Company Accounts: Shares & Debentures
Weightage: Chapter 11 of ICAI's Paper 1 syllabus, roughly 20 marks. It is the last chapter of the paper and one of the heaviest, and it is almost entirely format-driven, which makes it learnable by drilling rather than by insight alone.
Why company accounting is different
A sole proprietor's capital is a single figure that rises with profit and falls with drawings, and the proprietor may put money in or take it out at will. A company's capital cannot work that way, and the reason is the feature that defines a company: limited liability.
A shareholder's liability is limited to the amount unpaid on their shares. Once shares are fully paid, a shareholder can lose the investment but cannot be pursued for the company's debts. Creditors therefore have recourse only to the company's assets, not to its owners.
That protection has a price, and the price is that the capital must be maintained. If shareholders could withdraw capital freely, the fund on which creditors rely would evaporate while the shield remained. So company law surrounds capital with restrictions: it can be raised only in prescribed ways, it cannot be returned except by prescribed procedures, and every layer of it must be separately disclosed.
Nearly everything peculiar about company accounts follows from this. The elaborate share capital disclosure exists so that creditors can see what has been promised and what has actually been received. The Securities Premium Account is restricted in its use because it is capital in substance. Forfeited amounts go to Capital Reserve rather than to profit because they cannot be distributed as dividend.
The layers of share capital
Share capital is disclosed in a specific sequence, each layer narrower than the one before, and questions frequently ask for the distinction.
Authorised capital, also called nominal or registered capital, is the maximum the company is permitted to raise, as stated in its memorandum of association. It is disclosed but is not an amount the company has actually raised, and it can be increased by following the prescribed procedure.
Issued capital is the part of the authorised capital that the company has actually offered to the public for subscription.
Subscribed capital is the part of the issued capital that investors have agreed to take up. Where a company issues 1,00,000 shares and the public applies for 80,000, the subscribed capital is 80,000 shares.
Called-up capital is the amount the company has so far demanded from shareholders. A company may issue a share of ₹10 and call only ₹7, leaving ₹3 uncalled.
Paid-up capital is the amount actually received. It equals called-up capital less calls in arrears — amounts called but not paid.
Reserve capital is a portion of uncalled capital that the company has resolved, by special resolution, to call only in the event of winding up. It is distinct from a capital reserve, which is an entirely different thing — a reserve not available for dividend, arising from capital profits.
Types of shares
Equity shares carry the residual interest. They bear the risk and take whatever profit remains after preference dividends, and they carry voting rights.
Preference shares carry two preferential rights: a preferential right to a dividend at a fixed rate, and a preferential right to repayment of capital on winding up. They rank ahead of equity on both counts and correspondingly carry limited voting rights.
Preference shares are classified along several axes, and the classifications combine:
- Cumulative or non-cumulative. Where a cumulative preference dividend is not paid in a year, the arrear carries forward and must be paid before any equity dividend. A non-cumulative dividend not paid in a year is simply lost. Preference shares are presumed cumulative unless expressly stated otherwise.
- Participating or non-participating. Participating shares take their fixed dividend and then share further in surplus profits alongside equity.
- Convertible or non-convertible, according to whether they may be converted into equity shares.
- Redeemable or irredeemable. Under the Companies Act, 2013 a company limited by shares cannot issue irredeemable preference shares, and preference shares must be redeemable within twenty years of issue, with a limited exception for infrastructure projects.
Issue of shares
The sequence
Shares are usually issued in instalments: application, allotment, and one or more calls. Each stage generates its own entries.
On application, money received is credited to a Share Application Account, which is a personal account of the applicants — at this stage the money is not yet capital, because the applicants are not yet members.
On allotment, the application money of successful applicants is transferred to Share Capital, the allotment money becomes due, and money of rejected applicants is refunded.
On each call, the amount is made due and then received.
Issue at a premium
Where shares are issued at more than face value, the excess is credited to a Securities Premium Account. The premium is never part of share capital, and section 52 of the Companies Act, 2013 restricts its application to specified purposes:
- issuing fully paid bonus shares;
- writing off preliminary expenses;
- writing off the expenses, commission or discount on any issue of shares or debentures;
- providing for the premium payable on the redemption of redeemable preference shares or debentures;
- the purchase of the company's own shares or other securities.
The restriction exists because the premium is capital in substance — money received for shares — and permitting its distribution as dividend would be a return of capital in disguise. Note that issuing shares at a discount is prohibited under section 53, other than the issue of sweat equity shares.
Calls in arrears and calls in advance
Calls in arrears are amounts called but not received. They may be shown as a deduction from called-up capital in the balance sheet, or maintained in a Calls in Arrears Account. Where the articles adopt the model provisions, interest is chargeable at up to 10% per annum.
Calls in advance are amounts paid by a shareholder before being called. These are a liability of the company rather than capital, because the amount has not been called and the company must either apply it to a future call or return it. Under the model articles, interest at up to 12% per annum is payable by the company. Note the asymmetry: the company charges up to 10% on arrears and pays up to 12% on advances.
Over-subscription and pro-rata allotment
Where applications exceed the shares on offer, the company may reject some applications outright, allot some in full, and allot the balance on a pro-rata basis.
Pro-rata allotment is where questions become genuinely demanding, because the excess application money of a pro-rata applicant is not refunded — it is adjusted against the allotment money due, and any remaining surplus against calls. Tracing that adjustment correctly is the core skill of the topic.
The method that works reliably:
- Establish the pro-rata ratio — shares applied for against shares allotted.
- For the shareholder concerned, compute how many shares they applied for, working back from the shares allotted using the ratio.
- Compute the application money they paid on all shares applied for.
- Compute the application money properly due on the shares actually allotted.
- The difference is the excess, available to be adjusted against allotment.
- The amount actually unpaid on allotment is the allotment due on the shares allotted, less that excess, less anything paid.
Attempting this in one step is the commonest cause of error; setting it out as six numbered lines in a working note is both faster and separately markable.
Forfeiture and re-issue
Forfeiture
Where a shareholder fails to pay a call, the company may, if the articles permit, forfeit the shares — cancel them and retain the money already paid.
The entry debits Share Capital with the amount called up on those shares, debits Securities Premium only if the premium was called but not received, credits Share Forfeiture (or Shares Forfeited) with the amount actually received, and credits Calls in Arrears with the amount unpaid.
The premium point carries marks and is frequently mishandled. Where the premium was duly received before forfeiture, it is not cancelled — the company received that money and section 52 governs its use thereafter. Only an unreceived premium is written back.
Re-issue
Forfeited shares may be re-issued, and they may be re-issued at a discount. The maximum discount allowable is the amount forfeited on those shares, because the company must not end up worse off than if the shares had never been issued.
On re-issue, the Share Forfeiture Account is debited with the discount allowed, and any balance remaining in respect of the re-issued shares is transferred to Capital Reserve.
The reasoning for Capital Reserve is worth stating rather than memorising. The surplus is a gain arising from a capital transaction in the company's own shares, not from trading. Treating it as a revenue profit would allow it to be distributed as dividend, which would return capital to shareholders under the guise of profit and defeat the capital maintenance principle. Note also that only the portion relating to shares actually re-issued is transferred; the balance relating to shares still held forfeited remains in the Share Forfeiture Account.
Issue for consideration other than cash
Shares may be issued to vendors in payment for assets acquired, or to promoters for services. The entry debits the asset or the appropriate expense account and credits Share Capital, with any excess of the purchase consideration over the face value credited to Securities Premium.
Debentures
What a debenture is
A debenture acknowledges a debt. The holder is a creditor of the company, not a member. The differences from a share follow from that single fact and are examined regularly:
- A debenture holder receives interest, which is a charge against profit payable whether or not the company earns a profit. A shareholder receives a dividend, which is an appropriation payable only out of profits and only if declared.
- Debenture interest is deductible in computing taxable profits; dividend is not.
- A debenture is normally repayable on a fixed date; equity share capital is not repayable except by prescribed procedures.
- Debenture holders ordinarily have no voting rights.
- Debentures may be secured by a charge on assets; shares cannot be.
Debentures are classified as secured or unsecured, redeemable or perpetual, convertible or non-convertible, and registered or bearer.
Issue of debentures
Unlike shares, debentures may be issued at a discount, since the prohibition in section 53 applies to shares. The discount is a capital loss written off over the life of the debentures.
The complication that Foundation questions exploit is that the issue price and the redemption price are set independently, giving several combinations. The governing principle is simple once stated: any loss on issue and any premium payable on redemption are recognised immediately at the time of issue, because the obligation to pay that premium arises the moment the debentures are issued, even though payment is years away. This is prudence in operation.
The combinations:
- Issued at par, redeemable at par. Bank debited, Debentures credited. No loss.
- Issued at discount, redeemable at par. Bank and Discount on Issue debited; Debentures credited.
- Issued at par, redeemable at premium. Bank and Loss on Issue debited; Debentures and Premium on Redemption credited. The premium payable is a liability recognised at once.
- Issued at discount, redeemable at premium. Bank, Discount on Issue and Loss on Issue debited; Debentures and Premium on Redemption credited. Both losses are recognised at issue.
- Issued at premium, redeemable at par. Bank debited; Debentures and Securities Premium credited.
Discount and Loss on Issue are capital losses, written off over the life of the debentures, ordinarily against the Securities Premium Account where one exists, since section 52 expressly permits that application, and otherwise against profits.
Interest on debentures
Interest is calculated on the face value of the debentures at the stated rate, regardless of the price at which they were issued. This is examined often, because candidates instinctively apply the rate to the issue price. Debentures of ₹1,00,000 face value carrying 9% interest, issued at a discount for ₹95,000, still carry interest of ₹9,000 a year.
Tax is deductible at source on debenture interest. The entry debits Debenture Interest with the gross amount, credits the debenture holders with the net amount payable, and credits Tax Deducted at Source with the amount withheld, which is subsequently paid to the government.
How this chapter is examined
Expect either a full share issue question with over-subscription, pro-rata allotment, calls in arrears, forfeiture and re-issue, or a debenture issue question covering several combinations of issue and redemption terms, sometimes with interest and tax deducted at source.
The share question is where marks are most often lost, and almost always at the same point: the adjustment of excess application money on pro-rata allotment, and the computation of the amount unpaid by a defaulting shareholder. Set that computation out as numbered lines in a working note. Show the forfeiture entry with its four components separately, state the maximum discount available on re-issue before computing it, and transfer only the proportion relating to re-issued shares to Capital Reserve.
For debentures, write down which combination of issue and redemption terms applies before passing any entry, and remember that interest always runs on face value.
