserve. However no
redemption can begin unless Sinking Fund accumulates a sum of 50% of the amount of
debenture issue. When the debentures are redeemed, a sum equivalent to the amount of
face value debentures redeemed shall a transferred to General Reserve Account for
disclosure to investors because sinking fund itself substitutes for DRR. Debenture
Redemption Reserve is not required in case of convertible debenture i.e., conversion of
debentures into either or new debentures.

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2.7 REDEMPTION OF DEBENTURE OUT OF PROFIT

When the company withholds a part of divisible profits for redeeming the debentures, the
amount of profit is reduced to the extent of the debentures to be redeemed and hence not
available for distribution by way of dividends among the shareholders. The payment to
debenture holders in such a case is out of profit earned in the course of the business and
therefore it is termed as redemption out of profits. Thus the exiting liquid resources are not
affected out of profits. Thus the existing liquid resources are not affected by redemption in
this method.

There are two options available to the company in this regard:

(i) The amount of divisible profits withheld by company may be retained in the
business itself as a source of internal financing i.e. in the form of general reserve and
no investment is made outside to provide cash for redemption.

In such a case the following journal entries are passed.

(1) On debentures becoming due for payment
Debentures A/c Dr. (with the nominal value)

Premium Redemption of debenture A/c Dr. (with the amount of

Premium, if any)
To Debentureholders A/c (with the amount paid)

(2) On redemption

Debentureholders A/c Dr (with the amount paid)

To Bank

(3) On transfer of profit to General Reserve

Debenture Redemption Reserve Dr.

Profit and Loss Appropriation A/c Dr. (with the nominal value of
To General Reserve A/c debentures redeemed)

2.8 RESERVE ON REDEMPTION OF ALL THE DEBENTURES.

(A) The an\mount of divisible profits withheld from distribution as dividend may be
invested either in (i) readily marketable securities or (ii) taking out insurance policy
to provide funds when required. In either case, the profit set aside will be
accumulated in an account styled as Debenture Redemption Fund or Sinking Fund.

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(i) Debenture Redemption Fund / Sinking Fund Method:

The Accounting entries in such a case will be as follows:
First Year (At the end)

(1) On the transfer of profits to Debenture Redemption Fund Account –

Profit and Loss Appropriation A/c Dr. with the annual amount set
To Debenture Redemption Fund A/c aside out of profit*

(2) On investment of the amount of the profit set aside in readily marketable securities-

Debenture Redemption Fund

Investment A/c Dr. with the amount invested
To Bank

Debenture Redemption Fund Investment Account will appear on the Assets side of the
Balance Sheet while Debenture redemption Fund Account will appear on the liabilities
side of the Balance Sheet, substituting Profit and Loss Appropriation Account partly,
under the head “Reserves and Surplus”.

Second and subsequent years over the life of the Debentures exception the last year(At the end)-
(1) On the receipt of interest on Debenture Redemption Fund Investment –
Bank Dr. with the amount of interest
To Interest on Debenture received on investment.
Redemption Fund Investment A/c

(2) On Transfer of the interest to Debenture Redemption Fund –

Interest on Debenture Redemption Fund
Fund Investment A/c Dr. with the amount of interest
To Debenture Redemption Fund A/c. set aside

(3) On Transfer of Profits to Debenture Redemption Fund Account –

Profit and Loss Appropriation A/c Dr. with annual amount of profit
To Debenture Redemption Fund A/c set aside

(4) On investment of annual profit and interest received on investment –

Debenture Redemption Fund Investment A/c Dr. ( with the total amount of profit
To Bank set aside plus interest received
on investments).

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In the last year when the debentures become due for redemption (at the end)-

(1) On the receipt of interest on Debentures Redemption Fund Investment –

Bank Dr. with the amount of interest

To interest on Debenture Redemption received on investment.

(2) On transfer of the interest –

Interest on debenture Redemption

Fund investment A/c Dr. with amount of interest
To Debenture Redemption Fund A/c received on investments

(3) On the transfer of profits to Debenture Redemption Fund A/c-

Profits and Loss Appropriation A/c Dr. with the amount of annual
To Debenture Redemption Fund A/c profit set aside

(4) On realisation of Investments made so as to provide cash for the redemption –

Bank Dr. (with the realized value of
To Debenture Redemption
Fund Investments A/c investments)

(5) If there is any profit or loss on sale of investments, the same has also to be
transferred to Debenture Redemption Fund Account –

(a) In case of profit –

Debenture Redemption Fund

Investments A/c Dr. with the amount of profit

To Debenture Redemption Fund A/c

(b) In case of loss-

Debenture Redemption Fund A/c Dr With the amount of loss

To Debenture Redemption Fund
Investment A/c

(6) On transferof Debenture to debenture holders Account for payment to be made-

Debenture A/c Dr with the nominal value of
To Debenture holders A/c the debentures

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(7) If debentures are redeemable at premium-

Premium on redemption of Debenture A/c Dr with the amount of premium
To Debenture holders A/c on redemption
8) On Payment-
Debenture holders A/c Dr with the amount paid
To bank A/c
(9) On Transfer of premium on Redemption of Debentures to debenture
Redemption Fund Account (In case Premium on Redemption of debentures Account
is not opened at the time of issue of debentures)

Debenture Redemption Fund A/c Dr with the amount of premium

To Premium on Redemption
of Debenture A/c

(10) On transfer of loss of issue of debentures Account to Debenture redemption fund

Account ( In case the loss on issue of debentures account is not yet written off)-
Debenture redemption fund A/c Dr
To loss of issue of debentures A/c

N.B : Either entry (9) or entry (10) may be passed depending upon the circumstances:

(11) On transfer of debenture redemption fund account balance to general reserve-

Debenture Redemption Fund A/c Dr ( with the balance left after all the
To General Reserve A/c debentures are redeemed)

Notes:
(1) No investment should be made in last year for the simple reason that
payment have to be made to the Debenture holder in the last year by realizing the
investment. Therefore, there is no logic behind making investment in the last year
and then immediately realizing the same.

(2) If the debentures are redeemable at e premium, the total amount to be accumulated in
debenture Redemption Fund Account must include the amount of Premium.

(3) This method assumes the availability of profit and sufficient cash investment.

(4) Sometimes, it may so happen that Sinking fund may not be cumulative. In such a
case, the interest received on investments should not be credited to the sinking fund
nor should it be invested. Instead, interest should be treated as interest earned, as on
general investment and credited to profit and loss account.

(5) The balance in the Debenture Redemption Fund is transferred to General Reserve
Account after the redemption of all the debentures.

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(6) While transferring the balance of the Debenture redemption fund to General Reserve,
the Profit of Cancellation debenture and Profit on Sale of investments transferred to
Debenture Redemption Fund should be eliminated and the same should be
transferred to capital reserve.

(7) Where only a part of the debentures are redeemed, it must be ensured that the balance
in sinking fund is equal to 50% of the amount of debenture issue on the date of
redemption.

(8) According to SEBI guidelines, creation of debenture Redemption reserve equivalent

to 50% of the debenture issue is obligatory. However, a company may create more
reserve if it so desires, this being justified by the creation of sinking fund.

1.0 Sinking Fund to Replace an Asset to Reply a Liability

The sinking fund is created to provide the cash on the known data for two specific
purposes

(a) to replace an asset and

(b) redeem debentures (liability).

Though in practice the sinking funds for redemption of a liability and that for replacement
of an asset operate in a similar manner, yet there are some differences at stated below

i. The annual installment set aside for sinking fund for the replacement on an asset is
really depreciation and is a charge against profit and therefore it is debited to profit
and loss account. On the other hand, in cash of sinking fund created for redemption
of a liability, the annual installment is an appropriation of profit and debited to
profit and loss appropriation account since the purpose is to accumulate profits and
not to distribute dividends until the liability is repaid.

ii. At the end of the estimated useful life of the assets, the sinking fund investments are
sold to replace the old asset. The ultimate balance in sinking fund account then this
utilized to write off the book value of the old asset requiring replacement. The
sinking fund is therefore extinguished. In the other cash, the sale proceeds of the
investments would be utilized to discharge the liability involving the closure of
liability account and sinking fund investment account. The balance in the sinking
fund account is transferred to general reserve. It is in the nature of free reserves and
which can be used to pay dividends at the discretion of the company.

(ii) Insurance policy Method

Under this method also, profit are set aside and credited to Debenture redemption fund
account in the same manner as it is done in case of Sinking fund Method. But instead of
investing the amount of profit set aside in readily convertible securities an insurance policy

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is taken out for the required sum and an amount equal to the profit se aside is paid as
premium. Thus, at the maturity of the policy, the required cash would be available for
carrying out redemption of debentures. This method differs from the sinking fund method
in respect of interest on investment. Unlike sinking fund method, interest will not be
received every year but will accrue at a fixed rate. The total amount of premium will
always be less than the amount of policy. Thus, the difference between the amount of
policy amount and the total amount of premium paid on the policy is the total amount of
interest that accrues on the premium paid. The main advantages of this method is that the
policy is not subscribed to any fluctuation in prices unlike securities in the sinking fund
method and as such the exact sum insured will be available at maturity. However, the
following disadvantages may be accounted for:
(i) the annual rate of interest is lower than that obtainable from investment; and
(ii) if the policy is cancelled on account of non-payment of premium, the surrender
value will be very much less than the amount which has been paid by way of
annual premiums.

The accounting entries will be as follows:

All the years till the maturity of the policy (including the last year)-
(1) On payment of premium at the beginning of the year-
Debenture Redemption Fund policy A/c Dr with amount of annual premium
To Bank
(2) On transfer of profit to Debenture Redemption fund Account at the end of the year-
Profit and loss Application A/c Dr with the amount of profit
To Debenture redemption Fund A/c set aside

In the last year on maturity of the policy.

In addition to the above two entries, the following entries are also required on maturity of
the policy at the end of the last year.

(3) On realization of the policy amount from the insurance company-

Bank Dr with the amount policy
To Debenture Redemption Fund
policy A/c

(4) On transfer of accrued interest (i.e. the difference between the policy amount and the
total premium paid) to Debenture Redemption Fund Account-

Debenture redemption Fund policy A/c Dr with the difference between

To Debenture Redemption Fund A/c the policy amount and the total
Premium paid.

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(5) On transfer of Debentures Account to Debentures’ Account for payment to

be made-
Debentures A/c Dr with the nominal value of
To Debentureholders the debentures

(6) If debentures are redeemable at a premium-

Premium on Redemption of
Debentures A/c Dr with the amount of premium
To Debentureholders Of redemption

(7) On payment-
Debentureholders Dr with the amount paid
To Bank

(8) On transfer of Premium on Redemption of Debentures to Debenture to

Redemption Fund A/c (In cash Premium on Redemption of Debenture
Account is not opened at the time of issue of debentures)-

Debenture Redemption fund A/c Dr with the amount of premium

To premium on Redemption of on redemption
Debentures A/c

(9) On transfer of Loss of issue of Debentures account to debenture Redemption

Fund Account (In cash loss on Debentures Account is not yet written off)-

Debenture Redemption Fund A/c Dr with the amount

To loss of issue of debenture A/c

N.B.: Either entry (8) or entry (9) may be passed depending upon the Circumstances.

(10) On transfer of debenture redemption fund Account balance on General Reserve-

Debenture Redemption Fund A/c Dr with the balance left

To General Reserve A/c

Note: In some Cases, the company may decide to take credit every year. In such a case,
the entry for interest will be-

Debenture Redemption Fund policy A/c Dr with the interest

To Debenture Redemption Fund A/c

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Illustration: 1
(when debentures are redeemed out of profits)
Strong Ltd. issued 10,000, 14% debentures of Rs.100 each on 1st April, 2001 at a discount
of 5% repayable at a premium of 10% after 5 years out of the profits of the company. On
1st April, 2006, balance in the debenture Redemption Reserve Account stood At
Rs.3,40,000.

You are required to give journal entries in the books of the company both at the time of
issue and redemption of debentures.

Solution:

Journal Entries Dr Cr
2001
April 1 Bank Dr 9,50,000
Loss on issue of Debentures A/c Dr 1,50,000
To 14% Debenture A/c 10,00,000
To Premium on Redemption of
Debenture A/c 1,00,000
(Allotment of 10,000, 14% debenture
of Rs.100 each issued at a discount
of 5% and redeemable at a Premium
of 10% as per the Board
resolution dated…)

2006
April 1 14% Debenture A/c Dr 10,00,000
Premium on redemption
of Debenture A/c Dr 1,00,000
To Debenture holders A/c 11,00,000
(Being the amount due on redemption)

Profit and loss Appropriation A/c Dr 1,60,000

To Debenture Redemption
Reserve A/c 1,60,000
( Being the transfer of profit to debenture
Redemption reserve account as required
Under SEBI guidelines)

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Debenture holders A/c Dr 11,00,000

To Bank 11,00,000
(Being the amount paid to debenture holders)

Profit and loss Appropriation A/c Dr 5,00,000

To General Reserve 5,00,000
(Being the transfer of profit to the extent
Of 50% of the face value of debenture
redeemed)

Debenture Redemption Reserve A/c Dr 5,00,000

To General Reserve A/c 5,00,000
(Being the transfer of balance in debenture
Redemption reserve account to General
Reserves on redemption of debenture)

Note: Loss on issue of Debentures Account ahs to be written off by the company over the
period of 5 years preferably at the rate of (Rs. 1, 50000 *1/5)= Rs. 30,000 per year.

Illustration 2: (when sinking fund is created to redeem debentures at the end of the
specified period).

Steady Ltd. issued 2,000, 9% Debentures of Rs. 100 each at par on 1st April 2001
repayable at the end of 5 years at a premium of 6%. It was decided to institute a sinking
fund for the purpose, the investments being expected to yield 8% p.a. Sinking fund tables
show that Re.1 per annum at 8% compound interest amounts to Rs.5.867 in 5 years.
Investments were made in multiples of rupees ten only.

On 31st March, 2006 the investments realized Rs.1, 75,000 and the debentures were
redeemed. The bank balance as that date was Rs. 54,800.

You are required to show the journal entries relating to the creation of sinking fund and to
prepare the relevant ledger accounts in the books of the company. Ignore debenture
interest.

Solution:
Journal entries Dr Cr

2001
April 1 Bank A/c Dr 2,00,000
Loss on Issue of Debenture A/c Dr 12,000
To 9% Debentures A/c 2,00,000

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To Premium on redemption on
debenture A/c 12,000
( Allotment of 2000 9% debentures
of Rs.100 each issued at par
redeemable at a Premium of 6%)

2002
Mar 31 Profit and loss Appropriation A/c Dr 36,134
To Debenture Redemption Fund A/c 36,134
(transfer of the Amount out of Profit
to Debenture Redemption fund Account
to provide for the Redemption of
Debenture)
Debenture Redemption Fund
Investment A/c Dr 36,130
To Bank 36,130
(Amount of profit set aside invested
in outside securities in multiples of
Rs.10)
2003
Mar 31 Bank Dr 2,890
To Interest on Debenture Redemption
Fund Investment A/c 2,890
(Receipt of interest on investments
@ 8% p.a)

Interest on Debenture Redemption

Fund Investment A/c Dr 2,890
To Debenture Redemption Fund A/c 2,890
(Transfer of interest to Debenture Redemption
Fund Account)

Profit and Loss Appropriation A/c Dr 36,134

To Debenture Redemption Fund A/c 36,134
(Transfer of the amount out of the profit
to Debenture Redemption Fund Account
to provide for the redemption of debenture)

Debenture Redemption Fund A/c

Investment A/c Dr 39,020
To Bank 39,020
(Amount of Profit set aside together with
the interest received on investments
invested in outside securities in multiplies
of Rs.10)

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2004
Mar 31 Bank Dr 6,012
To interest on Debenture Redemption
Fund investment A/c 6,012
(Receipt of interest on investment @8%p.a)

Interest on Debenture Redemption

Fund investment A/c Dr 6,012
To Debenture Redemption Fund A/c 6,012
(Transfer of interest to Debenture Redemption
fund Account)

2004
Mar 31 Profit and Loss Appropriation A/c Dr 36,134
To Debenture Redemption fund A/c 36,134
(Transfer of the amount out of profit to Debenture
Redemption fund Account to provide for the
Redemption of debentures)

Debenture Redemption fund investment A/c Dr. 42,150

To Bank 42,150
. (Amount of profit set aside together With the interest received on
Investments invested in outside Securities in outside securities in Multiples of Rs.10)

2005
Mar 31 Bank Dr. 9,384
To interest on Debenture Redemption 9,384
Fund investment A/c
(Receipt of interest on investments@ 8% P.a.)

Interest on Debenture Redemption fund Dr. 9,384

Investment A/c
To Debenture Redemption fund A/c 9,384
(Transfer of interest to debenture
Redemption fund Account)

Profit and loss Appropriation A/c Dr 36,134

To Debenture Redemption Fund A/c 36,134
(Transfer of the amount out of profit to debenture
Redemption Fund Account to provide for the
redemption of debentures)

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Debenture Redemption Fund Investment A/c Dr 45,520

To Bank 45,520
(Amount of profit set aside together
with the interest received on investments
invested in out side securities in multiples
of Rs.10)
2006
Mar 31 Bank A/c Dr 13,025
To interest on Debenture Redemption
Fund Investment A/c 13,025
(Receipt of interest on investment @8%)]

Interest on Debenture Redemption

Fund investment A/c Dr 13,025
To Debenture Redemption Fund A/c 13,025
(Transfer of interest to debenture Redemption
Fund Account)

Profit and loss Appropriation A/c Dr 36,153

To Debenture Redemption Fund A/c 36,153
(Transfer of the amount out of profit to
Debenture Redemption Fund Account
to Provide for the redemption of debentures)

Bank Dr 1,75,000
To Debenture Redemption Fund investment A/c 1,75,000
(Realisation of investments to pay off the
debentures)

Debenture Redemption Fund Investment A/c Dr 12,180

To Debenture Redemption Fund A/c 12,180
(Transfer of profit on sale of investment to
Debenture Redemption Fund A/c)

9% Debentures A/c Dr 2,00,000

Premium on Redemption of Debentures A/c Dr 12,000
To Debenture holders A/c 2,12,000
(Amount due on redemption at a premium of 6%)

Debenture holders A/c Dr 2,12,000

To Bank 2,12,000
(Payment made for amount due)

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Debenture redemption Fund A/c Dr 12,000

To Loss on issue of Debentures A/c 12,000
(Transfer of loss on issue of debentures account to
Debenture Redemption Fund A/c)

Debenture Redemption Fund A/c Dr 2,12,180

To General Reserve A/c 2,00,000
To Capital Reserve A/c 12,180
(Transfer of balance standing at Debenture
Redemption Fund Account to General Reserve
Account and General Reserve A/c)

Ledger Accounts
Dr 9% Debentures Account Cr
Rs
31.3.2002 To Balance c/d 2,00,000 1.4.2001 By Bank 2,00,000
31.3.2003 To Balance c/d 2,00,000 1.4.2002 By Balance b/d 2,00,000
31.3.2004 To Balance c/d 2,00,000 1.4.2003 By Balance b/d 2,00,000
31.3.2005 To Balance c/d 2,00,000 1.4.2004 By Balance b/d 2,00,000
31.3.2006 To Debenture
Holder’s A/c 2,00,000 1.4.2005 By Balance b/d 2,00,000

Debenture holder Account

31.3.2006 To Bank 2,12,000 31.3.2006 By 9% Debenture A/c 2,00,000
By Premium on
Redemption of
Debentures A/c 12,000
_________ ________
2,12,000 2,12,000

Debenture Redemption Fund Account

31.3.2002 To Balance c/d 36,134 31.3.2002 By Profit and loss
Appropriation A/c 36,134
31.3.2003 To Balance c/d 75,158 1.4.2002 By Balance b/d 36,134
31.3.2003 By interest on Debenture
Redemption Fund
Investment A/c 2,890
By Profit and loss
Appropriation A/c 36,134
______ ______
75,158 75,158

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31.3.2004 To Balance c/d 1,17,304 1.4.2002 By Balance b/d 75,158

31.3.2003 By interest on Debenture
Redemption Fund
Investment A/c 6,012
By Profit and loss
Appropriation A/c 36,134
______ ______
1,17,304 1,17,304

31.3.2005 To Balance c/d 1,62,822 1.4.2004 By Balance b/d 1,17,304

31.3.2005 By interest on Debenture
Redemption Fund
Investment A/c 9,384
By Profit and loss
Appropriation A/c 36,134
_______ _______
1,62,822 1,62,822

31.3.2006 To Loss on issue 1.4.2005 By Balance b/d 1,62,822

of Debenture A/c 12,000 31.3.2006 By Interest on Debenture
To General Redemption Fund
Reserve A/c 2,00,000 Investment A/c 13,025
To Capital
Reserve A/c 12,180 By Profit and loss
(Profit on sale of Appropriation
investment treated A/c 36,153
as capital profit) By Debenture
Redemption
Fund Investment A/c 12,180
(Profit on sales of
investments)
_________ ________
2,24,180 2,24,180

Debenture Redemption Fund Investment A/c

31.3.2002 To Bank 36,130 31.3.2002 By Balance c/d 36,130

1.4.2002 To Balance b/d 36,130 31.3.2003 By Balance c/d 75,150

31.3.2003 To Bank 39,020 ______
75,150 75,150

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1.4.2003 To Balance b/d 75,150 31.3.2004 By Balance c/d 1,17,300

31.3.2004 To Bank 42,150 _______
1,17,300 1,17,300

1.4.2004 To Balance b/d 1,17,300 31.3.2005 By Balance c/d 1,62,820

31.3.2005 To Bank 45,520 _______
1,62,820 1,62,800

1.4.2005 To Balance b/d 1,62,820 31.3.2006 By Balance c/d 1,75,000

31.3.2006 To Debenture
Redemption
Fund A/c
(Profit on sale) 12,180
_______ _________
1,75,000 1,75,000

Dr Interest on Debenture Redemption Fund Investment Account Cr

Rs Rs
31.3.2003 To Debenture
Redemption
Fund A/c 2,890 31.3.2003 By Bank A/c 2,890

31.3.2004 To Debenture
Redemption
Fund A/c 6,012 31.3.2004 By Bank A/c 6,012

31.3.2005 To Debenture
Redemption
Fund A/c 9,384 31.3.2005 By Bank A/c 9,384

31.3.2006 To Debenture
Redemption
Fund A/c 13,025 31.3.2006 By Bank A/c 13,025

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Working Notes:

(1) Sum required for the redemption of debentures has been arrived at as follows:
Rs

Nominal value of 2,000 9% debentures @ Rs.100 2,00,000

Add: Premium payable on redemption @ 6% 12,000
Sum required after 5 years 2,12,000

(2) Amount of profit set aside every year has been arrived at as follows:

Sinking fund tables show that Re.1 per annum at 8% compound interest amounts to
Rs.5.867 in 5years. Since Rs.2,12,000 is required. The amount appropriated per annum
Will be:

2,12,000 / 5.867 = Rs.36,134(approx).

(3) Profit on sale of investment is a capital profit and hence transferred to capital Reserve
Account.

(5) The payment of debenture interest is ignored.

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Illustration: 3
(When Sinking Fund is created and debentures are redeemed party at any time
within the specified period).

S.S ltd.., had Rs.1,50,000, 12% debentures outstanding on 1st April,2006. The Debenture
Redemption Fund Account of the company stood at Rs.78,000 on the sane date
represented by investment in securities of rs.100 each. The directors of the company
decided to sell Rs.50,000 worth of securities at Rs.102 and to redeem rs.50,000 debentures
at a premium of 5%.
You are required to show the journal entries in the books of the company relating to the
sale of securities and the redemption of debentures.

Solution:
Journal entries Dr Cr
Rs Rs
2006
April 1 Bank A/c Dr 51,000
To Debenture Redemption Fund
Investment A/c 51,000
(Realisation of investments in
securities of Rs.100 each at
Rs.102 each to pay off the debenture)

Debenture Redemption Fund

Investment A/c Dr 1,000
To Debenture Redemption fund A/c 1,000
(Transfer of profit on sale of
Investments to Debenture
Redemption fund Account)

12% Debenture A/c Dr 50,000

Premium on Redemption of
Debenture A/c 2,500
To Debenture holders A/c 52,500
(Amount due on redemption at
a premium of 5%)

Debenture holders A/c Dr 52,500

To Bank 52,500
(Payment made of amount due)

Debenture Redemption fund A/c Dr 2,500

To Premium on Redemption of
Debenture A/c 2,500

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(Transfer of premium on Redemption

of Debentures to Debenture
Redemption Fund A/c)

Debenture Redemption Fund A/c Dr 50,000

To General Reserve A/c 50,000
(Transfer of nominal value of debenture
redeemed to General Reserve A/c)

Debenture Redemption Fund A/c Dr 1,000

To Capital Reserve A/c 1,000
(Profit on sale of investment
transferred to Capital Reserve)

Notes:
(1) It has been assumed that the provision has been made for the premium on
redemption. Hence, it has been debited to debenture Redemption Fund Account or
else it can be adjusted against Securities Premium Account.

(2) After debentures are redeemed, an amount equal to the nominal value of the
redeemed has been transferred to General Reserve from the Debenture Redemption
Fund Account.

Illustration: 4

(When Insurance policy is taken out to provide cash for redemption of debentures).

G.G Ltd. Issued 500, 12% Debentures of Rs.100 each at par on 1st April, 2003, repayable
at par after 3 years on 31st March,2006. The directors decided to take
out an insurance policy to provide necessary cash for the redemption of the debentures.
The annual premium for the policy, payable on 1st April every year was Rs.15,705.
You are required to show the journal entries and to prepare the relevant ledger accounts in
the books of the company relating to the issue and redemption of debentures.

Solution:

Journal Entries Dr Cr

2003
April 1 Bank Dr 50,000
To 12% Debenture A/c 50,000

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(Allotment of 500 12% Debenture

of Rs.100 each as per Board’s
resolution dated….)

Debenture Redemption fund

Policy A/c Dr 15,705
To Bank 15,705
(Payment of annual premium for
the policy taken out to provide
cash for redemption of debenture)
2004
March 31 Profit and loss Appropriation a/c Dr 15,705
To Debenture Redemption Fund A/c 15,705
(Transfer of profit to Debenture
Redemption Fund Account)

2004
April 1 Debenture Redemption Fund
policy A/c Dr 15,705
To Bank A/c 15,705
(Payment of annual premium for the
policy taken out to provide cash
for redemption of debenture)

2005
March 31 Profit and loss Appropriation a/c Dr 15,705
To Debenture Redemption Fund A/c 15,705
(Transfer of profit to Debenture
Redemption Fund Account)

2005
April 1 Debenture Redemption Fund
policy A/c Dr 15,705
To Bank A/c 15,705
(Payment of annual premium for the
policy taken out to provide cash
for redemption of debenture)

2006
March 31 Profit and loss Appropriation a/c Dr 15,705
To Debenture Redemption Fund A/c 15,705
(Transfer of profit to Debenture
Redemption Fund Account)

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2006
March 31 Bank Dr. 50,000
To Debenture Redemption
Fund Policy A/c 50,000
(Receipt of Policy amount on maturity)

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2006
March 31 Debenture Redemption Fund
Policy A/c Dr. 2,885
To Debenture Redemption
Fund A/c 2,885
(Transfer of accumulated interest on
the policy to Debenture Redemption
Fund A/c)
_______________________________
2006
March 31 12% Debenture A/C Dr. 50,000
To Debentureholder A/c 50,000
(Amount due on redemption)
_______________________________
2006
March 31 Debenture A/c Dr. 50,000
To Bank 50,000
(Payment made for the amount due)
_____________________________

2006
March 31 Debenture Redemption Fund A/c Dr. 50,000
To General Reserve A/c 50,000
(Transfer of the balance of Debenture Redemption Fund A/c to
General Reserve)
________________________________

Ledger Account
12% Debentures Account
Dr Cr
Rs.
Rs.
31.3.2004 To Balance c/d 50,000 1.4.2003 By Bank 50,000
31.3.2005 To Balance c/d 50,000 1.4.2003 By Bank b/d 50,000
31.3.2006 To Balance c/d 50,000 1.4.2003 By Bank 50,000

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Debenture Redemption Fund Policy Account

Rs.
Rs.
1.4.2003 To Bank 15,705 31.3.2004 By Balance c/d 15,705
1.4.2003 To Balance b/d 15,705 31.3.2005 By Balance c/d 31,410
31,410 31,410

1.4.2005 To Balance b/ 31,410 31.3.2006 By Bank 50,000

To Bank 15,705 31.3.2006
31.3.2006 To Debenture Redemption
Fund A/c 2,885 __________
50,000 50,000

Debenture Redemption Fund

Rs. Rs
31.4.2004 To Balance c/d 15,705 31.3.2004 By Profit and Loss
Appropriation A/c 15,705
31.3.2005 To Balance c/d 31,410 1.4.2004 By Balance b/d 15,705
31.3.2005 By Profit and Loss
______ Appropriation A/c 15,705
31,410 31,410

31.3.2006 To General 1.4.2005 By Balance b/d 31,410

Reserve A/c 50,000 31.3.2006 By Profit and Loss
Appropriated A/c 15,705
31.3.2006 Debenture Redemption
Fund Policy A/c
2,885
_______ _______
50,000 50,000
________________________________________________________________________

REDEMPTION OUT OF THE PROCEEDS OF FRESH ISSUE OF SHARES

OR DEBENTURES

Debenture may be redeemed from the funds raised by the issue of fresh shares or
debentures, Accounting entries are to be passed for fresh issue of shares debentures apart
from entries for redemption. The following entries will be passed.

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1. On issue of fresh shares or debentures-

Bank Dr. with the amount raised by fresh
To Share Capital A/c issue
To Debentures A/c

2. On Redemption of old debentures-

(a) Debentures A/c Dr. with the nominal value of the

To Debentureholder A/c debentures

(b) Debentureholders A/c Dr. with the amount paid

To Bank

Notes:

(1) Working capital remains intact as the new share capital or debenture takes the place
of old debentures.
(2) If the fresh issue is made at a premium or a discount the entry should be passed
accordingly.
(3) If the debentures are redeemed at a premium, Premium on Redemption of
Debentures A/c should be credited at the time of issue by debiting Loss on issue of
debentures A/c and before the payment is made, the same should be transferred to
Debenture holders A/c.
(4) The creation of Debenture Redemption Reserve may not be necessary in this case
since the additional capital or debentures raised for the purpose of redemption of
debentures replaces the existing debentures.

REDEMPTION OUT OF SALE PROCEEDS OF ASSETS OF THE COMPANY

When debentures are redeemed out of the sale of the asset of the company, the accounting
treatment is as follows:

(i) On sale of assets

Bank Dr. (with sale proceeds)
To Respective Assets A/c
The profit or loss on sale of the asset will be transferred to profit and loss account.
The entries for redemption of debentures will be the same as in 7 above.
Note: Debenture Redemption reserve account to the extent of 50% of the face value of the
debentures issued may be maintained as per the SEBI Guidelines.

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Illustration 5 (When Debentures are redeemed out of the proceeds of fresh issue of
shares or debentures).

The following is the Balance Sheet of Good Luck Ltd. as on 1st April 2006:
Liabilities Rs. Assets Rs.

Share Capital: Fixed Asset:

Authorised Capital Land and Building 2,00,000
1,00,000 Equity Shares Plant and Machinery 2,00,000
of Rs.10 each 10,00,000 Furniture and Fixtures 10,000
50,000 Equity shares of Current Assets,loans
Rs.10 each fully paid-up 5,00,000 and Advances:
Reserves and surplus: A. Current Assets
Profit & Loss A/c 50,000 Stock in Trade 1,70,000
Secured Loans: Sundry Debtors 2,00,000
1,000 12% Debentures of Cash at Bank 20,000
Rs.100 each fully paid-up 1,00,000 B.Loans and Advances: Nil
Current Liabilities
and Provisions:
Creditors 1,50,000
B.Provisions Nil

_________ ________
8,00,000 8,00,000

The Debenture trust Deed provides that the company may redeem the debentures at a
premium of 5% at any time before the maturity. In order to exercise this option, the
directors decided to issue 10,000 equity shares of Rs.10 each at Rs.11 on this day and to
redeem the debentures. All the shares were duly subscribed and the debentures were
redeemed.

Show the journal entries in the books of the company. Also prepare the balance sheet after
the redemption of debentures.

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Solution:

Journal Entries Dr Cr
Rs Rs
2006
April 1 Bank A/c Dr 1,10,000
To Equity Share Capital A/c 1,00,000
To Securities Premium A/c 10,000
(Allotment of 10,000 equity shares
Of Rs.10 each issued at a Premium
of Re.1/- per share as per Board’s
resolution dated…)

12% Debentures A/c Dr 1,00,000

Premium on Redemption of
Debenture A/c Dr 5,000
To Debenture holders A/c 1,05,000
(Amount due on redemption of
debentures at premium of 5%)

Debenture holders A/c Dr 1,05,000

To Bank A/c 1,05,000
(Payment made for the amount due)

Securities premium A/c Dr 5,000

To Premium on Redemption of
Debentures A/c 5,000
(writing off premium on Redemption of
Debentures against the securities
Premium A/c )

Balance sheet of Good luck ltd, as at 1st April,2006

(After Redemption of Debentures)

Liabilities Rs Assets Rs

Share Capital: Fixed Assets:

Authorised Capital Land and Building 2,00,000
1,00,000 Equity shares Plant and Machinery 2,00,000
Of Rs.10 each 10,00,000 Furniture and Fixture 10,000

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Issued, subscribed and Current Assets:

Paid-up capital-60,000 Stock in trade 1,70,000
Equity shares of Rs.10 Sundry Debtors 2,00,000
Each fully paid-up 6,00,000 Cash at Bank 25,000
Reserves and Surplus:
Securities Premium
Account 5,000
Profit and Loss A/c 50,000
Current Liabilities:
Creditors 1,50,000
_________ __________
8,05,000 8,05,000

Notes:
(1) In this case, additional equity shares capital raised for the purpose of redemption of
debentures replaces the debentures. As such transfer to general Reserve out of
profits of the company is not required.
(2) As section 78 permits the writing off of premium on redemption of debentures
against securities premium Account, the same has been written off against the
Securities premium Account.

2.9 LET US SUM UP

Redemption of Preference shares and Debentures refers to the discharge of the liability in
respect of Debentures/Preference shares. Debentures can be redeemed at any time either
at par or at a premium or at a discount without any legal formalities to be complied with.
The prospectus inviting applications for the debentures/preference shares generally
contains the terms of redemption.

2.10 LESSON-END ACTIVITIES

1 A Company issues early in 2002, 13% Rs.20,00,000 debentures at Rs.96, but redeemable at
Rs.103. Redemption will be carried out by annual drawings of Rs.4,00,000 (face value)
commencing at the end of 2006. What do you recommend as the amount to be charged to the
profit and loss account, apart from that of interest?
2 Redemption of 10,000 preference shares of Rs.100 each was carried out by
utilization of reserves and by issue of 4,000 equity shares of Rs.100 each at Rs.125.
How much should be credited to capital redemption reserve account? In the above
case, the redemption was carried out of reserves and out of the issue of 4,000 shares
of Rs.100 each @Rs.95. what is the amount of capital redemption reserve account
that is required?

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3 A company having free reserves of Rs.30,000 wants to redeem rupees one lakh
preference shares. Calculate the face value of fresh issue of shares of Rs.10 each to
be made at a premium of 10%.
4 P. Ltd issued Rs.10,00,000 Debentures at a discount of 5%; the debenture holders
have an option of converting the amount into Rs.10 equity shares at a premium of
10%. A debenture holder holding Rs.40,000 debentures wishes to exercise the
option. How many shares will he get?
5 Calculate the amount of discount to be written off each year on the debentures of
Rs.50,00,000 issued on 1.1.2006 at a discount of 5% repayable in annual drawings
of Rs.10,00,000 each year. Account period ends on 31st December.
6 Ess Ltd pays interest on its 12% Debentures on 30th September and 31st March. To
redeem the debtures it has maintained a sinking fund which stood on 31st December,
2005 at Rs.2,70,000 represented by 6% Government Loan of the nominal value of
Rs.3,00,000 (interest payable on the same dates as for debentures),
On 1st January, 2006, the company purchased Rs.1,00,000 of its debentures @96
raising the necessary funds by selling Government Loan @92.5(to the nearest 100).
What is the nominal value of Government loan sold and what is the profit and loss
on the sale?
(Note: Every Rs.100 of Debentures requires Rs.99 i.e. Rs.96 plus Rs.3 for interest. Every Rs.100 of
Government loan will yield Rs.94 i.e. the price stated plus Rs.1.50 interest for 3 months)
7 Bhalla and Co., Ltd., has an authorized equity capital of Rs.20,00,000 divided into
shares of Rs.100 each. The paid-up capital was Rs,12,50,000. Besides this, the
company had 9% Preference shares of Rs.10 each for Rs.2,50,000. Balance on other
accounts were- Securities Premium Rs.3,40,000, profit and loss account Rs.72,000
and General reserve Rs.3,40,000. Included in the Sundry Assets were investments
of the face value of Rs.30,000 carried in the books at a cost of Rs.34,000.
The Company decided to redeem the preference shares at 10% premium partly by
the issue of equity shares of the face value of Rs.1,20,000 at a premium of 10%.
Investments were sold at 105% of their face value. All preference shareholders were
paid off except 3 holding 240 shares.
Give necessary journal entries bearing in mind that the Directors wanted a minimum
reduction in free reserves, while effecting the above transactions. Working should
form part of your answer.

References
1) M.C. Shukla, T.S. Grewal & S.C.Gupta- Advanced accountancy
2) R.L. Gupta & M Radhaswamy – Company Accounts
3) S.P. Jain & K.L. Narang – Company Accounts
4) J.R. Monga- Fundamentals of Corporate Accounting

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UNIT - III
3.0 Aims and objectives
3.1 Final accounts of companies
3.1.2 Preparation and presentation of final accounts
3.1.3 Form and contents of balance sheet and profit and loss account:
3.2. Contingent liabilities
3.3. Share capital
3.3.1. Reserves and surplus
3.3.2 Secured loans
3.3.3 Unsecured loans
3.3.4 Current liabilities and provisions
3.3.5 Contingent liabilities
3.3.6 Fixed assets
3.3.7 Investments
3.3.8 Current assets, loans and advances
3.3.9 Miscellaneous expenditure
3.3.10 Other general instructions
3.4 Balance sheet abstract and company’s general business profile
3.5 Schedule vi to the companies act, 1956
3.5.1 Treatments of special item while preparing the final
accounts
3.5.2 Provisions and reserves:
3.5.3 Distinction between provisions and reserves:
3.5.4 Types of reserves
3.5.5 Provision and depreciation:
3.5.6 Provision for repairs, renewals and replacements:
3.6 Managerial remuneration
3.7 Director cannot to hold office or place of profit
3.8 Compensation for loss of office
3.9. Directors with unlimited liability in limited company
3.10 Special resolution of limited company making liability of directors unlimited
3.11 Determination of net profit for calculation of managerial remuneration
3.12 Credit Shall not be given for the following sums
3.13 Let us sum up
3.14 Lesson end activities
3.15 References

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3.0 AIMS AND OBJECTIVES

i) To know the Meaning, definition of Profit and loss Account and Balance sheet.
ii) To study the preparation and presentation of Final Accounts.
iii) To understand the interpretation of the various expressions used in the Final
Accounts.

3.1 FINAL ACCOUNTS OF COMPANIES

Final accounts of a company consists of the following two statements

1. Balance sheet as at the end of the accounting period disclosing the financial position
of the company
2. Profit and loss account for the period disclosing the results of the
operations of the company.

A company is under legal obligation to keep proper books of account and to prepare its
final accounts every year in the prescribed manner. There is no such obligation upon sole
proprietorship or partnership firms to prepare final accounts, but companies have a
statutory obligation to prepare final accounts under section 210 of the Companies Act. A
brief mention as to the legal provisions is given below.

Section 209:Books of accounts should be maintained on accrual basis and according to the
double entry system of book keeping.

Section 210:This deals with the presentation of final accounts of a joint stock company.

Section 211:this deals with the form and contnts of balance sheet and profit and loss
account.

Section 212:Disclosure of certain particulars in the balance sheet of a holding company in

respect of its subsidiaries

Section 214:This deals with the rights of the holding companies representatives.

Section 215:As per this section the balance sheet and profit and loss acounbt of the
company shall be authencitated by not less than two directors of the company or
secretary/manager of the company.

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3.1.2 PREPARATION AND PRESENTATION OF FINAL ACCOUNTS

At every general meeting of the company held in pursuance of section 166,the board of
directors of the company shall lay before the company
a. A balance sheet at the end of the period specified in sub section 3 of section 210
b. A profit and loss account for that period
In case of a company not carrying on business for profit, an income and expenditure
account shall be laid before the company at its annual general meeting.
The profit and loss account shall relate

In case of the first ANNUAL GENERAL MEETING OF THE COMPANY, to the period
beginning with the incorporation of the company and ending with the day which shall not
precede that day of the meeting by more than nine months.

In the case of any subsequent annual general meeting of the company to the period
beginning with the day immediately after the period for which the account was last
submitted and ending with the day which shall not precede the day of the meeting by more
than six months

The period to which the account afore said relates is referred to as “financial year” or it
may be less than or more than a calendar year. But it shall not exceed fifteen months.

3.1.3 FORM AND CONTENTS OF BALANCE SHEET AND PROFIT AND LOSS
ACCOUNT:

Every balance sheet of a company shall give a true and fair view of the state of affairs of
the company as at the end of the financial year and shall subject to the provisions of this
section,be in the form set out in para 1 of schedule 6 or as near there to as circumstances
admit.This provision shall not be applied to insurance or banking company or company
generating electricity.

Every profit and loss account of the company shall give a true and fair view of the profit
and loss account of the company for the financial year and shall,subject as afore said,
comply with the requirements of part 2 of schedule 6.
The central government may by notification in the official gazette exempt any class of
companies from compliance in the public interest.
The balance sheet and the profit and loss account of the company shall not be treated as
not disclosing a true and fair view of the state of affairs of the company.
For the purposes of the section, except where the context otherwise requires any reference
to a balance sheet or profit and loss account shall include any notes there on or documents
annexed there to giving information required by this act.

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SCHEDULE VI TO THE COMPANIES ACT,

1956
(See Section 211)

HORIZONTAL FORM Of Balance sheet

Balance Sheet of ........................ (name of the company) ...................................

As at ........................................................(date as at which it is made out)

Figures Figures Figures

Figures
for the for the for the
for the L I A B I L I T I E S ASSETS
C.Y. P.Y. C.Y.
P.Y.
(Rs.) (Rs.) (Rs.)
(Rs.)

SHARE CAPITAL FIXED ASSETS

Authorised 1. Goodwill
..... Shares of Rs....... each 2. Land
Issued 3. Buildings
..... Shares of Rs....... each 4. Leaseholds
Subscribed 5. Railway Sidings
..... Shares of Rs....... each 6. Plant and Machinery
Rs. .... per share called up 7. Furniture and Fittings
Less: Unpaid calls 8. Development of
Add: Forfeited shares Property
9. Patents, trademarks
RESERVES AND and designs
SURPLUS 10. Livestock
11. Vehicles etc.
1. Capital Reserves
2. Capital Redemption INVESTMENTS
Reserve
3. Share Premium 1. Investments in Govt.
Account or Trust Securities
4. Other Reserves 2. Investments in shares,
Less: Debit balance in debentures or bonds
profit and loss 3. Immovable properties
account, if any 4. Investments in the
5. Balance in the profit capital of partnership
and loss accounts after firms

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providing for proposed 5. Balance of unutilised

allocation namely monies raised by Issue
Dividend Bonus or
Reserves CURRENT ASSETS,
6. Proposed additions to LOANS & ADVANCES
Reserves
7. Sinking Funds A. Current Assets
1. Interest accrued on
SECURED LOANS investments
2. Stores and spare parts
1. Debentures 3. Loose tools
2. Loans and Advances
from Banks 4. Stock-in-trade
3. Loans and Advances 5. Works-in-progress
from Subsidiaries 6. Sundry debtors :
4. Other Loans and a. Debts outstanding
Advances for a period
exceeding 6
UNSECURED LOANS months
b. Other debts
1. Fixed Deposits Less: Provision
2. Loans and Advances 7.
from Subsidiaries a. Cash balance on
3. Short-term Loans and hand
Advances: b. Bank balances With
a. from Banks Scheduled Banks
b. from others c. With Others
4. Other Loans and B. Loans and Advances
Advances
a. from Banks 8. Advances and Loans
b. from others a. To subsidiaries
b. To partnership
CURRENT LIABILITIES firms in which
& PROVISIONS the co./its
subsidiary is a
A.Current Liabilities partner
1. Acceptances 9. Bills of Exchange
2. Sundry Creditors 10. Advances recoverable
i. Total outstanding in cash or in kind or
dues of small for value to be
scale industrial received; e.g.,
undertaking(s). Rates, Taxes,
ii. Total outstanding Insurance, etc.
dues of creditors 11. Balances with
Customs, Port

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other than small Trust, etc. (where

scale industrial payable on
undertaking(s). demand).
3. Subsidiary companies
4. Advance payments
and unexpired MISCELLANEOUS
discounts EXPENDITURE
5. Unclaimed Dividends (to the extent not written off
6. Other Liabilities (if or adjusted)
any)
7. Interest accrued but 1. Preliminary Expenses
not due on loans 2. Expenses including
B. Provisions commission/ brokerage
on underwriting or
8. Provision for subscription of shares
Taxation or debentures
9. Proposed Dividends 3. Discount allowed on
10. For contingencies issue of shares or
11. For Provident Fund debentures
Scheme 4. Interest paid out of
12. For Insurance, capital during
pension and similar construction
staff benefit schemes 5. Development
13. Other provisions expenditure not
adjusted
6. Other items
(Specifying nature)

PROFIT AND LOSS

ACCOUNT
(Debit Balance)

Total Total

3.2 CONTINGENT LIABILITIES

(Foot Note)
1. Claims against the company not acknowledged as debts
2. Uncalled liability on shares partly paid
3. Arrears of fixed cumulative dividends

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4. Estimated amount of contracts remaining to be executed on capital account and not

provided for
5. Other money for which the company is contingently liable

Requirements as to Balance Sheet

Under each of the heads in the above balance sheet of the companies, detailed notes are to
be given on various matters. These requirements are listed as under :

3.3 SHARE CAPITAL

1. The ‘issued capital’ and ‘subscribed capital’ must be distinguished into various
classes of capital; viz. preference and equity, and the particulars specified hereunder
must be given separately for each of them.
2. Shares allotted as fully paid, pursuant to a contract, for consideration other than
cash, should be separately shown; e.g., shares issued to promoters, or for the
purchase of a running business etc.
3. Shares allotted as fully paid-up by way of bonus shares, should be separately
disclosed. The source from which the bonus shares are issued must also be specified;
e.g., by capitalisation of reserves or profits or from share premium account, etc.
4. Terms of redemption or conversion, if any, in case of redeemable preference shares
must be stated, together with the earliest date of redemption or conversion.
5. Particulars of any option on unissued share capital should also be specified.
6. Preference shares should also be classified into different categories, if any.
7. Unpaid calls must be shown separately in respect of following:
a. By directors.
b. By others.
8. In case of forfeited shares, amount originally paid-up should be shown. Any profit
on reissue of forfeited shares should be transferred to capital reserve.
9. In case of subsidiary companies, the number of shares held by the holding company
as well as by the ultimate holding company and its subsidiaries must be separately
stated.
10. Any capital profit on reissue of forfeited shares should be transferred to Capital
Reserve.
The auditor is not required to certify the correctness of such shareholdings as certified by
the management.

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3.3.1. Reserves and Surplus

1. The item ‘Share Premium Account’ shall include the details of its utilisation in the
year of its utilisation in the manner provided in S. 78.
2. In case of ‘other reserves’, the nature and the amount of each reserve must be
specified; e.g., General Reserves, Dividend Equalisation Reserve etc.
3. The balance in the profit and loss account, should be the balance after providing for
all proposed allocations namely for dividend, bonus or reserves.
4. The debit balance in the profit and loss account should be shown as a deduction
from the uncommitted reserves, if any.
5. Additions and deductions in the reserves since last balance sheet must be shown
under each of the specified heads.
6. The word ‘fund’ in relation to any ‘reserve’ must be used only where such reserve is
specifically represented by earmarked investments.

3.3.2 Secured Loans

1. Loans from directors and managers must be shown separately, under each sub-head.
2. Interest accrued and due on secured loans should be included under appropriate sub-
heads under the head "Secured Loans".
3. The nature of security must be specified in each case.
4. Where loans have been guaranteed by managers and/or directors, a mention thereof
shall also be made and also the aggregate amount of such loans under each head.
5. In case of debentures, the terms of redemption or conversion, if any, of debentures
issued must be stated together with earliest date of redemption or conversion.
6. Particulars of redeemed debentures which the company has power to reissue should be given.
7. Where any of the company’s debentures are held by a nominee or a trustee for the
company, the nominal amount of the debentures and the amount at which they are
stated in the company’s books shall be stated.

3.3.3 Unsecured Loans

1. Loans from Directors; or Manager should be separately shown.
2. Interest accrued and due on unsecured loans must be included under the appropriate
sub-heads under the head "Unsecured Loans".
3. Where loans have been guaranteed by the managers and/or directors a mention thereof should
be made and also the aggregate amount of such loans under each head.
4. Short-term loans are defined to include those loans which are due for not more than
1 year as on the date of the balance sheet.
5. Maximum amount raised through ‘Commercial Paper’ and outstanding balance at
year end to be disclosed as per RBI stipulations.

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3.3.4 Current Liabilities and Provisions

1. Advance payments/unexpired discounts are that portion for which value has still to
be given; e.g. in case of following companies. Newspapers, Fire insurance,
Theatres, Clubs, Banking companies, Steamship companies, etc.
2. Current account balances with directors, and manager, shall be shown separately.
3. The name(s) of the small scale undertaking(s) to whom the company owes a sum
exceeding Rs. 1,00,000/- together with interest which is outstanding for more than
30 days are to be disclosed.
4. Investor's Education and Protection Fund shall be credited by unpaid dividend,
unpaid application money received for allotment of securities and due for refund,
unpaid matured deposits/debentures and interest on these unpaid amounts.

3.3.5 Contingent liabilities

1. These are to be shown by way of a footnote and their amounts do not form part of
the total of the balance sheet.
2. In case of arrears of fixed cumulative dividends, the period for which the dividends
are in arrears or if there is more than one class of shares, the dividends on each of
such class are in arrears, shall be stated separately. The amount shall be stated before
deduction of income tax except that in the case of tax free dividends the amount
shall be shown free of income-tax and the fact that it is so shown must be stated.
3. The amount of any guarantee given by the company on behalf of the directors or
other officers of the company should be stated.
The contingent liabilities with their general nature and amount of each such contingent
liability, if material, should be stated.

3.3.6 Fixed Assets

1. The fixed assets must be classified and distinguished as far as possible between the
heads given in the balance sheet.
2. Under each head, the following details have to be separately given:
a. Original cost of the asset.
b. Additions thereto during the year.
c. Deductions therefrom during the year.
d. Total depreciation written off or provided up to the end of the year.
3. Where the fixed asset was purchased from a foreign country, and as a result of a
change in the exchange rate after such purchase, there is an increase or reduction in
the liability of the company in terms of rupees, for making payment towards the
whole or part of the cost of the asset or for the repayment of the moneys borrowed in
foreign currency for such purchase of an asset, the amount by which the liability has
increased or reduced, must be added to or deducted from the cost of the asset, as the
case may be, and the resultant figure will be treated as the cost of the asset.

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4. Where the original cost of the asset cannot be ascertained without unreasonable
expense or delay, the valuation shown by the books must be given. Such valuation
shall be the net amount at which the asset stood in the company’s books at the
commencement of the Companies Act, 1956, after deduction for depreciation etc.
5. Where any sum has been written off on a reduction of capital or revaluation of
assets, every balance sheet subsequent to such reduction or revaluation must show
the reduced figures and the date of the reduction. For a period of five years, the
amount of the reduction made shall also be stated.
6. Similarly, where sums have been added by writing up the asset, each subsequent
balance sheet, should show the increased figures with the date of the increase. For a
period of five years, the amount of the increase shall also be stated.
7. Depreciation written off or provided should be allocated under the different heads of
assets and deducted in arriving at the value of the fixed assets.

3.3.7 Investments

1. The nature of investment and the mode of valuation for example at cost or market
value shall be stated.
2. The investments shall be distinguished between quoted and unquoted investments
and where quoted, the market value must be shown.
3. Investments in shares, debentures or bonds must be classified into fully paid or
partly paid and into different classes of shares.
4. Investments in subsidiaries must be separately stated.
5. Investments must also be classified into trade investments and other investments.
"Trade investment" means an investment by a company in the shares or debentures
of another company, not being its subsidiary, for the purpose of promoting the trade
or business of the first company.
6. A separate schedule of investments, showing the names of bodies corporate
(showing separately the bodies corporate under the same management) in whose
shares or debentures, investments have been made, should be annexed. The schedule
also should show all the investments whether existing or not, made subsequent to the
date as at which previous balance sheet was made out. In case of investment
company (principal business of acquisition of shares, debentures, etc.), investments
existing on the date as at which the balance sheet was made out may be given.
7. In regard to the investments in the capital of partnership firms, the names of the
firms, names of all other partners, total capital and share of each partner shall be
given.
8. All unutilised monies out of the issue must be separately disclosed in the Balance
Sheet of the company indicating the form in which such unutilised funds have been
invested.

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3.3.8 Current Assets, Loans and Advances

1. If, in the opinion of the Board, any of the current assets, loans and advances have
not a value on realisation in the ordinary course of the business at least equal to the
amount at which they are stated, the fact that the Board is of that opinion shall be
stated.
2. In case of stores and spare parts, stock-in-trade and work-in-progress, the mode of
valuation shall be stated. Amount in respect of raw materials should be stated
separately wherever practicable.
3. In case of investment in shares, debentures, etc. classified under current assets as a
stock-in-trade information as per paras 5 and 6 above under ‘Investment' shall also
be given separately.
4. In regard to sundry debtors particulars should be given separate in respect of :
a. debts considered good and in respect of which the company is fully secured.
b. debts considered good for which the company holds no security other than the
debtor’s personal security, and
c. debts considered doubtful or bad.

A separate disclosure should also be made in respect of following:

d. debts due by —
i. directors or other officers of the company
ii. directors or other officers of the company jointly with any other person
iii. firms in which any director is partner
iv. private companies in which any director is a director or a member
e. debts due from other companies under the same management within the
meaning of sub-section (1B) of S. 370 together with the names of such cos.
f. the maximum amount due by directors or other officers of the company at any
time during the year.

The term "Sundry Debtors" has been defined to include "the amounts due in respect of
goods sold or services rendered or in respect of other contractual obligations". It does not,
however, include amounts which are in the nature of loans or advances.

The provision for bad and doubtful debts under the head ‘sundry debtors’ should not
exceed the amount of debts stated to be considered bad or doubtful. Any surplus of such
provision should be shown as reserve for bad or doubtful debts under the head ‘Reserves
and Surplus’ on the liabilities side.

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5. In regard to ‘bank balances’, the following particulars should be given :

a. the balance lying with scheduled banks on current accounts, call accounts and
deposit accounts;
b. the names of the bankers (other than scheduled banks) and the balances lying
with each such banker on current accounts, call accounts and deposit accounts,
and the maximum amount outstanding at any time during the year from each
such banker; and
c. the nature of the interest, if any, of any director or his relative in each of the
banks, referred to in (b) above.

6. In regard to loans and advances, all instructions regarding ‘Sundry Debtors’ would
apply to "Loans and Advances" also.
The amounts due from other companies under the same management within the
meaning of S. 370(1B) shall be given with the names of such companies.
The maximum amount due from every one of such companies at any time during the
year must also be stated.
Current accounts with directors and managers should be shown separately.

3.3.9 Miscellaneous expenditure

1. The debit balance of profit and loss account should be shown as a deduction from
the free or uncommitted reserves, if any.
2. While showing "interest paid out of capital during construction", the rate of interest
shall be stated.

3.3.10 Other general instructions

1. If the required information cannot be given conveniently in the given form in the
balance sheet itself, it may be furnished in separate schedules annexed to and
forming part of the balance sheet.
2. Except in the case of the first balance sheet, the corresponding amounts for the
immediately preceding financial year for all items shall also be shown.
3. Paise can also be given in addition to rupees, if desired.
4. Dividends declared by subsidiary companies after the date of the balance sheet
should not be included unless they are in respect of the period which closed on or
before the date of the balance sheet.
5. Any reference to benefits expected from contracts to the extent executed shall not be
made in the balance sheet but shall be made in the Board's Report.

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6. A small-scale industrial undertaking has the same meaning as assigned to it under

clause (j) of sec. 3 of the Industries (Development and Regulation) Act, 1951.
7. The figures in the balance sheet may be rounded off as under:
o Less than Rs. 100 crores : to the nearest hundreds or thousands or decimal
thereof
o Between Rs. 100 crore or more, but less than Rs. 500 crores : to the nearest
hundreds, thousands, lakhs or millions or decimal thereof
o Rs. 500 crores or more, to the nearest hundreds, thousands, lakhs, millions or
crores or decimal thereof.

B. VERTICAL FORM

Name of the company

Balance Sheet as at

Sch. Figures as at Figures as at

No. the end of the the end of the
current previous
financial year financial year
(Rupees) (Rupees)
I. Sources of funds
1. Shareholders’ Funds :
a. Capital
b. Reserves and surplus
2. Loan funds
a. Secured loans
b. Unsecured loans

TOTAL ................

II. Application of funds

1. Fixed assets :
a. Gross block
b. Less: Depreciation
c. Net block
d. Capital work-in-progress
2. Investments:
3. Current assets, loans and advances
a. Inventories
b. Sundry debtors
c. Cash and bank balances

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d. Other current assets

e. Loans and advances

Less : Current liabilities and

provisions

f. Liabilities
g. Provisions

Net current assets

4.
a. Miscellaneous expenditure to the
extent not written off or adjusted
b. Profit and loss account

TOTAL ..............

Notes :

1. Details under each of the above items shall be given in separate Schedules. The
Schedules shall incorporate all the information required to be given under A
Horizontal Form read with notes containing general instructions for preparation of
balance sheet. The Schedules, referred to above, accounting policies and
explanatory notes that may be attached shall form an integral part of the balance
sheet.
2. The figures in the balance sheet may be rounded off to the nearest ‘000’ or ‘00’ as
may be convenient or may be expressed in terms of decimals of thousands.
3. A footnote to the balance sheet may be added to show separately contingent
liabilities.

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PART - IV
3.4 BALANCE SHEET ABSTRACT AND COMPANY’S GENERAL BUSINESS
PROFILE

1. REGISTRATION DETAILS:

Registration No
State code

Balance sheet
date Date month year

2.Capital raised during the year(amount in rs.thousands)

Public issue Rights issue

Bonus issue Private placement

3.position of mobilization and deployment of funds

(amount in rs.thousands)

Total liabilities Total assests

Sources of funds
Paid up capital Reserves and surplus

Secured loans Unsecured loans

Application of funds
Net fixed assets Investments

Net current assets Misc. expenditure

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Accumulated losses

4 Performance of company(amount in Rs.thousands)

Turnover Total Expenditure

Profit / loss before tax Profit/ loss after tax

Earning per share in rs Dividend rate %

5.Generic names of three principal products/ services of company(as per monetary terms)

Item code number

(itc code)

Product
description

Item code number

(itc code)

Product
description

Item code number

(itc code)

Product

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description

Note: for ITC code of products please refer to the publication Indian trade classification
based on harmonized description and coding system by Ministry of Commerce Directorate
General of Commercial intelligence & Statistics, Kolkatta 700 001.

3.5 SCHEDULE VI TO THE COMPANIES ACT, 1956

3.5.1. TREATMENTS OF SPECIAL ITEM WHILE PREPARING THE FINAL

ACCOUNTS

3.5.2 Provisions and reserves:

The expression “provision” shall mean any amount return of or retained by way of
providing for depreciation, renewals or decrease in the value of assets or retained for
known liability.few examples of provisions are provision for depreciation, provisions for
repairs and renewals, bad and doubtful debts, fluctuations in investments, contingent
liability and taxation etc. Provisions are definitely a charge against profits and as such they
should be shown in the profit and loss account proper. Provisions made in the excess of
the required amount will be regarded as reserves and not as provisions.A reserve therefore
by implication represents undistributed profits and reserves are appropriation of profits
and not charge against the profits.

3.5.3 DISTINCTION BETWEEN PROVISIONS AND RESERVES:

1) Provisions are created for specific purpose while reserve is created for probable
losses.
2) Provision is a charge against profit while reserves are an appropriation of profit.
3) Provision cannot be distributed as profit while reserves can be distributed.
4) Provision cannot be invested while reserves can be invested in securities
5) Provision is made because of legal necessity while reserve is a matter of financial
prudence.
6) Provision is deducted from the concerned head of account while the reserve is shown
separately under reserves and circulars.

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3.5.4 TYPES OF RESERVES

3.1.1. Revenue reserve: A reserve created out of profits by debiting profit and loss
appropriation account.
3.1.2. Revenue reserves are profits retained to strengthen the financial position of the
company.
3.1.3. Revenue reserves may be
a. General reserve which is created by setting aside a portion of the profit every year
for unforeseen contingency
b. A specific reserve is created by settin aside a porion of profit for the specific
purpose

3.5.5 Provision and Depreciation:

Part II schedule VI of the companies Act, 1956 requires that the profit and loss Account
must disclose the amount provided for depreciation, renewals or diminution in value of
fixed assets. If such provision is not made by means of a depreciation charge, the method
adopted for making such provision should be stated, But where no provisions is made for
depreciation, the fact no provision, has been made, must be stated and the quantum of
arrears of depreciation computed in accordance with section 205(2) of the Act, is also to
be stated by way of a note.

Section 205(2) of the companies Act, 1956 states that depreciation should be provided
either:

(a) to the extent specified in section 350;

(b) in respect of each item of depreciation asset for such an amount as is arrived at by
dividing 95 percent of the original cost to the company by the specified period in
respect of such assets; or
(c) on any other basis approved by the central Government which has the effect of
writing off by way of depreciation 95 percent of the original cost of the company of
each such depreciation assets on the expiry of the specified period;
or
(d) as regards ant other depreciable asset for which no rate of depreciation has been laid
down by this Act or any rules made there under, on such basis as may be approved
by the Government by any general order published in the official Gazette or any
special order in any particular case:

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Provided that if any of the aforesaid assets is sold, discarded, demolished or destroyed, the
excess (if any) of the written down value of such asset over its sale proceeds or, as the
case may be, its scrap value; must be written off in the financial year in which the asset is
sold, discarded, demolished or destroyed.

Depreciation may be provided either on the written –down value at the rates specified in
schedule XIV of the Act or on straight line basis. In straight line basis , depreciation may
be calculated by dividing 95% of the original cost of the asset by its specified period. it
means the number of years at the end of which atleast 95% of the original costs of that
asset will have been provided by way of depreciation if depreciation were to be calculated
in accordance with the provision of section 350.

The amount of depreciation charged on the asset every year is debited to the profit and
loss Account and the provision for depreciation Account which is allowed to accumulated
from year to year. The accounting entries required for this will be as follows:

(1) When depreciation is charged on assets:

Depreciation A/c Dr (With the amount of depreciation)

To Provision for depreciation A/c

(2) When depreciation is taken to the profit and loss Account :

Profit and loss A/c Dr (with the amount of depreciation)

To Provision for Depreciation A/c
The net effect of the above two entries will be:
Profit and loss Account Dr (with the amount of depreciation)
To provision for depreciation A/c

Notes:

(1) if any asset is sold, discarded, demolished or destroyed, the proportionate amount of
depreciation relating to the asset must be transferred from the provision for
depreciation Account to the Asset Disposal Account. For this the entry will be:

Provision for Depreciation A/c Dr (with the proportionate of depreciation)

To Asset Disposal A/c

(2) When the excess of the written down value of the asset sold; discarded demolished
or destroyed over the sale proceeds or scrap value is written off the following entry
is required:

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Profit and loss Account Dr (with the loss)

To Asset Disposal a/c
This entry will be reversed if the sale proceeds of the asset sold are greater than its written
down value. But the excess of sale proceeds over the original cost of the asset is capital
profit and should be credited to capital Reserve.
(3) if depreciation appears in the trial balance as a debit balance, it implies that the
credit has already been given to provision for Depreciation Account.
(4) If any asset is purchased during the accounting period, depreciation may be provided
for the full year and in such a case a note may be given to this effect. However,
according to accounting principles, depreciation should be provided only for the
period the asset was in use.
(5) Depreciation relating to past years should be treated as appropriation of profits and
not charge against profits.
(6) Any charge in the method of providing for depreciation should be disclosed along
with the quantum of effect on the profit/loss of the company.

3.5.6 Provision for Repairs, Renewals and Replacements:

While considering the question of depreciation, a clear distinction should be made

between the cost of upkeep in the shape of repairs and small renewals and the cost of large
renewals or the entire replacement of the asset concerned.

(a) Cost of Repairs and Renewals: The cost of upkeep should be charged to revenue in
addition to the necessary provision for depreciation. The current expenditure by way of
repairs is necessary to preserve the life of the asset to the extent of its normal estimated
life. Actually speaking, this is based upon which the rate of depreciation is determined;
otherwise the rate of depreciation would have been much higher. As a consequence, it is
essential that the cost of current repairs should be charged to revenue.

It is also important to consider whether it is necessary to provide for future expenditure on

repairs during the early years of the life of an asset. It is a recognized fact that the
expenditure on repairs in the early years of the life of an asset is much less as compared to
the subsequent years of its life. Where large sums are involved , the best method is to
estimate the total expenditure by the number of years of its estimated life. this average
estimated expenditure on repairs is debited every year to the profit and loss account and
credited to either “Provision for Repairs and Renewals Account” or to “ Provision for
Maintenance Account” The actual expenditure on repairs as and when it is incurred is
debited to Provision for Repairs and Renewals account and credited to bank. Thus, the
following two entries are required:

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1. When provision is made for repairs an renewals-

Profit and loss A/c Dr (with the average estimated expenditure)
To Provision for Repairs and Renewals A/c

2. When actual expenditure is incurred on repairs-

(i) Repairs and renewals A/c Dr (with the actual expenditure as and when made)
To Bank
(ii) Provision for Repairs and
Renewals A/c Dr (with the actual expenditure as and
To Bank when made)

(ii) Provision for Repairs and Renewals A/c Dr (transfer of the total sum to the
To Repairs and renewals A/c provision at the end of the year)

The balance of the provision for Repairs for Renewals Account will be carried
forward and shown on the liabilities side of the Balance sheet under the head
“Reserves and Surplus”. But it may so happen that the provision for Repairs and
Renewals Account may show temporarily a debit balance owing to excessive
expenditure in any particular year. In such a case, it has to seen whether this
excessive expenditure is likely to be recouped out of the provisions to be made during
the subsequent years. if so, such a debit balance can be carried forward otherwise, it
must be written off against the revenue of that particular year. For this the entry will
be-

Profit and loss A/c Dr (with the excess amount)

To Provision for Repairs and
Renewals A/c

If the estimated repairs prove exact at the end of the life of the asset, there will be no
balance left in the provisions for Repairs and Renewals Account. But usually, there will be
some balance left in the provision for Repairs and Renewals Account which should be
transferred to the profit and loss Account.

Illustration:1

Okay ltd. estimated its expenditure on repairs of machinery over a period of 10 years at
Rs.1,00,000 and decided to raise a Provision for Repairs and Renewals Account by
debiting its Profit and loss Account with a uniform figure every year. The actual repairs in
the 1st,2nd and 3rd years were respectively Rs.3,000, Rs.4,500 and Rs.7,000

Write up the provision for Repairs and Renewals Account.

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Solution :

Dr Provision for Repairs and Renewals Account Cr

Rs Rs
1st year To Bank 3,000 st
1 year By Profit and Loss A/c 10,000
To Balance c/d 7,000 _______
10,000 10,000

2nd Year To Bank 4,500 2nd year By Balance b/d 7,000

To Balance c/d 12,500 By Profit and Loss A/c 10,000
17,000 17,000

3rd Year To Bank 7,000 3rd year By Balance b/d 12,500

To Balance c/d 15,500 By Profit and Loss A/c 10,000
22,500 22,500

Notes:

(1) The balance of this account will be shown every year in the balance sheet on the
liabilities side under the head “Reserve and Surplus”.

(2) The annual amount to be debited to profit and loss Account every year will be
Rs. 1,00,000 = Rs.10,000
10
(3) Although, a provision of Rs.10,000 will be made every year in the profit and loss
Account of the company, for the purpose of determining the next profit for
calculation of managerial remuneration the excess of provision over actual
expenditure has to be added back to the profits.

(b) Cost of Replacement and provision for Replacement: Replacement of an asset

represents the complete exhaustion of the capital invested in the asset. It involves the
expenditure of large sums for the replacement of the asset. The annual charge of
depreciation spreads this cost equitably over the life of the asset.

An important point to be noted here is that where the cost of replacement of the asset is
estimated to exceed the original cost of the asset, it raises the question as to whether
depreciation should be calculated on the original cost of the asset or on the replacement
cost of the asset (i.e the amount required to replace the asset by a new one).

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Since one of the important objects of providing for depreciation is to collect funds for
replacement cost of the asset, it seems quite logical that the depreciation should be
charged on the replacements cost of the asset. But this principle cannot be followed in
practice due to the restrictions imposed by the companies Act, 1956.

According to the companies Act, 1956, depreciation has to be calculated on the original
cost of the asset. Part III of Schedule VI of the companies Act further states that where
any amount written off or retained by way of providing for depreciation in excess of the
amount which is necessary for the purpose, the excess shall be treated as a reserve and not
as a provision. Besides, depreciation is also not admissible on replacement cost basis
under the income-tax Act, 1961.

Under the circumstances, if it is not possible for the company to raise further capital
required to meet the excess expenditure on replacement of the asset, the company may
decide to create a reserve called “Replacement Reserve” out of the profits of the company
for the excess amount over the original cost of the asset. Such a Reserve is an
appropriation of profits and not a charge against profit and therefore, should be shown
below the line. “Replacement Reserve Account” should be shown as accumulated profits
on the liabilities side of the balance sheet under be head “Reserve and Surplus” .

Providing for depreciation every year has the effect of generating funds within the
business of the company with a view to replacing the asset at the end of its useful life.
These funds may be used within the business of the company, the same does not ensure
that cash will be available, when required, to replace the asset, as the funds may be
represented by other business asset which may not be readily realized.

In order to ensure that the cash is readily available at the time of replacement of the asset.
it is desirable that the funds should be invested outside the business of the company. This
can be done in the following two ways:

(i) By investing the funds every year in readily convertible securities known as the
sinking Fund or Depreciation Fund Method.
(ii) By taking out an insurance policy.

(vi) Provision for taxation and Advance payment of Tax:

Under clause 3(vi) of profit and loss Account of a company must set out the “amount of
charge for income tax and other taxation on profits, including where practicable, with
Indian income-tax, any taxation on profits, including where practicable, with Indian
Income tax, any taxation imposed elsewhere to the extent of the relief, if any, from Indian
Income tax and distinguishing where practicable between income-tax and other taxation.

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A company is liable to pay income-tax or tax on profits under the income-tax Act, 1961
and such tax is treated as charge against the profits of the accounting year, although the
profits are assessed and actual liability for tax is determined in the following year. The
estimated amount of tax is debited to the Profit and loss account proper i.e. above the line
and is credited to “provision for Taxation Account” which is shown on the liabilities side
of the Balance sheet under the head “Current liabilities and provisions”, the accounting
entry is required for this will be as follows:

Profit and Loss A/c Dr. (with the estimated amount of

To Provision for Taxation tax liability)

While making the estimate of provision for taxation, due consideration should be given to
the following points:

ii) Whether the net profit has been determined after deducting depreciation according
to Income tax Act and managerial remuneration.
iii) Whether Income tax has been computed at the rates prescribed.
iv) Whether profit sur tax is payable or not.
v) Whether capital gains tax is payable or not.
vi) Whether penalty is payable under any tax laws.
vii) Whether rebates are available for double taxation.
viii) Whether investment allowance, extra shift allowance, etc if any, have been duly
deducted or not in estimating the tax liability.
ix) Whether adjustment has been made for the last year’s actual tax liability or not.

Accounting entry for Advance Tax payment:

Advance payment of tax A/c Dr. (With the amount of advance

To Bank A/c tax paid)

Until and unless the actual tax liability is determined and adjusted against advance
payment of tax, “Advance payment of Tax account” will show a debit balance which may
be shown in the Balance sheet either on the assets side under the head “Current Assets,
Loans and Advances”, or alternatively, on the liabilities side as a deduction from
“Provision for taxation account” under the head “Current Liabilities and Provisions”.

When the profits of the company are assessed at a subsequent date and the actual tax
liability is determined. Advance Payment of Tax account relating to the period concerned
is closed by transfer to Provision for taxation Account. For this, the accounting entry will
be as follows:

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Provision for taxation A/c Dr. (with the amount of advance

To Advance payment of Tax a/c payment of tax)

If the actual tax liability is more or less than the provision made in the previous year, the
difference has to be adjusted through the appropriation section of the Profit and loss
account (i.e. below the line) by debiting or crediting the provision for taxation account.
The accounting entry for this will be as follows:
a) If the actual tax liability more than the provision made last year
Profit and Loss appropriation A/c Dr. (with the difference)
To Provision for taxation A/c
b) If the actual tax liability is less than the provision made last year
Provision to Taxation A/c Dr. (with the difference)
To Profit and loss appropriation A/c

If the advance payment of tax made for the previous year is less than the actual tax
liability, the difference has to be treated as the liability for taxation until it is paid and
should be shown on the liabilities side of the Balance sheet under the head “Current
Liabilities”. In such a case, the balance of the provision for taxation account for the
previous year may be transferred to “Liabilities for Taxation Account”. The Accounting
entry for this will be as follows:

Provision for taxation Dr. (with the net liability)

To Liabilities for taxation A/c
In case of payment

Liabilities for taxation A/c Dr. (with the amount paid)

To Bank

On the other hand, if the advance payment of tax made for the previous year is more than
the actual tax liability, the balance left in the Advance payment of tax account has to be
shown as an asset on the asset side of the Balance sheet under the head “Current Assets,
Loans and advances” and a refund claim has to be furnished for the same. On receipt of
the refund claim, the accounting entry will be as follows:

Bank A/c Dr. (with the amount of refund)

To Advance Payment of Tax A/c

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Illustration 2

The Trial balance of simplex Ltd as at 31st march, 2008 shows the following items:

Dr. Cr.

Provision for income tax account 60,000

Advance payment of Tax 1,10,000

You are also given the following information:

1) Advance payment of tax account includes Rs.70,000/- for 2006-07

2) Actual tax liability for 2006-07 amounts to Rs.786,000/- and no effect for the same
has so far been given in accounts.
3) Provision for income-tax has to be made for 2007-08 for Rs.80,000/-

Prepare the various ledger accounts involved and also show how the relevant items will
appear in the balance sheet of the company.

Solution
Provision for income tax account
Dr. Cr.

31.3.2008 To Advance payment of By Balance b/d 60,000

Tax A/c 70,000 By Profit and loss
To Liabilities for appropriation A/c 16,000
Taxation A/c 6,000
--------- ----------
76,000 76,000
--------- -----------

31.3.2008 To Balance c/d 80,000 By Profit and loss A/c 80,000

-------- -------

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Advance payment of tax a/c

31.3.2008 To Balance b/d 1,10,000 By provision for

Income tax a/c 70,000
By Balance c/d 40,000
----------- -----------
1,10,000 1,10,000

Liabilities for taxation account

31.3.2008 To Balance C/d 6,000 By Provision for

Income tax A/c 6,000
-------- --------
6,000 6,000

3.6 MANAGERIAL REMUNERATION

The remuneration payable to the directors of a company, including any managing or

whole-time director, shall be determined, in accordance the provisions given below either
by the articles of the company, or by a resolution ( special resolution if the articles so
require ), passed by the company in general meeting and the remuneration payable to any
such director determined as per the said provisions shall be inclusive of the remuneration
payable to such director for services rendered by him in any other capacity. However, any
remuneration for services will not be so included if the services are of a professional
nature and in the opinion of the Central Government, the director possesses the requisite
qualifications.

A director may receive remuneration by way of fees for attending each meeting of the
Board or of any committee thereof ( Sitting Fees ).

A director who is in whole time employment of the company or a managing director may
be paid remuneration either by way of a monthly payment or at a specified percentage of
net profits of the company or partly by one and partly by the other. Such remuneration
cannot exceed 5 % of the net profits of the company, except with the approval of the
Central Government in case of one director and 10 % for all such directors.

The total managerial remuneration payable by a public company or a private company

which is a subsidiary of a public company to its directors and its manager in any financial
year must not exceed 11 % of the net profits of the company calculated in accordance with
the provisions of section 349, 350 and 351.

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In the case of a director who is neither in the whole-time employment of the company nor
a managing director may be paid remuneration either by way of a monthly, quarterly or
annual payment with the approval of the Central Government or by way of commission if
the company by special resolution authorises such payment. Such special resolution to in
sub-section (4) shall not remain in force for a period of more than five years; but may be
renewed, from time to time, by special resolution for further periods of not more than five
years at a time. Remuneration payable to such directors cannot exceed :-

a. if the company has a managing or whole-time director or a manager, one per cent, of
the net profits of the company;
b. in any other case, three percent of the net profits of the company.
If any director earns remuneration from a company in excess of the above limits without
prior approval of the Central Government, he shall refund the excess to the company and
until such repayment, hold the money in trust with him.
The Company cannot waive recovery of such sum due from the director unless approved
by the Central Government.
No approval of the Central Government is required in case the remuneration is within the
limits mentioned in Schedule XIII to the Companies Act, 1956.
No director of a company who is in receipt of any commission from the company and who
is either in the whole-time employment of the company or a managing director shall be
entitled to receive any commission or other remuneration from any subsidiary of such
company.
The above provisions pertaining to remuneration do not apply to a private company unless
it is a subsidiary of a public company.
Provision for increase in remuneration to require Government sanction
In the case of a public company, or a private company which is a subsidiary of a public
company, any provision relating to the remuneration of any director or any amendment
thereof, which purports to increase or has the effect of increasing, whether directly or
indirectly, the amount of remuneration shall not have any effect unless :-
i. is within the limits specified in Schedule XIII, where Schedule XIII is applicable ;
or
ii. approved by the Central Government
and the amendment shall become void if, and in so far as, it is disapproved by the
Government.
Increase in remuneration of managing director on reappointment or appointment after Act
to require government sanction
In the case of a public company, or a private company, which is a subsidiary of a public
company, if the terms of any re-appointment or appointment of a managing or whole-time

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director, purport to increase or have the effect of increasing, whether directly or indirectly,
the remuneration which the managing or whole-time director or the previous managing or
whole-time director, as the case may be, was receiving immediately before such
appointment, the or appointment shall not have any effect unless :-
i. is within the limits specified in Schedule XIII, where Schedule XIII is applicable ; or
ii. approved by the Central Government
and the amendment shall become void if, and in so far as, it is disapproved by the
Government.

3.7 DIRECTOR CANNOT TO HOLD OFFICE OR PLACE OF PROFIT

Except with the previous consent of the company accorded by a special resolution :-

i. No director of a company can hold any office or place of profit in that company
ii. No partner or relative of such a director ( i.e. a director holding an office or place of
profit in the company ), no firm in which such a director or relative is a partner, no
private company of which such a director is a director or member, and no director,
or manger of such a private company can hold any office or place of profit carrying
monthly remuneration in excess of the prescribed amount ( Rs. 10000/-).
However, the above restrictions are not applicable to the office of managing director,
manager, banker, or trustee for the holders of debentures of the company either :-
i. in the company ; or
ii. in any subsidiary of the company, unless the remuneration received from such
subsidiary in respect of such office or place is paid over to the company or its
holding company.
The special resolution required for the above purpose may be passed at the first general
meeting after the appointment. Such special resolutions will required at subsequent re-
appointments also on a higher remuneration not covered by the earlier special resolution.
However, if the monthly remuneration is not less than Rs. 20000/- per month, the special
resolution mentioned above has to be obtained prior to the appointment and in addition to
the special resolution, approval of the Central Government will also be required for the
appointment.
If any office or place of profit under the company or a subsidiary thereof is held in
contravention of the above provisions, the director, partner, relative, firm, private
company or, manager shall be deemed to have vacated his office, with effect from the day
following the date of general meeting mentioned above. Such person will also be liable to
refund to the company any remuneration received, or the monetary equivalent of any
perquisites or advantage enjoyed by him, in respect of such office or place of profit. The
company will not be able to waive recovery of such amounts, except with the approval of
the Central Government.

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Any office or place in a company shall be deemed to be an office or place or profit under
the company for these provisions :-
a. in case the office or place is held by a director, if the director holding it obtains from the
company anything by way of remuneration over and above the remuneration to which he is
entitled as such director, whether as salary, fees, commission, perquisites, the right to occupy
free of rent any premises as a place of residence, or otherwise;
b. in case the office or place is held by an individual other than a director or by any
firm, private company or other body corporate, if the individual, firm private
company or body corporate holding it obtains from the company anything by way of
remuneration whether as salary, fees, commission, perquisites, the right to occupy
free of rent any premises as a place of residence, or otherwise.

None of the above provisions apply to a director appointed by the Central Government u/s
408 of the Companies Act, 1956

3.8 COMPENSATION FOR LOSS OF OFFICE

Payment may be made by a company, except in the cases specified below and subject to
the limit specified, to a managing director or a director holding the office of manager or in
the whole time employment of the company, by way of compensation for loss of office, or
as consideration for retirement from office, or in connection with such loss or retirement.

However, such payment cannot be made by the company to any other director.

No payment shall be made to a managing or other director in the following cases :-

a. where the director resigns his office in view of the reconstruction of the company, or
of its amalgamation with any other body corporate or bodies corporate, and is
appointed as the managing director, manager or other officer of the reconstructed
company or of the body corporate resulting from the amalgamation;
b. where the director resigns his office otherwise than on the reconstruction of the
company or its amalgamation as aforesaid;
c. where the office of the director is vacated
d. where the company is being wound up, whether by or subject to the supervision of
the Court or voluntarily, provided the winding up was due to the negligence or
default of the director;
e. where the director has been guilty of fraud or breach of trust in relation to, or gross
negligence in or gross mismanagement or, the conduct of the affairs of the company
or any subsidiary or holding company thereof;
f. whether the director has instigated, or has taken part directly or indirectly in
bringing about, the termination of his office.

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Any such payment made to a managing or other director shall not exceed the remuneration
which he would have earned if he had been in office for the unexpired residue of his term
or for three years, whichever is shorter, calculated on the basis of the average
remuneration actually earned by him during a period of three years immediately
proceeding the date on which he ceased to hold the office, or where he held the office for a
lesser period than three years, during such period.
No such payment shall be made to the director in the event of the commencement of the
winding up of the company, whether before, or at any time within twelve months after, the
date on which he ceased to hold office, if the assets of the company on the winding up,
after deducting the expenses thereof , are not sufficient to repay to the share-holders the
share capital (including the premiums, if any) contributed by them.
These provisions do not prohibit the payment to a managing director or a director holding
the office of manager, of any remuneration for services rendered by him to the company in
any other capacity.
Payment to director for loss of office in connection with transfer of undertaking or
property
No director of a company shall, in connection with the transfer of the whole or any part of
any undertaking of property of the company, receive any payment, by way of
compensation for loss of office, or as consideration for retirement from office, or in
connection with such loss or retirement
a. from such company; or
b. from the transferee of such undertaking or property or from any other person, unless
particulars with respect to the payment proposed to be made by such transferee or
person (including the amount thereof) have been disclosed to the members of the
company and the proposal has been approved by the company in general meeting.
Where a director of a company receives payment of any amount in contravention of the
above provisions, the amount shall be deemed to have been received by him in trust for
the company. Payment to director for loss of office, etc., in connection with transfer of
shares
No director of a company shall, in connection with the transfer to any persons of all or any
of the shares in a company, being a transfer resulting from-

i. an offer made to the general body of shareholders;

ii. an offer made by or on behalf of some other body corporate with a view to the
company becoming a subsidiary of such body corporate or a subsidiary of its
holding company;
iii. an offer made by or on behalf of an individual with a view to his obtaining the
right to exercise, or control the exercise of, not less than one-third of the total
voting power at any general meetings of the company; or
iv. any other offer which is conditional on acceptance to a given extent;

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receive any payment by way of compensation for loss of office, or as consideration for
retirement from office, or in connection with such loss or retirement,-
a. from such company; or
b. from the transferees of the shares or from any other person except as provided
below.

It shall be the duty of the director concerned to take all reasonable steps to secure that
details with respect to the payment proposed to be made by the transferees or other person
(including the amount thereof) are sent with, any notice of the offer made for their shares
which is given to any shareholders.

If :-
a. any such director fails to take reasonable steps as aforesaid; or
b. any person who has been properly required by any such director to include the said
details in the aforesaid notice fails so to do;

he shall be punishable with fine which may extend to two hundred and fifty rupees.

If-
a. the above provisions are not complied with ; or
b. the making of the proposed payment is not, before the transfer of any shares in
pursuance of the offer, approved by a meeting, called for the purpose ,of the
concerned shareholders

any sum received by the director on account of the payment shall be deemed to have been
received by him in trust for any persons who have sold their shares as a result of the offer
made, and the expenses incurred by him in distributing that sum amongst those persons
shall be borne by him and not retained out of that sum.

If at a meeting called for the purpose of approving any payment, a quorum is not present
and, after the meeting has been adjourned to a later date, a quorum is again not present,
the payment shall, be deemed to have been approved.

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3.9 DIRECTORS WITH UNLIMITED LIABILITY IN LIMITED COMPANY

In a limited company, the liability of the directors or of any director or of the manager
may ie generally limited to the amount of investment in shares of that company. However,
if so provided by the memorandum, it may become unlimited.

In a limited company in which the liability of a director or manager is unlimited, the

directors, and the manager of the company, and the member who proposes a person for
appointment, to the office of director or manager, shall add to that proposal a statement
that the liability of the person holding that office will be unlimited and before the person
accepts the office or acts therein, notice in writing that his liability will be unlimited, shall
be given to him.

If any director, manager or proposer makes default in adding such a statement, or if any
promoter, director, manager or officer of the company makes default in giving such a
notice, he shall be punishable with fine which may extend to one thousand rupees and
shall also be liable for any damage which the person so appointed may sustain from the
default; but the liability of the person appointed shall continue to remain unlimited.

3.10 SPECIAL RESOLUTION OF LIMITED COMPANY MAKING LIABILITY OF

DIRECTORS UNLIMITED

A limited company may, if so authorised by its articles, by special resolution, alter its
memorandum so as to render unlimited the liability of its directors or of any director or of
its manager.

However no alteration of the memorandum making the liability of any of the officers
unlimited shall apply to such officer, if he was holding the office from before the date of
the alteration, until the expiry of his then term, unless he has accorded his consent to his
liability becoming unlimited.

To sum up the discussion on managerial remuneration, the following rates should be

remembered.

Maximum Limit

1. Overall Managerial remuneration 11% of Net Profit

(inclusive of fee for attending meetings)
2, If the company has one managing 5% of the Net profit
Director or whole time director
3. If the company has more than one 10% of the Net profit
Managing Director or whole time

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Director (for all of them)

4. Remuneration of part time directors 3% of the Net profit
Where the company has no
Managing director (for all of them)
5. Remuneration of part time director 1% of the Net profit
Where the company has one or more
Managing director (for all of them)
6. Remuneration to the manager 5% of the Net profit

Please note that the Companies Act has only prescribed the maximum limit and hence the
companies are at liberty to fix the remuneration within the limit.
If nothing is mentioned in the problem as to whether the managerial remuneration is to be
calculated on the net profits of the company before charging such remuneration or after
charging such remuneration, it is always to be assumed that the remuneration has to be
calculated on the net profits before charging such remuneration.

3.11 DETERMINATION OF NET PROFIT FOR CALCULATION OF

MANAGERIAL REMUNERATION
Section 349 and 350 of the Companies Act contain the provisions relating to the manner
of determination of net profits for the purpose of calculating the managerial remuneration.
All these provisions are based on sound accounting principles and practice.
The Provisions of the above sections require that in computing net profits of a company in
any financial year for the purpose of calculating managerial remuneration the following
points should be considered.
8.1.1 Credit shall be given for-
Bounties and subsidies received from any Government or its Agencies

3.12 CREDIT SHALL NOT BE GIVEN FOR THE FOLLOWING SUMS-

a) profits, by way of premium, on shares or debentures of the company which are
issued or sold by the company.
b) Profits on sales by the company of forfeited shares.
c) Profits of capital nature including profits from the sale of undertaking or any of the
undertakings of the company, or any part thereof.
d) Profits from the sale of any immovable property or fixed assets of a capital nature
comprised in the undertaking or any of the undertakings of the company unless the
business of the company consists, whether wholly or partly, of buying and selling
any such property or assets.

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8.1.3. The following sums shall be deducted-

a) All the usual working charges
b) Director’s remuneration
c) Bonus or commission paid or payable to any member of the company’s staff, or to
any engineer, technician, or person employed or engaged by the company, whether
on a whole time or on a part time basis.
d) Any tax notified by the Central Government as being in the nature of a tax on excess
or abnormal profits
e) any tax on business profits imposed for special reasons or in special circumstances
and notified by the Central Government in this behalf.
f) Interest on mortage, debentures, unsecured loans etc
g) Expenses on repairs
h) Depreciation to the extent specified in Sectin 350

8.1.4 The following sums shall not be deducted

a) Income tax and super tax payable by the company
b) any compensation, damages or payment s made voluntarily
c) Loss of capital nature including loss on sale of undertakings.

It is important to note here that the above provisions do not apply to Private company,
unless it is subsidiary of a public company.

Illustration 3

The following particulars are extracted from the Profit and loss Accouts of Hema Ltd for
the year ended 31st March 2006
i) Remuneration paid to
a) Managing Director Rs.75,000
b) Whole time Director Rs.60,000
ii) Provisions for bonus Rs.5,50,000 and for gratuity Rs.50,000, this includes
provision for above Directors-Bonus Rs.5,0000 and gratuity Rs.6,000.
iii) Provision for doubtful debts made during the year Rs.30,000
iv) Surplus on sale of building credited in the Profit and Loss account Rs.1,50,000.
This includes a short term capital gain of Rs.1,30,000.

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v) Loss on sale of machinery debited in Profit and Loss Account,Rs.7,000

(representing difference between sale price Rs.1,43,000 and written down value of
Rs.1,50,000.
vi) The company has made donations of Rs.50,000 to charitable institutions and
contributed Rs.4,00,000 to an approved research association for research related to
the company’s business.
vii) Provision for Income tax Rs.8,00,000 and for surtax Rs.60,000 made in the
accounts.
viii) The net profit as per Profit and Loss accounts is Rs.16,00,000. The company had
suffered losses in the earlier years . The aggregate amount of such brought forward
losses (after adjustments required to be made under Section 349) works out to
Rs.2,50,000/
You are required to calculate the net profit for the purpose of computing managerial
remuneration.

Solution
Rs.
Profit as per Profit and loss account 16,00,000
Add: Items not deductible:
Managerial remuneration charged in the profit and loss A/c 1,46,000
Provisions for doubtful debts 30,000
Provisions for income tax 8,00,000
_________
25,76,000
Short term capital gain 1,30,000
Past losses 2,50,000
3,80,000
________
Net profit for calculation of managerial remuneration 21,96,000
________

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Illustration 4

The following is the Profit and loss Account of Harini Ltd for the year ended 31st March
2006

Rs. Rs.

To Salaries and Wages 1,50,000 By Gross profit 40,00,000

To Repairs to Fixed Assets 50,000 By Profit on sale of machinery
To General expenses 40,000 (Cost Rs.8,00,000 and Written
To Compensation for breach down value Rs,4,00,000) 4,00,000
of contract 25,000 By subsidy from Government 1,00,000
To Depreciation 2,40,000
To Loss on sale of investment 35,000
To Expenditure on scientific
Research (cost of setting
Up a new laboratory) 2,50,000
To Debenture interest 75,000
To Interest on unsecured
Loans 15,000
To Provision for Income tax 16,00,000
To Proposed dividends 10,00,000
To Balance C/d 10,70,000
__________ ________
45,50,000 45,50,000
__________ ________
Calculate the overall managerial remuneration under Section 198

Solution Rs.
Net Profit as per Profit and loss Account 10,70,000
Add: Items not to be deducted under Section 349 and 350
Rs.
Loss on sale of investment 35,000
Expenditure on Scientific research 2,50,000
Provision for income tax 16,00,000
Proposed dividend 10,00,000
28,85,000
_____________
39,95,000

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Less: Capital profit on sale of machinery

i.e. sale price Rs.(4,00,000+4,50,000)-Cost price
8,50,000-8,00,000 50,000
________
Net Profit under Section 198 for managerial remuneration 39,05,000
________
Maximum overall managerial remuneration @11% on Rs,39,05,000
= 4,29,550

Illustration 5
(Calculation of maximum remuneration where there is a managing director)

From the following particulars of R.P.Ltd., calculate the maximum remuneration payable
to the Managing Director and other part time directors of the company.
Rs.
Net profit before provisions for income tax and managerial
Remuneration, but after depreciation and provisions for repairs 86,84,100
Depreciation provided in the books 32,00,000
Repairs for machinery provided for during the year 2,50,000
Actual expenditure incurred on repairs during the year 1,50,000

Solution Rs.
Net profit as stated 86,84,100
Excess provision made for repairs and machinery
(Rs.2,50,000 – 1,50,000) 1,00,000
_________
Net profit for the purpose of calculating managerial remuneration 87,84,100

Managing Directors @ 5% on Rs.87,84,100 4,39,205

Part time directors @ 1% on Rs.87,84,100 87,841
_________
Total managerial remuneration 5,27,046

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Illustration:6

M.E Ltd have authorized capital of Rs.50 lakhs, divided into 5,00,000 equity shares of
Rs.10 each. Their books show the following balances as on 31.3.06:
Rs Rs
Stock 6,65,000 Bank Current account 20,000
Discount and rebates 30,000 Cash in Hand 8,000
Carriage inwards 57,500 Debenture interest
Patterns 3,65,000 (for ½ year to 30.9.2005) 20,000
Rates,taxes and insurance 55,000 Interest banks (Dr) 91,000
Furniture and fixtures 1,50,000 Preliminary Expenses 10,000
Materials Purchased 12,32,500 Calls-in-arrears 10,000
Wages 13,05,000 Equity Share Capital
Coal and Coke 63,000 (2,00,000 share of Rs.10
Freehold Land 12,50,000 each) 20,00,000
Plant and machinery 7,50,000 8% Debentures 5,00,000
Engineering tools 1,50,000 Bank Overdraft 7,57,000
Goodwill 3,75,000 Sundry Creditors (for
Sundry Debtors 2,66,000 goods) 2,40,500
Bills receivable 1,34,500 Sales
36,17,000
Advertisement 15,000 Rents (cr)
30,000
Commission and brokerage 67,500 Transfer fees
6,500
Business expenses 56,000 Profit and loss A/c (Cr)
67,000
Repairs 46,500
Bad debts 25,500

The Stock (valued at cost or market value whichever is lower) as an 31.3.06 was
Rs.7,08,000.
Outstanding Liability for wages Rs.25,000 and Business expenses Rs.25,000.
Dividend declared @8% on paid-up capital.
To Charge depreciation: Plant and Machinery @ 15% Engineering Tools @ 20%. Patterns
@ 10% and furniture and fixture @ 10%. Provide 2% on debtors as doubtful debts after
writing off Rs.21,500 as bad debts. Write off Preliminary expenses RS.5,000 and create
Debenture Redemption Reserve RS.50,000. Provide RS.1,30,000 for income-tax.
Prepare Profit and loss Account for the year ended 31.3.06 and Balance Sheet, as on that
date, in accordance with the Companies Act, 1956, giving as much information as
necessary, Ignore Previous year’s figures.

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Solution:
Profit and loss Account of M.E ltd.
For the year ended 31st Mar,06
Dr Rs Rs Cr
To Opening Stock 6,65,000 By Sales 36,17,000
To Materials Purchased 12,32,500 By Closing Stock 7,08,000
To Carriage inwards 57,500 By Rent 30,000
To Wages 13,30,000 By Transfer Fees 6,500
To Coal and Coke 63,000
To Discount and rebates 30,000
To Rates,taxes and insurance 55,000
To Advertisement 15,000
To Commission and brokerage 67,500
To Business expenses
81,000
To Repairs
To Bad debts 46,500
To Debenture Interest 47,000
To Interest-Banks 40,000
To Preliminary expenses 91,000
To Depreciation on 5,000
Plants and
Machinery 1,12,500
Engineering
Tools 30,000
Patterns 37,500
Furniture and
Fixtures 15,000 1,95,000
To Provision for Doubtful
Debts 4,890
To Provision for Income-tax 1,30,000
To Profit for the year c/d 2,05,610 _________
43,61,500 43,61,5000

To Debenture Redemption By Balance as per

Reserve-transfer 50,000 last year 67,000
To Proposed Dividend 1,59,200 By Profit for the
To Corporate Dividend Tax year b/d 2,05,610
@ 12.5 % 19,900
To Balance c\d 43,510
__________ _________
2,72,610 2,72,610
__________ __________

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Balance Sheet of M.E ltd. as at 31st March, 2006

Liabilities Amount Assets Amount

Share Capital: Fixed Assets:
Authorized Capital Goodwill 3,65,000
5,00,000 Equity shares Freehold Land at cost 12,50,000
of RS.10 each 50,00,000 Plant and
Issued and Subscribed Machinery** 7,50,000
Capital Less: Depreciation 1,12,500 6,37,500
2,00,000 Equity shares Furniture and
Of Rs.10 each , fully Fixtures** 1,50,000
Called-up 20,00,000 Less: Depreciation 15,000 1,35,000
Less: Calls- Patterns* 3,75,000
in arrears 10,000 19,90,000 Less: Depreciation 37,500 3,37,500
Reserves and Surplus: Engineering
Debenture Redemption Tools* 1,50,000
Reserve 50,000 Less: Depreciation 30,000 1,20,000
Profit and Loss Account 43,510
Secured Loan: Investments:
8% Debentures Current Assets, loans
(repayable after 10 years) 5,00,000 And Advances:
Interest due and payable 20,000 A. Current Assets:
Bank overdraft** 7,57,000 Stock-in Trade
Unsecured Loans (Valued at cost or market
Current Liabilities and value whichever is lower) 7,08,000
Provision: Sundry Debtors 2,44,500
A. Current Liabilities: Less: Provision
Sundry Creditors For Doubtful Debts 4,890 2,39,610
(for goods) 2,40,500 Cash in Hand 8,000
Outstanding wages 25,000 Bank Balance in Current A/c 20,000
Outstanding expenses 25,000 B.Loans and Advances:
B.Provisions: Bills Receivable 1,34,500
Provision for income-tax 1,30,000 Miscellaneous Expenditure:
Proposed Dividend 1,59,200 Preliminary expenses 5,000
Corporate Dividend Tax 19,900
________ _________
39,60,110 39,60,110

Note: As the rate of dividend is 8% Transfer to Statutory reserve as per Section 205 2(a)
is not essential.

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Balance Sheet of M.E ltd. as at 31st March, 2006

Schedule Figure as at the end of Current financial

No year
I.Sources of Funds Rs Rs Rs

1.Shareholder’s funds:
(a) Capital 1 19,90,000
(b) Reserves and Surplus 2 93,510 20,83,510
2. Loan funds:
(a) Secured loans 3 12,77,000
(b) Unsecured loans - 12,77,000 33,60,510
II. Application of funds:

1. Fixed assets:
(a) Gross Blocks 4 30,40,000
(b) less depreciation 1,95,000 28,45,000
(c) Net blocks - 28,45,000
(d) Capital work-in –progress
2. Investments
3. Current Assets, loans and
Advances:
(a) Inventories valued at cost
or market value whichever 7,08,000
is lower 2,39,610
(b)Sundry debtors 28,000
(c) Cash and bank balances
(d) Other current assets 1,34,500 11,10,110
(e) Loans and advances
Less: Current liabilities and
Provisions: 5 2,90,500
(a)Liabilities 3,09,100 5,99,600 5,10,510
(b) Provisions
Net current assets
4.(a) Miscellaneous expenditure
(to the extent not written of or
adjusted) 5,000
Preliminary expenses _________
(b)Profit and loss Account 33,60,510
Total

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Schedules:
1.Shareholder’s Funds:

Capital
Authorised 5,00,000 equity shares of Rs.10 each 50,00,000
Subscribed and paid-up
2,00,000 equity shares of Rs.10 each 20,00,000
Less: Calls-in arrears 10,000
Amount as per balance sheet 19,90,000

2.Reserves and Surplus

Debenture Redemption Reserve 50,000
Surplus as per Profit and loss A/c 43,510
Amount as per Balance sheet 93,510

3.Loan Funds:
Secured loans
8% Debentures 5,00,000
Interest accrued and due 20,000
Bank overdraft 7,57,000
Amount as per Balance sheet 12,77,000

4.Fixed Assets

Particulars Value given Depreciation Written down

Value on
31.3.06
Good will 3,65,000 - 3.65,000
Land 12,50,000 - 12,50,000
Plant and Machinery 7,50,000 1,12,500 6.37,000
Furniture and Fixtures 1,50,000 15,000 1,35,000
Patterns 3,75,000 37,500 3,37,500
Engineering tools 1,50,000 30,000 1,20,000
30,40,000 1,95,000 28,45,000

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5.Current liabilities and provisions

Current liabilities
Sundry Creditors 2,40,500
Outstanding Wages 25,000
Outstanding Business expenses 25,000 2,90,500
Provisions:
Proposed Dividend 1,59,200
Corporate dividend tax 19,900
Taxation 1,30,000 3,09,100
5,99,600

3.13 LET US SUM UP

Companies have no statutory obligation to prepare final accounts as required under

Section 210 of the Companies Act. In addition to general principles, a joint stock
company must conform to certain legal provisions as given in the Companies Act,1956 in
respect of forms and contents of the final accounts. It may be remembered that the
provisions of the Companies Act, 1956 do not apply to Insurance, Banking and electricity
companies, which are governed by special Acts relating to such companies.

3.14 LESSON END ACTIVITIES

1. Who is responsible for maintenance of Books of Account? Briefly explain the

provisions of company law regarding maintenance of proper Books of account.
2. Explain and illustrate how the following items are to be shown in the Balance sheet
of a Company to comply with the requirements of Companies Act, 1956.
a) Share Capital
b) Secured Loans
c) Fixed capital expenditure
d) Current liabilities
3) What are the statutory requirements relating to profit and loss account of a joint
stock company in regard to the following matters?
a) Raw materials consumed
b) Foreign exchange earnings
c) Miscellaneous expenditure
d) Payment made to managerial personnel

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4) Write short notes on :

a) Miscellaneous expenditure to the extent not written off
b) Provisions for taxation and dividend
c) Rights issue
d) Auditor’s report
e) Directors Report
5) What are the various heads under which profits are usually appropriated by
companies and for what reasons?
6) “Published accounts conceal much more than they reveal” Critically examine the
statement/
7) What do you understand by the concept of true and fair disclosure in the accounts of
a company?
8) State how the matters given below will be dealt with while preparing the profit and
loss account for the year ended 31st march 2006
a) A company whose profit runs into lakhs of rupees and has large inventories
finds at the end of March 2006 that the stock sheets, for 31.3.2005 were over
cast by Rs.10,000/
b) The provision of tax at the end of 31.3.2005 stood at Rs.1,50,000 during 2005-
06 the tax liabilities were settled for Rs.1,37,000. Provision required in
respect of 2005-06 is Rs.41,000/
c) Government imposed penalty of Rs.30,000 for non-payment of P.F.dues in
time.
9) State how you will treat the following while preparing the final accounts of the
company concerned for the year ending 31st march 2006.
a) Land and Buildings (Cost Rs.5,00,000 depreciation provided Rs.80,000) sold
for Rs.7,50,000.
b) It was discovered in September 2005 that the purchase invoice of Rs.50,000
dated 11.2.2004 was not entered in the book at all; accounts for 2003-04 were
passed at the AGM in August, 2005.
c) While preparing the accounts for 2004-2005 closing stock was valued at
market price Rs.6,20,000 instead of cost which was Rs.6,50,000
10) A company acquires plant and machinery on 1st October 2005, it paid Rs.30,00,000
to the supplier and incurred transport charges of Rs.1,00,000 installation charges of
Rs.1,00,000 in addition to repairs of Rs.1,40,000 because of accidental damage
during transit. Depreciation according to Schedule XIV is 15% and its life is
estimated at 15 years. The accounts are closed on 31st march each year. What is the
figure at which the asset will be capitalized and what is the depreciation charge for
the first year?
___________________________________________________________________

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3.15 REFERENCES

1. Gupta R.L & Radhaswamy M. “Corporate Accounts” Theory method and

application- 13th revised edition 2006, Sultan chand & Co.,, New delhi.
2. S.P.Jain & K.L Narang, “ Advanced Accounting “, Kalyani publications, New
delhi.
3. Reddy & Murthy, “Financial accounting”, Margham publications, Chennai 2004
4. J.R. Monga – Fundamentals for Corporate Accounting

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UNIT - IV
4.0 Aims and objectives
4.1 Introduction:
4.2 Features of Goodwill
4.3 Need for Valuation of Goodwill:
4.4 Factors Affecting Goodwill:
4.5 Factors having a bearing on valuation;
4.6 Determination of Future Maintainable Profit:
4.7 Normal Rate of Return:
4.8 Capital Employed:
4.9 Methods of Valuing Goodwill:
4.10 Simple Profit Method:
4.11 Super Profit Method:
4.12 VALUTION OF SHARES
4.13 Methods of Valuation of shares
4.13.1. Net Assets Basis or Intrinsic Value Method
4.14 The mechanism of asset valuation:
4.15 Determination of normal Rate of return and capitalization Factor:
4.16 Fair Value of Shares
4.17 Special Factors for valuation of Shares
4.17.1.Importance of the size of the block of shares:
4.17.2 Restricted transferability:
4.18 Dividends and valuation:
4.19 Bonus and right issues:
4.20 Valuation of Preference Shares:
4.21 LET US SUM UP
4.22 LESSON-END ACTIVITIES
4.23 References

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4.0 AIMS AND OBJECTIVES

1) To understand Meaning of Goodwill and the necessity for valuation of Good will.
2) To understand the Types of goodwill and the valuation
3) To understand the factors affecting valuation of goodwill
4) To understand the Valuation of Shares and the various types of valuation.

4.1 INTRODUCTION:

Goodwill may be defined as the value of the reputation of a business house in respect of
profits expected in future over and above the normal level of profits earned by
undertakings belonging to the same class of business. In other words, goodwill is the
present value of a firm’s anticipated super normal earnings. The term ‘super normal
earnings’ means the excess of earnings attributable to operating tangible and intangible
assets(other than goodwill) over and above the normal rate of return earned by
representative firms in the same degree. In his “A dictionary for Accountants”, kohler
defines goodwill as “the current value of expected future income in excess of a normal
return on the investment in net tangible assets….”.

4.2 FEATURES OF GOODWILL

a) Goodwill can be sold only with the entire business or it cannot be sold in part or in
isolation except on admission or retirement of a partner when a new partner
compensate the old partners or the retiring partner gives up his rights in favour of
remaining partners.
b) Goodwill is valuable only if it s capable of being transferred from one person to
another.
c) Goodwill represents a non physical value over and above the physical assets.
d) Goodwill cannot have an exact cost as its value fluctuates from time to time due to
internal or external factors which ultimately affect the fortune of the company.
e) The value of goodwill is based on subjective judgement of the valuer.

4.3 NEED FOR VALUATION OF GOODWILL:

In the case of partnership, the necessity of valuation goodwill arises in connection with
the following:
(1) When there is a change in the profit-sharing ratio among the partners;
(2) When a new partner is admitted;
(3) When a partner retires or dies; and

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(4) When the firm sells its business to a company or is amalgamation with another
firm.
In the case of a joint stock company, the need for evaluation goodwill may arise in the
following cases;
(1) When the business or a company is to be sold to another company or when the
company is to be amalgamated with another company.
(2) When stock exchange quotations not being available, shares have to be valued for
taxation purpose-gift tax, etc.;
(3) When a large block of shares, so as to enable the holder to exercise control over the
company concerned, has to be bought or sold; and
(4) When the company has previously written off goodwill and wants to write it back.
(5) When the company is being taken over by the government.

4.4 FACTORS AFFECTING GOODWILL

The valuation of goodwill depends upon the circumstances of each case. Each business
has its own peculiar characteristics and its special set of circumstances and these factors
make it difficult to lay down a general formula which will cover all cases
The factors leading to goodwill are the following:
(1) Special locational advantages;
(2) Special commercial advantages such as long-term contract for supply of raw
materials at a low price or for sale of finished goods at remunerative prices;
(3) Advantages because of prior entry specially if later is very difficult;
(4) Advantages enjoyed by it because of certain patents available to it;
(5) Technical Know-how possessed by the firm;
(6) The research and development effort; and
(7) Above all,the advantages enjoyed by the superiority of its man-power specially
management; this is superior products, better exploitation of markets, new products
and new markets,etc.

4.5 FACTORS HAVING A BEARING ON VALUATION;

In addition to what has already been stated, in a valuation, consideration of the following
factors is also necessary:
(a) Nature of the industry, its history and the risks to which it is subjected to ;

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(b) Prospects of the industry in the future;

(c) The company’s history-its past performance and its record of past profits and
dividends;
(d) The basis of valuation of assets of the company and their value;
(e) The ratio of liabilities to capital;
(f) The nature of management and the chance for its continuation;
(g) Capital Structure or gearing;
(h) Size, location and reputation of the company’s products;
(i) The incidence of taxation;
(j) The number of shareholders;
(k) Yield on shares of companies engaged in the same industry, which are listed in the
stock-exchanges;
(l) Composition of purchase of the products of the company; and
(m) Size of block of shares offered for sale since for large blocks very few buyers would
be available and that has a depressing effect on the valuation. Question of control,
however, may become important, when large blocks of shares are involved.

To put the above in different words, the factors would be:

(i) Profitability: Profitability of a concern is the chief factor in valuation of goodwill.

one who pays for goodwill looks to the future profit. The profits that are expected to be
earned in future are extremely important for valuation of goodwill. the following are the
important factors that have a bearing on future profits and, therefore, the value of
goodwill:

(a) Personal skill in management;

(b) Nature of business;
(c) Favorable location
(d) Access to suppliers;
(e) Patents and trade marks protection;
(f) Exceptionally favorable contracts; and
(g) Capital requirements and arrangement of capital.

N.B: A very careful estimate of the profits expected to be earned by the firm and the
amount of capital employed to earn such profits, has to be made;
(ii) General reputation which the firms or the company and its management enjoys;
(iii) Yield expected by investors in the industry to which the firm or company belongs.

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4.6 DETERMINATION OF FUTURE MAINTAINABLE PROFIT

Determination of future maintainable profits is based on past record is a delicate and

complicated task as it involves not only the objective consideration of the available
financial information but also subjective evaluation of many other factors, such as
capabilities of the company’s management, general economic conditions, future
Government policies. etc.. Guiding principles can be laid down only in respect of the
former and the valuer will have to give due consideration to the other matters according to
his reading of the situation in each individual case. The steps necessary to arrive at the
future maintainable profits of the company are: (a) calculation of past average taxed
earnings; (b) Projection of the future maintainable taxed profits; and (c) adjustments of
preferred rights.

(a) Calculation of past average earnings: In order to calculate the past average earnings.
it is necessary to decide upon the number of years whose results should be taken for
averaging; select these years and adjust their profits to make them acceptable for
averaging.

The number of years to be selected must be large enough so as to cover generally the
length of a business cycle; an average for a shorter period might not be suitable. but it
should not go too far back, e.g., results in the 80’s will have no bearing on the results
expected in the 90’s. In inflationary conditions, that are present today, it is considered that
a relatively shorter period may be more representative since it reveals more recent results.
Similarly, for companies having steady and gradual growth, average of a shorter period is
more useful. In some unusual circumstances, average of still shorter period or even only
one year’s profit may be more significant in estimating future earnings, such as where a
change in the business or a change in trading conditions forces the valuer to discard earlier
years and to rely upon one year only or to select certain normal years and exclude others.
In all these matters, a sound reasoning would alone aid the valuer. whether a 3 yearly, 5
yearly or longer average would reflect the correct future earnings of a company mostly
depends upon the nature of the individual case.

The followings are some items which generally require adjustment in arriving at the
average of the past earnings:

(i) Elimination of material non recurring items such as loss of exceptional nature
through strikes, fires, floods and theft, etc., profits or loss of any isolated transaction
not being part of the business of the company, lump sum compensation of retiring
allowances, damages and costs in legal actions, abnormal repair charges in a
particular year, etc.
(ii) Elimination of income and profits and losses from non-trading assets.
(iii) Elimination of any capital profit or loss or receipt or expense included in the profit
and loss account.

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(iv) Adjustments for any interest, remuneration, commission, etc., foregone or

overcharged by directors and other managerial personnel.
(v) Adjustments for any matters suggested by notes, appended to the accounts or by
Qualifications in the Auditor’s report, such as provision for taxation and gratuities,
bad debts, under or over provision for depreciation, inconsistency in valuation of
stock, etc..
(vi) Taxation: According to the opinion of the valuer, the tax rates may be such as were
ruling for the respective years or the latest ruling rate may be deducted from the
average profit. However, the consensus of opinion is for adjusting tax payable rather
than tax-paid because so many short-term reliefs and tax holidays might have
reduced the effective tax burden.
(vii) Depreciation: it is a significant item that calls for careful review. The valuer may
adopt book depreciation provided he is satisfied that the rate was realistic and the
method was suitable for the nature of the company and they were consistently
applied from year to year. But imbalances do arise in cases where consistently
written down value method was in use and heavy expenditure in the recent past has
been madein rehabilitating or expanding fixed assets, since the depreciation charges
would be unfairly heavy and would prejudice the seller. Under such circumstances,
it would be desirable to readjust depreciation suitably as to bring a more equitable
charge on the profits meant for averaging.
In averaging past earnings, consideration is to be given to the trend of profits earned. It is
indeed imperative that estimation of maintainable profits be based only on the available
record. i.e., the record of past earnings, but indiscrete use of past results may lead to an
entirely fallacious and unrealistic result.

In this regard, three situations may have to be faced. where the past profits of a company
are widely fluctuating from year to year, an average fails to aid future projection. in such
cases, a study of the whole history of the company and of earnings of a fairly long period
may be necessary. if the profits of a company do not show a regular trend, upward or
download, an average of the cycle can usefully be employed for projection of future
earnings. In some companies, profits may record a distinct rising or falling trend from year
to year; in these circumstances, a simple average fails to consider a significant factor,
namely, trend in earnings. The shares of a company which record a clear upward trend of
past profits would certainly be more valuable than those of a company whose trend of past
earnings indicates a static or doem-trend. In such cases, a weighted average, giving more
weight to the recent years than to the past, is appropriate. A simple way of weighting is to
multiply the profits by the respective number of the years arranged chronologically so that
the largest weight is associated with the most recent past year and the least for the
remotest. (similarly, if net worth is under consideration, the respective years average net
worth may also be weighted in a similar way).

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(b) Projection of future maintainable taxed profits: Projection is more a matter of

intelligent guesswork since it is essentially an estimation of what will happen in the risky
an uncertain future. The average profit earned by a company in the past could be normally
taken as the average profit that would be maintainable by it in the future, if the future is
considered basically as a continuation of the past. If future performance as the company is
viewed as departing significally from the past, then appropriate adjustments will be called
for before accepting the past average profit as the future maintainable profit of the
company. These are stated below:

(i) Discontinuance of a part of the business;

(ii) Under-utilization of installed capacity;
(iii) Expansion Programmes;
(iv) Major change in the policy of the company; and
(v) Adjustment for rehabilitation and replacement.

(c) Adjustments of Preferred rights: In arriving at the average profits and their future
projection, all charges including interest on debentures and other borrowings are of course
deducted. But the dividend on preference shares should also be considered after the
estimate of future profits has been arrived at. Dividends payable to preference
shareholders, according to the terms of their issue, should be deducted from the
maintainable profit.

4.7 NORMAL RATE OF RETURN:

Normal rate of return is the rate of return that the investors in general expect on their
investments in a particular industry. This rate differs from industry to industry. The
normal rate of return is required to be adjusted in the light of certain circumstances, i.e.,

(i) Risk attached to the investment: If a business is having more risk the risk of return
should also be more. Risk may be due to high borrowings or by the mature of
business.
(ii) Period of investment: The longer the period of investment, the higher is the rate of
return
(iii) Higher bank rate: An increase in bank rate gives higher expectations to the investors.
(iv) Boom period: When there is a boom in the industry, the investors have higher
expectations and the normal rate of return is to be increased.

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4.8 CAPITAL EMPLOYED

The goodwill of a business depends on the amount of capital employed also. the term
‘capital employed’ for the valuation of goodwill should be calculated from the point of
view of shareholders. Capital employed may be expressed as the aggregate of share capital
and reserves less the amount of non-trading assets and fictitious assets and deducting all
liabilities. For this purpose, the amount of debentures or loans should also be excluded
from capital employed. Of course any profit or loss on revaluation of assets should be
taken into account.

It is considered desirable to use average capital employed in place of ‘ capital employed’

because the capital must be such as may fairly represent the capital investment throughout
the year. Average capital employed is the end of the year. But if the current year’s profit is
not disturbed during the year itself the average capital employed is to be ascertained by
deducting half the profit from capital employed at the end. This is appropriate for goodwill
to be ascertained by reference to current year’s profit and current year’s capital employed.

Illustration 1

Exe Ltd. gives you the following summarized balance sheet as at 31st March, 2006:

11% Preference share capital 5,00,000 Fixed Assets:

Equity share capital 20,00,000 Cost 50,00,000
Reserves and surplus 25,00,000 Depreciation 30,00,000 20,00,000
10% loans 27,00,000 Capital work-in-progress 40,00,000
Current liabilities and provisions 15,00,000 6% Government securities 5,00,000
Current Assets 25,00,000
_________ Underwriting commission 2,00,000
92,00,000 92,00,000

The company earned a profit of Rs.9,00,000 after tax @ 50% in 2005-2006. The capital
work in progress represents additional plant equal to half the capacity of the present plant
it will be immediately operational, there being no difficulty in sales. With effect form
1stApril,2006 , two additional part-time directors are being appointed at Rs.75,000 p.a.
Ascertain the future maintainable profit and the capital employed, assuming the present
replacement cost of fixed assets is Rs.1,00,00,000 and the annual rate of depreciation is
10% an original cost.

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Solution:
Future Maintainable Profit:
Rs
After-tax profit at present 9,00,000
Add. Tax 9,00,000
Depreciation-10% of Rs.50,00,000 5,00,000
Present profit before depreciation and tax 23,00,000
less: Interest of Investments (non-trading income) 30,000
22,70,000
Add: Increase in profit since sales will increase by 50% 11,35,000
34,05,000
less: Depreciation @ 10% on Rs.1,00,00,000 10,00,000
on Rs. 40,00,000 4,00,000
14,00,000
Annual remuneration 1,50,000 15,50,000
18,55,000
less: Tax @ 50% 9,27,500
Future Maintainable Profit 9,27,500

Capital Employed:
Fixed Assets-Present Replacement cost 1,00,00,000
Depreciation (adjusted) 60,00,000
40,00,000
Additions to plant 40,00,000
80,00,000
Current Assets 25,00,000
1,05,00,000
less: 10% loans 27,00,000
Current liabilities and provisions 15,00,000 42,00,000
Alternatively: 63,00,000

Rs
Preference share capital 5,00,000
Equity share capital 20,00,000
Reserves and surplus-At present 25,00,000
Profit on Revaluation 20,00,000 45,00,000
70,00,000
less: Non-trading assets, Investments 5,00,000
Underwriting Commission 2,00,000 7,00,000
Capital Employed 63,00,000

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4.9 METHODS OF VALUING GOODWILL:

There are basically two methods of valuing goodwill: (i) Simple Profit method;
(ii) Super profit method.

4.10 SIMPLE PROFIT METHOD:

Goodwill is sometimes valued on the basis of a certain number of years’ purchase of the
average profits of the past few years. While calculating average profits for the purpose of
valuation of goodwill certain adjustments are made. Some of them are the following:
(a) All actual expenses and losses not likely to occur in the future are added back to
profits;
(b) Expenses and losses expected to be borne in future are deducted from such profits;
(c) All profits likely to come in the future are added: and
(d) Even actual profits not likely to recur are deducted

After having adjusted profit in the light of future possibilities, average profits are
estimated and then the value of goodwill is estimated by a particular number,
representing ascertained and then the average is multiplied by a particular number,
representing the number of years’ purchase. if goodwill is to be valued at 3 years’
purchase of the average profits which come to Rs.20,000, the goodwill will be Rs.60,000.
i.e., 3*Rs.20,000.
This method has nothing to recommend itself since goodwill is attached to profits over
and above what one can earn by starting a new business and not to total profits. it ignores
the amount of capital employed for earning the profits. However, it is usual to adopt this
method for valuing the goodwill of the goodwill of the practice of a professional person
such as a chartered accountant or a doctor.

4.11 SUPER PROFIT METHOD

In this case the future maintainable profits of the firm are compared with the normal
profits of the firm. Normal earnings of a business can be judged only in the light of normal
rate of earning and capital employed in the business. However, this method of valuing
goodwill would require the following informations:
(1) A normal rate of return for representative firms in the industry.
(2) The fair value of capital employed.
(3) Estimated future maintainable profit.

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Example:
In the Illustration no.1 given above, suppose the investors are satisfied with 12% return,
then normal profit will be Rs.7,56,000 i.e., 12% of Rs.63,00,000. The future maintainable
profit being rs.9,27,500, super profit will be Rs.1,71,500.

There are three methods of calculating goodwill based on super profit which are as under:

(a) (i) Purchase of Super Profit Method:

Goodwill as per this method is: Super profit * A certain number of years. Under this
method, an important point to note is that the number of years of purchase as goodwill will
differ from industry to industry and from firm to firm. Theoretically, the number of years
is to be determined with reference to the probability of a new business catching up with an
old business. Suppose it is estimated that in four years time a business, if Started de novo,
will be earning about the same profits as an old business is earning now, goodwill will be
equivalent to four times the super profits. In the example given above, goodwill will be
Rs.6,86,000. i.e., 4* Rs.1,71,500.

(ii) Sliding Scale Valuation of Super Profit :

This method is a variation of the purchase method. This has been advocated by A.E.
Cutforth and is based upon the theory that the greater the amount of Super Profit, the
more difficult it would be to maintain. In this method the super profit is divided in to two
or three divisions. Each of these is multiplied by a different number of years purchase, in
descending order from the first division. For example, if super profit is estimated at
Rs.2,25,000. Goodwill be calculated as follows:
Rs
First Rs.75,000 say 5 years 3,75,000
Second Rs.75,000 say 4 years 3,00,000
Third Rs.75,000 say 3 years 2,25,000
Total goodwill 9,00,000

(b) Annuity Method of Super Profit:

Goodwill as per this method is: Super profit* Annuity of re.1 at the normal rate of return
for the stated number of years. Goodwill in this case is the discounted value of the total
amount calculated as per purchase method. The idea behind super profit method is that the
amount paid for goodwill will be recouped during the coming few years. But in this case,
there is a heavy loss of interest. hence, properly speaking what should be paid now is only
the present value of super profits paid annually at the proper rate of interest.Tables show
that the present value @ 12% oe Re.1 received annually for four years is 3.037. In the
above illustration, the value of goodwill under this method will be Rs.5,20,845. i.e
3.37*1,71,500.

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(c) Capitalisation of super profit:

In this method, the amount of super profit is capitalized at the normal rate of return. in
other words, this method tries to find out the amount of capital needed for earning the
super profit. the formula is:
Average Annual super profit * 100
Normal rate of return
In the example given above, the value of goodwill will be Rs.14,29,167 i.e..
1,71,500*100
12
There is also another method of capitalization frequently used. under this method adjusted
average profits are capitalized on the basis of normal rate of return and from such a value,
the net assets of the business are substracted to arrive at the value of goodwill.
In the illustration given above, value of total business will be Rs.77,29,167 or say
Rs.77,29,200. Therefore goodwill will be 14,29,200. i.e., Rs.77,29,200 less Rs.63,00,000.
This method puts a very large value on goodwill. Really it is useful only when the future
maintainable profit is less than the normal profit. it then determines the proper value of
the firm.
Suppose the total net tangible assets of a company is Rs.50,00,000. the normal rate of
return in the concerned industry is 14%; and the company earns the profit of Rs.8,40,000.
The total value of the business will be Rs.60,00,000, i.e
8,40,000*100 In that the goodwill be Rs.10lakhs. The normal profit being Rs.
14
7,00,000, the super profit will be Rs.1,40,000; goodwill, therefore, will be more than
seven years purchase. This is too high since it is not expected that super profits will
continue for as long as seven years.
Suppose on the other hand, that the future maintainable profit is Rs.6,30,000. In that case
the total value of business will be Rs.45 lakhs, i.e., 6,30,000*100
14
There is naturally no goodwill since the actual profit is less than the normal profit.
However, it will be improper to pay Rs.50 lakhs for the business since then the earning
will not be 14%. The proper value of the business is Rs. 45lakhs.

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Illustration 2
A Ltd. proposed to purchase the business carried on by M/s. X & Co. Goodwill for this
purpose is agreed to be valued at three years purchase of the weighted average profits of
the past four years. The appropriate weights to be used are:

2002-03 1 2004-05 3
2003-04 2 2005-06 4

The profit for these years are 2002-03 – Rs. 1,01,000: 2003-04 –Rs. 1,24,000: 2004-05 –
Rs.1,00,000 and 2005-06 – Rs. 1,40,000.

On a scrutiny of the accounts the following matters are revealed:

(i) On 1st December, 2004 a major repair was made in respect of the plant incurring
Rs. 3,00,000 which was charged to revenue. The said sum is agreed to be capitalized
for goodwill calculation subject to adjustment of depreciation of 10% p.a.on
reducing balance method.
ii) The closing stock for the year 2003-04 was overvalued by Rs.12,000.
iii) To cover management cost an annual charge of Rs. 24,000 should be made for
the purpose of goodwill valuation.
Compute the value of goodwill of the firm.

Solution:
Calculation of Adjusted Profits
. Rs
Profits-2002-03 1,01,000
Less: Management expenses 24,000
Adjusted Profits -2002-03 77,000

Profits-2003-2004 1,24,000
Less: Over-valuation of closing stock 12,000
Management expenses 24,000 36,000
Adjusted Profits-2003-2004 88,000
Profits-2004-2005 1,00,000

Add: over- valuation of opening stock 12,000

Major repairs of plant to be treated
As capital expenditure 30,000 42,000
1,42,000
Less: Depreciation on capital expenditure
@ 10% p.a for 4 months from
December 1,2004 to mar 31, 2005

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30,000* 10 * 4
100* 12 1,000
1,41,000
Less: Management expenses 24,000
Adjusted profits-2004-2005 1,17,000

Profits-2005-2006 1,40,000
Less: 10% depreciation on Rs.29,000 (book value
Rs.30,000-Rs.1,000- Capital expenditure) 2,900
1,37,100
Less: Management expenses 24,000
Adjusted Profits-2005-2006 1,13,100

Calculation of Average profits

Year ended Profits weight Product

31st march Rs
2002-2003 77,000 1 77,000
2003-2004 88,000 2 1,76,000
2004-2005 1,17,000 3 3,51,000
2005-2006 1,13,100 4 4,52,400
10,56,400

Average profits = 10,56,400/10 = 1,05,640

Goodwill at three years purchase = Rs.1,05,640 x 3
= Rs.3,16,920

Illustration:3

From the following information ascertain the value to goodwill of X ltd. under super
profit method.

Balance sheet as on 31st march, 2006

Liabilities Rs Assets Rs
Paid-up capital: Goodwill at cost 50,000
5,000 shares of Rs.100 each Land and buildings at cost 2,20,000
fully paid 5,00,000 Plant and machinery at cost 2,00,000
Bank overdraft 1,16,700 Stock in trade 3,00,000
Sundry creditors 1,81,000 Book debts less provision

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Provision for taxation 39,000 for bad debts 1,80,000

Profit and loss appropriation
Account 1,13,300

9,50,000 9,50,000

The Company commenced operations in 2000 with a paid-up capital of Rs. 5,00,000.
Profits for recent years(after taxation) have been as follows:

Year ended 31st march Rs

2002 40,000
2003 88,000
2004 1,03,000
2005 1,16,000
2006 1,30,000

The loss in 2002 occurred due to a prolonged strike.

The income-tax paid so far has been at the average rate of 40%. But it is likely to be 35%
from April 2006 onwards. Dividends were distributed at the rate of 10% on the paid up
capital in 2003 and 2004 and the rate of 15% in 2005 and 2006. The market price of share
is ruling at Rs. 125 at the end of the year ended 31st March 2006. Profits till 2006 have
been ascertained after debiting Rs. 40,000. As remuneration to the director, the company
has approved a remuneration of Rs. 60,000 with effect from 1st April, 2006. The company
has been able to secure a contract at an advantageous price thereby it can save materials
worth Rs.40,000 per annum for the next five years

Valuation of Goodwill of X ltd.

Solution:

(i) Capital employed: Rs

Land and building at cost 2,20,000

Plant and Machinery 2,00,000
Stock in trade 3,00,000
Sundry Debtors 1,80,000
9,00,000
Less: Sundry Liabilities:
Bank overdraft 1,16,700
Sundry Creditors 1,81,000
Provision for taxation 39,000 3,36,700

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Capital employed at the end of the year 5,63,300

Add back:
Dividend paid for the year 75,000
less: Half of the year 65,000 10,000
Average Capital employed 5,73,300

(ii) Normal rate of Return:

Average Dividend for the last 4 years 12.5%

Market price of shares on 31st March Rs.125

Normal Rate of Return : 12.5 x100 /125

Note:
It may be more appropriate to relate the normal rate of return to the dividend paid in the
last two years since price is related to dividend expected in future and, for that, the most
recent experience is relevant.

In that case,the normal rate of return will be 15 x 100/125 = 12%

(iii) Normal profit on average capital employed :

@ 10% on Rs.5,73,300 57,330

@ 12% 0n Rs.5,73,300 68,796

(iv) Future maintainable Profit- Weighted Average:

Year ended Profit Weight Product

31st march Rs Rs
2003 88,000 1 88,000
2004 1,03,000 2 2,06,000
2005 1,16,000 3 3,48,000
2006 1,30,000 4 5,20,000
10 11,62,000
Average Annual profit (After tax) 1,16,200
Average Annual Profit (before tax)

1,16,200x100/60 1,93,667

Adjustments:
(i) Increase in remuneration -20,000
(ii) Saving in cost of materials +40,000 20,000
2,13,667
Less: Taxation @ 35% 74,783
Future maintainable Profit 1,38,884

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(v) Super Profits Normal rate Normal Rate

12% 10%
Rs Rs
Average Maintainable Profits 1,38,884 1,38,884
Normal Profit on capital employed 68,796 57,330
Super Profit 70,088 81,554

Goodwill at 5 years purchase

of super profits 3,50,440 4,07,770
Goodwill at 3 years purchase 2,10,264 2,44,662

Note:
Three to five years purchase of super profits can be taken as fair value of goodwill.
thus, depending on the assumptions regarding the normal rate of return and the number of
years purchase, goodwill may range between Rs.2,10,264 and Rs.4,07,770 .

4.12 VALUTION OF SHARES

The valuation of shares is necessitated because of the non availability of market price for a
proprietary company and even if it is available the price doesnot reflect the true or
intrinsic value of shares.

The necessity for valuation of shares arises inter alia in the following circumstances:
(i) Assessments under the wealth Tax or Gift Tax Acts.
(ii) Purchase of a block of shares which may or may not give the holder thereof a
controlling interest in the company.
(iii) Purchase of a shares by employees of the company where the retention of such
shares is limited to the period of their employment.
(iv) Formulation of schemes of amalgamation, absorption, etc.
(v) Acquisition of interest of dissenting shareholders under a scheme of reconstruction.
(vi) Compensating shareholders on the acquisition of their shares by the Government
under a scheme of rationalization.
(vii) Conversion of shares, say, preference into equity.
(viii) Advancing a loan on the security of shares.
(ix) Resolving a deadlock in the management of a private limited company on the basis
of the controlling block of shares being given to either of the parties.

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Normally, the price prevailing on the stock exchange is accepted. However, valuation by
expert is called for when parties involved in the transactions/deal/scheme, etc., fail to
arrive at a mutually acceptable value or the agreements or Articles of Association, etc.,
provide for valuation by experts. For isolated transactions of relatively small blocks of
shares which are quoted on the stock exchanges, generally ruling stock exchange price
provides the basis. Thus,
valuation by a valuer becomes necessary when:
(i) Shares are unquoted,
(ii) Shares relate to provide limited companies.
(iii) Courts so direct.
(iv) Articles of Association or relevant agreements so provide.
(v) Large block of shares is under transfer.
(vi) Statutes so require.

4.13 METHODS OF VALUATION OF SHARES

As stated earlier, principally two basic methods are used for share valuation: one on the
basis of net assets and the other on the basis of earning capacity or yield.

4.13.1. Net Assets Basis or Intrinsic Value Method

The method relating to asset may take various forms depending upon circumstances:
(i) Break –up value method ( or liquidation value method);
(ii) Appraised value method: and
(iii) Book value method.

Depending on the circumstances of the case, goodwill may not be included. Goodwill
comes in for distinct consideration only when the number of shares involved is large
giving to the holder a measure of control. Normally, earning represents the result of
application of all assets of every description in the business, whether it is plant and
machinery or goodwill or patent or know-how; for a small number of shares in a going
concern, earning is the only appropriate basis.

Valuation on the basis of assets is generally not recommended for a going concern,
because, there the predominant factor is yield: but for certain types of companies, for
example, investment companies, assets basis valuation may be acceptable since yield itself
will depend almost wholly on the assets position. In case of a company in respect of which
no realistic yield or earning capacity is discernible, because of highly uneven past results,
valuation only on assets basis may be acceptable.

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For a company which shows consistent loss over a number of immediate past years and
which has no apparent prospect of recovery, the appropriate method would be the break-
up value method. According to Sidney, an authority in share valuation, the realizable
value of assets, for arriving at the break-up value, should be discounted at rates varying
from 20% to 33 1/3% for taking care of realization losses and expenses.

Book value method does not have any practical application except to disclose the
unexpired costs of asset of a going concern which were acquired in the course of the
company’s operations. But statutes like the Gift Tax Act, Wealth Tax Act, etc., have in
fact adopted book value method for valuation of unquoted equity shares for companies
other than an investment company. Book value of assets does help the valuer in
determining the useful employment of such assets and their state of efficiency. In turn, this
leads the valuer to the determination of rehabilitation requirements with reference to
current replacement values.

In all cases of valuation on assets basis, except book value basis, it is important to arrive at
current replacement and realization value. It is more so in case of assets like patents,
trademarks, know-how,etc., which may possess values substantially more or less than
those shown in the books.

4.14 THE MECHANISM OF ASSET VALUATION

(i) Arrive at the current replacement costs of assets for valuation based on appraisal or, in
the case of a firm which is not a going concern, determine the net reliasable value for
break-up valuation and deduct there from all liabilities in the books of account and such
other liabilities which have not been recorded but are likely to rank for payment, and the
amount payable to preference shareholders. The approach should be conservative. Under
provision for taxation, liabilities on account of gratuities arrears of preference dividends,
etc., are instances, of what may not appear in books.

(ii) If circumstances suggest existence of goodwill from a study of the profit record,
particular advantages, etc., the same should be evaluated with reference to any method
appropriate for the purpose, i.e purchase of net profit or purchase of gross earning or by
reference to super profit, etc., for addition to the result obtained in (i) above

(iii) The result, as arrived at, shall represent the asset value for the whole undertaking; to
arrive at value per share, the same should be dividend by the number of equity shares in
the company provided all shares are equally paid-up. If the company has equity shares of
varying fully paid-up values, the total value should first be allocated to the different paid-
up value groups and each such allocation would be divided by the number of shares in
each of such groups.

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(ii) Yield Basis

Yield basis valuation may take the form of valuation based on rate and productivity factor.
(a) Valuation Based on Rate Return

Rate of returns to the returns which a shareholder earns on his investment. It may be
classified into (a) Rate of dividend and (b) Rate of earning.

Valuation based on rate of dividend: This method of valuation is suitable for small blocks
of shares because small shareholders are usually interested in dividends. The value of a
share according to this method is ascertained as follows:

Value of share = Possible rate of dividend X Paid up value

Normal rate of dividend per share
OR
= Dividend (in rupees) per share X 100
Normal rate of dividend
Possible rate of dividend = Total profit available for dividend X 100
Total paid up equity capital

(a) In other words, dividend on equity shares should be calculated by deducting from
the maintainable profits
(2) Taxation;
(3) Transfers to reserve;
(4) Transfers to debenture redemption fund;
(5) Preference dividend, and

(b) By dividing the remaining by the number of shares.

Valuation based o rate of earning: This method of valuation of shares is suitable for
valuing large blocks of company’s shares because they are more interested in
company’s earnings rather than what the company distributes in the form of
dividends.
Value of share = Rate of earning X Paid up value of share
Normal rate of earning
Rate of earning = Actual profit earnedX100
Capital employed
Rate of earning is calculated by taking into account the total capital employed including
long time borrowings. Since the total capital is taken into account the profit figure should
be before debenture interest, preference dividend but after income tax. This is quite
appropriate when the divided is much more than the rate of earning on capital.

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Valuation based on price earning ratio: This method is suitable for ascertaining the market
value of shares which are quoted on a recognized stock exchange. According to this
method, the shares are valued on the basis of earning per share multiplied by price earning
ratio. Thus,
Market value of share = Price Earning ratio X Earning per share

Earning per share = Profit available for equity shareholders

Number of equity shares

Price earning ratio = Market value per share

Earnings per share
OR
Price earnings ratio = 100
Normal rate of return
Capitalization factor: The value of a share according to yield basis can also be ascertained
by finding out the capitalization factor or the multiplier. The capitalization factor will be
ascertained by dividing 100 by the normal rate return. The profit available is capitalized
by multiplying it with the capitalization factor. The value of equity share is obtained by
dividing the capitalized value by the number of equity shares.
(b)Valuation Based on productivity Factor
Productivity factor is a concept of relative earning power. It represents the earning
power in relation to the value of assets employed for such earnings. This gives a ratio
which is applied to the net worth of the business as on the valuation date to arrive at the
projected earning figure for the company. This projected earning after necessary
adjustments (discussed later) shall be multiplied by the appropriate capitalization factor to
arrive at the value of the company’s business. The total value is divided by the number of
equity shares to ascertain the value of each share.

The productivity factor valuation is really a method for arriving at a reliable figure of
future profits. The steps are the following:
(i) Take a number of years whose results are relevant to the future. Determine net worth
of the business at the commencement and close of each of the accounting years
under consideration and find out the average net worth for each year by adding the
opening and closing net worth and dividing the result by 2; and, in turn, arriving at
the average net worth of the business during the period under study.
(ii) Determine the net worth of the business on the valuation date.
(iii) Ascertain the average, weighted, if necessary, adjusted profit earned during
the years under consideration.
(iv) Find out the percentage that (iii) bears to (i); that represents the productivity factor

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i.e Average (weighted) profit x 100

Average (weighted) networth
(v) Apply the productivity factor as obtained in (iv) above to the net worth on the
valuation date to find out the projected income in future.
(vi) Adjust the projected taxed income for factors like appropriations for provision for
replacement and rehabilitation of plant and equipment, tax, dividends on preference
shares, under utilization of productive capacity, effects of restrictions on monopoly,
etc.
(vii) Determine the normal rate of return for the company, having particular regard to the
nature and size of the undertaking.
(ix) Apply the multiplier obtained in (viii) above to the adjusted projected taxed income
to arrive at the capitalized value of the undertaking.
(x) Divide the result in (ix) above by the number of equity shares to arrive at the value
per share.

In this context, it may be noted that vary often companies have non-trading assets like
investments and sometimes idle assets in their balance sheets. The income from non -
trading asset does not reflect the earning power of the company and consequently that part
of income should be taken out of consideration in determining the average maintainable
profit. Also, the value of non-trading and idle assets, after proper determination, should be
excluded in the determination of networth at each stage. But non-trading assets should be
added to the value of undertaking as obtained in (ix) above.

4.15 DETERMINATION OF NORMAL RATE OF RETURN AND

CAPITALIZATION FACTOR:

This obviously has a tremendous bearing on the ultimate result, but unfortunately it is
subjective and, therefore, valuers differ more widely in this area than any other in the
whole valuation process. As a general rule, the nature of investment would decide the rate
of return, companies, investment in which is more risky would call for a larger rate of
return, and, consequently they will have a lower capitalization factor and lower valuation
than companies with assured profits. For investments in Government securities, the risk is
least and, consequently, an investor would be content with a very low rate of return. In a
logical order, we find mortgage debentures, being riskier than government paper, require
slightly higher rate of return. Preference shares are less risky than equity shares
but more risky than mortgage debenture; preference shares rank in between debentures
and equity shares in the matter of return. Equity shares are exposed to highest risks and,
consequently, the normal rate of return is highest in case of equity shares, though equity
shares of progressive and soundly managed companies, provide a safeguard against
inflation – equity share prices are likely to rise sufficiently high to counteract the effect of
a rise in prices.

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The above also applies to companies and industries and the normal rate of return will
always depend on the attendant risk. In this respect, net tangible asset backing is relevant.
The higher net tangible asset backing for each share , greater would be the confidence of
the investor. Normally, 2 to 3 times backing is considered satisfactory. This ratio should
be reviewed carefully to ascertain whether shares are inadequately covered or too much
covered which may indicate over capitalization in the form of idle funds or inadequate use
of productive resources. Symptoms suggesting idle assets would be holding of large cash
and bank balances, high current ratio, unutilized land, plant and machinery, etc. The
normal rate of return should be increased suitably in either case. Further, if any disabilities
attach to the concerned share such as the share being party paid, the normal rate of return
would be higher.

If the concerned company has special features, the normal rate of return will have to be
suitably modified. Thus, the following additional factors are to be considered:
(i) Restrictions on transfer of shares –The normal rate of return will be increased say,
by ½%.
(ii) Disabilities attached to shares will also cause the normal rate of return to go up e.g.
if shares are partly paid-up, the investors will expect a high yield (say by ½%
higher) than in case of fully paid shares.
(iii) Dividend performance –stability in dividend will decrease the normal rate.
(iv) Financial prudence on the part of the company’s management also affects the
normal rate of return. A company which distributes only a part of the profit will
attract investors without offering high yield.
(v) Net asset backing is important from the point of view of safety. The poor net asset
backing will increase the normal rate since the investors consider themselves unsafe.

4.16 FAIR VALUE OF SHARES

The fair value of a share is the average of the value of shares obtained by the net asset
method and the one obtained by yield method. Under net assets method, the value of an
equity share is arrived at by valuing the assets of a company and deducting therefrom all
the liabilities and claims of preference shareholders and dividing the resultant figure by
the total number of equity shares with the same paid up value. Under yield method, the
value of an equity share is arrived at by comparing the expected rate of return with the
normal rate of return. If the expected rate of return is more than normal rate of return, the
market value of the share is increased proportionately.

The fair value of shares can be calculated by using the following formula:

Fair value of share = value by net assets method + Value by yield method
2
Or (Intrinsic value + Yield value)/ 2

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This method is also known as dual method of share valuation. This method attempts to
minimize the demerits of both the methods. This is of course, no valuation but a
compromised formula for bringing the parties to an agreement. However it is recognized
in Government circles for valuing shares of investment companies for wealth tax
purposes.

4.17 SPECIAL FACTORS FOR VALUATION OF SHARES

Valuation of equity shares must take note of special features in the company or in the
particular case. These are briefly stated below:

4.17.1. Importance of the size of the block of shares:

Valuations of the identical shares of a company may vary quite significantly at the same
point of time on a consideration of the size of the block of shares under negotiation. It is
common knowledge that the holder of 75% of the voting power in a company can alter
even the provisions of the articles to suit himself; a holder of voting power exceeding 50%
and than less than 75% can substantially influence the operations of the company even to
alter the articles of association or comfortably pass a special resolution.

Even persons holding less than 50% of the total voting strength in a public limited
company may control the affairs of the company, if the shares carrying the rest of the
voting power are widely scattered; such shareholders rarely combine to defeat a
determined block. Usually a person holding 10 to 15% of the total voting powers is in a
position to have his way in the company- even to change the provisions of the articles of
association or pass any special resolution.

The above analysis is associated with the concept of the controlling interest, which
according to most authorities carries a separate value to the tune of additional 10to 20% of
the value of shares otherwise obtained.

4.17.2 Restricted transferability:

Along with principal considerations of yield and safety of capital, another important factor
is the easy exchangeability or liquidity. Shares of reputed companies generally enjoy the
advantage of easy marketability which is of great significance to the holder. At the time of
need, he may get cash in exchange of shares without being required to hunt out a willing
buyer, or without being required to go through a process of protected negotiation and
valuation. Generally quoted shares of good companies are preferred for the purpose. On
the other hand, holders of shares of unquoted public companies or of private companies do
not enjoy this advantage; therefore, such shares, however good, are discounted for lack of
liquidity at rates which may be determined on the basis of circumstances of each case. The

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discount may be either in the form of a reduction in the value otherwise determined or an
increase in the normal rate of return. Generally, the articles of private companies contain
provisions for offering shares to one who is already a member of the company and this
necessarily restricts the ready market for the shares. These shares are also discounted for
limited transferability. But exceptions are also there; by acquisition of a small back, if one
can extend his holding in the company to such an extent as to effectively control the
company, the share values may not be depressed in that deal.

4.18 DIVIDENDS AND VALUATION

Generally companies paying dividends at steady rates enjoy greater popularity and the
prices of their shares are high while shares of companies with unstable dividends do not
enjoy confidence of the investing public as to the returns they expect to get and
consequently they suffer in valuation. For companies paying dividends at unsteady rates,
the question of risk also becomes great and it depresses the price. The question of risk may
be looked upon from another angle. A company which pays only a small proportion of its
profit as dividend and thus builds up reserves is less risky than the one which has a high
pay out ratio. The dividend rate is also likely to fluctuate in the latter case. Investors,
however, do not like a company whose pay-out ratio is too small.

Shares are generally quoted high immediately before the declaration of dividend if the
dividend prospect is good; or immediately after the declaration of dividend (if it is
satisfactory) to take care of the dividend money that the prospective holder would get.

4.19 BONUS AND RIGHT ISSUES

Share values have been noticed to go up when bonus or right issues are announced, since
they indicate an immediate prospect of gain to the holder although, in the ultimate
analysis, it is doubtful whether really these can alter the valuation. Bonus issues are made
out of the accumulated reserves in the employment of the business, which in no way
contribute to the increased earning capacity of the business and ultimately depress the
dividend rate since the same quantum of profit would be distributed over a larger number
of shares. However, a progressive company generally picks up the old rate of dividend
after a short while but this is no way a result of bonus; it is the contribution of nature
growth potential of the company. However, in the case of right issues, the existing holders
are offered the shares forming part of the new issue; more funds flows into the company
for improving the earning capacity. Share values will naturally depend on the
effectiveness with which new funds will be used.

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4.20 VALUATION OF PREFERENCE SHARES:

These are valued on yield basis in a going concern. Compared to

Equity shares, the rate of return in preference shares would be generally, lower because of
greater safety. With fluctuations in the normal rate of return in respect of preference
shares,the value of preference share will fluctuate but in the opposite direction, i.e., if the
normal rate of return increase, the value tends to diminish. For instance,12%preference
shares of rs.100 each would be valued at Rs.85.72 when the expected rate of return is 14%
(i.e., 12/14x100). The same share would be valued at Rs.120 if the expected rate of return
is 10% (i.e.,12/10x100). In case the dividend on cumulative preference shares is in
arrears. the present value of such arrears of dividend (if there is a possibility of their
payment)should be added to the value of preference share calculated.

As stated earlier, a valuer must exercise his own judgement in valuing preference shares,
because of the diminishing real value of the fixed preference dividend.This is considered
to be a handicap for sellers in an inflationary economy. The yield based Valuation of
preference shares would hold good only if:

(i) the dividend on the share has been paid regularly and it is reasonably expected that it
would continue to be paid; and
(ii) that investment is adjudged by the criteria that the total assets of the concern are equal
to 4 or 5 times the preference capital.

Preference shares may have certain additional rights, for example, the right to get an
additional share of profits or the right to get the share converted into equity shares at a
certain rate. The right to get an additional share of profit will probably increase the market value of
the share depending upon the size of the total profit and conditions under which the additional
dividend will come to preference share holders. Total yield per share will have to be worked out and
on that basis the market value will be ascertained by the formula:
Total yield per share x 100
Normal rate of yield
The right to get the preference share converted into equity share will be valuable only if
the equity share of the company commands good value in the market. As against this,
there will also be the possibility that wholesale conversion into equity shares may depress
the dividend on these shares and thus bring down their price. The price of such a right will
be roughly equal to the difference in the market value of an equity share and the
conversion price. Suppose holders of preference shares of Rs.100 have a right to convert
their holding into equity shares at the end of 3 years at Rs.130 per equity share and the
market value of the equity share at the time is likely to be Rs.160 which is not likely to be
affected by the conversion. The right of conversion in the circumstances would be
ultimately worth Rs.30 (Rs.160 minus Rs.130). Taking 12% as the proper rate of interest,
the present value of such a right (discounting it @ 12% for 3 years) would be Rs.21.36.
The preference share therefore will command a value based upon its yield plus Rs.21.36.

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Illustration:4
From the following figures calculate the value of a share of Rs.10 on (i) dividend basis,
and (ii) return on capital employed basis, the market expectation being 12%.

Year ended capital employed profit Dividend (%)

st
31 march Rs. Rs.

2003 5,00,000 80,000 12

2004 8,00,000 1,60,000 15
2005 10,00,000 2,20,000 18
2006 15,00,000 3,75,000 20

Solution:
(i)Valuation of share on dividend basis:
The dividend rate on the simple average is 65/4 or 16 x1/4%. But since the dividend has
been rising it would be better to take the weighted average which come to 17.6% - thus:

Year ended Rate weight product

31st March
2003 12 1 12
2004 15 2 30
2005 18 3 54
2006 20 4 80
10 176
Dividing 176 by, we get 17.6%
The value of the share on the basis of dividend (weighted average) should be
17.6x10=Rs.14.67
12

(ii) Valuation of share on return on capital employed basis:

The return on capital employed for each year and its weighted average is as follows:

Year ended Return on capital weight Product

st
31 march employed %
2003 16 1 16
2004 20 2 40
2005 22 3 66
2006 25 4 100
10 222

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Weighted average is 22.2%

The value of the share should be:

22.2 x 10 = Rs.18.50.
12

Illustration:5

Balance sheet of Diamond ltd. as on 30.6.2006

Liabilities Rs
Share Capital:
2,000,shares of Rs.100 each 2,00,000
General Reserve 40,000
Profit and loss account 32,000
Sundry creditors 1,28,000
Income Tax reserve 60,000
4,60,000
Assets:
Land and Buildings 1,10,000
Plant and machinery 1,30,000
Patents and trade marks 20,000
Stock 48,000
Debtors 88,000
Bank Balance 52,000
Preliminary expenses 12,000
4,60,000

The expert valuer valued the land and buildings at Rs.2,40,000; goodwill at Rs.1,60,000;
and Plant and machinery at Rs.1,20,000. Out of the total debtors,
it is found that debtors of Rs.8,000 are bad. The profits of the company have been
as follows:
Rs
31.3.2004 92,000
31.3.2005 88,000
31.3.2006 96,000

The company follows the practice of transferring 25% of profits to general reserve.
Similar type of companies earn at 10% of the value of their shares. Ascertain the value of
shares of the company under:
(i) Intrinsic Value Method;
(ii) Yield value Method;
(iii) Fair Value Method;

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Solution:
Diamond Ltd.

Valuation of shares:

(i) Intrinsic value method:

Assets Rs

Land and buildings 2,40,000

Goodwill 1,60,000
Plant and machinery 1,20,000
Patents and trade marks 20,000
Stock 48,000
Debtors less bad debts 80,000
Bank balance 52,000
7,20,000
Less:
Liabilities:
Sundry creditors 1,28,000
Net assets 5,92,000

Intrinsic value of shares (each share) = Net Assets

No.of Shares

= Rs.5,92,000 = Rs.296.
2,000

(ii) Yield value method:

Rs
Total profit of last three years 2,76,000
Less: Bad debts 8,000
2,68,000

Average profit = Rs.2,68,000 = 89,333

3

Add: Decrease in depreciation on

plant and machinery say
@10% on Rs.1,30,000 13,000
Average profit 77,833
Less: Transfer to reserve
@ 25% of Rs.77,833 19,458
Profit available for dividend 58,375

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Rate of dividend = Rs.58,375 x100 =29.187%

2,00,000

Yield value of each share = Rate of Dividend x paid-up value of each share
Normal rate of return

= 29.187 x 100=Rs.291.87
10

(iii)Fair value method:

Fair value of each share = Intrinsic value +Yield value
2

= Rs.296+Rs.291.87 = Rs.293.93
2
Illustration:6

The balance sheet of super sound ltd. as at 31st March,2006 is given below:

Liabilities Rs Assets Rs

Share Capital: Buildings 2,25,000

9,000 equity shares Machinery 3,30,000
of Rs.100 each, Stock 4,50,000
fully Paid-up 9,00,000 Sundry debtors 2,40,000
Profit and loss account 75,000 Bank 90,000
Bank overdraft 15,000
Creditors 90,000
Provision for taxation 1,65,000
Provision for dividends 90,000 _________
13,35,000 13,35,000

The net profits of the company after deducting usual working expenses but before
providing for taxation were as under:
Year Rs

2003-04 3,00,000
2004-05 3,60,000
2005-06 3,30,000

On 31st March, 2006, building was revalued at Rs.3,00,000.Machinery at Rs.3,75,000 and

sundry debtors on the same date including Rs.10,000 as irrecoverable. Having regard to
nature of the business, 10% return on net tangible capital invested is considered
reasonable.

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You are required to value the company’s share ex-dividend. Valuation of goodwill may be
based on three years purchase of annual super profits. Rate of depreciation on buildings is
20% and on machinery is 10%. The income-tax rate is ti be assumed at 35%. All workings
should form part of your answer.

Solution:

In the books of super sound Limited

Calculated of value of Equity share:

Rs Rs
Goodwill- WN. (v) 2,72,800
Buildings (revalued value) 3,00,000
Machinery (revalued value) 3,75,000
Stock 4,50,000
Sundry Debtors 2,30,000
Bank 90,000
Total Assets: 17,17,800
Less: Liabilities:
Bank Overdraft 15,000
Creditors 90,000
Provision for taxation 1,65,000
Proposed Dividend 90,000 3,60,000
Net Assets 13,57,800

Value of an equity share = Net Assets/No.of Equity shares

= Rs.13,57,800/9,000= Rs.150.87

Working Notes:
(i) Calculation of Average Capital Employed:

Closing Capital Employed:

Assets

Building (revalued) 3,00,000

Machinery (revalued) 3,75,000
Sundry Debtors (less bad debts) 2,30,000
Stock 4,50,000
Bank 90,000
14,45,000

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Less: Liabilities

Bank overdraft 15,000

Sundry Creditors 90,000 1,05,000
Closing Capital employed 13,40,000
Less: 50% of profit before tax 1,65,000
Average Capital employed 11,75,000

(ii) Calculation of normal rate of returns on average capital employed:

Average Capital Employed x NRR/100 = Rs.11,75,000 x 10/100= Rs.1,17,500

(iii) Calculation of future Maintainable Profits:

Average profits of last three years =Rs.3,00,000 + Rs.3,60,000+Rs.3,30,000
Rs
Cumulative Profits 9,90,000
Less: Bad debts 10,000
9,80,000
Average Profits=Rs.9,80,00/3 = 3,26,667
Less: Depreciation on revaluation of assets
Rs
2% on Rs.75,000 = 1,500
10% on Rs.45,000 = 4,500 6,000
3,20,667.00
Less: Income tax @ 35% 1,12,233.45
Future maintainable Profit 2,08,433.55

(iv) Calculation of super Profits

= Future Maintainable Profit - Normal Rate of return

= Rs.2,08,433.55 - Rs.1,17,500 =Rs.90,933.55

(v) Calculation of Goodwill:

Super profits x 3years purchase =Rs.90,933.55 x3 =Rs.2,72,800.

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Illustration:7
From the following particulars calculated the value of share of Z ltd. on yield basis:

Balance sheet of Z ltd. as on 31st march, 2006.

Liabilities Rs Assets Rs
8,000 equity shares Land and buildings 5,00,000
of Rs.100 each 8,00,000 Plant and machinery 6,00,000
4,000 9% preference Patents 2,00,000
Shares of Rs.100 each 4,00,000 Sundry Debtors 3,00,000
10% Debentures 2,00,000 Work-in-progress
Reserves 4,00,000 and stock 5,00,000
Sundry creditors 4,00,000 Cash at bank 1,00,000
22,00,000 22,00,000
Land and buildings to be valued at Rs.9,00,000. The company’s earnings were,

Year ended Profits before tax Tax paid

31st march Rs Rs
2002 3,00,000 80,000
2003 4,00,000 1,60,000
2004 1,00,000 40,000(strike)
2005 5,00,000 2,30,000
2006 5,50,000 3,00,000

The company paid managerial remuneration of Rs.60,000 per annum but itwill become
Rs.1,00,000 in future. There has been no change in capital employed. The company paid
dividend ofRs.9 per share and it will maintain the same in future. The
company proposes to build up a plant rehabilitation reserve. Dividend rate in this type of
company is fluctuating and the asset backing of an equity share is about 1-1/2 times.
The equity shares with an average dividend of 8% sell at par. (tax rate is assumed to be
40%)

Solution:
Average maintainable profits in future.2003-2004 not considered because of low profits
for abnormal reasons:

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Year ended Profits weight Product

31st March Rs Rs
2002 3,00,000 1 3,00,000
2003 4,00,000 2 8,00,000
2004 - - -
2005 5,00,000 3 15,00,000
2006 5,50,000 4 22,00,000
10 48,00,000

Rs
Weighted average: 4,80,000
Adjustment:
Less: Increase in managerial remuneration 40,000
4,40,000
Less: Tax @40% 1,76,000
Profit available for distribution 2,64,000
Less: Rehabilitation Reserve (12.5% estimated) 33,000
2,31,000
Less: Dividend on preference shares 36,000
Profit available for distribution to
equity shareholders _________
1,95,000

Rs.195,000 capitalised at 8%=Rs.1,95,000x100 =Rs.24,37,500

The value of equity share will be = Rs.24,37,500 = 304.69

8,000
=Rs.305.00 (Approximately)
Altermatively:

Assets backing per equity share: Rs

Total Asset as per balance sheet 22,00,000
Add: Increase in value of land and buildings 4,00,000
26,00,000
Less: Sundry Creditors 4,00,000
10% Debentures 2,00,000
9% Preference shares 4,00,000 10,00,000
Net assets available for equity shareholders 16,00,000
Equity share capital 8,00,000

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Asset backing 2times

Normal dividend rate 8.0%
Less: For higher dividend rate (9%) and stability (say) 0.5%
Less: For higher asset backing 2 times as compared
to 1.5times) (say)
Adjusted normal rate of return 0.5%
7.00

Capital employed:

Equity share capital 8,00,000

9% preference share capital 4,00,000
10% Debentures 2,00,000
Reserves 4,00,000
Increase in value of land and buildings 4,00,000
22,00,000
Profit after tax 2,64,000
Add: Debenture interest (after effect of income tax) 12,000
Profit earned 2,88,000

Rate of earning: Rs.2,88,000 x100 =13.09%

Rs.22,00,000
(since the capital employed includes the amount of debentures, debenture interest after the
effect of income tax has been adjusted.)
alue of share:
on actual dividend basis = 9/7 x100 = Rs.129(appx)
on earning basis = 13.09/7 x100 = Rs.187

Illustration:8

Year ended Average networth Adjusted taxed

31st March (excluding investmant) profit
Rs Rs
2004 18,50,000 1,80,000
2005 21,20,000 2,00,000
2006 21,30,000 2,30,000

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The aforesaid figures relate to a company which has Rs.10,00,000 on equity shares of
Rs.100 each and Rs.3,00,000 in 9% preference shares of Rs.100 each. The company has
investments worth Rs.2,50,000 (at market value) on the valuation date the yield in respect
of which has been excluded in arriving at the adjusted tax profits figures. It is usual for
similar type of companies to set aside 25% of the taxed profit for rehabilitation and
replacement purpose. On the valuation day the net worth (excluding investment) amounts
to Rs.22,00,000. The normal rate of return expected is 9%. The company paid dividends
consistently within a range of 8 to 10% on equity shares over the previous seven years and
the company expects to maintain the same. Compute the value of each equity share on the
basis of productivity.

Solution:
Since both profits and net worth of the company are showing a steady growth, it would be
reasonable to attach due weightage to them foe valuation purposes.

Year ended Average Adj.taxed Weight Weighted

31st march Networth Profit factors Networth Profit
Rs Rs Rs Rs
2004 18,50,000 1,80,000 1 18,50,000 1,80,000
2005 21,20,000 2,00,000 2 42,40,000 4,00,000
2006 21,30,000 2,30,000 3 63,90,000 6,90,000
6 1,24,80,000 12,70,000
weighted average 20,80,000 2,11,667

Productivity Factor = Rs.2,11,667 x 100 =10.18%

Rs.20,80,000

Net worth on valuation date = Rs.22,00,000 Rs

Projected future maintainable profit = 10.18% of Rs.22,00,000 2,23,960
less: Rehabilitation and replacement @ 25% 55,990
1,67,970
less:Preference Dividend 27,000
1,40,970
Rs.1,40,970 capitalised @ 9 rate of return would be 15,66,334
Add: Value of investments 2,50,000
Value of 10,000 equity shares 18,16,334

Therefore, the value of each equity share would be = 18,16,334 = Rs.181.63

10,000

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Illustration:9
From the following balance sheet of M.P products ltd. Find out the values of equity shares
and preference shares:

Balance sheet of M.P Products ltd.

Liabilities Rs Assets Rs
20,000 equity shares Goodwill 25,000
of Rs.10 each 2,00,000 Machinery 1,60,000
8% 1,000 preference Furniture 5,000
shares of Rs,100 each 1,00,000 Stock 80,000
Reserves 30,000 Debtors 1,50,000
Profit and loss account 10,000 cash 2,000

Sundry creditors 60,000 Preliminary expenses 3,000

proposed preference
dividend 8,000
other liabilities 12,000
overdraft 5,000 ________
4,25,000 4,25,000

Goodwill is valued at Rs.15,000. Stock is overvalued by Rs.10,000, Machinery is

Undervalued by Rs.15,000.

Solution:
RS
Net Assets:
Goodwill 15,000
Machinery 1,75,000
Furniture 5,000
Stock 70,000
Debtors 1,50,000
Cash 2,000
4,17,000
Less: Liabilities
Creditors 60,000
Proposed preference dividend 8,000
overdraft 5,000
Other liabilities 12,000 85,000
3,32,000
Less:Preference share capital 1,00,000
Net Assets for equity shareholders 2,32,000

Intrinsic Value of equity shares: Rs.2,32,000 / 20,000 =Rs.11.60 per share.

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Intrinsic value of preference shares:

Rs.100 + proposed dividend Rs.(8,000 /1,000= Rs.8) = Rs.108 per share.

If they are participating preference shares, the excess of net assets less preference share
capital over the paid -up value of equity shares will be distributed over equity shares and
preference shares converting them to equivalent number of same paid-up values. The
share is to be added to the paid up amount of the respective shares. The total excess may
also be distributed in the ratio of equity capital and prefernce capital. Participating shares
in this connection are taken to mean that they participate in surplus in liquidation pari-
passu with equity shares. In reality, the articles of association will govern the situation.

Assuming the preference shares in illustration above are participating shares. Determine
the values of equity shares and preference shares, assuming they rank Pari-passu.

Rs
Net assets less preference share capital (as above) 2,32,000
less: Equity share capital 2,00,000
32,000
Equivalent number of equity and preference shares:

20,000 equity shares equivalent to 20,000 shares of Rs.10 each

1,000 preference shares equivalent to 10,000 shares of Rs.10 each
30,000 shares of Rs.10 each

Surplus per share of Rs.10 = Rs.32,000 = Rs.1.07

30,000

Hence the value of equity shares: Rs.10 + Rs.1.07 = Rs.11.07 per share.

Value of preference shares : Rs.100 + Rs.8 + (Rs.1.07x10)=Rs.118.70

or, the surplus of Rs.32,000 may be dividend between equity capital and preference
capital in the ratio of 2:1, i.e., Rs.21,333 and Rs.10,667 respectively.

Values of shares:

Equity : 2,00,000 + 21,333 = 2,21,333 =11.07

20,000 20,000

Preference: 1,00,000 + 10,667 +8,000 = 1,18,667 = 118.67

1,000 1,000

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4.21 LET US SUM UP

Share forms the basis of ownership in the Company and the people who contribute the
money. The valuation of Goodwill and Shares has to be done when there is no market
price as in the case of Proprietary company and where for special reasons, the market
price does not reflect the true or intrinsic value of shares/Goodwill. This problem does not
arise if the shares are quoted on the stock exchange as it provide a ready means of
ascertaining the value placed on such shares by buyers and sellers. The valuation depends
on the purpose the nature of business, demand and supply, the government policy, past
performance of the company, growth prospects of the company and many other related
factors.

4.22 LESSON-END ACTIVITIES

1. Explain the factors that affect the valuation of goodwill and shares.
2. Ramesh runs a general store. His net assets on 31st Marchm2006m amounted to
Rs.20,00,000. After paying a rent of Rs.20,000 a year and salary of Rs.10,000 to the
manager, he earns a profit of Rs.1,50,000. His landlord is interested in acquiring the
business. 8% is considered to be a reasonable return on capital employed. What can
Ramesh expect as payment for Goodwill?
3. Sita Ltd., is desirous of selling its business to another company and has earned an
average profit in the past of Rs. 60,000 per annum. It is considered that such
average profit fairly represents the profit likely to be earned in the future except that
(a) Director’s fee Rs.4,000 charged against such profits will not be payable by the
purchasing company whose existing board can easily cope with the additional
administrative work at the present fees payable to the directors. (b) Rent at Rs.8,000
p.a. which had been paid by the vendor company will not be charged in future, since
the purchasing company owns its own premises and can supply the accommodation
necessary for the staff and equipment of the vendor company. The value of the net
tangible assets of the vendor company at the beginning of the year i.e. 12 months
before the date of purchase, was Rs.7,30,000. It was considered that a reasonable
return on capital invested, for the type of company was 8%. The profit of the vendor
company and goodwill existed and was to be paid for on the basis that vendor
company was a continuing enterprise. Calculate the value of goodwill.
4. Renga Co Ltd., is to be absorbed by Ram Co Ltd and in order to decide upon the
purchase consideration, it is necessary, amongst other things, to value the good will
attaching to the business of Ranga Co Ltd., The two companies agree that the basis
of the calculation of goodwill shall be three years purchase of the average annual

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super profits, the net profits being averaged over five years and subject to whatever
adjustments you, as the accountant for making the valuation, consider necessary.
The profits of Ranga Co Ltd., for the last five years ending 31st March (before
charging income tax @40% on income) are as follows: 2002 Rs.5,00,000 2003
Rs.6,50,000 2004 Rs.4,50,000 2005 Rs.5,50,000 and 2006 Rs. 7,50,000. The
Directors of Renga Co Ltd., (3 in number) will be appointed to the Board of Ram
Co. ltd on absorption and it is considered that their services have been (and will be
in the future) worth Rs.50,000 each per annum. There has never been made any
charge against the profits of Ranga Co Ltd., for such services. The average capital
invested in tangible assets over the period is Rs.18,00,000. And it is considered that
the normal return to be expected from the particular type of business carried on by
Ranga Co Ltd.,is 10%. Calculate the goodwill of Ranga Co Ltd.,
5. It is provided in the Articles of Association that on the death of a shareholder, his
shares shall be purchased by the remaining shareholders at a price to be settled by
the Auditors. On the basis of the last balance sheet. It is further provided that for
this purpose, goodwill was to be of the value of three years’ purchase of the average
annual profits for the last four years. The last balance sheet is as follows:
Liabilities Rs. Assets Rs.
Capital Goodwill 1,00,000
20,000 shares of Investment at cost
Rs.10 each fully 2,00,000 (market value Rs1,25,000
Paid 1,50,000
Reserve 1,00,000 Stock at cost 2,50,000
Debentures 2,00,000 Debtors 1,50,000
Sundry Creditors 1,50,000 Cash 35,000
Profi & Loss A/c 35,000
_________ _______
6,85,000 6,85,000
The profits for the last four years were (after tax) Rs.15,000, 20,000, 25,000 and 40,000
respectively.
You are required to state with details of working the price which should be paid per share.

4.23 REFERENCES

1. Gupta R.L & Radhaswamy M. “Corporate Accounts” Theory method and

application- 13th revised edition 2006, Sultan chand & Co.,, New delhi.
2. S.P.Jain & K.L Narang, “ Advanced Accounting “, Kalyani publications, New delhi.
3. Reddy & Murthy, “Financial accounting”, Margham publications, Chennai 2004

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UNIT - V
5.0 AIMS AND OBJECTIVES
5.1. Introduction
5.1.1 Avoiding bankruptcy and winding up
5.2 Modes of winding up or Liquidation
5.2.1 Solvent and insolvent liquidations
5.2.2 Winding up Under Supervision of the Court
5.2.3. Contributory
5.2.4 Fraudulent Preference.
5.3 Employees and Officers.
5.4 Interest on Liabilities;
5.5 Liquidator
5.6 Creditors’ voluntary liquidation (CVL)
5.7 Order of Payment:
5.8 The Preferential creditors:
5.9 Due to Workers.
5.10 What are the consequences of liquidating a company?
5.11 FORM OF STATEMENT OF AFFAIRS
5.11.1 Procedure of Preparation of Statement of Affairs:
5.11.2. Lists to be attached to the Statement of Affairs:
5.12 Liquidator’s Remuneration:
5.13 Receiver for Debenture holders:
5.14 Role played by the Court
5.15 LET US SUM UP
5.16 LESSON-END ACTIVITIES
5.17 References

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5.0 AIMS AND OBJECTIVES

i) To know the Meaning, definition of Liquidation of companies.
ii) To study the modes of winding up
iii) To study the procedure to prepare Statement of affairs & Liquidators’ final
statement.

5.1 INTRODUCTION

A company comes into being through a legal process and also comes to an end by the
same legal process. Liquidation is the legal procedure by which the company comes to an
end. Thus, a company being a creation of law cannot die a natural death. A company,
when found necessary, can be liquidated. Insolvency proceedings are not applicable to a
company as are applicable to an individual or partnership firms. For liquidation of limited
company liquidation proceedings are applied. But it may be mentioned that the insolvency
of a company is not a necessary condition for its liquidation; a solvent company can also
be liquidated.
If you cannot pay your business debts when they become due, or if the assets of your
business are less than your debts, your business is insolvent.

Liquidation (or "winding up") is a process by which a company’s existence is

brought to an end.
Unless you pay those debts quickly, then the insolvency will lead to bankruptcy or
winding up. Bankruptcy applies to individuals such as sole traders and those that have
given personal guarantees for loans. Winding up and liquidation apply to companies.

5.1.1 Avoiding bankruptcy and winding up

To keep your business solvent you should bear the following in mind:

• Do not allow your debts to exceed your assets.

• Keep an eye on your cashflow.
• Choose the right business structure.
• Implement good credit-control structures.
• Take care before offering personal guarantees for business loans.

If your assets – e.g. stock, buildings, machinery or debts owed to you - equal the amount
of loans and debts that you owe then you are in a situation where all of your capital could
be wiped out.

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Your creditors effectively own your business and if the value of the assets fall further
your creditors could realise that their money is at risk and want it back. This would make
you insolvent, as you wouldn't be able to pay them all.

To avoid this you need to make sure that your capital is maintained. You should try to
keep your own capital up by holding back profits where possible. Do not be tempted to
take on loans that would increase your borrowing far above your own investment in the
business.

Even though you are making profits and have enough capital you can still become
insolvent if you cannot make payments on time. You need to make sure you have a good
cashflow so that you can pay debts on time. A common problem is to take on too much
debt while chasing new business. This is known as overtrading. Careful planning and
forecasting will help you to avoid this. See our guide on how to avoid the problems of
overtrading

5.2 MODES OF WINDING UP OR LIQUIDATION

Section 425(1) of the Companies Act provides that a company can be liquidated in any of
the following three ways:
(i) Compulsory winding up by the court;
(ii) Voluntary winding up by the members or creditors;
(iii) Winding up under the supervision of the court.

Generally (unless the contrary appears), the provisions of the Act with respect to winding
up apply to winding up of a company whether it be by the court or voluntary or subject to
the supervision of the court [Section 425 (2)].
Liquidations are also classified according to whether the company is solvent or insolvent.

5.2.1 Solvent and insolvent liquidations

If the company is insolvent, this means it is unable to pay its debts as they fall due. In this
situation there is potential conflict between creditors (those to whom money is owed), as
there will be insufficient assets for all creditors to be paid in full.
The law attempts to maintain an equality between creditors, so the assets are distributed
proportionately according to the size of each creditor’s claim. However, the law gives
priority to secured creditors (those with a charge over some of the company’s property as
security for the debt). In addition, a number of rules exist to prevent one or more creditors
from gaining an unfair advantage.

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5.2.2 Winding up Under Supervision of the Court

Your company can also be wound up by compulsory liquidation under a court order. If
there are sufficient assets, the official receiver will call a first meeting of creditors to
appoint an insolvency practitioner as liquidator. When a company is being wound up
voluntarily, the court under Section 522 of the Companies Act, at any time after a
company has passed a resolution for voluntary winding up, may make an order that
voluntary winding up shall continue but subject to the supervision of the Court. Such an
order is passed by the Court on the application of any creditor or contributory or liquidator
or the company itself when the liquidator under voluntary winding up is prejudiced or is
negligent in collecting the assets of the company or the resolution for winding up was
obtained by fraud. The liquidator will continue to exercise all powers but powers will be
exercisable subject to any restrictions or conditions laid down by the court. This type o
winding up is made to safeguard the interest o the creditors and contributors or members
of the company.

5.2.3. Contributory
According to Section 428 of the Companies Act, 1956, a contributory is “every person
liable to contribute to the assets of a company in the event of its being wound up, and
includes a holder of fully paid-up shares, and also any person alleged to be contributory”.
A contributory can be either a preset member or a past member. A present member is that
member whose name is included in the register of member when the shares held by him if
the amounts is needed to make the payment to the legal claimants. In the case of a
company limited by guarantee, he is liable for the amount undertaken to be contributed by
him in the event of the company being wound up.

The holders of fully paid up shares are also treated as contributories even though they are
not to contribute to the assets of the company because it is necessary to complete a list of
all the members of the company so that the court may be able to know, not only those
who will contribute but also who will share the surplus assets, if any. The present
members are included in “A” List of contributories. It may be remembered that a
contributor’s liability is legal and not contractual as he cannot set off his debts against his
liability for unpaid amount on shares held by him even if there is an express agreement to
do so.

On the other hand, past members are those members who ceased to be shareholders
(except by death) within one year of the winding up of the company and can be called
upon to pay if the present contributories are not able to pay the liabilities of the company.
As regards past members, section 426 of the companies Act provided as follows:

(a) A past members is not liable to contribute in respect of any liability of the company
contracted after he ceased to be a member of the company.

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(b) A past member is not liable to contribute if he ceased to be a member of the

company for one year or upward before the commencement of the winding up.
(c) A past member is liable to contribute only if it appears to the court that present
members are unable to make the contributions required to be made by them in
pursuance of the Companies Act.
(d) In the case of a company limited by shares, no contribution is required from any past
member excluding the amount)if any) unpaid on the shares in respect of which he is
liable as such member.
(e) In the case of a company limited by guarantee, no contribution is required from any
past member excluding the amount undertaken to be contributed by him in the event
of the company being wound up.

The past members are included in “B” list contributories.

5.2.4 Fraudulent Preference.

Fraudulent preference takes place when one creditor is preferred to another creditor in the
matter of payment of his dues. The object of the Companies Act is pari passu distribution
amongst creditors; so it has been provided in Section 531 that every transfer of property
or money made within 6 months before the commencement of the winding up, which
amounts to fraudulent preference, is invalid.

Voluntary transfer. All voluntary transfers, made by the company within a period of one
year before the presentation of a petition for winding up or the passing of a resolution for
voluntary winding up, are void as against the liquidator.

5.3 EMPLOYEES AND OFFICERS

According to Section 444, a winding up order operators as a notice of discharge to the
employees and officers of the company, except when the business of the company is being
continued. A voluntary winding up also operates as a notice of discharge.

5.4 INTEREST ON LIABILITIES

Interest on liabilities is payable upto the date of actual payment if the company is solvent.
But if the company is insolvent, interest on liabilities is payable up to the date of
commencement of insolvency proceedings.

5.5 LIQUIDATOR
In case of compulsory winding up, the official liquidator attached to each High Court will
become the liquidator after the winding up order is passed. The company must submit a
Statement of Affairs to such liquidators within 21 days of the passing of the winding up

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order. This statement shows assets at realizable values and liabilities at values expected to
rank and shows surplus or deficiency as per list H. The Official Liquidator must convene a
meeting of the creditors within 2 months of the winding up order to ascertain whether they
like to appoint a “Committee of Inspection”. The committee so appointed should not have
more than 12 members, made up of equal number representing creditors and
contributories. In case of voluntary winding up, the voluntary liquidator is appointed by a
resolution in general meeting of the company and/or of the creditors. The general duties of
the liquidator are to take into his custody or under his control all the property of the
company and its effects and actionable claims and pay the right claimants.

5.6 CREDITORS’ VOLUNTARY LIQUIDATION (CVL)

If your company becomes unable to pay its debts and no arrangement or period of
administration is likely to save it then you, as director, can propose a creditors'
voluntary liquidation (CVL).

The amounts realized from the assets not specifically pledged and the amounts contributed
by the contributories must be distributed by the liquidator in the following order:

(1) Expenses of winding up including the liquidator’s remuneration.

(2) Creditors,(i.e., debentures etc.) secured by a floating charge on the assets of the
company..
(3) Preferential creditors ( they are unsecured even if they enjoy priority).
(4) Unsecured creditors.
(5) The surplus, if any, amongst the contributories, (i.e. preference shareholders and
equity shareholders) according to their respective rights and interests.

5.7 ORDER OF PAYMENT

(a) Preference shareholders. Preference shareholders get the priority over the equity
shareholders as regards the payment of their capital and the dividend payable upto the date
of the winding up. The holders of cumulative preference shares are entitled to arrears of
dividend if there is a surplus after the return of the amount of the equity share capital or if
the Articles state that arrears of preference dividend are to be paid before anything is paid
to equity shareholders. In the latter case the arrears of dividend must be paid even by
contributions from equity shareholders if equity shares are party paid.

(b) Equity Shareholders. Any surplus left after making the payment of the preference
shareholders is distributed among equity shareholders pari passu if all shares are equally
paid up. But if the shares are called in unequal proportions, the liquidator should see that
the capital contribution by the shareholders should be the same. For example, a company
has issued equity shares of Rs.10 each, but if the shares of some shareholders have been

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called up Rs.7 per share and those of other shareholders Rs.5 per share. Further, if the
amount realized from the sale of he assets is not sufficient to pay the liabilities and the
cost of the winding up, the liquidator will make a call of Rs.2 per share on those
shareholders who have paid Rs.5 per share to bring their capital contribution equal to other
shareholders. A further call, if necessary, would be made equally on all equity
shareholders. In case of surplus of assets, the shareholders who have paid Rs.7 per share
will get preference of rs.2 per share and if still there is a surplus, all equity shareholders
will be entitled to pari passu distribution.

It may be remembered that calls-in-advance will have priority on repayment over the paid
up share capital of that class.

Preferential creditors are paid out of the proceeds of the assets not specifically pledged,
surplus from the assets specifically pledged and amount contributed by the contributories
after retaining the amount necessary for the payment of legal expenses ,cost of winding up
and liquidator’s remuneration but before making any payment to other claimants. It must
be remembered that preferential creditors are in the nature of unsecured creditors who
have priority of claims over other unsecured creditors not because of any security held by
them but because of Section 530 of the Companies Act.

5.8 THE PREFERENTIAL CREDITORS

(a) All revenues, taxes , cess and rates, whether payable to the Government or local
authority, due and payable by the company within 12 months before the date of
commencement of winding up.
(b) All wages or salaries (including commission earned) of any employee in respect of
services rendered to the company and due for a period not exceeding four months
within the said twelve months before the relevant date such sum may be specified by
the Government in the Official Gazette in respect of each claimant. Such sum has
been specified as Rs.20,000 w.e.f.from March,1997.
Salaries due to an officer like director, maneger, secretary, assistant secretary,
branch manager etc. are not preferential.
(c) All accrued holiday remuneration becoming payable to an employee on account of
the termination of his employment before or on account of winding up.
Note. Persons who advance money for the purpose of making preference payments under
(b) and (c ) above will be treated as preferential creditors.
(d) Unless the company is being wound up voluntarily for the purpose of reconstruction
or amalgamation, all contributions payable during the 12 months previous to the
winding up, by the company as the employer of any person, under Employees’ State
Insurance Act,1948 or any other law for the time being in force.
(e) All sums due as compensation under Workmen’s compensation Act,1923 unless the
winding up is for reconstruction or amalgamation.

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(f) All sums due to an employee from a provident fund, pension fund, gratuity fund, or
any other fund maintained for the welfare of the employees.
(g) The expenses of any investigation held under section 235 or 237 in so far as they are
payable by the company.

The forgoing preferential creditors rank equally among themselves and must be paid in
full unless the assets are not sufficient to meet their claims, in which case they shall abate
proportionately.

5.9 DUE TO WORKERS

In order to protect the interest of workers, Section 529 has been amended by the
Companies (Amended) Act, 1985.As per this amendment the legitimate dues of the
workers will rank pari passu with secured creditors in the event of the liquidation of the
company. Dues ton workers will be above even the dues to government. The security
of every secured creditors, according to this amendment, shall be deemed to be subject to
a pari passu charge in favour of workmen to the extent of workmen’s portion therein. As
per Section 2 (s) “workman means any person (including an apprentice) employed in any
industry to any skilled or unskilled, manual, supervisory, technical or clerical work for
hire or reward. The terms of employment may be express or implied. It includes any
person who has been dismissed, discharged or retrenched in connection with, or as a
consequence of an industrial dispute or whose dismissal, or discharge, or retrenchment has
led to that dispute.”

The following persons are specified excluded from the definition of workman.

(1) A person who is subject to the Army Act, 1950, or the Air Force Act,1950 or the
Navy (Discipline) Act, 1934.
(2) A person who is employed in the police service or as an officer or other employee of
a prison.
(3) A person who is employed mainly in a managerial or administrative capacity.
(4) A person who is employed in a supervisory capacity and draws wages exceeding
Rs.1600 per month or exercise functions mainly of a managerial nature”

Section 529A added in the Companies Act in 1985 makes provision for overriding
preferential payment. This Section gives priority in payment to workmen’s dues and debts
due to secured creditors to the extent they could not be paid because of the former, ranking
pari passu with the latter as provided in section 529. The unpaid amount of dues to
workmen and Secured creditors after making payment as per section 529 shall be paid in
full, unless the assets are insufficient to meet them, in which case they shall abate in equal
proportions.

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5.10 WHAT ARE THE CONSEQUENCES OF LIQUIDATING A COMPANY?

The main consequences of the company being liquidated are as follows:

• The company no longer has the power to dispose of its property.
• The company may carry on business only for the limited purpose of completing the
liquidation process.
• The powers of the company directors come to an end when a liquidator is appointed.
• A liquidation order operates as a notice of dismissal to all of the company’s
employees. Note, however, that if an employee is on a fixed-term contract and is
required under this contract to be given a period of notice, then a liquidation order
will breach this and the employee will be entitled to damages.
• When an application is made for a court-ordered liquidation, the court may stay or
restrain any proceedings against the company as the court sees fit. When a liquidator
is appointed, no person can begin or continue legal proceedings against the company
or in relation to its property, unless the liquidator agrees or the court permits it.

5.11 FORM OF STATEMENT OF AFFAIRS

Statement as to the affairs of …..ltd., on the ….day of …..19…… being the date of the
winding up order appointing Provisional Liquidator or the date directed by the official
Liquidator as the case may be showing assets of estimated realizable values and liabilities
expected to rank.

Assets not specially pledged (as per list A) Estimate

d
Realizab
Balance at Bank le
Cash in hand Value
Marketable Securities Rs
Bills Receivable
Trade Debtors
Loans & Advances
Unpaid Calls
Stock-in-trade
work-in-progress
______________

Freehold Property, Land & Buildings

Leasehold Property
Plant& Machinery
Furniture Fittings, Utensils etc.
Livestock

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Other Property, viz..

_____________

* Asset specially (a) (b) (c) (d)

pledged Estimated Due to Deficiency Surplus
(as per List ‘B’) realizable Secured ranking as carried to
values Creditors unsecured last column
Rs Rs Rs Rs
Freehold Property
________________

Estimated Surplus from assets specially pledged

Estimated total assets available for preferential creditors,
Debenture holders secured by a floating charge, and unsecured
creditors (carried forward).

SUMMARY OF GROSS ASSETS

Gross realizable value of assets specially pledged
Other Assets
GrossAssets
Liabilities

(to be deducted from surplus or added to

deficiency as the case may be)
Secured Creditors (as per list ‘B’) to the extent to which
claims are estimated to be covered by assets specially
Pledged item (a) or (b) whichever is less
(Insert in ‘Gross Liabilities’ column only)
Preferential Creditors (as per list ‘C’)
Estimatedbalanceofassetsavailablefordebentureholders
Secured by a floating charge and unsecured Creditors)**
Debenture holders secured by a floating charge (as per list ’D’)
Estimated Surplus/ Deficiency as regards Debenture holders
Unsecured Creditors (as per list ‘E’)
Estimated unsecured balance of claims of creditors partly
secured on specific asset, brought from preceding page
Trade Accounts
Bills payable
Out standing Expenses
___________________

Contingent Liabilities (state nature)

_____________________

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Estimated Surplus/Deficiency as regards

Creditors (being difference between
Gross Assets and Gross Liabilities

Issued and Called-up Capital: Rs

Preference Shares of ………each
Called-up (as per list ‘F’)
Equity Shares of …….each
………..Called-up (as per list ‘G’)

Estimated Surplus / Deficiency as regards Members (as per list ‘H’)

* Notes:
1. All assets specially mortgaged, pledged, or otherwise given as security should be
included under this head. In the case of goods given as security, those in possession
of the company and those not in possessions, should be separately set out.
2. The figures must be read subject to the following:
(a) There is no unpaid capital liable to be called up or the nominal amount of unpaid
capital liable to be called up is Rs…..estimated to produce Rs…… which is not
charged in favour of Debenture holders.
(b) The estimates are subject to cost of the winding up and to any surplus or deficiency
on trading pending realization of assets.

5.11.1 Procedure of Preparation of Statement of Affairs:

For the preparation of statement of Affaires, the following points are worth-noting:

(1) First of all, take all assets which are not specifically pleadged. These assets are taken
at their realizable values and not at book values because creditors for their payment
are concerned with the realizable values of the assets. It may be noted that calls in
arrears are also treated as an asset not specifically pledged to the extent of estimated
realizable amount, but uncalled capital is not shown as an asset.
(2) Add to the realizable value of the assets not specifically pledged, any surplus from
assets specifically pledged.
(3) From the total as obtained by adding (1) and (2) first deduct the amount of
preferential creditors, then the amount of creditors having a floating charge (e.g.
debentures)and the result will be surplus or deficiency as regards debenture holders.

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(4) Deduct the amount of unsecured creditors from the figure as obtained in (3) above
the resultant figure will be either surplus or deficiency as regards unsecured
creditors.
(5) Add the amount of paid up share capital to the figure as obtained in (4) above; the
result will be either surplus or deficiency as regards members or contributories.
(6) Any likely expenditure on liquidation should be ignored. A note may simply be
given that deficiency or surplus as shown by the statement of affaires is subject to
the cost of liquidation.
(7) Any unrecorded asset or liability should be shown both in the statement of Affairs
and the deficiency or surplus Account to make double entry complete.
(8) Personal guarantee given by any party including the guarantees given by the
directors for loans raised by the company should be ignored while preparing the
Statement of affairs.

5.11.2. Lists to be attached to the Statement of Affairs:

The following lists are attached to the statement of Affairs;

List A gives a complete list of assets not specially pledged in favour of secured creditors.
Creditors having a floating charge on the assets are considered as having assets not
specifically pledged with them; so such assets are included in this list.
List B gives the list of assets which are specifically pledged in favour of fully secured and
partly secured creditors.
List C gives the list of preferential Creditors.
List D gives the list of debenture holders and other creditors having a floating charge on
the assets.
List E gives the names, addresses and occupations of unsecured creditors and the amount
due.
List F gives the names and number and value of shares held by various preference
shareholders.
List G gives the names and holdings of equity shareholders.
List H shows how Deficiency or surplus in the Statement of Affairs has been arrived at,
i.e. , it explains the reasons responsible for the surplus or deficiency. According to the law,
the period covered by Deficiency or surplus must commence on a date not less than 3
years before the winding up order, or if the company has not been incorporated for the
whole of that period, the date of incorporation of the company, unless the official
Liquidator otherwise agrees.

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Illustration:1

Shri. Govindan is appointed liquidator of a company in voluntary liquidation on july,2002,

and the following balance are extracted from the books of that date:
Rs Rs
Capital: Machinery 30,000
16,000 shares of Rs.5 each 80,000 leasehold Properties 40,000
Provision for Bad Debts 10,000 stock in Trade 1,000
Debentures 50,000 Book Debts 60,000
Bank Overdraft 18,000 Investments 6,000
Liabilities foe purchases 20,000 Calls in Arrear 5,000
Cash in hand 1,000
Profit and loss Account 35,000
________ _______
1,78,000 1,78,000

The Machinery is Valued at Rs.60,000; the leasehold Properties at Rs.73,000;

Investments at Rs.4,000; Stock in Trade at Rs.2,000 ; Bad debts are Rs.2,000 ;
Doubtful debts are Rs.4,000 , estimated to realize Rs.2,000. The Bank Overdraft
Is secured by deposit of title deeds of leasehold Properties. Preferential Creditors for taxes
and wages Rs.1,000. Telephone rent owing is Rs.80. You are required to make out (1)
Statement of Affairs as regards creditors and contributors and (2) Deficiency or Surplus
Account.

Solution:

STATEMENT OF AFFAIRS OF SHRI.GOVINDAN

As on July 1,2002

Assets Estimated
Realisable
Value
Rs
Asset not Specifically Pledged (as per list A)
Cash in hand 1,000
Trade Debtors 56,000
Calls in Arrear 5,000
Investments 4,000
Stock 2,000
Machinery 60,000
1, 28,000

Asset Specifically Pledged (as per list B)

Estimated Due to Deficiency Surplus

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Realizable secured ranking as carried to

Value creditors unsecured last column
Rs Rs Rs Rs
Leasehold Property 73,000 18,000 ___ 55,000

Estimated Surplus from assets Specifically pledged 55,000

Estimated total assets available for preferential creditor, debentureholders 1,83,000
secured by a floating charge, and unsecured creditors

Summary of Gross Assets Rs

Gross realizable value of assets specifically pledged 73,000
Other assets 1,28,000
Gross Assets 2,01,000

Gross Liabilities
Liabilities
Rs
18,000 Secured creditors (as per List B) to the extent to which claims
are estimated to be covered by assets specially pledged
Preferential Creditors(as per list C)
1,000 1,000
Estimated balance of assets available for debentureholders
Secured by a floating charge, and unsecured creditors
Debentureholders secured by a floating charge (as per list D) 1,82,000
50,000 Estimated surplus as regards debenture holders 50,000
Unsecured Creditors (as per list E) Rs 1,32,000

Liabilities for purchases 20,000

Telephone Rent outstanding 80
20,080
20,080 Estimated surplus as regards creditors
(being the difference between gross assets and Gross
89,080 liabilities) 1,11,920
Issued and called up capital (as per list G)
80,000
Estimated surplus as regards contributions(as per List H)
31,920

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SURPLUS ACCOUNT (LIST H)

Items reducing surplus: Rs
Excess of capital and liabilities over assets, i.e, Profit and Loss Account 35,000
Estimated losses now written off for which provision has been made for
the purpose of preparing the statement:
Rs
Investments (Rs.6,000-Rs.4,000) 2,000
Preferential creditors for taxes and wages 1,000
Telephone rent outstanding 80 3,080
38,080

Items Contributing to surplus:

Machinery (Rs.60,000- Rs.30,000) 30,000
Leasehold Properties (Rs.73,000-Rs.40,000) 33,000
Stock (Rs.2,000-Rs.1,000) 1,000
Debtors: Provision for Bad debts 10,000
Less: Bad Debts 2,000
Doubtful Debts 2,000 4,000 6,000 70,000

Surplus as shown by the Statement of Affairs 31,920

5.12 LIQUIDATOR’S REMUNERATION

The liquidator normally gets the remuneration I the form of commission which is usually
based as a percentage on the value of assets realized and amount paid to unsecured
creditors. In calculating the liquidator’s remuneration, the following points
May be noted:
(1) Commission on assets given as securities to secured creditors. The Liquidator gets
commission on the surplus from such assets left after making the payment of
secured creditors because he make an effort of realizing the surplus of such assets
from secured creditors. However, if he sells the assets himself, he gets commission
on the total proceeds of such assets.
(2) Cash and bank Balance. If the liquidator is to get a commission on assets realized,
he also gets a commission on cash and bank balance unless otherwise stated.
(3) Unsecured Creditors. If the liquidator is to get a commission on amount paid to
unsecured creditors, unsecured creditors will also include preferential creditors for
the purpose of calculation of remuneration unless otherwise stated. If the amount
available is sufficient to make the full payment of unsecured creditors, the
commission is calculated as follows:

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Liquidators
Remuneration = Amount due to Unsecured creditors X % of commission on
creditors
100

If the amount available is not sufficient to make the full payment of unsecured creditors,
the commission is calculated as below:

Amount available for unsecured creditors X % of commission

100+ % of Commission

For example, if the amount due to unsecured creditors is Rs.5,00,000 and the amount
available for unsecured creditors before charging commission on amount paid to
unsecured creditors is rs.2,06,000. Suppose 3% commission is to be paid on the amount
paid to unsecured creditors, the commission in this case will be calculated as below:

RS.2,06,000 X 3 = Rs.2,06,000 X 3 = Rs.6,000.

100 +3 103

Illustration:2

The following particulars relate to a limited company which has gone into voluntary
liquidation. You are required to prepare the liquidator’s Final Account allowing for his
remuneration @ 2% on the amount realized on assets and 2% on the amount distributed to
unsecured creditors other than preferential creditors:
Rs
Unsecured Creditors 2,24,000
Preferential Creditors 70,000
Debentures 75,000
The assets realized the following sums:
Cash in hand 20,000
Land and Buildings 1,30,000
Plant and machinery 1,10,500
Fixtures and Fittings 7,500

The liquidation expenses amount to Rs.2,000. A call of Rs.2 per share on the partly Paid
10,000 equity shares was made and duly paid except in case of one shareholder owing 500
shares.

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Solution:
In the books of …..Ltd. (in Liquidation)
LIQUIDATOR’S FINAL STATEMANT OF ACCOUNT

Rs Rs Rs Rs
To Assets realized:
To Cash in hand 20,000 By Liquidation
To Land and Expenses: 2,000
Buildings 1,30,000
To Plant and By Liquidator’s
Machinery 1,10,500 Remuneration
To Fixtures and 2% on
Fittings 7,500 2,68,000 Rs.2,68,000 5,360
2% on
To Calls (9,500 shares Rs.1,32,000 2,640 8,000
@ Rs.2 each) 19,000
By Debenture holders
By Preferential 75,000
Creditors 70,000
By Unsecured
Creditors 1,32,000
(58.93% of Rs.2,24,000)

2,87,000 2,87,000

Notes:
(1) Shareholders will not get anything as the amount is not sufficient even to make the
payment of the unsecured creditors.
(2) Since the amount is not sufficient to make the full payment of the unsecured
creditors, the commission payable to the liquidator on the paymenet made to the
unsecured creditors is to be calculated as follows:
RS RS
Total of the receipts side 2,87,000
Less: Liquidation Expenses 2,000
Liquidator’s Remuneration on assets realized 5,360
Payment to Debenture holders 75,000
Payment to Preferential Creditors 70,000 1,52,360
Amount available for Unsecured Creditors &
Liquidator’s Remuneration 1,34,640

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Therefore, liquidator’s Commission on payment to unsecured Creditors is

RS.2,640 = 2 X Rs.1,34,640
102

Illustration:3

ou are asked by a liquidator of a company to prepare a statement of account to be laid

before a meeting of the shareholders from the following:

BALANCE SHEET OF THE COMPANY

As on date of liquidation 1-1-2002

Rs Rs
Share capital: Fixed Assets 4,00,000
4,000 Equity Shares of Book debts 3,00,000
Rs.100 each called Rs.80 3,20,000 Loss-to-date 1,00,000
1,000 Preference Shares of
Rs.100 each called Rs.70 70,000
Secured Loan From Bank
on:
Building and Machinery
1,50,000
Trade Creditors
2,60,000

8,00,000 8,00,000

The assets realized as follows: 1-4-2002- Book debts Rs.1,00,000, expenses paid Rs.4,000
; 1-6-2002- Fixed Assets (final)Rs.3,00,000, Book Debts Rs.1,00,000. 1-8-2002 –Book
debts (final) Rs.50,000. The liquidator is entitled to 5% on collections from book debts
and 2% on the amount paid to equity shareholders. Prepare the statement on the
assumption that disbursements are made in accordance with law, as and when cash is
available.

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Solution:
In the books of the company (In liquidation)
LIQUIDATOR’S STATEMENT OFACCOUNT
From 1-1-2002 to 1-8-2002

Date Receipt Rs Date Payment Rs

1-4-02 To Realisation of 1-4-02 By Liquitator’s
Assets: Remuneration(5%
Book Debts 1,00,000 On Rs.1,00,000) 5,000
By Liquidation Expenses 4,000
By Balance c/d 91,000
______ _______
1,00,000 1,00,000
1-4-02 To Balance b/d
1-6-02 To Realisation of 91,000 1-6-02 By Liquidator’s
Assets: Remuneration 5% on
Book debts Rs.1,00,000 5,000
Surplus from 1,00,000 2% on rs.5,882 118 5,118
Securities
1,50,000 By Trade creditors 2,60,000
By Refund of capital to
Preference
Shareholders on
1000 preference
Shares @ Rs.70 per 70,000
Share
Equity Shareholders @
Rs.1.47 per share on
4,000 shares 5,882
_______ _______
3,41,000 3,41,000
1-8-02 To Realisation of 1-8-02 By Liquidator’s
Assets: Remuneration:
Book debts 50,000 5% on
(final) Rs.50,000 2,500
2% on
Rs.46,569 931 3,431

By Refund of capital to
Equity shareholders
On 4,000 Equity
Shares @ RS.11.64 46,569
_______ Per share _______
50,000 50,000

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Note: The balance in hand on 1st April,2002 has to be carried forward since the position as
regards Bank has not yet crystallized.

5.13 RECEIVER FOR DEBENTURE HOLDERS

The terms of issue of debentures may give express power to the debenture holders to
appoint a receiver on failure of the company to pay them their interest or the instalment
On the due date of liquidation of the company. In case of liquidation, debenture
Holders may appoint an independent person as receiver to take over the assets specifically
or generally charged in their favour. The receiver will realize such assets and after meeting
his expenses, remuneration and making payment to claimants entitled to get payment in
priority to the debenture holders, he will make payment to the debenture holders. The
receiver will hand over the surplus, if any, to the liquidator of the company so that the
latter may make the payment to the claimants who are to get the payment after the
debenture holders. Thus, if a receiver is appointed by the debenture holders to protect their
interest, two statements of accounts namely Receiver’s Statement of Account and
liquidator’s Final Statement of Account will have to be prepared.

Illustration:4

The following is the balance sheet of A ltd. As at 30th Sep,2002:

Liabilities Rs Assets Rs
Share capital: Land And Buildings 1,20,000
Issued: 11% Pref.shares of 1,00,000 Sundry Current Assets 3,95,000
Rs.10 each Profit and loss Account 38,500
10000 equity shares of Debenture Issue Expenses
Rs.10 each, fully paid-up 1,00,000 Not Written off 2,000
5000 equity shares of
Rs.7.50 per share paid-up 37,500
13% Debentures 1,50,000
Mortgage Loan 80,000
Bank Overdraft 30,000
Creditors for trade 32,000
Income-tax Arrears:
(assessments concluded
In july 2002)
Assessment year
2000-01 21,000
2001-02 5,000 26,000 _________
5,55,000 5,55,000

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Mortgage loan was secured against land and buildings. Debentures were secured by a
floating charge on all the other assets. The company was unable to meet the payments
And therefore the debenture holders appointed a receiver and this was followed by a
Resolution for members voluntary winding up. The Receiver for the Debenture holders
Brought the land and buildings to auction and realized Rs.1,50,000.He also took charge of
sundry assets of the value of Rs.2,40,000 and realized Rs.2,00,000. The liquidator realized
Rs.1,00,000 on the sale of the balance of sundry current assets. The bank overdraft was
secured by a personal guarantee of two of the directors of the company and on the Bank
raising a demand, the directors paid off the dues from their personal resources. Costs
incurred by the Receiver were Rs.2,000 and by the liquidator was to receive 3% fee on the
value of assets realized by him. Preference shareholders had not been paid dividend for
period after 30th September,1996 and interest for the last half-year was due to the
debenture holders.

Prepare the accounts to be submitted by the Receiver and the liquidator.

Solution

RECEIVER’S STATEMENT OF ACCOUNT

Liabilities Rs Assets Rs
Sundry Assets Realised 2,00,000 Cost of the Receiver Payment 2,000
Surplus Realised from of Preferential Creditors
Mortgage: Income Tax raised within 12
months
Sale proceeds of land 26,000
Payment of Debentureholders:
and buildings 1,50,000
Principal 1,50,000
less:Applied to discharge 70,000
of mortgage loan 80,000 Interest for
1/2year@13% p.a. 9,750
Surplus handed over
1,59,750
to the liquidator

82,250
2,70,000 2,70,000

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LIQUIDATORS FINAL STATEMENT OF ACCOUNT

Liabilities Rs Assets Rs

Surplus received from Cost of Liquidation 2,800

The Receiver 82,250 Liquidator,s Remuneration
Sundry Assets realized by (3% of assets realized) 3,000
the Liquidator 1,00,000 Payment of Unsecured
Amount realized from Creditors:
Contributories: Creditors for Trade 32,000
From holders of 5,000 Payment of amount
party paid shares @ 10,850 due to Directors
Rs.2.17 per share (1) for Bank Overdraft 30,000 62,000

Payment of
Preference
Shareholders
Principal 1,00,000
Arrears of
Dividends
For 2 years @ 1,22,000
11% p.a. 22,000
Equity Shareholders to
get:
Return of money to
holders of 10,000 shares
_________ fully paid up @ 33 paise per 3,300
1,93,100 share 1,93,100

Working Note:

(1) Calculation of Amount Payable by Partly Paid Shareholders:

Rs. Rs.

Amount available before call from partly paid

1,82,250 shareholders
Less: Amount payable to various claimants:
Cost of Liquidator 2,800
Liquidator’s remuneration 3,000
Unsecured creditors 62,000
Preference shareholders 1,22,000 1,89,800
Deficiency (-) 7,550

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Add: Total amount receivable from Party Paid

shareholders on the basis of notional call
of Rs.2.50 per share on 5,000 shares 12,500
Net Surplus after notional call 4,950
Number of shares deemed fully paid(10000+5000) 15,000

Refund on each fully paid share (Rs.4,950+15,000) =33 paise

Call on party paid share = Rs.2.50 –Re.0.33 =Rs.2.17.

The Companies (Second Amendment) Act 2002 (India's new corporate insolvency law) is
now operational and the Sick Industrial Companies (Special Provisions) Act 1985 has
been repealed by the Sick Industrial Companies (Special Provisions) Repeal Act 2003.
ƒ Companies Act 1956 as amended by the Companies (Second Amendment) Act
2002.
ƒ Securitisation and Reconstruction of Financial Assets and Enforcement of Security
Interest Act 2002 (SARFAESI)
With the passing of the Second Amendment, a new National Company Law
Tribunal (NCLT) has been established. The Tribunal will be empowered:
ƒ To consider revival and rehabilitation of companies.
ƒ With jurisdiction relating to the winding up of companies. The Tribunal stands in the
stead of the High Court and pending liquidation applications are being transferred
from the High Court to the Tribunal.
ƒ The jurisdiction previously exercised by the Company Law Board. The Board has
been abolished.

In India now, procedures for the reorganization and liquidation of companies are
contained in the same Act. The Second Amendment is an attempt to create a balance
between reorganization and liquidation.

The Second Amendment seeks to provide a quick, convenient and timely procedure for
dealing with the affairs of a sick industrial company. A sick industrial company is defined
as an industrial company that has, at the end of a financial year, accumulated losses equal
to 50% of the average net worth of the company in the four preceding financial years, or
which has been unable to pay creditors as debts have fallen due in three consecutive
quarters.

The Companies (Second Amendment) Act 2002 (India's new corporate insolvency law) is
now operational and the Sick Industrial Companies (Special Provisions) Act 1985 has
been repealed by the Sick Industrial Companies (Special Provisions) Repeal Act 2003.

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The Companies (Second Amendment) Act 2002 (India's new corporate insolvency law) is
now operational and the Sick Industrial Companies (Special Provisions) Act 1985 has
been repealed by the Sick Industrial Companies (Special Provisions) Repeal Act 2003.

With the passing of the Second Amendment, a new National Company Law Tribunal
(NCLT) has been established. The Tribunal will be empowered:

ƒ To consider revival and rehabilitation of companies.

ƒ With jurisdiction relating to the winding up of companies. The Tribunal stands in
the stead of the High Court and pending liquidation applications are being
transferred from the High Court to the Tribunal.
ƒ The jurisdiction previously exercised by the Company Law Board. The Board has
been abolished.

In India now, procedures for the reorganization and liquidation of companies are
contained in the same Act. The Second Amendment is an attempt to create a balance
between reorganization and liquidation.

The Second Amendment seeks to provide a quick, convenient and timely procedure for
dealing with the affairs of a sick industrial company. A sick industrial company is defined
as an industrial company that has, at the end of a financial year, accumulated losses equal
to 50% of the average net worth of the company in the four preceding financial years, or
which has been unable to pay creditors as debts have fallen due in three consecutive
quarters.
The Board of Directors apply to the NCLT and prepare a scheme for the revival and
rehabilitation of the company. The application and scheme must be accompanied by a
statement by the company's auditor.
The NCLT may make inquiries about the financial state of the company and its prospects.
They may require an Operating Agency (a group of experts) to assist. The NCLT can
make an order putting a scheme in place or ordering that the company be liquidated.
Creditors may also put forward a scheme.
Approval of a scheme requires consent by all parties providing financial assistance within
60 days. However, a non-reply is taken as a consent. Every party providing financial
assistance has a right of veto. This right of veto cannot be overridden by a Court.
In a rehabilitation, the debtor remains in possession of the entity.
Where the NCLT comes to the conclusion that the sick industrial company cannot be
revived and that it is just and equitable for the company to be wound up, the Tribunal shall
order the winding-up of the company.

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A levy is charged on each company to establish a rehabilitation and revival fund for sick
industrial companies.

SARFAESI provides for the enforcement of security interests in movable (tangible and
intangible, including accounts receivable) and immovable property without the
intervention of the court and by way of a simple, expeditious and cost effective process.
SARFAESI also enables the establishment of asset reconstruction companies.

Role played by Government

Given that the Second Amendment now allows the emergence of a private sector
insolvency profession in India, the Government bureaucracy is looking at ways of
regulating this profession.

Role played by private sector practitioners

Under the 1956 Act as it was before the passing of the Second Amendment, an Official
Liquidator was attached to every High Court. This court officer undertook all liquidations.
The Second Amendment allows for private sector practitioners to be appointed from a
panel of Chartered Accountants, Cost Accountants, Lawyers and Company Secretaries.
Thus, a private sector insolvency profession is just starting to emerge in India.

5.14 ROLE PLAYED BY THE COURT

With the passing of the Second Amendment, the National Company Law Tribunal
(NCLT) has been established to deal with reorganization and liquidation of sick industrial
companies. The Tribunal consists of a President and not more than 62 Judicial and
Technical members. The President of the NCLT is to be a former judge or a person
qualified for appointment as a High court judge. Benches of the tribunal dealing with
reorganization and liquidation matters will consist of three members, including one
judicial member and one technical member. Judicial members are judges or lawyers (of at
least 15 years standing) and the technical members are accountants.

There is also a National Company Law Appellate Tribunal (NCLAT) that hears appeals
from orders made by the NCLT.

In a significant step to build investors' confidence, the Department of Company Affairs

(DCA) has shortened the time limit for liquidation of companies under the Companies
Act, 1956 to seven months against the current 12 months.

Accordingly, official liquidators will take over possession of assets, books of accounts and
other records of companies in liquidation within 15-30 days from the date of winding up
order from the High Court concerned.

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Time taken for valuation of the property will be 30 days from the date of completion of
inventories. Completion of sale of assets will take 45 days from the date of valuation of
properties. Handing over possession of property to buyers will take seven days from the
date of payment of sale price, a DCA press release said.

Scrutiny of books and records of companies and submission of reports to the High Court
in respect of transfer company under Section 394 (1) of the Companies Act will take 30
days.

5.15 LET US SUM UP

In law, liquidation refers to the process by which a company (or part of a company) is
brought to an end, and the assets and property of the company redistributed. Liquidation
can also be referred to as winding-up or dissolution, although dissolution technically
refers to the last stage of liquidation. Liquidation may either be compulsory (sometimes
referred to as a creditors' liquidation) or voluntary (sometimes referred to as a
shareholders' liquidation, although some voluntary liquidations are controlled by the
creditors, see below).

In finance, liquidation is also sometimes used as convenient shorthand for converting an

asset to cash.

The main purpose of a liquidation where the company is insolvent is to collect in the
company's assets, determine the outstanding claims against the company, and satisfy those
claims in the manner and order prescribed by law. The liquidator must determine the
company's title to property in its possession. Property which is in the possession of the
company, but which was supplied under a valid retention of title clause will generally
have to be returned to the supplier. Property which is held by the company on trust for
third parties will not form part of the company's assets available to pay creditors. Before
the claims are met, secured creditors are entitled to enforce their claims against the assets
of the company to the extent that they are subject to a valid security interest. In most legal
systems, only fixed security takes precedence over all claims; security by way of floating
charge may be postponed to the preferred creditors.

Claimants with non-monetary claims against the company may be able to enforce their
rights against the company. For example, a party who had a valid contract for the purchase
of land against the company may be able to obtain an order for specific performance, and
compel the liquidator to transfer title to the land to him, upon tender of the purchase price.
After the removal of all assets which are subject to retention of title arrangements, fixed
security, or are otherwise subject to proprietary claims of others, the liquidator will pay
the claims against the company's assets. Generally, the priority of claims on the company's
assets will be determined in the following order:

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1. Firstly, the costs of the liquidation are met out of the company's remaining assets
2. Secondly, the preferred creditors under applicable law are paid
3. Thirdly, in many legal systems, the claims of the holders of a floating charge will be
paid; other claims may also fit into this layer
4. Fourthly, if there is anything left, the unsecured creditors are paid out pari passu in
accordance with their claims. In many jurisdictions, a portion of the assets which
would otherwise be caught by a floating charge are reserved for the unsecured
creditors.
5. In the very rare instances where the unsecured creditors are repaid in full, any
surplus assets are distributed between the members in accordance with their
entitlements.

5.16 LESSON-END ACTIVITIES

1. What do you mean by liquidation of a company?describe the different modes of

winding up?
2. Bring out clearly the distinction between a winding – up by the court and a members
voluntary winding – up.
3. Give a proforma of the statement of affairs and the deficiency/ surplus account with
imaginary figures which complies with the requirements of the Indian companies
act, 1956.
4. What do you mean by the term “ contributory” ? Describe the various types of
contributaries.
5. Explain the circumstances under which a liquidator would have to make a call on
partly paid shares.
6. Shri Chopra is appointed liquidator of moon company limited in voluntary liquidation on 1st
July, 2002. Following balances are extracted from the books on that date:
Capital Rs Machinery Rs
24,000 shares of Rs. 5 each 1, 20,000 Leasehold properties 45,000
Reserve for bad Debts 15,000 Stock in trade 1,500
Debentures 75,000 Book debts 90,000
Bank overdraft 27,000 Investments 9,000
Liabilities for purchase 30,000 Calls- in- arrear 7,500
Cash in hand 1,500
Profit and loss account 52,500
Total 2, 67,000 2, 67,000

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7. The following particulars relate to a limited company which has gone into voluntary
liquidation. You are required to prepare the liquidator’s final account allowing for
his renumeration @ 3% on the amount realized and 2% on the amount paid to the
unsecured creditors

Secured creditors( security realized Rs.54,000) 46, 000

Unsecured creditors 2,83,698
Preferential creditors 8, 000
Debentures having a floating charge on the assets 1, 00, 000
Expenses of liquidation amounted to Rs. 3, 000
A call of Rs. 2 per share on the partly paid equity shares were duly paid except in case of
one shareholder owning 400 shares.

5.17 REFERENCES

1. Gupta R.L & Radhaswamy M. “Corporate Accounts” Theory method and

application- 13th revised edition 2006, Sultan chand & Co.,, New delhi.
2. S.P.Jain & K.L Narang, “ Advanced Accounting “, Kalyani publications, New
delhi.
3. Reddy & Murthy, “Financial accounting”, Margham publications, Chennai 2004
4. J.R. Monga – Fundamentals for Corporate Accounting

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MODEL QUESTION PAPER I

TOTAL MARKS 100

ALL QUESTIONS CARRY EQUAL MARKS

ANSWER ALL QUESTIONS

1) What do you mean by a ‘share’ and what are the types of shares? Distinguish
between a Equity share and Preference share?
2) The Nagpur Chemical Works Ltd., issued for public subscription 1,00,000, Equity
shares of Rs.100/- each at a premium of Rs.20/-per share payable as under:
On application, Rs.20 per share, On allotment Rs.50 per share(including premium),
On first call Rs.20 per share and on final call Rs.30, per share.
Applications were received for 1,50,000 shares. The shares were allotted pro rata to
the applicants for 1,20,000 shares, the remaining applications being rejected.
Money over-paid on application was utilized towards sums due on allotment.
Ram Lal to whom 4,000 shares were allotted, failed to pay allotment and call money
and Krishnan kumar, to whom 5,000 shares were allotted failed to pay the two calls.
These were subsequently forfeited after the second call was made. All the forfeited
shares were sold to Mohit as fully paid up shares at Rs.80/- per share.
Pass the necessary Journal entries and also prepare the Balance sheet, after the
transactions are complete.
3) E ltd had allotted 10,000 shares to applicants for 14,000 shares on a pro rata
Basis. The amount payable was Rs.2/- on application, Rs.5/- on allotment (including
premium of Rs.2/- each), Rs.3/.- on first call and Rs.2/- on final call. V failed to pay
the first cal and final call on his 300 shares. All the shares were forfeited and out of
these 200 shares were re-issued @Rs.9/- per share. What is the amount credited to
capital reserve?
4) The Balance sheet of Hari & Hema Ltd., as at 31st December,2001 inter alia include
the following: Rs.

50,000 8% Preferebce shares of Rs.100 each Rs.70 paid up 35,00,000

100,000 Equity shares of Rs.100 each fully paid up 1,00,00,000
Securities Premium 5,00,000
Capital Redemption reserve 20,00,000
General Reserve 50,00,000
Under the terms of their issue, the preference shares are redeemable on March 31,
2002 at a premium of 5%. In order to finance the redemption, the company makes a

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right issue of 50,000 equity shares of Rs.100 each at Rs.110/- per share, Rs.20 being
payable on application, Rs.35 (including premium) on allotment and the balance on
January 1st, 2003. The issue was fully subscribed and allotment made on March 1,
2002. The moneys due on allotment were received by March 30, 2002.
The preference were redeemed after fulfilling the necessary conditions of Section 80
of the Companies Act, 1956. The company decided to make the minimum
utilization of general reserve.
You are asked to pass the necessary journal entries and show the relevant extracts
from the Balance Sheet as on 31st March, 2002 with the corresponding figures as on
31st December,2001.

5) The Balance Sheet of Producers ltd. as at 31st march 2006 is as follows:

Liabilities Rs Assets Rs

Share Capital: Fixed Assets:

Authorised capital Plant and Machinery 190000
40000 equity shares Furniture and Fixtures 20000
of Rs.10 each 400000 Investments 60000
1000 8% Preference shares Current Assets, loans and
of Rs.100 each 100000 Advances:
500000 A. Current Assets:
Issued and subscribed Capital: Stock 130500
25000 Equity Shares of Debtors 49550
Rs.10 each fully Paid 250000 Cash at Bank 4950
1000 8% Preference shares B. Loans And Advances
Of Rs.100 each fully Paid-up Prepaid Expenses 1000
Reserves and Surplus:
Securities premium Account 9000
Profit and Loss Account
Current Liabilities and Provisions
A. Current Liabilities:
Sundry Creditors 22500
B. Provisions:
Provisions for taxation 19500
________ ________
456000 456000
________ _________
In order to redeem its Preference shares, the company issued 5,000 equity shares of Rs.10
each at a premium of 10% and sold its investment of Rs.70800. Preference shares were
redeemed at a premium of 10%.

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Show the necessary journal entries in the books of the company and prepare the balance
sheet of the company immediately after redemption of Preference shares.
6) A Company issues early in 2002, 13% Rs.20,00,000 debentures at Rs.96, but
redeemable at Rs.103. Redemption will be carried out by annual drawings of
Rs.4,00,000 (face value) commencing at the end of 2006. What do you recommend
as the amount to be charged to the profit and loss account, apart from that of
interest?
Redemption of 10,000 preference shares of Rs.100 each was carried out by
utilization of reserves and by issue of 4,000 equity shares of Rs.100 each at Rs.125.
How much should be credited to capital redemption reserve account? In the above
case, the redemption was carried out of reserves and out of the issue of 4,000 shares
of Rs.100 each @Rs.95. what is the amount of capital redemption reserve account
that is required?
7) Give a proforma of the statement of affairs and the deficiency/ surplus account with
imaginary figures which complies with the requirements of the Indian companies
act, 1956. What do you mean by the term “ contributory” ? Describe the various
types of contributaries. Explain the circumstances under which a liquidator would
have to make a call on partly paid shares.
8) What are the consequences of liquidating a company?
9) Explain the factors that affect the valuation of goodwill and shares.
10) It is provided in the Articles of Association that on the death of a shareholder, his
shares shall be purchased by the remaining shareholders at a price to be settled by
the Auditors. On the basis of the last balance sheet. It is further provided that for
this purpose, goodwill was to be of the value of three years’ purchase of the average
annual profits for the last four years. The last balance sheet is as follows:
Liabilities Rs. Assets Rs.
Capital Goodwill 1,00,000
20,000 shares of Investment at cost
Rs.10 each fully 2,00,000 (market value Rs1,25,000
Paid 1,50,000
Reserve 1,00,000 Stock at cost 2,50,000
Debentures 2,00,000 Debtors 1,50,000
Sundry Creditors 1,50,000 Cash 35,000
Profi & Loss A/c 35,000
_________ _______
6,85,000 6,85,000

The profits for the last four years were (after tax) Rs.15,000, 20,000, 25,000 and 40,000
respectively.
You are required to state with details of working the price which should be paid per share.

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MODEL QUESTION PAPER - II

TOTAL MARKS 100

ALL QUESTIONS CARRY EQUAL MARKS

ANSWER ALL QUESTIONS

1) X ltd issued for public subscription 20,000 equity shares of Rs.10/- each at a
premium of Rs.2 per share payable as under:
Rs.2 per share on application; Rs.5 per share (including premium) on allotment;
Rs.2 per share on first call: Rs.3 per share on final call.
Applications for 30,000 shares were received. Allotment was made pro-rata to the
applicants for 24,000 shares, remaining applications being rejected. Money over
paid on application was utilized towards sums due on allotment. Shri Y to whom
800 shares were allotted failed to pay the allotment money, first and second calls.
These shares were subsequently forfeited after the second call was made. All these
forfeited shares were reissued to Shri D as fully paid up at Rs.8 per share.
Give necessary journal entries to record the above transactions.
2) H ltd was registered with an authorized capital of Rs.10,00,000/- divided into
1,00,000 equity shares of Rs.10/- each out of which 50,000 equity shares were
offered to the public for subscription. The shares were payable as under:
Rs. 3/- per share on application
Rs.2/- per share on allotment
Rs. 2/- per share on 1st call
Rs.3/- per share on 2nd and final call
The shares were fully subscribed for and the money was duly received.
Show the journal and cash book entries
3) The following particulars relate to a limited company which has gone into voluntary
liquidation. You are required to prepare the liquidator’s final account allowing for
his renumeration @ 3% on the amount realized and 2% on the amount paid to the
unsecured creditors
Secured creditors( security realized Rs.54,000) 46, 000
Unsecured creditors 2,83,698
Preferential creditors 8, 000
Debentures having a floating charge on the assets 1, 00, 000
Expenses of liquidation amounted to Rs. 3, 000
A call of Rs. 2 per share on the partly paid equity shares were duly paid except in
case of one shareholder owning 400 shares.

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4) Give a proforma of the statement of affairs and the deficiency/ surplus account with imaginary
figures which complies with the requirements of the Indian companies act, 1956.
5) What are the various Modes of winding up or Liquidation, explain them?
6) From the following balance sheet of M.P products ltd. Find out the values of equity
shares and preference shares:

Balance sheet of M.P Products ltd.

Liabilities Rs Assets R
20,000 equity shares Goodwill 25,000
of Rs.10 each 2,00,000 Machinery 1,60,000
8% 1,000 preference Furniture 5,000
shares of Rs,100 each 1,00,000 Stock 80,000
Reserves 30,000 Debtors 1,50,000
Profit and loss account 10,000 cash 2,000
Sundry creditors 60,000 Preliminary expenses 3,000
Proposed preference
Dividend 8,000
Other liabilities 12,000
Overdraft 5,000 ________
4,25,000 4,25,000

Goodwill is valued at Rs.15,000. Stock is overvalued by Rs.10,000, Machinery is

Undervalued by Rs.15,000.

7) The balance sheet of super sound ltd. as at 31st March,2006 is given below:

Liabilities Rs Assets Rs
Share Capital: Buildings 2,25,000
9,000 equity shares Machinery 3,30,000
of Rs.100 each, Stock 4,50,000
fully Paid-up 9,00,000 Sundry debtors 2,40,000
Profit and loss account 75,000 Bank 90,000
Bank overdraft 15,000
Creditors 90,000
Provision for taxation 1,65,000
Provision for dividends 90,000 _________
13,35,000 13,35,000

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The net profits of the company after deducting usual working expenses but before
providing for taxation were as under:
Year Rs
2003-04 3,00,000
2004-05 3,60,000
2005-06 3,30,000

On 31st March, 2006, building was revalued at Rs.3,00,000.Machinery at Rs.3,75,000 and

sundry debtors on the same date including Rs.10,000 as irrecoverable. Having regard to
nature of the business, 10% return on net tangible capital invested is considered
reasonable.
You are required to value the company’s share ex-dividend. Valuation of goodwill
may be based on three years purchase of annual super profits. Rate of depreciation on
buildings is 20% and on machinery is 10%. The income-tax rate is ti be assumed at 35%.
All workings should form part of your answer.
8) Harini overseas Ltd had an issue 1,000, 12% redeemable preference shares of
Rs.100/- each, repayable at a premium of 10%. These shares are to be redeemed
now out of the accumulated reserves, which are more than the necessary sum
required for redemption. Show the necessary entries in the books of the company,
assuming that the premium on redemption of shares has to be written off against the
company’s Securities Premium Account.
9) A Company has decided to increase its existing share capital by making rights issue
to the existing shareholders in the proportion of one new share for every two old
shares held. You are required to calculate the value of the right if the market value
of share at the time of announcement of right issue is Rs.240/- . The company has
decided to give one share of Rs.100/- each at a premium of Rs.20/- each.
10) Explain in detail the treatments of special items while preparing the final accounts of
a Company.

THIS IS THE CORRECT FORM CORRECTED UPTO UNIT V

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