Accounting Chapter 5 To 21
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Trial Balance
Double Entry Accounting System
All the debits must be equal to All the credits
What if any error is done in the Journal or Ledger?
Trial Balance helps us in identifying some (not all) those errors
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Where does Trial Balance Fits in?
Journal Posted to Respective Accounts Record credit/debit balance of
in Ledger all the Accounts in Ledger in
Trial Balance
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Format of Trial Balance
In Trial Balance we note down credit
balance or debit balance of all the
accounts in ledger
1. It is normally prepared at the end of an accounting year
2. Organization may prepare a trial balance at the end of any chosen period, which may be monthly, quarterly, half
yearly or annually depending upon its requirements
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Trial Balance Illustration
An Illustrative Trial Balance
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Steps in Making a Trial Balance
Journal
Posted to Respective Accounts in Ledger and Balance them
Record credit/debit balance of all the Accounts in Ledger in Trial Balance
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Making of Journal
1. Ram Contributed 100 to the business Cash A/c Dr. 100
2. Company purchased furniture worth Rs. 10 To Capital A/c 100
3. Company purchased goods worth Rs. 30
4. Company Sold goods worth Rs. 20 Furniture A/c Dr. 10
To Cash A/c 10
Purchase A/c Dr. 30
To Cash A/c 30
Cash A/c Dr. 20
To Sale A/c 20
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Posting to Ledger Accounts
Cash Account
Particular Amount Particular Amount
Capital 100 Furniture 10
Sale 20 Purchase 30
Capital
Particular Amount Particular Amount
Cash 100
Furniture
Particular Amount Particular Amount
Cash 10
Sale Purchase
Particular Amount Particular Amount Particular Amount Particular Amount
Cash 30
Cash 20
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Balancing Ledger Accounts
Cash Account Cash Account
Particular Amount Particular Amount Particular Amount Particular Amount
Capital 100 Furniture 10 Capital 100 Furniture 10
Sale 20 Purchase 30 Sale 20 Purchase 30
Balance C/d 80
Capital Capital
Particular Amount Particular Amount
Particular Amount Particular Amount
Cash 100
Balance C/d 100 Cash 100
Furniture Furniture
Particular Amount Particular Amount
Particular Amount Particular Amount
Cash 10 Balance c/d 10
Cash 10
Purchase Purchase
Particular Amount Particular Amount Particular Amount Particular Amount
Cash 30 Cash 30
Sale Sale
Particular Amount Particular Amount Particular Amount Particular Amount
Cash 20 Cash 20
Trial Balance from Balanced Accounts
Cash Account
We copy the debit/credit balance to the Trial balance
Particular Amount Particular Amount
Capital 100 Furniture 10
Sale 20 Purchase 30 Balances Method
Balance C/d 80 Account Title Debit Balance Credit Balance
Capital Cash 80
Particular Amount Particular Amount
Capital 100
Balance C/d 100 Cash 100
Furniture 10
Furniture Purchase 30
Particular Amount Particular Amount Sale 20
Cash 10 Balance c/d 10
Total 120 120
Purchase
Particular Amount Particular Amount
The debit and Credit balance will always be equal.
If they are not equal, then there is some error in
Cash 30
accounting
Sale
Particular Amount Particular Amount
Known as Balances Method
Cash 20 of Trial Balance
Trial Balance from Balanced Accounts
Balances Method
Account Title Debit Balance Credit Balance
Cash 80 Asset must have debit Balance
Expenses must have debit balance
Capital 100 Liabilities must have credit balance
Furniture 10 Capital Account must have credit balance
Purchase 30 Revenue Account must have Credit Balance
Sale 20
Total 120 120
Trial Balance from Balanced Accounts
1. Owner withdraws 500 for personal use
2. Sales return worth Rs. 1000 Asset must have debit Balance
3. Purchase Return worth Rs. 1000 Expenses must have debit balance
Liabilities must have credit balance
Drawing
Capital Account must have credit balance
Particular Amount Particular Amount Revenue Account must have Credit Balance
Cash 500
Sales Return
Particular Amount Particular Amount
Cash 1000
Sales Return will have debit balance (Contra Revenue Account)
Drawings will have debit balance (Contra Capital Account)
Purchase Return Purchase return will have credit balance (Contra Expense Account)
Particular Amount Particular Amount
Cash 1000
Till now we have studied
Basics of Trian Balance, How it is Constructed and How Trial Balance helps us in Finding Errors
Balances Method
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Methods of Preparation of Trial Balance
Totals Method Balances Method Totals-cum-balances Method
This method is a combination of
Total of each side in the The credit/Debit balance of totals method and balances
ledger (debit and credit) is each account is shown in the method
ascertained separately and ledger
shown in the trial balance in Two columns for writing the debit
the respective columns and credit totals of various
accounts and two columns for
It is the same method we just writing the debit and credit
used in the previous question balances of these accounts.
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Totals Method
Cash Account
Particular Amount Particular Amount
Capital 100 Furniture 10
In Totals Method we use unbalanced Ledger Accounts
Sale 20 Purchase 30 and we copy the debit side and credit side total to the
Trial Balance
Capital
Particular Amount Particular Amount
Totals Method
Cash 100
Account Title Debit Total Credit Total
Cash 120 40
Furniture
Capital 100
Particular Amount Particular Amount
Cash 10
Furniture 10
Purchase
Purchase 30
Particular Amount Particular Amount Sale 20
Cash 30 Total 160 160
Sale
Particular Amount Particular Amount Debit and Credit side must be balanced
Cash 20 If they are not balanced, then there is some error
in accounting
Total cum Balances Method Method
Balances Method
Account Title Debit Balance Credit Balance This is combination of Balances and Totals Method
In this method we have 4 columns in Trial Balance.
Cash 80 2 Columns record the debit/credit balance
Capital 100 3 columns record the debit total and credit Total
Furniture 10 Total cum Balances Method
Purchase 30 Account Debit Total Credit Debit Credit
Sale 20 title Total Balance Balance
Total 120 120
Cash 120 40 80
Totals Method Capital 100 100
Account Title Debit Total Credit Total Furniture 10 10
Cash 120 40 Purchase 30 30
Capital 100 Sale 20 20
Furniture 10 160 160 120 120
Purchase 30
Sale 20 Debit and Credit side must be balanced
If they are not balanced, then there is some error in
Total 160 160 accounting
Methods of Preparation of Trial Balance
Totals Method Balances Method Totals-cum-balances Method
This method is a combination of
Total of each side in the The credit/Debit balance of totals method and balances
ledger (debit and credit) is each account is shown in the method
ascertained separately and ledger
shown in the trial balance in Two columns for writing the debit
the respective columns and credit totals of various
accounts and two columns for
Most Used writing the debit and credit
balances of these accounts.
Example – Balances Method
Example – Balances Method
Example – Balances Method
Next Video -> Trial Balance and Errors
Thanks
Trial Balance
Type of Errors
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Objective of Preparing Trial Balance
Balances Method
Account Title Debit Balance Credit Balance To ascertain the arithmetical accuracy of the ledger accounts
Cash 90
Capital 100
To help in locating errors.
Furniture 10
Purchase 30
Sale 30 To help in the preparation of the financial statements
Total 130 130
The debit and Credit balance will always be equal.
If they are not equal, then there is some error in
accounting
Does Trial Balance Always catches errors?
Debiting or Crediting wrong account with right value. Below
Bank Account is debited instead of Cash Account
Bank A/c Dr. 100
1. Ram Contributed 100 to the business in cash
To Capital A/c 100
Both debiting and Crediting right accounts with wrong value.
Both debit and credit are done with 150 instead of 100
Cash A/c Dr. 150
To Capital A/c 150
The answer to the question “Does Trial Balance Always catches errors “ is No. Mismatch in Trial balance will help us know
that there is error, but a balanced Trial Balance does not guarantee that Trial Balance is error fee
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Errors – Where they can occur?
Making Entries into Journal Posting them to ledger Posting Balances from
Accounts to Trial Balance
Making Entries into Special Totaling of Debit /Credit
Journal Books side of an Account in Totaling of debit/credit
Ledger side in Trial balance
Totaling of special Journal
books
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Errors – Where they can occur?
Making Entries into Journal Posting them to ledger Posting Balances from
Accounts to Trial Balance
Making Entries into Special Totaling of Debit /Credit
Journal Books side of an Account in Totaling of debit/credit
Ledger side in Trial balance
Totaling of special Journal
books
Errors can occur at any stage but mismatch in Trial balance will tell us that error has occurred
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Types of Errors in Trial Balance
Errors of Commission You do something wrong as a clerical
mistake
Errors of Omission You Omit something
Errors of Principle You violate some principle of accounting
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Errors of Commission (clerical Errors)
Wrong Recording of Transaction in
Journal Raj Hans Traders paid Rs. 25,000 to Preetpal Traders (a supplier of goods).
Wrong Posting of Transactions
Preetpal A/c Dr. 25000
To Cash A/c 25000
Wrong Balancing of Accounts
Preepal Traders Account
Wrong Entry in Trial Balance Particular Amount Particular Amount
Cash 2500
Wrong Total in Trial Balance
Wrong Debit
Etc. Most of times Errors of commission will lead to Imbalance in Trial
balance unless and until two mistakes are such that they negate each
other
Errors of Principle
When the principle of Accounting is not applied correctly
For example, an accountant treats expense as an Asset, then this is error of Principle
Company Purchased Machinery worth 10,000 Purchase A/c Dr. 10,000
in Cash To Cash A/c 10,000
Cash A/c Purchase A/c
Particular Amount Particular Amount Particular Amount Particular Amount
Stationary 10,000 Cash 10,000
Errors of Principle do not impact the Trial Balance Machinery is an Asset and not
Purchase (Expense Account)
Errors of Principle
More Examples
Sale of Machinery credited into Sales A/c -> Machinery is an Asset and not a Revenue Account
Wages paid for installation of new machinery is debited to wages Account
Wages for Installation are to be treated as part of Asset and not as Expense
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Errors of Omission
error of complete omission error of partial omission
Raj Hans Traders paid Rs. 25,000 to Preetpal Raj Hans Traders paid Rs. 25,000 to Preetpal
Traders (a supplier of goods). Traders (a supplier of goods).
Complete Omission
Preetpal A/c Dr. 25000
Nothing Recorded in the Journal To Cash A/c 25000
Partial omission
Cash A/c
Particular Amount Particular Amount
Preetpal Traders 25000
Preetpal Traders A/c
Particular Amount Particular Amount
Omitted Omitted
Errors of Omission
error of complete omission error of partial omission
Trial balance will still be balanced Trial balance will not be balanced
Another Classification for Types of Errors in Trial Balance
Errors that impact the Trial Balance (Make it Errors that Do not Impact the Trial Balance (Still
Unbalanced) Balanced)
Non-Compensating Errors Compensating Errors
Errors of Principle – Always Compensating
Errors of Partial Omission – Always Non- Compensating Errors of Complete Omission – Always Compensating
Error of Commission – Most of times Non-Compensating Error of Commission – May be Compensating
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Concept Check
If credit purchase of machinery is recorded in purchases book instead of journal proper, then it is
1) Error of Principle
2) Error of Commission
3) Error of Omission
4) NOTA
Ans: Option 1
If an accountant is not able to differentiate between Capital and Revenue expenditure, then it is
1) Error of Principle
2) Error of Commission
3) Error of Omission
4) NOTA
Ans: Option 1
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Concept check – Identify the Type of Error (Omission, Commission or Principle)
Credit sales to Rajni Rs. 5,000 recorded in Purchases book: Error of Principle
Furniture purchased from M/s Rao Furnishings for Rs. 8,000
was entered into the purchases book. Error of Principle
Cash sales to Radhika Rs. 15,000 was shown as receipt of Error
Goods of the value of $ 1,000 returned to Brown but omitted to record theoftransaction
Commission in the books of accounts.
commission in the cash book.
Cash received from Karim Rs. 6,000 posted to Nadeem Error of Commission
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Next Video -> Rectification of Errors
Thanks
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Trial Balance
Rectification of Errors
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Rectification of Errors
Errors that Do not Impact the Trial Balance (Still Errors that impact the Trial Balance (Make in
Balanced) Unbalanced)
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Rectification of Errors which do not Affect the Trial Balance
These errors are committed in two or more accounts. Such errors are also known as two sided errors
Example of Rectification
Credit sales to Mohan Rs. 10,000 were not recorded in the sales book
Error of Complete Omission -> Sales A/c was not credited, and Mohan Account was not debited
Rectification Entry in Journal
Debit the Account with Short Debit
Credit the Account with short Credit
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Rectification of Errors which do not Affect the Trial Balance
Example of Rectification
Credit sales to Mohan Rs. 10,000 were recorded as Rs. 1,000 in the
sales book.
Error of Commission -> Mohan Account is debited by 1000 instead of 10,000 and Sales is credited by 1000 instead of 10000
Rectification Entry in Journal
Debit the Account with Short Debit
Credit the Account with short Credit
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Rectification of Errors which do not Affect the Trial Balance
Example of Rectification
Credit sales to Mohan Rs. 10,000 were recorded as Rs. 12,000
Error of Commission -> Mohan Account is debited by 12000 instead of 10,000 and Sales is credited by 12000 instead of 10000
Rectification Entry in Journal
Debit the Account with excess Credit
Credit the Account with excess Debit
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Rectification of Errors which do not Affect the Trial Balance
Example of Rectification
Credit sales to Mohan Rs. 10,000 was correctly recorded in the
sales book but was posted to Ram’s account
Error of Commission -> Ram’s A/c is debited by 10000 instead of Ram’s A/c
Rectification Entry in Journal
Debit the Account with Short Debit
Credit the Account with excess Debit
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Rectification of Errors which do not Affect the Trial Balance
Example of Rectification
Rent paid Rs. 2,000 was wrongly shown as payment to landlord in
the cash book:
Error of Commission -> Landlord A/c is debited by 2000 instead of Rent A/c
Rectification Entry in Journal
Debit the Account with Short Debit
Credit the Account with excess Debit
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Rectification of Errors which do not Affect the Trial Balance
Making Entries into Journal Posting them to ledger Posting Balances from Accounts
to Trial Balance
Error may be at any stage but once you have corrected the journal entries, the correction will get implemented at all the
stages since journal is starting Point
1. Ram Contributed 100 to the business Cash A/c Dr. 100
To Capital A/c 100
Cash A/c Capital A/c
Particular Amount Particular Amount
Particular Amount Particular Amount
Capital 10 (Wrong Amt.)
Cash 10 (Wrong Amt.)
Wrong Entry Rectification Entry
Cash A/c Dr. 10 Cash A/c Dr. 90
To Capital A/c 10 To Capital A/c 90
Cash A/c Capital A/c
Particular Amount Particular Amount Particular Amount Particular Amount
Capital 10 Cash 10
Capital 90 Cash 90
Concept check
Goods of the value of $ 1,000 returned to Brown but omitted to record the transaction in the books of accounts.
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Concept check
Goods of the value of $ 1,000 returned to Brown but omitted to record the transaction in the books of accounts.
Goods of the value of $ 1,000 returned to Brown but omitted to record the transaction in the books of accounts.
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Concept check – Identify the Type of Error (Omission, Commission or Principle) and Do Rectification
Entry
Credit sales to Rajni Rs. 5,000 recorded in Purchases book: Error of Principle
Wrong Entry Correct Entry
Goods of the value of $ 1,000 returned to Brown but omitted to record the transaction in the books of accounts.
Rectification Entry
Debit the Account with Short Debit/excess Credit
Credit the Account with excess Debit/short crrdit
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Concept check – Identify the Type of Error (Omission, Commission or Principle)
Furniture purchased from M/s Rao Furnishings for Rs. 8,000
was entered into the purchases book. Error of Principle
Wrong Entry Correct Entry
Furniture A/c Dr. 8000
to Rao’s A/c 8000
Goods of the value of $ 1,000 returned to Brown but omitted to record the transaction in the books of accounts.
Rectification Entry
Debit the Account with Short Debit
Credit the Account with excess Debit
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Concept check – Identify the Type of Error (Omission, Commission or Principle)
Cash sales to Radhika Rs. 15,000 was shown as receipt of Error of Commission
commission in the cash book.
Wrong Entry Correct Entry
Goods of the value of $ 1,000 returned to Brown but omitted to record the transaction in the books of accounts.
Rectification Entry
Debit the Account with excess Credit
Credit the Account with short credit
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Concept check – Identify the Type of Error (Omission, Commission or Principle)
Cash received from Karim Rs. 6,000 posted to Nadeem Error of Commission
Wrong Entry Correct Entry
Cash A/c Dr. 6000
To Karim A/c 6000
Goods of the value of $ 1,000 returned to Brown but omitted to record the transaction in the books of accounts.
Rectification Entry
Nadeem A/c
Debit the Account with excess Credit
Credit the Account with short credit
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Rectification of Errors
Errors that Do not Impact the Trial Balance (Still Errors that impact the Trial Balance (Make in
Balanced) Unbalanced)
Debiting the account with short debit or with excess credit
Crediting the account with excess debit or with short credit.
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Rectification of Errors Affecting Trial Balance
Correction of Error in Journal
1. Ram Contributed 100 to the business Cash A/c Dr. 100
To Capital A/c 10
Wrong Amount Entered In Journal (10 instead of 100)
Rectification Entry
Cash A/c Dr. 90
To Capital A/c 90
We can’t do correction this way because then cash a/c will get
debited by 90 but that is not to be done as Cash A/c is already
correct
Rectification of Errors Affecting Trial Balance
Point to Remember
1. Compensating Errors can be corrected with
Opposite Journal Entries
2. Non-Compensating Errors cannot be
corrected with Opposite Journal Entries
Rectification of Errors Affecting Trial Balance
Corrections through Suspense A/c
Credit sales to Mohan Rs. 5000 were posted to his account as Rs. 2000
Mohan A/c Dr. 5000
To Sale A/c 5000
Sale A/c Mohan A/c
Particular Amount Particular Amount Particular Amount Particular Amount
Mohan 5000 Sales 2000 (Wrong
amount)
Trial Balance -> Balances Method
Account Title Debit Balance Credit Balance
Sale 5000
Mohan 2000 Trial Balance not
Total 2000 5000 matching debit side
short by 3000
Rectification of Errors Affecting Trial Balance
Corrections through Suspense A/c
Credit sales to Mohan Rs. 5000 were posted to his account as Rs. 2000
Correct Entry Wrong Entry
Mohan A/c Dr. 5000 Mohan A/c Dr. 2000
To Sale A/c 5000 To Sale A/c 5000
Rectification Entry
Correction Journal Entry through Suspense A/c
Mohan A/c Dr. 3000
To Suspense A/c 3000
Rectification of Errors Affecting Trial Balance
Corrections through Suspense A/c
Credit sales to Mohan Rs. 5000 were posted to his account as Rs. 2000
Correction Journal Entry through Suspense A/c
Mohan A/c Dr. 5000 Mohan A/c Dr. 3000
To Sale A/c 5000 To Suspense A/c 3000
Mohan A/c
Sale A/c
Particular Amount Particul Amount
ar
Particular Amount Particular Amount
Sales 2000 (Wrong amount)
Mohan 5000
Suspense 3000 (Corrected entry)
Trial Balance -> Balances Method
Account Title Debit Balance Credit Balance Suspense A/c
Particular Amount Particul Amount
Sale 5000 ar
Diff as per Trial 3000 Mohan 3000
Mohan 5000 Balance
Total 5000 5000
Rectification of Errors Affecting Trial Balance
Examples Corrections through Suspense A/c
Credit sales to Mohan Rs. 10,000 were posted to his account as Rs. 12,000.
Equivalent Wrong Journal Entry
Error of Commission – Mohan A/c debited by 12000 instead of
10,000
Rectification Entry
Rectification of Errors Affecting Trial Balance
Examples Corrections through Suspense A/c
1. Ram Contributed 100 to the business Cash A/c Dr. 100
To Capital A/c 10
Rectification Entry
Suspense A/c Dr. 90
To Capital A/c 90
Rectification of Errors Affecting Trial Balance
Examples – Corrections through Suspense A/c
Credit sales to Mohan Rs. 10,000 were not posted to his account
Equivalent Wrong Journal Entry
Error of Partial Ommision – Mohan A/c debited by zero instead
of 10,000
Rectification Entry
Rectification of Errors Affecting Trial Balance
Examples – Corrections through Suspense A/c
Credit sales to Mohan Rs. 10,000 were posted to his account as Rs. 7000.
Equivalent Wrong Journal Entry
Error of Commission – Mohan A/c debited by 7000 instead of
10,000
Rectification Entry
Thanks
Trial Balance and Rectification of Errors
Practice Problems
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Practice Problem - 1
Practice Problem - 1
Practice Problem - 1
Practice Problem - 2
Practice Problem - 3
Depreciation : Expense
Machinery: Asset
Practice Problem - 4
Also show the suspense A/c in ledger
Practice Problem - 4
Solution(iv)
Wrong Entry
Ram A/c Dr. 1000
To Sales A/c 1000
Also show the suspense A/c in ledger Correct Entry
Ram A/c Dr. 1000
To Purchase Return 1000
Rectification Entry
Practice Problem - 4
Solution(v)
Wrong Entry
M&Co. Dr. 8000
To Sales A/c 8000
Also show the suspense A/c in ledger Correct Entry
Purchase A/c Dr. 8000
To M&Co. A/c 8000
Practice Problem - 4
Solution(vi)
Wrong Entry
S&Co. Dr. 5000
To Sales A/c 5000
Also show the suspense A/c in ledger Correct Entry
Purchase A/c Dr. 5000
To S&Co. A/c 5000
Practice Problem - 4
Solution(vii)
Wrong Entry
Employee Personal A/c Dr. 2000
To Cash A/c 2000
Also show the suspense A/c in ledger Correct Entry
Salary A/c Dr. 2000
To Cash A/c 2000
Practice Problem - 4
Constructing a Suspense A/c in Ledger
Practice Problem - 5
Solution(i)
Wrong Entry
Wages A/c Dr. 600
To Cash A/c 600
Correct Entry
Machinery A/c 600
To Cash A/c 600
Practice Problem - 5
Solution(ii)
Wrong Entry
Machinery A/c Dr. 400
To Cash A/c 400
Correct Entry
Repair A/c 400
To Cash A/c 400
Practice Problem - 5
Solution(iii)
Wrong Entry
Repairs A/c Dr. 1000
To Cash A/c 1000
Correct Entry
This is a case where secondhand machinery has been
Machinery A/c 1000
bought and repair at the start would be part of buying
To Cash A/c 1000
the machinery itself
Practice MCQs
Agreement of trial balance is affected by:
(a) One sided errors only.
(b) Two sided errors only.
(c) Both a and b.
(d) None of the above.
Ans: Option 1
Which of the following is not an error of principle:
(a) Purchase of furniture debited to purchases account.
(b) Repairs on the overhauling of secondhand machinery purchased debited to repairs account.
(c) Cash received from Manoj posted to Saroj.
(d) Sale of old car credited to sales account.
Ans: Option 3
Practice MCQs
Which of the following is not an error of commission:
(a) Overcasting of sales book.
(b) Credit sales to Ramesh Rs. 5,000 credited to his account.
(c) Wrong balancing of machinery account.
(d) Cash sales not recorded in cash book but in Purchase book
Ans: Option 4
Which of following errors will be rectified through suspense account:
(a) Sales return book undercast by Rs. 1,000.
(b) Sales return by Madhu Rs. 1,000 not recorded.
(c) Sales return by Madhu Rs 1,000. recorded as Rs,100.
(d) Sales return by Madhu Rs. 1,000 recorded through purchases returns book
Ans: Option 1
Practice MCQs
If the trial balance agrees, it implies that:
(a) There is no error in the books.
(b) There may be two sided errors in the book.
(c) There may be one sided error in the books.
(d) There may be both two sided and one-sided errors in the books.
Ans: Option 2
If suspense account does not balance off even after rectification of errors, it implies that:
(a) There are some one-sided errors in the books yet to be located.
(b) There are no more errors yet to be located.
(c) There are some two-sided errors only yet to be located.
(d) There may be some errors of Principle to be located
Ans: Option 1
Practice MCQs
If wages paid for installation of new machinery is debited to wages Account, it is:
(a) An error of commission.
(b) An error of principle.
(c) A compensating error.
(d) An error of omission.
Ans: Option 2
Trial balance is:
(a) An account.
(b) A statement.
(c) A subsidiary book.
(d) A principal book.
Ans: Option 2
Practice MCQs
A Trial balance is prepared:
(a) After preparation financial statement.
(b) After recording transactions in subsidiary books.
(c) After posting to ledger is complete.
(d) After posting to ledger is complete and accounts have been balanced
Ans: Option 4
Thanks
Bills of Exchange
Basics of Bills of Exchange and Promissory Note
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What is Bills of Exchange?
Ram Sells Goods worth 10,000 on Credit to Sham, to be paid by
Sham after 3 months
Ram Draws a Bill of Exchange for
10,000 to be Payable after 3 months
Ram
Sham Accepts the Bill of Exchange Sham
Bill of exchange is an Unconditional Order by the Maker to the
Acceptor to pay certain sum of money to the maker after
certain time
What is Bills of Exchange?
Ram Sells Goods on Credit to Sham
Ram Draws a Bill of Exchange for
10,000 to be Payable after 3 months
Ram
Sham Accepts the Bill of Exchange Sham
Bill of exchange is an Unconditional Order by the
Maker to the Acceptor to pay certain sum of money
Maker/Drawer/Holder to the maker after certain time Drawee
Seller/Creditor Purchaser/Debtor
Endorsement of Bill of Exchange
Ram Owes 10,000 to Ravi
Bill Transferred to Ravi
Ram - Endorser
Ram may transfer the bill to Ravi. This process is called Endorsement and
person endorsing another party is called endorser
Bill of exchange is an Unconditional Order by the Maker to the Acceptor to pay
certain sum of money to the maker or to any other person as ordered by maker
after certain time
Discounting of Bills of Exchange
Bank
Encashed from bank
1. Suppose Ram needs money now
2. He might get it encashed it from the bank earlier than
3 months
3. Bank will charge some interest/Profit, so bank will This Process is called Discounting of Bill
give it less than 10,000
4. Suppose Bank Given 9,000 and later after 3 months
bank will get 10,000 from Sham. Here 1000 will be
the Interest/Profit of the bank
Parties to the Bill Of Exchange
We already Know who is Drawer and the Drawee
Parties to the Bill Of Exchange
Payee
Payee is Same as Drawer Payee is the one in whose name bill
Ram is Payee has been Endorsed
Ravi is Payee
Payee is the one who has
discounted the Bill
Bank is the payee
Sample Bill of Exchange and Salient Features
1. Acceptance by other person is must, otherwise it
would not be a valid bill of Exchange
Mamta sold some goods to Jyoti
Bill of Exchange Prepared by Mamata for the order of payment
2. A bill of exchange must be in writing.
to Jyoti
3. The order to make payment is unconditional
4. The maker of the bill of exchange must sign it.
5. The payment to be made must be certain.
6. The date on which payment is made must also be
certain.
7. The bill of exchange must be payable to a certain
person.
8. It must be stamped as per the requirement of law
Concept Check
A bill of exchange is drawn by the ________________upon his___________.
a) Drawee, Drawer
b) Drawee, Debtor
c) Drawer, Debtor
d) Drawer, Creditor
Ans: Option C
What is Promissory Note
Ram Sells Goods on Credit to Sham
worth Rs. 10,000
Sham Gives Promissory note to Ram
to pay 10,000 after 3 months
Sham
Ram
Maker/Drawer
Drawee
Promisee Promissor
Seller/Creditor Purchaser/Debtor
A promissory note is defined as an instrument in writing containing an unconditional undertaking signed by the
maker to pay a certain sum of money to the Creditor
Endorsement of Promissory Note
Ram Owes 10,000 to Ravi
Promissory Note Transferred
to Ravi
Ram may transfer the Note to Ravi. This process is called Endorsement of Promissory
Note
A promissory note is defined as an instrument in writing containing an unconditional
undertaking signed by the maker to pay a certain sum of money to the Creditor or to any
other person as suggested by the creditor
Discounting of Promissory Note
Encashed from bank
1. Suppose Ram needs money now
2. He might get Promissory note encashed it from the
bank earlier than 3 months
3. Bank will charge some interest/Profit, so bank will This Process is called Discounting of
give it less than 10,000 Promissory Note
4. Suppose Bank Gives 9,000 and later after 3 months
bank will get 10,000 from Sham. Here 1000 will be
the Interest/Profit of the bank
Promissory Note Sample and Salient Features
1. It must be in writing Some goods are sold by Harish Chander to the Ashok Kumar
worth Rs. 30,000
2. It must contain an unconditional promise to
pay. Promissory Note is prepared by Ashok as a promise to pay
30,000 to Harish Chander
3. The sum payable must be certain.
4. It must be signed by the maker.
5. The maker must sign it.
6. It must be payable to a certain person.
7. It should be properly stamped.
8. Acceptance is not required by the
Creditor/Drawee in this case
Distinction between Bill of Exchange and Promissory Note
Maturity of the Bill of Exchange
Bill Drawn on 5th Payable after 30 Maturity Date 4th Default Grace Final Maturity Date
March Days April Period -> 3 days 7th April
Bill Drawn on 5th Payable after 1 Maturity Date 5th Default Grace Final Maturity Date
March Month April Period -> 3 days 8th April
Bill Drawn on Payable after 30
April 1st Days Final Maturity - 4th May
Bill Drawn on Payable after 60
April 1st Days Final Maturity - 3rd June
Concept Check
A promissory note is drawn by ______________in favor of his__________.
a) Creditor, Debtor
b) Debtor, Creditor
c) Drawer, Creditor
d) Both 2 and 3
Ans: Option 4
Drawer and ______________can not be the same parties in case of a bill of exchange.
Ans: Drawee
__________days of grace are added in terms of the bill to calculate the date of its__________
Ans: 3, Maturity
Concept Check
The person to whom the amount mentioned in the promissory note is payable is known as _____________.
Ans: Drawee or Creditor or Promisee
Transfer of a negotiable instrument to another person by signing on it, is known as _____________.
Ans: Endorsement
Concept Check
In a promissory note, the person who makes the promise to pay is called as ____________.
Ans: Promissor or Drawer or Debtor
A person who endorses the promissory note in favour of another is known as____________.
Ans: Endorser
Next Video – Accounting Treatment of Bills of Exchange
Thanks
Bills of Exchange
Accounting Treatment for Bills of Exchange
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Accounting Treatment for Bills of Exchange
Bill of Exchange
Ram
Sham
Drawer Drawee
Creditor Debtor
Bills Bills Payable
Receivable
Accounting Treatment for Bills of Exchange
Books of Creditor Books of Debtor
Accounting Treatment for Bills of Exchange
Books of Creditor
3 Scenarios
Creditor Retains the Bill till Maturity
Creditor can get the bill discounted from the bank
Creditor can endorse the bill in favor of his Creditor
Accounting Treatment for Bills of Exchange
Creditor Retains the Bill till Maturity
2 Scenarios
Collects on date of maturity
Collects Through the bank
directly
Few Days Before
Maturity, bill is sent for
collection tot bank
Accounting Treatment
Books of Creditor
3 Scenarios
Creditor Retains the Bill till Maturity
Creditor can get the bill discounted from the bank
Creditor can endorse the bill in favor of his Creditor
Accounting Treatment
Creditor can get the bill discounted from the bank
On Maturity, Accounts of creditor
will not be impacted as Creditor
has already kind of sold it to the
bank
Accounting Treatment
Books of Creditor
3 Scenarios
Creditor Retains the Bill till Maturity
Creditor can get the bill discounted from the bank
Creditor can endorse the bill in favor of his Creditor
Accounting Treatment
Creditor can endorse the bill in favor of his Creditor
On Maturity, Accounts of creditor
will not be impacted as Creditor has
already transferred it to other party
Accounting Treatment
Books of Creditor Books of Debtor
Accounting Treatment
Books of Debtor
Makes no difference whether the bill is retained till Maturity, discounted or endorsed
Example 1
Solution – (i) – Creditor (Amit) Books
Rules
Example 1
Solution – (ii) – Creditor (Amit) Books
Rules
Working Notes - > 12% for 12 months -> 3 % for 3 months
3% of 20,000 = 600
Example 1
Solution – (iii) – Creditor (Amit) Books
Rules
Example
Solution – (iv) – Creditor (Amit) Books
Rules
Example 1
Solution – (All parts) – Debtor (Sumit) Books
Rules
Example 2
Solution – Creditor Ramesh Books
Example 2
Solution – Debtor Deepak Books
Example 2
Solution – Poonam Books
Next Video – Dishonor of Bill and Retirement of Bill, Renewal of Bill and Accomodation of Bill
Thanks
Bills of Exchange
Dishonor of Bill, Retirement of Bill, Renewal of Bill, Accommodation of Bill
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Dishonor of Bill
Dishonor of bill means that bill which was accepted
by debtor was not honored
In other words at maturity the money which debtor
owed was not returned
Accounting Treatment for Dishonor of Bill
Books of Creditor Books of Debtor
Accounting Treatment for Dishonor of Bill
Books of Creditor
3 Scenarios
Creditor Retains the Bill till Maturity
Creditor can get the bill discounted from the bank
Creditor can endorse the bill in favor of his Creditor
Accounting Treatment for Dishonor of Bill
Creditor Retains the Bill till Maturity
Collects on date of maturity
Collects Through the bank
directly
Reverse Entry
Reverse Entry
Debtor’s a/c Debtor’s a/c
Accounting Treatment for Dishonor of Bill
Books of Creditor
3 Scenarios
Creditor Retains the Bill till Maturity
Creditor can get the bill discounted from the bank
Creditor can endorse the bill in favor of his Creditor
Accounting Treatment for Dishonor of Bill
Creditor can get the bill discounted from the bank Creditor can endorse the bill in favor of his Creditor
Reverse Entry Reverse Entry
Debtors A/c Dr. Debtor A/c Dr.
To Bank A/c To Creditors A/c
Accounting Treatment for Dishonor of Bill
Books of Creditor Books of Debtor
Accounting Treatment for Dishonor of Bill
Books of Debtor
Reverse Entry
Bills Payable A/c Dr.
To Creditor’s A/c
Example - 3
Solution (i) – Sheiba Books
Example - 3
Solution (ii) – Sheiba Books
Example - 3
Solution (iii) – Sheiba Books
Example - 3
Solution (All Parts) – Vishal Books
Retirement of Bill
Retiring the Bill
Ram Sells Goods on Credit to Sham
Ram Draws a Bill of Exchange for
10,000 to be Payable after 3 months
Ram Sham Accepts the Bill of Exchange Sham
Now suppose before the completion of 3 months Sham (Drawee /Debtor) Offers to pay the money because he
has some extra funds
If Ram (Drawer) agrees then bill is said to be Retired
Sham would take some rebate (discount) because he is paying the money early
Accounting Treatment for Retiring the Bill
Ram Sells Goods on Credit to Sham
Ram Draws a Bill of Exchange for
10,000 to be Payable after 3 months
Ram Sham Accepts the Bill of Exchange Sham
Example 4
Amit sold goods Rs. 10,000 to Babli on Jan. 01, Solution
2015 and immediately drew a bill on Babli for
three month for the same amount, Babli accepted
the bill and returned it to Amit. On March 04,
2015 Babli retired her acceptance under rebate of
6% per annum.
Show the entry in books of Amit
Renewal of Bill
Renewal of Bill
Suppose after 3 months Sham is not able to pay.
Instead of dishonoring the bill Sham requests Ram to Renew
the Bill
Renewing means to create a new bill and Cancel the old bill
Since Ram will get his money late, he asks for interest for this
extra duration
So they will create a new bill with new date, cancel the old bill
and Shall will Pay interest for this extra duration
This whole process is called Renewal of Bill
Accommodation of Bill
Accommodation of Bill
Ram is need of Money
Ram draws a bill upon Sham worth Rs. 5000 Payable after 3 months
Sham Accepts the same
Ram then goes to Bank and gets it discounted at 12%. So Bank gives
him 4850
Ram Sham
Ram uses this money
Accommodation On Maturity Bank must take 5000 from Sham Accommodating
Party Party
Just before maturity Ram gives 5000 to Sham
On the maturity Date Bank gets its 5000
Accommodation of Bills
Accommodation of Bill
Ram and Sham are need of Money
Ram draws a bill upon Sham worth Rs. 5000 Payable after 3 months
Sham Accepts the same
Ram then goes to Bank and gets it discounted at 12%. So Bank gives
him 4850
Ram Sham
Ram and Sham share 2425 each
Accommodation
Accommodation On Maturity Bank must take 5000 from Sham and
and
Accommodating
Accommodating Just before maturity Ram gives 2500 to Sham Party
Party
On the maturity Date Bank gets its 5000
Accommodation of Bills
Journal Entries for Accommodation of Bill
Concept Check
What are the three additional days known as that a drawer gives to the drawee for payment
A) Conditional days
B) Additional days
C) Days of grace
D) Days of rebate
Ans: Option C
When the drawee signs the bill, it is considered as
A) Accepted
B) Retired
C) Renewed
D) Endorsed
Ans: Option A
Concept Check
At the time of endorsement of a bill, the drawer credits:
(A) Bill payable
(B) Drawee A/C
(C) Drawer A/C
(D) Bill Receivable A/C
Ans: Option D
When the bill is written it is known as:
(A) Renewed
(B) Accepted
(C) Retired
(D) Drawn
Ans: Option D
Concept Check
Due Date for Bill of Exchange payable after 1 month and Drawn on 30th Jan would be
(A) 3rd march
(B) 5th March
(C) 29th Feb
(D) 7th March
Ans: Option A
If Ram and Sham enter into agreement for Bill of Exchange worth Rs. 10,000 payable after 3 months where Sham is
Accommodating Party. How much and who would get the money if bill is discounted with the bank for 12%
(A) Ram, 8700
(B) Ram, 9700
(C) Sham, 9400
(D) Sham, 8800
Ans: Option B
Thanks
VIDEO LESSON ON
INCOME STATEMENT
By Edutap - http://www.edutap.co.in/
Importance
Not Part of Syllabus Directly
Questions on Ratios Last Year
Income Statement is must to Understand
Ratios
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Various Statements
Income Statement
Balance Sheet
Cash Flow
Statement
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P rinc iple of Ac c rual
Ac c ounting And C as h
Ac c ounting
Example
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Introduction
Profit = Revenues - Expenses
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Introduction
Sukhwinder
Starts
Loan of 2,00000
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Revenues
Sukhwinder
Sells clothes worth
1 lac in quarter from Jan to
March
Revenues = 1 lac
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Expenses
Sukhwinder Buy Clothes
Salary
Interest On Loan
Utilities
Fixed Assets
Expense = 70,000
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Profit
Profit = Revenues - Expenses
=
1,00000- 70,000
=
30,000
Is it that Simple
Yes and No
Lets Construct a Income Statement of Sukhwinder’s Business from Jan to March
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Income Statement
Inc ome Statement
Jan to Marc h
S ales 1,00000
Cos t of Goods Sold
Gros s Profit
Operating Expens e
S alaries
Rent
Utilities
Deprec iation
Total Operating Expens e
Operating Inc ome (E B IT )
Non -Operating or Other
Interes t Revenues
Gains
Interes t Expens e
Los s es
Total Non-Operating Inc ome
Pro fit Before taxes (E B T )
Taxes (10%)
PAT or Net Inc om e
Remarks : The values in ( ) indic ates the negative value or the expes ne
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From Where did he get the
Clothes?
Sukhwinder
Paid 50,000
Bought
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Income Statement
Inc ome Statement
Jan to Marc h
S ales 1,00000
Cos t of Goods Sold 50,000
Gros s Profit
Operating Expens e
S alaries
Rent
Utilities
Deprec iation
Total Operating Expens e
Operating Inc ome (E B IT )
Non -Operating or Other
Interes t Revenues
Gains
Interes t Expens e
Los s es
Total Non-Operating Inc ome
Pro fit Before taxes (E B T )
Taxes (10%)
PAT or Net Inc om e
Remarks : The values in ( ) indic ates the negative value or the expes ne
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Cost of Goods Sold (COGS)
COGS is direct cost
Cost of Manufacturing or Buying a Product you are selling
Generally Variable Costs which Increase or Decrease with Volumes
Cost of clothes Purchased
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Cost of Goods Sold (COGS)
NO !!!!!!
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COGS - Manufacturing
Companies
Raw Material
Labor
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Gross Profit
Gross Profit = Revenues - COGS
Gross profit is important because it reflects the core profitability of a company
Higher Revenues by Charging Higher Price Lower Cost of the Goods Sold
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Income Statement
Inc ome Statement
Jan to Marc h
S ales 1,00000
Cos t of Goods Sold 50,000
Gros s Profit 50,000
Operating Expens e
S alaries
Rent
Utilities
Deprec iation
Total Operating Expens e
Operating Inc ome (E B IT )
Non -Operating or Other
Interes t Revenues
Gains
Interes t Expens e
Los s es
Total Non-Operating Inc ome
Pro fit Before taxes (E B T )
Taxes (10%)
PAT or Net Inc om e
Remarks : The values in ( ) indic ates the negative value or the expes ne
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Operating Expenses
Operating Expenses are the indirect expenses which relate to core business but are not
directly associated with acquiring or manufacturing product to be sold
Depreciation
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Operating Expenses - Salary
Salary
= 5,000
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Income Statement
Inc ome Statement
Jan to Marc h
S ales 1,00000
Cos t of Goods Sold 50,000
Gros s Profit 50,000
Operating Expens e
S alaries 5,000
Rent
Utilities
Deprec iation
Total Operating Expens e
Operating Inc ome (E B IT )
Non -Operating or Other
Interes t Revenues
Gains
Interes t Expens e
Los s es
Total Non-Operating Inc ome
Profit Before taxes (E B T )
Taxes (10%)
PAT or Net Inc om e
Remarks : The values in ( ) indic ates the negative value or the expes ne
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Operating Expenses - Rent
= 10,000
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Income Statement
Inc ome Statement
Jan to Marc h
S ales 1,00000
Cos t of Goods Sold 50,000
Gros s Profit 50,000
Operating Expens e
S alaries 5,000
Rent 10,000
Utilities
Deprec iation
Total Operating Expens e
Operating Inc ome (E B IT )
Non -Operating or Other
Interes t Revenues
Gains
Interes t Expens e
Los s es
Total Non-Operating Inc ome
Pro fit Before taxes (E B T )
Taxes (10%)
PAT or Net Inc ome
Remarks : The values in ( ) indic ates the negative value or the expes ne
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Operating Expenses - Utilities
Utilities
= 1,000
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Income Statement
Inc ome Statement
Jan to Marc h
S ales 1,00000
Cos t of Goods Sold 50,000
Gros s Profit 50,000
Operating Expens e
S alaries 5,000
Rent 10,000
Utilities 1,000
Deprec iation
Total Operating Expens e
Operating Inc ome (E B IT )
Non -Operating or Other
Interes t Revenues
Gains
Interes t Expens e
Los s es
Total Non-Operating Inc ome
Pro fit Before taxes (E B T )
Taxes (10%)
PAT or Net Inc ome
Remarks : The values in ( ) indic ates the negative value or the expes ne
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Operating Expenses -
Depreciation
Fixed Assets
= 80,000
= 20,000
1,00000
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Depreciation Cost
Fixed Assets give benefits Over Long Term
Tempo and Computer can be used for next 10
years
Cost spent on them is divided over their life
Depreciation Costs
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Depreciation
Fixed Amount or 90,000 – 1st Year
Percentage 80,000 – 2nd Year
70,000 – 3rd Year
60,000 – 4th Year
= 1,00000 50,000 – 5th Year
40,000 – 6th Year
30,000 - 7th Year
20,000 – 8th Year
So Depreciation Cost is 10,000
per year or 2500 per quarter 10,000 – 9th Year
0 – 10th Year
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Income Statement
Inc ome Statement
Jan to Marc h
S ales 1,00000
Cos t of Goods Sold 50,000
Gros s Profit 50,000
Operating Expens e
S alaries 5,000
Rent 10,000
Utilities 1,000
Deprec iation 25,00
Total Operating Expens e 18,500
Operating Inc ome (E B IT )
Non -Operating or Other
Interes t Revenues
Gains
Interes t Expens e
Los s es
Total Non-Operating Inc ome
Pro fit Before taxes (E B T )
Taxes (10%)
PAT or Net Inc om e
Remarks : The values in ( ) indic ates the negative value or the expes ne
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Operating Profit
Operating Profit = Sales – COGS – Operating Expenses
Operating Profit = Gross Profit – Operating Expenses
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Income Statement
Inc ome Statement
Jan to Marc h
S ales 1,00000
Cos t of Goods Sold 50,000
Gros s Profit 50,000
Operating Expens e
S alaries 5,000
Rent 10,000
Utilities 1,000
Deprec iation 25,00
Total Operating Expens e 18,500
Operating Inc ome (E B IT ) 31,500
Non -Operating or Other
Interes t Revenues
Gains
Interes t Expens e
Los s es
Total Non-Operating Inc ome
Pro fit Before taxes (E B T )
Taxes (10%)
PAT or Net Inc om e
Remarks : The values in ( ) indic ates the negative value or the expes ne
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EBIDT
Operating Profit is EBIT
EBIDT ?
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Income Statement
Inc ome Statement
Jan to Marc h
S ales 1,00000
Cos t of Goods Sold 50,000
Gros s Profit 50,000
Operating Expens e
S alaries 5,000
Rent 10,000
Utilities 1,000
Deprec iation 25,00
Total Operating Expens e 18,500
Operating Inc ome (E B IT ) 31,500
Non -Operating or Other
Interes t Revenues
Gains
Interes t Expens e
Los s es
Total Non-Operating Inc ome
Pro fit Before taxes (E B T )
Taxes (10%)
PAT or Net Inc om e
Remarks : The values in ( ) indic ates the negative value or the expes ne
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Non Operating Expense
Not Related Main Activity of the Organization
Example of Non Operating Expense
Loss from Selling Anything not part of
Interest On Loan
main business
20,000
Loan of 2 lakh at 4 % per year
19,000
So Interest is 8,000 per year or 2,000
per quarter
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Income Statement
Inc ome Statement
Jan to Marc h
S ales 1,00000
Cos t of Goods Sold 50,000
Gros s Profit 50,000
Operating Expens e
S alaries 5,000
Rent 10,000
Utilities 1,000
Deprec iation 25,00
Total Operating Expens e 18,500
Operating Inc ome (E B IT ) 31,500
Non -Operating or Other
Interes t Revenues
Gains
Interes t Expens e 2,000
Los s es 1,000
Total Non-Operating Inc ome
Pro fit Before taxes (E B T )
Taxes (10%)
PAT or Net Inc om e
Remarks : The values in ( ) indic ates the negative value or the expes ne
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Non Operating Income
Not Related Main Activity of the Organization
Example of Non Operating Income
Interest On Deposit Gain from Selling Anything not part
of Core business
Loan of 2 lakh at 4 % per year
80,000
Pays 50,000 for buying clothes and 1,00000
for buying Tempo and Computer 81,000
Deposits remaining 50,000 in bank the bank
at 4%
Interest for year is 2000 or for quarter would
be 500
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Income Statement
Inc ome Statement
Jan to Marc h
S ales 1,00000
Cos t of Goods Sold 50,000
Gros s Profit 50,000
Operating Expens e
S alaries 5,000
Rent 10,000
Utilities 1,000
Deprec iation 25,00
Total Operating Expens e 18,500
Operating Inc ome (E B IT ) 31,500
Non -Operating or Other
Interes t Revenues 500
Gains 1,000
Interes t Expens e 2,000
Los s es 1,000
Total Non-Operating Inc ome (1500)
Pro fit Before taxes (E B T )
Taxes (10%)
PAT or Net Inc om e
Remarks : The values in ( ) indic ates the negative value or the expes ne
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Profit Before Taxes
PBT or Profit Before Taxes = Gross Profit - Operating Expense – Non
Operating Expense
PBT or Profit Before Taxes = Gross Profit - Operating Expense + Non
Operating Income
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Income Statement
Inc ome Statement
Jan to Marc h
S ales 1,00000
Cos t of Goods Sold 50,000
Gros s Profit 50,000
Operating Expens e
S alaries 5,000
Rent 10,000
Utilities 1,000
Deprec iation 25,00
Total Operating Expens e 18,500
Operating Inc ome (E B IT ) 31,500
Non -Operating or Other
Interes t Revenues 500
Gains 2,000
Interes t Expens e 2,000
Los s es 1,000
Total Non-Operating Inc ome (1500)
Pro fit Before taxes (E B T ) 30,000
Taxes (10%)
PAT or Net Inc om e
Remarks : The values in ( ) indic ates the negative value or the expes ne
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Taxes or PAT
10%
Profit Before Tax = 30,000
Tax at 30,000 = 10% of 30,000 = 3,000
Profit After Tax (PAT) = 27,000
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Income Statement
Inc ome Statement
Jan to Marc h
S ales 1,00000
Cos t of Goods Sold 50,000
Gros s Profit 50,000
Operating Expens e
S alaries 5,000
Rent 10,000
Utilities 1,000
Deprec iation 25,00
Total Operating Expens e 18,500
Operating Inc ome (E B IT ) 31,500
Non -Operating or Other
Interes t Revenues 500
Gains 2,000
Interes t Expens e 2,000
Los s es 1,000
Total Non-Operating Inc ome (1500)
Pro fit Before taxes (E B T ) 30,000
Taxes (10%) 3,000
PAT or Net Inc om e 27,000
Remarks : The values in ( ) indic ates the negative value or the expes ne
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Significance of Difference Profits
Gross Profit is high but Operating Profit is low
Means Company is spending too much on
Rent, Salaries i.e. too much indirect expenses
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Significance of Difference Profits
Both Gross Profit and Operating Profit are
high but PAT is very low
Too much Non Operating
Expenses….Sometimes due to debt
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Learn Anytime, Anywhere
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VIDEO LESSON ON
BALANCE SHEET
By Edutap - http://www.edutap.co.in/
Importance
Not Part of Syllabus Directly
Questions on Ratios Last Year
Balance Sheet is must to Understand
Ratios
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Various Statements
For a Particular Period –
Income Statement
Say 1st Jan to 31st March
Balance Sheet For a Particular Point in
Time– Say as of 31st March
Cash Flow
Statement
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Components of Balance Sheet
Assets are the Cash, Movable or Immovable Property Owned By Business. For example
Land, Cash, Cars owned by business are examples of Assets
Liabilities is the money owed by the business to other entities. For example loan taken
from the bank
Equity is money invested by other people or self in the business
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Lets Construct Balance Sheet
We will Try to Construct a Balance Sheet from the basics
Trust me……it would be very Interesting
Keep Patience
Sukhwinder
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Constructing a Balance Sheet
Sukhwinder
Starts
Loan of 2,00000
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Constructing a Balance Sheet
Assets Liabilities
Cash 200000
Long Term Debt 2,00000
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Constructing a Balance Sheet
Sukhwinder
Paid 50,000
Bought
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Constructing a Balance Sheet
Assets Liabilities
Cash 1,50000
Clothes 50,000
(Inventories)
Long Term Debt 2,00000
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Constructing a Balance Sheet
Sukhwinder
Pays 20,000
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Constructing a Balance Sheet
Assets Liabilities
Cash 1,30000
Clothes (Inventories) 50,000
Long Term Debt 2,00000
Computer 20,000
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Constructing a Balance Sheet
Sukhwinder 80,000
Pays 60,000
Rest 20,000 is to be paid in future
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Constructing a Balance Sheet
Assets Liabilities
Cash 70,000 Accounts Payable 20,000
Clothes (Inventories) 50,000
Long Term Debt 2,00000
Computer 20,000
Tempo 80,000
Total Fixed Assets 1,00000
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Constructing a Balance Sheet
Sukhwinder
Invests 70,000
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Constructing a Balance Sheet
Assets Liabilities
Cash 70,000 Accounts Payable 20,000
Clothes (Inventories) 50,000
Long Term Debt 2,00000
Computer 20,000
Tempo 80,000
Total Fixed Assets 1,00000
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Constructing a Balance Sheet
Sukhwinder
No Money
Takes Short Term Loan of 10,000 from Bank
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Constructing a Balance Sheet
Assets Liabilities
Cash 80,000 Accounts Payable 20,000
Clothes (Inventories) 50,000 Notes Payable 10,000
Long Term Debt 2,00000
Computer 20,000
Tempo 80,000
Total Fixed Assets 1,00000
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Constructing a Balance Sheet
Sukhwinder
Pays 5,000 to buy
High End
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Constructing a Balance Sheet
Assets Liabilities
Cash 75,000 Accounts Payable 20,000
Clothes (Inventories) 50,000 Notes Payable 10,000
High End Clothes 5,000
Long Term Debt 2,00000
Computer 20,000
Tempo 80,000
Total Fixed Assets 1,00000
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Constructing a Balance Sheet
Sukhwinder
Pays 3,000 as
Internet Bill for whole
quarter in Advance
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Constructing a Balance Sheet
Assets Liabilities
Cash 72,000 Accounts Payable 20,000
Clothes (Inventories) 50,000 Notes Payable 10,000
High End Clothes 5,000
Prepaid Expenses 3,000
Long Term Debt 2,00000
Computer 20,000
Tempo 80,000
Total Fixed Assets 1,00000
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Constructing a Balance Sheet
Suppose this was the look of balance sheet for the first 2-3 days.
How does it Looks After 1 Month of Operations of Business
Lets see what happened during that one month period?
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Constructing a Balance Sheet
Sales 50,000
COGS 25,000
Depreciation Cost 10,000
Internet Expenses 1,000
Electricity Expenses (to be paid 1,000
at the end of quarter)
Profit 13,000
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Constructing a Balance Sheet
Assets Liabilities
Cash 72,000 + 50,000 1 Accounts Payable 20,000
Clothes (Inventories) 50000 - 25000 Notes Payable 10,000
2
High End Clothes 5,000 Accrued Expense (Electricity) 1000
5
Prepaid Expenses 3,000 - 1000
4
Long Term Debt 2,00000
Computer 20,000 Retained Earnings 13,000
6
Tempo 80,000
Depreciation (10,000)
3
Total Fixed Assets 90,0000
Total Asset side 2,44,000 Total Liabilities side 2,44,000
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Constructing a Balance Sheet
Assets Liabilities
Cash 72,000 + 50,000 Accounts Payable 20,000
Clothes (Inventories) 50000 - 25000 Notes Payable 10,000
High End Clothes 5,000 Accrued Expense (Electricity) 1000
Prepaid Expenses 3,000 - 1000
Current Assets 1,54000 Current Liability 31,000
Long Term Debt 2,00000
Total Liabilities 2,31,000
Computer 20,000 Retained Earnings 13,000
Tempo 80,000 Total Equity 13,000
Depreciation (10,000)
Total Fixed Assets 90,000
Total Asset side 2,44,000 Total Liabilities side 2,44,000
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Constructing a Balance Sheet
Sales 50,000
COGS 25,000
Depreciation Cost 10,000
Internet Expenses 1,000
Electricity Expenses (to be paid 1,000
at the end of quarter)
Interest Expense 1,000
Profit 12,000
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Constructing a Balance Sheet
Assets Liabilities
Cash 72,000 + 50,000 - Accounts Payable 20,000
1000
Clothes (Inventories) 50000 - 25000 Notes Payable 10,000
High End Clothes 5,000 Accrued Expense (Electricity) 1000
Prepaid Expenses 3,000 - 1000
Current Assets 1,53000 Current Liability 31,000
Long Term Debt 2,00000
Total Liabilities 2,31,000
Computer 20,000 Retained Earnings 12,000
Tempo 80,000 Total Equity 12,000
Depreciation (10,000)
Total Fixed Assets 90,000
Total Asset side 2,43,000 Total Liabilities side 2,43,000
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Constructing a Balance Sheet
Numerical 5: Following information is given
Cash: $10,000
Accounts receivable: $20,000
Inventory: $14,000
Prepaid expenses: $3,000 28,000
Property, plant, and equipment: $35,000
Accumulated depreciation: $2,000
Accounts payable: $5,000
Accrued expenses: $6,000
Short-term notes: $7,000
Long-term notes: $10,000
Capital stock: $40,000
Retained earnings: $12,000
What are the company’s total liabilities?
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Some Additional Terms
Preferred Stock = 5000
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Constructing a Balance Sheet
Assets Liabilities
Cash 72,000 + 50,000 - Accounts Payable 20,000
1000 + 5000
Clothes (Inventories) 50000 - 25000 Notes Payable 10,000
High End Clothes 5,000 Accrued Expense (Electricity) 1000
Prepaid Expenses 3,000 - 1000
Current Assets 1,58000 Current Liability 31,000
Long Term Debt 2,00000
Total Liabilities 2,31,000
Computer 20,000 Retained Earnings 12,000
Tempo 80,000 Preferred Stock 5,000
Depreciation (10,000) Total Equity 17,000
Total Fixed Assets 90,000
Total Asset side 2,48,000 Total Liabilities side 2,48,000
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Common Stock
Common Stock
Common Stock at par Value Additional Paid-Up Capital
Suppose Company Issues 100 shares of Face value 10 at Rs. 50
Common Stock at par Value = Additional Paid up Capital=
100* 10 = 1000 100*(50-10) = 4000
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Constructing a Balance Sheet
Assets Liabilities
Cash 72,000 + 50,000 - Accounts Payable 20,000
1000 + 5000 + 5000
Clothes (Inventories) 50000 - 25000 Notes Payable 10,000
High End Clothes 5,000 Accrued Expense (Electricity) 1000
Prepaid Expenses 3,000 - 1000
Current Assets 1,63000 Current Liability 31,000
Long Term Debt 2,00000
Total Liabilities 2,31,000
Computer 20,000 Retained Earnings 12,000
Tempo 80,000 Preferred Stock 5,000
Depreciation (10,000) Common Stock (Par Value) 1000
Total Fixed Assets 90,000 Additional Paid up Capital 4000
Total Equity 22,000
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Total Asset side 2,53,000 Total Liabilities side http://www.edutap.co.in/
2,53,000
Learn Anytime, Anywhere
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Income Statement and Balance Sheet – Video 3
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Constructing a Balance Sheet
Assets Liabilities
Cash 72,000 + 50,000 -1000 Accounts Payable 20,000
+ 5000 + 5000
Clothes (Inventories) 50000 - 25000 Notes Payable 10,000 Assets = Liabilities
High End Clothes 5,000 Accrued Expense (Electricity) 1000
Prepaid Expenses 3,000 - 1000
Current Assets 1,63000 Current Liability 31,000
Long Term Debt 2,00000 Assets = Liabilities +
Total Liabilities 2,31,000 Shareholder’s Equity
Computer 20,000 Retained Earnings 12,000
Tempo 80,000 Preferred Stock 5,000
Depreciation (10,000) Common Stock (Par Value) 1000
Total Fixed Assets 90,000 Additional Paid up Capital 4000
Total Equity 22,000
Total Asset side 2,53,000 Total Liabilities side 2,53,000
Another View to Balance Sheet
This can be used to meet
issuance expenditure like
payment of underwriter’s or
merchant bankers fee or to issue
bonus shares
Another View to Balance Sheet
Profit accumulated till last year was 25 and this year’s Profit is 7.But suppose you are distributing a dividend
of Re 2 then your retained earnings for this year would be (7-2) = 5
Total Retained Earnings = 25 + 5 = 30
Another View to Balance Sheet
Another View to Balance Sheet
Suppose they distribute 5 from this 30 of retained earnings to Capital reserves and 5 to General Reserve then
Capital Reserve and General Reserve would show 5 each and Retained earnings will show 20
Another View to Balance Sheet
Capital Reserves is the money reserved
from Retained earnings for Capital
Investment. Sometimes you do
revaluation of your assets and you find
that assets like land has increased in value,
so in that case the increase in value of
assets due to revaluation will go to tis
reserve. This reserve cannot be used to
issue dividends or Bonus shares. This can
be used for making capital investments
Another View to Balance Sheet
General Reserves are free reserves which
can be used for anything. The money in
General Reserves is also transferred from
the Retained Earnings.
Types of Share Capital
Types of Share Capital
Types of Share Capital
Types of Share Capital
Types of Share Capital
Types of Share Capital
Types of Share Capital
Types of Share Capital
Types of Share Capital
Types of Share Capital
Types of Share Capital
Types of Share Capital
Another Format of Balance Sheet
Another Format of Balance Sheet
Another Format of Balance Sheet
Another Format of Balance Sheet
Book Value would be high when
1) Fixed Assets are more
2) Liabilities are More
3) High Reserves and SurPlus
4) Gross Assets are more
Ans: (3)
Book Value = (Assets – Liabilities) / Number of Shares
Another Format of Balance Sheet
If more loans are borrowed from the bank and used to invest in Land then which of the following would increase?
1) Capital Employed
2) Fixed Assets
3) Shareholder’s Equity
4) Long Term debt
5) 1 and 2
6) 1,2 and 4
Ans: 6
Another Format of Balance Sheet
If a company bought a land and then after 5 years its at a value increases five times than the acquisition value then
where it would be shown in the liabilities side
1) Long Term Debt
2) Retained Earnings
3) General Reserve
4) Capital Reserve
Ans: 4
Another Format of Balance Sheet
Which of the following is True?
1) Share Capital can Increase over a period of time
2) Share Capital can decrease over a period of time
3) Share Capital can both increase and Decrease over a period of time
4) None of the above as share capital remains constant
Ans: 3
Another Format of Balance Sheet
Thanks
Financial Ratios – Video 1
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Ratios
Numerical?
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Concept of Ratio
Earn = 10,000 Earn = 20,000
Spend = 5000 Spend = 8000
Spend/Earn Ratio = 1/2 = 0.5 Spend/Earn Ratio = 2/5 = 0.4
Types of Ratios
1. Liquidity Ratios
2. Leverage Ratios. Also known as Solvency Ratios or Capital
Structure Ratios
3. Profitability Ratios
4. Activity Ratios
Liquidity Ratios
How Quickly you can convert
Liquidity
into assets into cash
Liquidity Ratios
Liquidity Ratios Ability to meet its Current Obligations
Current Ratio
Current Assets Current Liabilities
(Cash or get Converted into (Obligations maturing with
Cash with in 1 year) in 1 year)
1. Cash 1. Creditors
2. Market Securities 2. Bills Payable
3. Debtors 3. Accrued Expense
4. Inventories 4. Short Term bank Loan
5. Prepaid Expenses 5. Income Tax Liability
6. Long term debt
maturing in current year
Current Ratio
A ratio of > one means that the firm has more current assets than current claims against them
As a conventional rule, a current ratio of 2 to 1 or more is considered satisfactory
Should not be
followed Blindly
1. Cash
2. Market Securities
3. Debtors
4. Inventories
5. Prepaid Expenses
Current Ratio - Example
Solution:
Current Assets = Inventories + Trade Receivables + Advance Tax + Cash and Cash Equivalents
Current Assets = 50,000 + 50,000 + 4,000 + 30,000 = 1,34,000
Current Liabilities = Trades Payable + Short Term Borrowings = 1,04,000
Current Ratio = 1,34,000/1,04,000 = 1.29
Liquidity Ratios
Liquidity Ratios Ability to meet its Current Obligations
Quick Ratio ( Acid-Test Ratio or Liquid Ratio)
Current Assets
(Cash or get Converted into Quick Assets
Cash with in 1 year)
1. Cash
2. Market Securities 1. Cash
3. Debtors 2. Market Securities
4. Inventories 3. Debtors
5. Prepaid Expenses
Quick Ratio ( Acid-Test Ratio) - Example
Current Assets = Inventories + Trade Receivables + Advance Tax + Cash and Cash Equivalents
Current Assets = 50,000 + 50,000 + 4,000 + 30,000 = 1,34,000
Current Liabilities = Trades Payable + Short Term Borrowings = 1,04,000
Inventories and Advance Tax are not Quick Assets since they cannot be converted into cash easily
Quick Ratio
As a conventional rule, a Quick ratio of 1 to 1 or more is considered satisfactory
Should not be followed Blindly
1. Cash
2. Market Securities
3. Debtors
Liquidity Ratios
Liquidity Ratios Ability to meet its Current Obligations
Cash Ratio (Absolute Liquid Ratio or Super Quick Ratio)
Current Assets
(Cash or get Converted into
Cash with in 1 year)
1. Cash
2. Market Securities
3. Debtors
4. Inventories
5. Prepaid Expenses
Cash Ratio (Absolute Liquid Ratio or Super Quick Ratio)
Example
Cash and Its Equivalents = 30,000
Marketable Securities are not given here so we assume them to be zero. Marketable securities in this
example are generally part of Cash and Cash Equivalents itself
Current Liabilities = 1,04,000
Cash Ratio = 30,000 / 1,04,000 = .28
Cash Ratio (Absolute Liquid Ratio or Super Quick Ratio)
Example
Cash Ratio of 1:2 or 0.5 is generally considered to be good
Value less than 0.5 can be considered risky but there is nothing to be worried about the lack of cash
if the company has reserve borrowing power. In India, firms have credit limits sanctioned from
banks, and can easily draw cash
Value greater than 1 means company has excess Cash which is lying idle and should be put to productive use
such as putting it in a fixed deposit
Liquidity Ratios
Liquidity Ratios Ability to meet its Current Obligations
Interval Measure Ratio (Defensive Interval Ratio)
Average Daily Operating Cash
Quick (Liquid) Assets Outflows
1. Cash
2. Market Securities Average Daily Expenses would be =
3. Debtors Cost of Goods Sold + Selling and Administrative Expenses –
Depreciation
Numerical – Liquidity Ratios
Numerical – Liquidity Ratios
This is an exam level question. Very good question
Total Assets = 3,00,000
Non-Current Assets = 1,00,000 + 1,60,000 = 2,60,000
Current Assets = Total Assets - Non-Current Assets = 40,000
Now we must calculate current liabilities
Total Assets = Total Liability + Shareholder Funds
3,00000 = Total Liability + 2,00,000
Total liability = 1,00,000
Now Total Liability = Current Liability + Non-Current Lability
1,00,000 = Current Liability + 80,000
Current Liability = 20,0000
So Current ratio = 40,000/20,000 = 2
Thanks
Financial Ratios – Video 2
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Types of Ratios
1. Liquidity Ratios
2. Leverage Ratios. Also known as Solvency Ratios or Capital
Structure Ratios
3. Profitability Ratios
4. Activity Ratios
Leverage Ratios (Solvency Ratios)
Long Term Creditors
Also known as Solvency
Short Term Creditors like Bond HoldersRatios or Capital Structure
like Bankers Ratios
Short term Financial Long term Financial
Strength Strength
Leverage Ratios (Solvency Ratios)
Debt/Equity Mix Leverage can be double edge
Debt Provided Leverage
sword
Balance Sheet Terms
Balance Sheet Terms
Net Current Assets = Current Assets – Current Liabilities = 2000 – 1000 = 1000
Net Assets = Net Current Assets + Net Fixed Assets = 1000 + 3000 = 4000
Net Assets = Total Assets – Current Liabilities = 5000-1000 =4000
Capital Employed = Total Long-Term Debt + Shareholder Capital = 2000+2000 = 4000
Capital Employed = Current Assets – Current Liabilities + Net Fixed Assets = 2000-1000+3000 = 4000
Capital Employed = Total Assets – Current Liabilities = 5000 -1000 = 4000
Capital Employed = Net Current Assets + Net Fixed Assets = 1000 + 3000 = 4000
Capital Employed = Net Assets = 4000
Balance Sheet Terms
Total Assets = Total Liability + Share Holder Capital = 5000
Total Assets = = Long Term Debt + Current Liabilities + Shareholder Capital = 5000
Leverage Ratios (Solvency Ratios)
Debt/Equity Mix Leverage can be double edge
Debt Provided Leverage
sword
Debt-Equity Ratio
Some say that Debt Equity Ratio
Example - Debt-Equity Ratio
Example: Find the Debt-Equity Ratio for the below data
Solution:
Debt-Equity Ratio would be = 90,00000 / (1500000 + 5,00,000 + 2500000) = 2
Leverage Ratios (Solvency Ratios)
Debt/Equity Mix Leverage can be double edge
Debt Provided Leverage
sword
Debt Ratio
Some say that Debt Equity Ratio = Total Liabilities / Total Assets
Debt Ratio
Example: Find the Debt Ratio for the below data
Solution:
Debt = 70,00000
Total Assets = 70,00000+1,50,000 + 5,00,000 + 2,50,000+20,00000 = 99,00000
Debt ratio would be = 70,00000 / (70,00000+1,50,000 + 5,00,000 + 2,50,000+20,00000) = 70.70%
Leverage Ratios (Solvency Ratios)
Debt/Equity Mix Leverage can be double edge
Debt Provided Leverage
sword
Total Debt Ratio
Example - Total Debt Ratio
Example: Find the Total Debt Ratio for the below data
Solution:
Total Liabilities = 70,00000 + 20,00000 = 90,00000
Total Assets = 70,00000+1,50,000 + 5,00,000 + 2,50,000+20,00000 = 99,00000
Total Debt ratio would be = 70,00000+20,00000 / (70,00000+1,50,000 + 5,00,000 + 2,50,000+20,00000) = 90.90%
Leverage Ratios (Solvency Ratios)
Debt/Equity Mix Leverage can be double edge
Debt Provided Leverage
sword
Proprietary Ratio
Proprietary Ratio
Proprietary Ratio = Shareholders’ Funds/Total Assets
S/H Funds = 10,00,000 + 2,00,000 = 12,00000
Total Assets = 16,40,000
Proprietary Ratio = 12,00,000/16,40,000
Proprietary ratio = 0.73
What does Debt Ratios Imply?
Whatever way the debt ratio is calculated, it shows the extent to which debt financing has been used in the business.
A high ratio means that claims of creditors are greater than those of owners. An elevated level of debt introduces
inflexibility in the firm’s operations due to the increasing interference and pressures from creditors. A high-debt
company can borrow funds on very restrictive terms and conditions. A firm might not be able to pay the interest on
debt when profits are low
A low debt-equity ratio implies a greater claim of owners than creditors. From the point of view of creditors, it
represents a satisfactory situation since a high proportion of equity provides a larger margin of safety for them.
During the periods of low profits, the debt servicing will prove to be less burdensome for a company with low debt–
equity ratio. However, from the shareholders’ point of view, there is a disadvantage during the periods of good
economic activities if the firm employs a low amount of debt. The higher the debt-equity ratio, the larger the
shareholders’ earnings when the cost of debt is less than the firm’s overall rate of return on investment
Leverage Ratios (Solvency Ratios)
Debt/Equity Mix Leverage can be double edge
Debt Provided Leverage
sword
Interest Coverage Ratio
Sometimes a variation of Interest Coverage ratio is used in some books. Since depreciation does not
actually includes any cash outflow from the company, the interest coverage ratio can also be calculated as
below
Interest Coverage Ratio
Example: The firm has an EBIT of 25,00,000 and fixed interest liability is 6,25,000. Find the Interest Coverage Ratio
Solution:
Interest Coverage Ratio = 25,00,000/6,25,000 = 4
Leverage Ratios (Solvency Ratios)
Debt/Equity Mix Leverage can be double edge
Debt Provided Leverage
sword
Preference Capital Coverage Ratio
This ratio is like Interest Coverage Ratio. Here instead of measuring the capability of the firm for paying interest, we
measure the capability of the firm in paying dividends to Preference Share Holders
Leverage Ratios (Solvency Ratios)
Debt/Equity Mix Leverage can be double edge
Debt Provided Leverage
sword
Fixed Payment Coverage Ratio
The limitation of the interest coverage ratio is that it does not consider repayment of loan. Therefore, a more
inclusive ratio—the fixed-Payment coverage—is calculated. It is also known as fixed charge Coverage ratio
Numerical
Example: A firm has operating profit of 4,50,000. The interest which needs to given by the company is 90,000 and
tax liability is 30%. It has to pay a debt of 70,000 during the year and preference dividend of 10,000. The FC ratio in
this case would be
FC ratio = EBIT / [ I + (PR + PD )/ (1-t) ]
I = 90,000
PR = 70,000
PD = 10,000
T = 30% or 0.3
= 4,50,000 / [90,000 + (70,000+10,000) / (1-0.3) ] = 2.2
Numerical on Leverage Ratios
Calculate the Debt-Equity Ratio:
Solution:
Total Liabilities = Non-Current Liabilities + Current Liabilities = 10,00000
Equity = Shareholder Capital = 12,00000+2,00000+1,00000 = 15,00000
Debt-Equity Ratio = 10,00000/15,00000 = 2/3 = .66 or 66%
Numerical on Leverage Ratios
Calculate the Debt-Equity Ratio:
Solution:
Total Liabilities = Non-Current Liabilities + Current Liabilities
= 1,50,000 + 1,50,000 = 3,00000
Equity = 10,00000+1,00000 = 11,00000
Debt-Equity Ratio = 3,00000/11,00000 = .2727 = 27.27%
Numerical on Leverage Ratios
From the following information, calculate Debt Equity Ratio,
Proprietary Ratio, and Debt to Capital Employed Ratio:
Solution:
Debt Equity Ratio
Total Liabilities = 2,00000
Equity = 4,00000 + 1,00000 = 5,00000
Ratio = 2,00000 / 50,00000 = 0.40
Debt to Capital Employed Ratio
Debt = Long Term Debt + Short Term Debt + Current Portion of Long-term Debt = 1,50,0000
Capital Employed = Long Term Debt + Shareholder Funds = 1,50,000 + 500000 = 6,50,000
Debt-Capital Employed Ratio = 1,50,000 / 6,50,000 = 0.23
Numerical on Leverage Ratios
From the following information, calculate Debt Equity Ratio,
Proprietary Ratio, and Debt to Capital Employed Ratio:
Solution:
Proprietary Ratio
Shareholder Funds = 5,00,000
Total Assets = 7,00000
Proprietary Ratio = Shareholder Funds/Total Assets = 5,00000/7,00000 = .71
Thanks
Financial Ratios – Video 3
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Types of Ratios
1. Liquidity Ratios
2. Leverage Ratios. Also known as Solvency Ratios or Capital
Structure Ratios
3. Profitability Ratios
4. Activity Ratios
Activity Ratios (Turnover Ratios)
Invest in Company to generate Sales
Owners and Creditors and Profits
They indicate the speed with which
Better the management of assets
assets are being converted or turned
better the Sales/Profits
over into sales
Activity Ratios (Turnover Ratios)
Inventory Turnover Ratio
When the numbers of days in a year (say, 360) are divided by inventory turnover we obtain days of inventory holdings (DIH):
Inventory Turnover Ratio (Example)
Example: A firm has opening stock of 2,00,000 and closing stock of 2,50,000. The net sales made by the company is
12,00000. Gross Profit is 25% of the selling price. Calculate the Inventory turnover ratio
Solution:
Gross profit = Sales - Cost of Goods Sold
Cost of Goods Sold = Sales – Gross Profit
Cost of Goods Sold = 12,00000 – 25% of 12,00000
Cost of Goods Sold = 12,00000 – 3,00000
Cost of Goods Sold = 9,00000
Inventory = Average of Opening and Closing Inventory = ( 2,00000 + 2,50,000) /2= 2,25,000
Inventory Turnover ratio = 9,00000/2,25000 = 4
If we calculate DIH = 360/Inventory turnover = 360/4 = 90 days
Inventory Turnover Ratio
Interpretation:
1. The inventory turnover shows how rapidly the inventory is turning into receivable through sales.
2. Generally, a high inventory turnover is indicative of good inventory management. A low inventory turnover implies
excessive inventory levels than warranted by production and sales activities, or a slow-moving or obsolete inventory. A
high level of sluggish inventory amounts to unnecessary tie-up of funds, reduced profit and increased costs.
3. In the above example Inventory turnover of 4 means that company replenishes it inventory 4 times a year or it converts
inventory into finished goods 4 times a year
4. DIH of 4 means inventory is held for 90 days after which it is converted into finished goods
Activity Ratios (Turnover Ratios)
DebtorsTurnover
Debtors turnover indicates the number of times debtors turnover each year. Generally, the higher the value of debtors
turnover, the more efficient is the management of credit.
We can also calculate the average collection period by using the below formula. Average Collection Period indicates how
many days it takes to collect money from Debtors
DebtorsTurnover
Example: A firm has total sales of 10,00000 in a year. Out of this 80% sales are made on credit. The firm has opening
and closing of debtors of amount 1,50,000 and 1,70,000. Find out the receivables Turnover Ratio
Solution:
Total Sales = 10,00000
Credit Sales = 80% of 10,00000 = 8,00000
Average Debtors are = (1,50,000 + 1,70,000)/2 = 1,60,000
Receivables Turover ratio = 8,00000/1,60,000 = 5
Average Collection Period = 360/5 = 72
DebtorsTurnover
Interpretation
1. The average collection period measures the quality of debtors since it indicates the speed of their collection.
2. The shorter the average collection period, the better the quality of debtors, since a short collection period
implies the prompt payments by debtors.
3. The average collection period should be compared against the firm’s credit terms and policy to judge its credit
and collection efficiency. For example, if the credit period granted by a firm is 35 days, and its average collection
period is 50 days, the comparison reveals that the firm’s debtors are outstanding for a longer period than
warranted by the credit period of 35 days. An excessively long collection period implies a very liberal and
inefficient credit and collection performance.
Activity Ratios (Turnover Ratios)
Payable or Creditors Turnover Ratio
Payables turnover indicates the number of times Creditors turnover each year
Another measure which can be used is Average Payment Period.
Average payment Period indicates the number of days the firm takes to pay its creditors.
Payable or Creditors Turnover Ratio
Example: A firm makes total credit purchase of 5,00,000 during a year and opening and closing of creditors were
50,000 and 80,000. Find the Payable turnover ratio
Solution:
Credit Purchase = 5,00000
Average Payables = (50,000+80,000)/ 2 = 65,000
Payable Turnover Ratio = 5,00000/65,000 = 7.69
So, firm turnovers the creditors 7.69 times a year
Average Payment Period = 360/7.69 = 47.5 Days
This means firm takes 47.5 days to pay the creditors of the company
Payable or Creditors Turnover Ratio
Interpretation
1. One might think that keeping the money of the creditors is good for the company. So, if one can keep money for
longer days the better it is. This means lower the value of Payable turnover the better it would be. But if you keep
money of creditors for a very long period the creditors might not like it and may stop doing the business with the
company. So there needs to be a right balance
Activity Ratios (Turnover Ratios)
Assets Turnover Ratio
A firm’s ability to produce a large volume of sales for a given amount of net assets is the most important aspect of its
operating performance.
Unutilized or under-utilized assets increase the firm’s need for costly financing as well as expenses for maintenance and
upkeep. The net assets turnover should be interpreted cautiously. The net assets in the denominator of the ratio include fixed
assets net of depreciation. Thus, old assets with lower book (depreciated) values may create a misleading impression of high
turnover without any improvement in sales.
Now, Since Net Assets = Net fixed Assets + Net Current Assets
Net Assets Turnover may also be further analyzed by two ratios below
1. Fixed Asset Turnover
2. Net Current Assets Turnover
Assets Turnover Ratio
Assets Turnover Ratio
Assets Turnover Ratio (Example)
From the following information, calculate (i) Net assets turnover, (ii) Fixed assets turnover, and (iii) Working capital
turnover ratios
Revenue from operations for the year 2014-15 were Rs. 30,00,000
Assets Turnover Ratio (Example)
Revenue from operations for the year
2014-15 were Rs. 30,00,000
Assets Turnover Ratio (Example)
Revenue from operations for the year
2014-15 were Rs. 30,00,000
Shareholder Capital = Preference Capital + Share Capital + General Reserve + Retained Earnings
= 4,00,000 + 6,00,000 + 1,00,000 + 3,00,000
= 14,00000
Long term Debt = Debentures +Loans = 2,00,000 + 2,00,000 = 4,00,000
Capital Employed = Shareholder Capital + Long Term Debt
= 14,00,000 + 4,00000 = 18,000000
Net Assets = Capital Employed = 18,00,000
So, Net Assets Turnover = 30,00000 / 18,00000 = 1.67 times
Assets Turnover Ratio (Example)
Revenue from operations for the year
2014-15 were Rs. 30,00,000
Assets Turnover Ratio (Example)
Revenue from operations for the year
2014-15 were Rs. 30,00,000
Working Capital = Current Assets – Current Liabilities
Current Assets = Inventory + Debtor + Bank + Cash = 4,00,000
Current Liabilities = Creditors + Bills Payable + Outstanding Expenses
= 1,40,000 + 50,000 + 10,000 = 2,00,000
Working Capital = 4,00,000 – 2,00,000 = 2,00,000
Working Capital Turnover = 30,00000/2,00000 = 15 times
Numerical Activity Ratios
From the following information, calculate inventory turnover ratio:
Cost of Goods Sold = Inventory in the beginning + Net Purchases + Wages + Carriage – Inventory in End
Cost of Goods Sold = 18,000 + 46,000 + 14,000 + 4,000 – 22,000 = 60,000
Average Inventory = (Beginning Inventory + Closing Inventory / 2
Average Inventory = (18000 + 22000) /2 = 20,000
Inventory Turnover = 60,000/20,000 = 3
Numerical Activity Ratios
From the following information, calculate inventory turnover ratio:
Solution:
Sales = 4,00,000
Gross Profit = 10% of 4,00000 = 40,000
Gross Profit = Sales – Cost of Goods Sold
40,000 = 4,00000 – Cost of Goods Sold
Cost of Goods Sold = 3,60000
Average Inventory = 55,000
Inventory Turnover = 3,60,000 / 55,000 = 6.55 times
Numerical Activity Ratios
Calculate the Trade receivables turnover ratio from the following information:
Numerical Activity Ratios
Calculate the Trade payables turnover ratio from the
following figures:
Thanks
Financial Ratios – Video 4
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Please read
Income Statement and Balance Sheet
In case you have not read
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Types of Ratios
1. Liquidity Ratios
2. Leverage Ratios. Also known as Solvency Ratios or Capital
Structure Ratios
3. Profitability Ratios
4. Activity Ratios
Profitability Ratios
Ultimate output is profitability Everyone is interested in Profitability
Gross Profit Ratio
Gross Profit Ratio (Example)
Following information is available
for the year 2014-15, calculate
gross profit ratio:
Gross Profit Ratio
Interpretation
1. The gross profit margin reflects the efficiency with which management produces each unit
of product. This ratio show profits relative to sales after the deduction of production costs,
and indicate the relation between production costs and selling price.
2. High Gross Profit margin means either you have an advantage to sell at higher price or you
are managing your cost properly
3. Low Gross Profit margin means either you are selling at lower price or you are not
managing your cost properly
Profitability Ratios
Ultimate output is profitability Everyone is interested in Profitability
Net Profit Ratio
Net profit is obtained when operating expenses, interest and taxes are subtracted from the gross profit. The net profit
margin ratio is measured by dividing profit after tax by sales
Net profit margin ratio establishes a relationship between net profit and sales and indicates management’s efficiency in
manufacturing, administering and selling the products. This ratio is the overall measure of the firm’s ability to turn each
rupee sales into net profit. If the net margin is inadequate, the firm will fail to achieve satisfactory return on shareholders’
funds.
Net Profit Ratio
Example: Gross profit ratio of a company was 25%. Its credit revenue from operations was Rs. 20,00,000 and its cash
revenue from operations was 10% of the total revenue from operations. If the indirect expenses of the company were Rs.
50,000, calculate its net profit ratio.
Solution:
Let Total Sales be X
Sale from Cash = 10%
Sale from Credit = 90% of X = 9/10 X = 20,00,000
X = 20,00000 * 10/9 = 22,22,222
Gross Profit = 25% of 22,22,222 = 5,55,555
Net Profit = Gross Profit – Operating Expenses – Non-Operating Expenses
Indirect Expenses = Operating Expenses + Non-operating Expenses
So, Net Profit = Gross Profit – Indirect Expenses = 5,55,555 – 50,000 = 5,05,555
Net Profit Ratio = 5,05,555/22,22,222 = 22.75 %
Net Profit Ratio
A firm with a high net margin ratio would be in an advantageous position to survive in the
face of falling selling prices, rising costs of production or declining demand for the product.
It would really be difficult for a low net margin firm to withstand these adversities
An analyst will be able to interpret the firm’s profitability more meaningfully if he/she
evaluates both the ratios—gross margin and net margin—jointly. To illustrate, if the gross
profit margin has increased over the years, but the net profit margin has either remained
constant or declined, or has not increased as fast as the gross margin, it implies that the
operating expenses relative to sales have been increasing
Profitability Ratios
Ultimate output is profitability Everyone is interested in Profitability
Operating Expense Ratio
Operating Expense Ratio (Example)
Example: Calculate the Operating Expense Ratio
Solution:
Sales = 3,40,000
Cost of Goods Sold = 1,20,000
Operating Expenses = 80,000 + 40,000 = 1,20,000
Operating Expense Ratio = (1,20,000 + 1,20,000) / 3,40,000 = 70.59%
Operating Expense Ratio
Interpretation: A higher operating expenses ratio is unfavorable since it will leave a small amount of operating
income to meet interest, dividends, etc.
Profitability Ratios
Ultimate output is profitability Everyone is interested in Profitability
Operating Profit Ratio
Also, Operating Profit Ratio = 1 - Operating Expense Ratio
Operating Profit Ratio (Example)
Solution:
Sales = 3,40,000
Cost of Goods Sold = 1,20,000
Operating Expenses = 80,000 + 40,000 = 1,20,000
Operating Profit = Sales – Cost of Goods Sold - Operating Expenses = 1,00000
So Operating Profit Ratio = 1,00000/3,40,000 = 29.41%
Other way to solve this question
In the earlier Example we calculated operating expense ratio = 70.59%
So, if we go by the rule
Operating Profit Ratio = 1 - Operating Expense Ratio then
Operating Profit Ratio = 1 - .7059 = .2941 = 29.41 %
Profitability Ratios
Ultimate output is profitability Everyone is interested in Profitability
Return on Investment
The term investment may refer to total assets or net assets. You must remember that
Net Assets = Total Assets – Current Liabilities
Return on Investment
The term investment may refer to total assets or net assets. You must remember that
Net Assets = Total Assets – Current Liabilities
Profitability Ratios
Ultimate output is profitability Everyone is interested in Profitability
Return on Assets
Profitability Ratios
Ultimate output is profitability Everyone is interested in Profitability
Return on Capital Employed
Confused – Which Formula to use when?
Profitability Ratios
Ultimate output is profitability Everyone is interested in Profitability
Return on Shareholder Equity
1. ROE indicates how well the firm has used the resources of owners. In fact, this ratio is one of the most important
relationships in financial analysis.
2. The earning of a satisfactory return is the most desirable objective of a business. The ratio of net profit to
owners’ equity reflects the extent to which this objective has been accomplished.
3. This ratio is, thus, of great interest to the present as well as the prospective shareholders and of great concern to
the management, which has the responsibility of maximizing the owners’ welfare.
Profitability Ratios
Ultimate output is profitability Everyone is interested in Profitability
Earning Per Share
1. EPS calculations made over the years indicate whether the firm’s earnings power on per-share basis has changed
over that period.
2. The EPS of the company should be compared with the industry average and the earnings per share of other firms.
3. EPS simply shows the profitability of the firm on a per-share basis; it does not reflect how much is paid as dividend
and how much is retained in the business. But as a profitability index, it is a valuable and widely used ratio
Profitability Ratios
Ultimate output is profitability Everyone is interested in Profitability
Dividend Per Share
The net profits after taxes belong to shareholders. But the income, which they really receive, is the amount of earnings
distributed as cash dividends. Therefore, many present and potential investors may be interested in DPS, rather than EPS.
DPS is the earnings distributed to ordinary shareholders divided by the number of ordinary shares outstanding
Profitability Ratios
Ultimate output is profitability Everyone is interested in Profitability
Dividend Pay out Ratio
The dividend-payout ratio or simply payout ratio is DPS (or total equity dividends) divided by the EPS (or profit after tax):
Profitability Ratios
Ultimate output is profitability Everyone is interested in Profitability
P/E Ratio
Price/Earnings Ratio is ratio of Price of a share to Earning Per Share. Price of Share is also known as Market Value of Share
Profitability Ratios
Ultimate output is profitability Everyone is interested in Profitability
Market to Book Value Ratio
Market value-to-book value (M/B) ratio is the ratio of share price to book value per share
Numerical
From the following details, calculate Return on Shareholders’ Funds, EPS, Book value per share and P/E ratio if
the market price of the share is Rs. 34 and the net profit after tax was Rs. 1,50,000
Solution:
PAT = 1,50,000
Return on Shareholders’ Funds = PAT/Shareholder Funds
Now Shareholder Funds = Equity + Preference + General Reserve
= 4,00000+1,00000+1,84,000 = 6,84,000
So, Return on Shareholder Funds = 1,50,000/6,84,000 = 21.93%
Numerical
From the following details, calculate Return on Shareholders’ Funds, EPS, Book value per share and P/E ratio if
the market price of the share is Rs. 34 and the net profit after tax was Rs. 1,50,000.
EPS = (PAT – Preference Dividend) /Number of Shares
Preference Dividend = 12% of 1,00,000 = 12000
Now Number of Shares = Total Value of Shares/ Value per share = 4,00,000/10 = 40,000
EPS = (150,000 – 12000) /40,000 = 3.45
Numerical
From the following details, calculate Return on Shareholders’ Funds, EPS, Book value per share and P/E ratio if
the market price of the share is Rs. 34 and the net profit after tax was Rs. 1,50,000.
Book Value Per Share = (Shareholder Equity – Preference Capital) / Number of Shares
= (6,84,000 - 1,00,000)/40,000
= 14.60
Numerical
From the following details, calculate Return on Shareholders’ Funds, EPS, Book value per share and P/E ratio if
the market price of the share is Rs. 34 and the net profit after tax was Rs. 1,50,000.
P/E = Price of Share / Earning Per Share = 34/3.45 = 9.86 times
Numerical
From the following information calculate (i) Earning per share (ii) Book value per share (iii) Dividend payout ratio (iv) Price
earnings ratio
Solution:
PAT = 1,75,000
Number of Shares = 70,000
EPS = PAT/Number of Shares = 1,75,000/70,000 = 2.50
Book Value of Share = (Equity Capital + PAT) /Number of Shares = (7,00,000 + 1,75,000)/70,000 = 12.50
Numerical
From the following information calculate (i) Earning per share (ii) Book value per share (iii) Dividend payout ratio (iv) Price
earnings ratio
Solution:
Dividend Payout = DPS/EPS
Now, DPS = 15% face value = 15% of 10 = 1.5
So, dividend Payout = DPS/EPS = 1.5/2.5 = 0.6
Price Earnings Ratio = Price of share/EPS = 13/2.5 = 5.20
Thanks
Financial Ratios – Video 5
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Types of Ratios
1. Liquidity Ratios
2. Leverage Ratios. Also known as Solvency Ratios or Capital
Structure Ratios
3. Profitability Ratios
4. Activity Ratios
Du Point Analysis
ROE = PAT / Shareholder Equity
ROE = (Net Income or PAT /Revenues) x (Revenues/Total Assets) x (Total Assets/ Shareholders' Equity)
Profit Margin Total Asset Turnover Equity Multiplier
Du Point Analysis
Using the formula above, we can calculate that Company XYZ's ROE is:
ROE = ($2,000/$10,000) x ($10,000/$25,000) x ($25,000/$5,000) = 0.20 x 0.40 x 5 = 0.40 or 40%
The DuPont analysis analyzes the numbers shown in profit margin ($2,000/$10,000), total asset turnover
($10,000/$25,000) and leverage factor ($25,000/$5,000) to find Company XYZ's ROE.
Du Point Analysis
WHY IT MATTERS:
The DuPont Analysis is important determines what is driving a company's ROE
1. Profit margin shows the operating efficiency
2. Asset turnover shows the asset use efficiency
3. Leverage factor shows how much leverage is being used.
Capital Gearing Ratio
Capital Gearing Ratio = Common Stockholders’ Equity / Fixed Interest-bearing funds
Common Stockholders’ Equity: We will take the shareholders’ equity and deduct the preferred stock (if any).
Fixed Interest-bearing funds: Here the list is long. We need to include a lot of components on which the companies pay
interest. For example, we will include long term loans/debts, debentures, bonds and preferred stock. Please remember the
interest/Dividend bearing component might be a component in current liability or long-term liability or Capital (Preferred
Stock)
By analyzing the capital gearing ratio, you get to know the exact
proportion of capital structure Companies which are low geared tend to pay less
interests or dividends ensuring the interest of
The firm’s capital can either be low geared or high geared. When a common stock holders. On the other hands, high
firm’s capital is composed of more common stocks rather than geared companies need to give more interest
other fixed interest or dividend bearing funds, it’s said to have been increasing the risk of investors. For this reason, banks
low geared. On the other hand, when the firm’s capital consists of and financial institutions don’t want to lend money
less common stocks and more of interest or dividend bearing funds, to the companies which are already high geared.
it’s said to be high geared.
Capital Gearing Ratio
Solution:
Common Stockholders’ Equity = 3,00000
Fixed Interest-bearing funds = Long term Debt + Short Term Debt = 2,00000 + 3,00000 = 5,00000
Ratio = 3,00000/5,00000 = 0.6
Capital Gearing Ratio
Solution:
Common Stockholders’ Equity = Shareholder Equity – Preferred Stock = 840000 – 160000 = 680000
Fixed Interest/Dividend-bearing funds = Preferred Stock + Bank Overdraft + Short Term Debt + Long Term Debt =
160000 + 50000 + 600000 + 300000 = 11,10000
Ratio = 680000/11,10000 = .61
Thanks
CASH FLOW STATEMENT
VIDEO 1
By Edutap - http://www.edutap.co.in/
Introduction
Sales in Cash 50,000
Sales on Credit 50,000
Total Sales 1,00,000
Expenses 50,000
Profit 50,000
Cash = zero
Cash Flow
Sales 1,00,000
Cost of Goods Sold 15000
Depreciation 5000
Operating Profit 80,000
Interest 50,000
Profit before Tax 30,000
Tax 9,000
PAT 21,000 Cash = 26,000
Balance Sheet Information
Last Year This Year
Trade Payables = 5,000 Trade Payables = 6,000
Increase in Cash 1000
Accounts Receivables = 5,000 Account Receivables = 4,000
Increase in Cash 1000
Inventory = 2,000 Inventory = 4,000 Decrease in Cash 2000
Outstanding Employee Salary = 6,000 Outstanding Employee Salary = 3,000
Decrease in Cash 3000
Cash = 10,000 Cash = ?
Net Decrease in Cash = 3000
Sales 1,00,000 Cash = 26,000
Cost of Goods Sold 15000
Depreciation 5000 Net Decrease in Cash = 3000
Operating Profit 80,000
Interest 50,000 Net Cash = 23000
Profit before Tax 30,000
Cash from Previous Year =10,000
Tax 9,000
PAT 21,000
Total Cash = 23000+10,000 = 33,000
Concept Check
Salaries of Employees
Buying Raw material
Buying Shares of another company
Raising money by issuing shares of the company
Interest received on Bonds bought by company of another company
Interest given on Loan taken by the company
Dividend received from investment on shares of another company
Dividend given to shareholders of the company
Principal payment on loan taken for buying Machinery
Cash Flow from Operating Activities
Cash Flow from Operating Activities
Cash Flow from Operating Activities
Interest from Investments in Bonds = 8000
Income Tax = 12000
Dividend given to Shareholders = 5000
Cash Flow from
Operating Activities
Interest from Investments in Bonds = 8000
Income Tax = 12000
Dividend given to Shareholders = 5000
Cash Flow
Sales 1,00,000
Cost of Goods Sold 15000
Depreciation 5000
Operating Profit 80,000
Interest 50,000
Profit before Tax 30,000
Tax 9,000
PAT 21,000 Cash = 26,000
Balance Sheet Information
Last Year This Year
Trade Payables = 5,000 Trade Payables = 6,000
Increase in Cash 1000
Accounts Receivables = 5,000 Account Receivables = 4,000
Increase in Cash 1000
Inventory = 2,000 Inventory = 4,000 Decrease in Cash 2000
Outstanding Employee Salary = 6,000 Outstanding Employee Salary = 3,000
Decrease in Cash 3000
Cash = 10,000 Cash = ?
Net Decrease in Cash = 3000
Sales 1,00,000 Cash = 26,000
Cost of Goods Sold 15000
Depreciation 5000 Net Decrease in Cash = 3000
Operating Profit 80,000
Interest 50,000 Net Cash = 23000
Profit before Tax 30,000
Cash from Previous Year =10,000
Tax 9,000
PAT 21,000
Total Cash = 23000+10,000 = 33,000
Cash Flow
Sales 1,00,000
Cost of Goods Sold 15000 Cash = 26000
Depreciation 5000
Operating Profit 80,000
Interest 50,000 Cash = 76000
Profit before Tax 30,000
Tax 9,000
PAT 21,000
Balance Sheet Information
Last Year This Year
Trade Payables = 5,000 Trade Payables = 6,000
Increase in Cash 1000
Accounts Receivables = 5,000 Account Receivables = 4,000
Increase in Cash 1000
Inventory = 2,000 Inventory = 4,000 Decrease in Cash 2000
Outstanding Employee Salary = 6,000 Outstanding Employee Salary = 3,000
Decrease in Cash 3000
Cash = 10,000 Cash = ?
Net Decrease in Cash = 3000
Cash Flow
Sales 1,00,000
Cost of Goods Sold 15000 Cash = 26000
Depreciation 5000
Operating Profit 80,000
Interest 50,000 Cash = 76000
Profit before Tax 30,000
Tax 9,000
Cash form Operating = 76000 -3000 = 73000
PAT 21,000
Cash Flow
Sales 1,00,000
Cost of Goods Sold 15000 Cash from financing activity= -50000
Depreciation 5000
Operating Profit 80,000
Interest 50,000
Net Cash = 73000 – 50000 =
Profit before Tax 30,000 23000
Tax 9,000
PAT 21,000
Cash Flow form Investing Activities
Cash Flow from Financing Activities
Revenues 125000
Operating Expenses 85000 PBT = 30,000
Operating Profit 40,000
Cash including Dep = 39,000
Depreciation 9000
Interest Less Interest (Net Cash flow 1000 Cash including Interest addition = 40000
from Financing)= 55000
PBT 30,000 Cash from Operating Activity
Income Tax 6000 = 9000
Net Profit 24000 Net Cash from Operating=
Dividend Less Dividend= 56000 4000 3000
Last Year This Year
Cash =0 Cash = ?
Accounts Receivable = 0 Accounts Receivable = 36000 Decrease = 36,000
Accounts Payable = 0 Accounts Payable = 5000 Increase = 5,000
Cash from Equity= 60,000
Equity = 0 Equity = 60,000
Retained Earnings = 0 Retained Earnings =20,000
Machinery = 0 Machinery =10,000 Net Cash Flow from Investment =
-10,000
Thanks
Accounting for Share Capital Transactions
Basics of Equity and Types of Share Capital
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Introduction to Equity
Person A
Person B
Company is doing Well, So company needs
money for expansion
Introduction to Equity
Person A – 100
Shares
Person B – 100
Sells
Shares/Equity/Stock
Shares
to these people
Person C Person D Person E
Shareholders/Owners
Introduction to Equity
Person A – 70 Person B – 70 Person C – Person D – Person E –
Shares Shares 20 Shares 20 Shares 20 Shares
Inside Outside
Rule of 1 Share = 1 Vote
Part Ownership
A Stake would be 70/200 = 35%
C Stake Would be = 20/200 = 10%
Face Value of Share
The nominal vale printed on the share
Face Value
certificate is called
Face Value is Different
From Market Value
Face Value can be 10 but
Market Value can be 100
Concept Check
Equity shareholders are:
(i) creditors
(ii) owners
(iii) customers of the company
(iv) none of the above
Ans: Option 2
What is Share Capital
Amount Contributed Share Capital
by Shareholders
Suppose Company Issues 100 Shares of face value 10 at Rs. 10, then share Capital would be = 100*10 = 1000
Balance Sheet
Liabilities Assets
Share Capital -> 1000 Cash -> 100
What is Share Capital – Types of Shares
There are 2 types of Shares
1) Preference Shares
2) Equity Shares (Ordinary Shares)
According to Section 43 of the Companies Act, 2013
persons holding preference shares, called preference
shareholders, are assured of a preferential dividend at a
fixed rate.
Preference Share Holders also have first right to recover
their money vis-à-vis the Equity Shareholders
What is Share Capital and Types of Shares
Categories of Share Capital
Categories of Share Capital
Authorized Capital
Issued Capital
Subscribed Capital
Called Up Capital and Uncalled Capital
Paid-Up Capital
Reserve Capital
Categories of Share Capital
Authorized Share Capital (Nominal Share Capital) : Authorized capital is the amount of share capital which a company is
authorized to issue by its Memorandum of Association. The company cannot raise more than the amount of capital as
specified in the Memorandum of Association. It is also called Nominal or Registered capital
Example: Suppose Company A has authorized Capital of Rs. 100
Can company increase its Authorized Capital?
The answer is yes. Company can increase its Authorized capital, but it has to follow the process laid down in the company
Law
Categories of Share Capital
Issued Capital: The part of Authorized share capital that has been issued to investors
Example: Suppose Company A has authorized Capital of Rs. 100 but it has issued 10 Shares of face value 4 at Rs. 4 to
investors then issued capital is 40
Categories of Share Capital
Subscribed Capital: It is that part of the issued capital which has been subscribed by the public.
Case : When all issued Capital is Subscribed
Example:
Shares Subscribed are worth Rs. 40 (10 Shares with face value of 4) . So in this case Issued Capital = Subscribed Capital
Case : When all issued Capital is not Subscribed
Example:
Shares Subscribed are worth Rs. 20 (5 Shares with face value of 4). So in this case Issued Capital > Subscribed Capital
But once the subscription process ends, company will ultimately say that only capital worth Rs. 20 is issued and 80 is unissued
Categories of Share Capital
Subscribed Capital: It is that part of the issued capital which has been subscribed by the public.
Case : When all issued Capital is not Subscribed
Example:
Shares Subscribed are worth Rs. 20 (5 Shares with face value of 4). So in this case Issued Capital > Subscribed Capital
But once the subscription process ends, company will ultimately say that only capital worth Rs. 20 is issued and 80 is unissued
Regulation by SEBI ->Min 90% of the issued capital must be subscribed
If this condition is not satisfied, the company shall forthwith refund the entire subscription amount received with in 15
days of from the date of closure of subscription. If there is delay, then company shall be liable to pay the amount with
interest at the rate of 15%
Categories of Share Capital
Called Up Capital : It is that part of the subscribed capital which has been called up on the shares. The remaining part is
called Uncalled Capital
The company may decide to call the entire amount or part of the face value of the shares.
For example, if the face value (also called nominal value) of a share allotted is Rs. 10 and the company has called up only Rs.
7 per share, in that scenario, the called-up capital is Rs. 7 per share. The remaining Rs. 3 may be collected from its
shareholders as and when needed.
Example:
Called Up Capital Can be = Subscribed Capital
Company Calls up Rs. 4 per Share From face value of 4. So Called up Capital = 10 Shares * 4 = 40
Uncalled Capital = zero
Or
Called Up Capital < Subscribed Capital
Company Calls up Rs. 2 per Share From face value of 4. So Called up Capital = 10 Shares * 2 = 20
Uncalled Capital = 40 – 20 = 20
Categories of Share Capital
Paid Up Capital: It is that portion of the called-up capital which has been received from the shareholders
Example: When the shareholders have paid all the call amount, the called-up capital is the same to the paid-up capital. If
any of the shareholders has not paid amount on calls, such an amount may be called as ‘calls in arrears.
Therefore, paid up capital = Called-up capital - call in arrears
Example:
Suppose from the Called-up Capital of 40 only 32 is paid, then
Called up Capital = 40
Paid-Up Capital = 32
Calls in Arrears = 8
Paid up Capital (40) = Called Up Capital (32) – Calls in Arrears (8)
Categories of Share Capital
Reserve Capital: As per Section 65 of the Companies Act, 2013 some uncalled capital is kept as reserve and is only called in
case of winding up of the company
Such uncalled amount is called ‘Reserve Capital’ of the company. It is available only for the creditors on winding up of the
company.
Example:
Suppose Called Up capital out of subscribed capital of 40 was 20. Then uncalled capital = 20
Now a part of this Uncalled Capital say 10 is kept as reserve and is only called in case of winding up of the company. So this
10 out of uncalled capital of 20 would be called reserve Capital
Share Capital – Summarized View
Shares would be subscribed and Fully Paid up only when
Subscribed Capital = Paid up Capital
Example:
Example: Example:
Subscribed Capital = 40
Subscribed Capital = 40 Subscribed Capital = 40
Called Up Capital = 30
Called Up Capital = 40 Called Up Capital = 40
Paid up Capital = 30
Paid up Capital = 30 Paid up Capital = 40
In this case these would not be fully
In this case these would In this case these would
paid up though all the called-up
not be fully paid up be fully paid up
capital has been paid up
Categories of Share Capital
Issue of Shares (Process)
Issue of Shares (Process)
Issued of Prospectus Receipt of Applications Allotment of Shares
Company tell people People Submit their Company Allots shares to
about its business Plans Applications for people
and other details subscribing to the shares
of the company
Issue of Shares (Process) – Collection of Money
Receipt of Applications Allotment of Shares First Call Second Call Last Call
Allotment Money
Application Money
Second Installment for Collected through Calls
First Installment for share
Shares
Many a times all the money due (Full Paid up Capital) for
shares is collected during allotment itself and nothing is
kept to be called
Example – Categories of Share Capital
Solution
Amount
Authorized Capital 40,00000
Issued Capital (200000*10) 20,00000
Subscribed Capital (200000*10) 20,00000
Called Up Capital (200000* 8) 1600000
Calls in Arrears (2000*3) 6000
Paid Up Capital (198000*8) 1594000
1. Called up Capital is 8 because final call of Rs. 2 is not made
2. This is Subscribed Capital Not Fully Paid Up
Example – Categories of Share Capital
Solution
Amount
Authorized Capital 40,00000
Balance Sheet
Issued Capital (200000*10) 20,00000
Liabilities Assets
Subscribed Capital (200000*10) 20,00000
Share Capital -> 1594000 Cash -> 1594000
Called Up Capital (200000* 8) 1600000
Calls in Arrears (2000*3) 6000
Paid Up Capital (198000*8) 1594000
Concept Check
Nominal share capital is :
(i) that part of the authorized capital which is issued by the company.
(ii) the amount of capital which is applied for by the prospective shareholders.
(iii) the maximum amount of share capital which a company is authorized to issue.
(iv) the amount actually paid by the shareholders
Ans: Option 3
If issued capital is 1 lakh and only 80% is subscribed, then what can be the maximum paid up capital
(i) 70,000
(ii) 80,000
(iii) 90,000
(iv) 1,00000
Ans: Option 2
Concept Check
Issued capital is 1 lakh and only 80% is subscribed. 50% of the subscribed capital is called up but only 90% of the Called-up
capital has been paid up. In the Balance sheet of company what will the amount of share Capital recorded?
(i) 25000
(ii) 40000
(iii) 36000
(iv) 60000
Ans: Option 3
Preference shareholders have
(A) Preferential right as to dividend only
(B) Preferential right in the management
(C) Preferential right as to repayment of capital at the time of liquidation of the company
(D) Preferential right as to dividend and repayment of capital at the time of liquidation of the Company
Ans: Option D
Concept Check
Reserve Capital is :
(A) Subscribed Capital
(B) Capital Reserve
(C) Uncalled Capital
(D) Part of the uncalled capital which may be called only at the time of liquidation of the Company
Ans: Option 4
Which of the following is not shown under the heading ‘Share Capital’ in a Balance Sheet:
(A) Subscribed Capital
(B) Issued Capital
(C) Reserve Capital
(D) Authorized Capital
Ans: Option C
Concept Check
Authorized Capital of a Company is mentioned in :
(A) Memorandum of Association
(B) Articles of Association
(C) Prospectus
(D) Statement in lieu of Prospectus
Ans: Option 1
Which of the following statements is true?
(A) Authorised Capital = Issued Capital
(B) Authorised Capital > Issued Capital
(C) Paid up Capital > Issued Capital
(D) None of the above
Ans: Option B
Concept Check
Shares issued by a company to its employees or directors in consideration of ‘Intellectual Property Rights’ are called :
(A) Right Equity Shares
(B) Private Equity Shares
(C) Sweat Equity Shares
(D) Bonus Equity Shares
Ans: Option C
Public subscription of shares include :
(A) To Issue Prospectus
(B) To Receive Applications
(C) To Make Allotment
(D) All of the Above
Ans: Option D
Next Video -> Accounting Treatment for Issuing of Shares
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Accounting for Share Capital Transactions
Accounting Treatment of Shares
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Accounting Treatment
Suppose 100 shares at were Issued at 10 and total Application was for 200 Shares. On Application they asked for Installment
of Rs. 3 and on Allotment they asked for Rs. 5
Ram Applied for 50 Shares, Sham applied for 50 Shares, Arun applied for 50 Shares and Varun applied for 50 Shares
25 Shares allotted to Ram, 25 Shares Allotted to Sham, and 50 Shares Allotted to Arun, Varun’s application was Rejected
On Application
Step 1: Money Received in the Bank for Share Applications
Share Application Money Recvd = (Total Applied Shares * Application Money)
= 200* 3 = 600
Account Debit Credit Net New Old balance
balance
Bank (Asset) 600 600 Debit 0
Share Application (Liability) 600 600 Credit 0
Share Capital (Capital) 0 Bank A/c Dr. 600 (200*3)
Share Allotment (Asset: Debtor) 0 To Share Application A/c 600
Accounting Treatment
Suppose 100 shares at were Issued at 10 and total Application was for 200 Shares. On Application they asked for Installment
of Rs. 3 and on Allotment they asked for Rs. 5
Ram Applied for 50 Shares, Sham applied for 50 Shares, Arun applied for 50 Shares and Varun applied for 50 Shares
25 Shares allotted to Ram, 25 Shares Allotted to Sham, and 50 Shares Allotted to Arun, Varun’s application was Rejected
On Allottment
Step 2: Once the Shares are allotted, the money which is there in the Share Application A/c corresponding to Allotted
shares shall be transferred to the Share Capital A/c
Share Application Money Transferred to Share Capital A/c = (Total Allotted Shares * Application Money)
= 100* 3 = 300
Account Debit Credit Net New balance Old balance
Bank (Asset) 600 Debit 600 Debit
Share Application (Liability) 300 300 Credit 600 Credit
Share Capital (Capital) 300 300 Credit 0
Share Allotment (Asset: Debtor) 0 0 Share Application A/c Dr. 3,00 (100*3)
To Share Capital A/c 3,00
Accounting Treatment
Suppose 100 shares at were Issued at 10 and total Application was for 200 Shares. On Application they asked for Installment
of Rs. 3 and on Allotment they asked for Rs. 5
Ram Applied for 50 Shares, Sham applied for 50 Shares, Arun applied for 50 Shares and Varun applied for 50 Shares
25 Shares allotted to Ram, 25 Shares Allotted to Sham, and 50 Shares Allotted to Arun, Varun’s application was Rejected
On Allottment
Step 3: Refund shall be made to the parties whose application has been rejected (in this case Varun)
Application Money Refunded = (Total Shares applied in Refunded Application * Application Money per share)
= 50* 3 = 150
Account Debit Credit Net New balance Old balance
Bank (Asset) 150 450 Debit 600 Debit
Share Application (Liability) 150 150 Credit 300 Credit
Share Capital (Capital) 300 Credit 300 Credit
Share Capital A/c Dr. 150 (50*3)
Share Allotment (Asset: Debtor) 0 0
To Bank A/c 150
Accounting Treatment
Suppose 100 shares at were Issued at 10 and total Application was for 200 Shares. On Application they asked for Installment
of Rs. 3 and on Allotment they asked for Rs. 5
Ram Applied for 50 Shares, Sham applied for 50 Shares, Arun applied for 50 Shares and Varun applied for 50 Shares
25 Shares allotted to Ram, 25 Shares Allotted to Sham, and 50 Shares Allotted to Arun, Varun’s application was Rejected
On Allottment
Step 4 : Amount Due on Allotment = (Total Allotted Shares * Allottment Money)
= (100 * 5)
= 500
Account Debit Credit Net New balance Old balance
Bank (Asset) 450 Debit 450 Debit
Share Application (Liability) 150 Credit 150 Credit
Share Capital (Capital) 500 800 Credit 300 Credit Share Allotment A/c Dr. 500
Share Allotment (Asset: Debtor) 500 500 Debit 0 To Share Capital A/c 500
Accounting Treatment
Suppose 100 shares at were Issued at 10 and total Application was for 200 Shares. On Application they asked for Installment
of Rs. 3 and on Allotment they asked for Rs. 5
Ram Applied for 50 Shares, Sham applied for 50 Shares, Arun applied for 50 Shares and Varun applied for 50 Shares
25 Shares allotted to Ram, 25 Shares Allotted to Sham, and 50 Shares Allotted to Arun, Varun’s application was Rejected
On Allottment
Step 5: For Adjustment of Excess Application Money for Allotment
Adjusted Excess Application Money for Allottment = Application Money Recvd – (Application Money Transferred to Share Capital + Application Money Refunded)
= 600 – (300 + 150)
= 150
Account Debit Credit Net New balance Old balance
Bank (Asset) 450 Debit 450 Debit
Share Application (Liability) 150 0 150 Credit
Share Capital (Capital) 800 Credit 800 Credit Share Application A/c Dr. 150 (50*3)
Share Allotment (Asset: Debtor) 150 350 Debit 500 Debit To Share Allotment A/c 150
Accounting Treatment
Suppose 100 shares at were Issued at 10 and total Application was for 200 Shares. On Application they asked for Installment
of Rs. 3 and on Allotment they asked for Rs. 5
Ram Applied for 50 Shares, Sham applied for 50 Shares, Arun applied for 50 Shares and Varun applied for 50 Shares
25 Shares allotted to Ram, 25 Shares Allotted to Sham, and 50 Shares Allotted to Arun, Varun’s application was Rejected
On Allottment
Step 6 : Receipt of Amount after adjustment of Application Money to be paid by the Parties for Share Allotment
Amount Paid for Share Allottment = Total Allot. money – Allot. Money Adjusted from Application Money
= 500 – 150
= 350
Account Debit Credit Net New balance Old balance
Bank (Asset) 350 800 Debit 450 Debit
Share Application (Liability) 0 0
Share Capital (Capital) 800 Credit 800 Credit
Share Allotment (Asset: Debtor) 350 0 350 Debit
Bank A/c Dr. 350
To Share Allotment A/c 350
Accounting Treatment
Summary
Step 1: Money Received in the Bank for Share Applications
Step 2: Once the Shares are allotted, the money which is there in the
Share Application A/c corresponding to Allotted shares shall be
transferred to the Share Capital A/c
Step 3: Refund for Rejected Applications
Step 4: Amount Due on Allotment
Step 5: Adjustment of Excess Application Money for Allotment
Step 6: : Receipt of Amount after adjustment of Application Money to
be paid by the Parties for Share Allotment
Accounting Treatment
Accounting Treatment is same in case of
Equity Shares and Preference Shares
Sometimes we even replace share by ‘Equity
Share’ and ‘Preference Share’ to differentiate
between them
Accounting Treatment
All the money could have been collected By the
time Allotment is made
Or
Left Over money is collected through Calls
Accounting Treatment - Calls
Suppose 100 shares at were Issued at 10 and total Application was for 200 Shares. On Application they asked for
Installment of Rs. 3 and on Allotment they asked for Rs. 5 (left Over money of 2 , Re 1 in first Call and Re. 1 in second call)
Ram Applied for 50 Shares, Sham applied for 50 Shares, Arun applied for 50 Shares and Varun applied for 50 Shares
25 Shares allotted to Ram, 25 Shares Allotted to Sham, and 50 Shares Allotted to Arun, Varun’s application was Rejected
On First Call Due Date
Account Debit Credit Net New balance Old balance
Bank 800 Debit 800 Debit
Share Application 0 0
Share Capital 100 900 Credit 800 Credit
Share First Call A/c Dr. 100
Share Allotment 0 0 To Share Capital A/c 100
Shall First Call A/c (Debtor) 100 100 Debit 0
For Receipt of First Call Amount
Account Debit Credit Net New balance Old balance
Bank 100 900 Debit 800 Debit
Share Application 0 0
Share Capital 900 Credit 900 Credit
Share Allotment 0 0 Bank A/c Dr. 100
Shall First Call A/c (Debtor) 100 0 100 Debit To Share First Call A/c 100
Accounting Treatment - Calls
Suppose 100 shares at were Issued at 10 and total Application was for 200 Shares. On Application they asked for
Installment of Rs. 3 and on Allotment they asked for Rs. 5 (left Over money of 2 , Re 1 in first Call and Re. 1 in second call)
Ram Applied for 50 Shares, Sham applied for 50 Shares, Arun applied for 50 Shares and Varun applied for 50 Shares
25 Shares allotted to Ram, 25 Shares Allotted to Sham, and 50 Shares Allotted to Arun, Varun’s application was Rejected
On Second Call Due Date
Account Debit Credit Net New balance Old balance
Bank 900 Debit 900 Debit
Share Application 0 0
Share Capital 100 1000 Credit 900 Credit Share Second and Final Call A/c Dr. 100
Share Allotment 0 0 To Share Capital A/c 100
Share First Call A/c 0 0
Share Second Call A/c 100 100 debit 0
Word final is appended during last call
For Receipt of Second Call Amount
Account Debit Credit Net New balance Old balance
Bank 100 1000 Debit 900 Debit
Share Application 0 0
Share Capital 1000 Credit 1000 Credit
Share Allotment 0 0 Bank A/c Dr. 100
Shall First Call A/c 0 0 To Share Second and Final Call A/c 100
Share Second Call A/c 100 0 100 debit
Important Points – Money Collected during Application and Through Calls
Application Money
Regulations as per Company Law and SEBI
As per section 39 of the companies Act, The application As per SEBI Regulations:
money should be at least 5% of the face value of the share. The minimum application moneys to be paid by an
Example: if Face value of share is 10 then application applicant along with the application money shall not be
money asked should be minimum of 0.5 less than 25% of the issue price.
Important Points – Money Collected during Application and Through Calls
Allotment
Regulations by SEBI
Allotment can be done only if minimum 90% of the shares have been subscribed
Important Points – Money Collected during Application and Through Calls
Calls
Regulations
Calls should be made Articles of Association
If nothing is mentioned regarding Calls
in Articles of Association
1. A period of one month must elapse between two calls
2. The amount of call should not exceed 25% of the face value of the share
3. A minimum of 14 days’ notice is given to the shareholders to pay the amount
Example 1
Solution
Step 1: Money Received in the Bank for Share Applications
Step 2: Once the Shares are allotted, the money which is there in the
Share Application A/c corresponding to Allotted shares shall be
transferred to the Share Capital A/c
Step 3: Refund for Rejected Applications
Step 4: Amount Due on Allotment
Example 1
Solution
No Adjustment Required
Step 5: Adjustment of Excess Application Money for Allotment Excess Application Money = 39,0000 – 360000 - 30,000
=0
Step 6: : Receipt of Amount after adjustment of Application
Money to be paid by the Parties for Share Allotment
Due of First Call
Receipt of First call Amount
Example 1
Solution
Due of Second Call
Receipt of amount due on Second call
Example 2
Solution
Step 1: Money Received in the Bank for Share Applications
Step 2: Once the Shares are allotted, the money which is there in the
Share Application A/c corresponding to Allotted shares shall be
transferred to the Share Capital A/c
Step 3: Refund for Rejected Applications No Refund
Step 4: Amount Due on Allotment
Example 2
Solution
Step 5: Adjustment of Excess Application Money for Allotment No Adjustment Required
Step 6: : Receipt of Amount after adjustment of Application
Money to be paid by the Parties for Share Allotment
Due of First Call
Receipt of First call Amount
Next Video -> Calls in Arrears and Calls in Advance
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Accounting for Share Capital Transactions
Calls in Arrears, Calls in Advance and Practice Questions
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Accounting Treatment – Calls in Arrears (Unpaid Calls)
These balances are consolidated in Calls in Arrears Share First call A/c has a debit balance of 2000 indicating
A/c which is Asset (Debtor) A/c unpaid call amount from the first call
Similarly Share Second and Final call A/c would have
unpaid call amount of 1000 from second call in the above
example
Accounting Treatment – Calls in Arrears (Unpaid Calls)
There might be some interest charged on Unpaid Calls as per details given in Articles of Association
Directors can charge interest as per articles of Association
If nothing is mentioned in Articles of Association, then Directors can charge interest up to 10% as per Table F
On receipt of Money in Bank for Unpaid call along with On receipt of Money in Bank for Unpaid call along
Interest when there is no Interest to be charged
Example – 3
Solution
Step 1: Money Received in the Bank for Share Applications
Step 2: Once the Shares are allotted, the money which is there in the
Share Application A/c corresponding to Allotted shares shall be
transferred to the Share Capital A/c
Step 3: Refund for Rejected Applications No Refund
Step 4: Amount Due on Allotment
Example – 3
Solution
Step 5: Adjustment of Excess Application Money for Allotment No adjustment
Step 6: : Receipt of Amount after adjustment of Application
Money to be paid by the Parties for Share Allotment
Due of First Call
Receipt of First call Amount
Example – 3
Solution
Due of Second Call
Receipt of Second call Amount and Calls in Arrears
We have combined the entry for Payment of Second call and
consolidating the Unpaid calls in Arrears
Payment of Second Call Call in Arrears A/c
Bank A/c Dr. 24750 Calls in Arrears A/c Dr. 250
To Share Second and Final Call A/c 24750 To Share Second and Final Call A/c 250
Accounting Treatment – Calls in Advance
Sometimes the subscriber pays the calls in advance even before they are called. The accounting treatment is shown
below
When Advance money is received, Calls in Advance is a liability A/c
Max. Interest of 12% p.a
as per Table F
When Call paid in Advance becomes due When Call paid in Advance is paid
Accounting Treatment – Calls in Advance
Example: 100 shares have been subscribed. Till Allotment all money is paid. Now during first call of 20, all amount was paid up for 100 shares and in addition for
10 shares even the second call of 20 was paid up during the first call itself. After 2 months the second call of Rs. 20 was made. Kindly show the journal entries
corresponding to Calls in Advance
Solution
When Advance money is received, Calls Bank A/c Dr. 200
in Advance is a liability A/c
To Calls in Advance A/c 200
Share Second and Final Call A/c Dr. 2000
When Call paid in Advance
To Share Capital A/c 2000
becomes due
Calls in Advance A/c Dr. 200
To Share Second and Final Call A/c 200
When Call paid in Bank A/c Dr. 1800
Advance is paid To Share Second and Final Call A/c 1800
Example - 4
Solution
Step 1: Money Received in the Bank for Share Applications
Step 2: Once the Shares are allotted, the money which is there in the
Share Application A/c corresponding to Allotted shares shall be
transferred to the Share Capital A/c
Step 3: Refund for Rejected Applications No Refund
Step 4: Amount Due on Allotment
Example - 4
Solution
Step 5: Adjustment of Excess Application Money for Allotment No adjustment
Step 6: : Receipt of Amount after adjustment of Application
Money to be paid by the Parties for Share Allotment
Due of First Call
Example - 4
Solution
Receipt of First call Amount with Arrears and Calls in
Advance
We have combined the entry for Payment of First call and
consolidating the Unpaid calls in Arrears and Calls Paid in advance
Payment of First Call Call in Arrears A/c Calls Paid in Advance
Bank A/c Dr. 18000 Calls in Arrears A/c Dr. 2000 Bank A/C Dr. 1250
To Share First Call A/c 18000 To Share First Call A/c 2000 To Calls in Advance A/c 1250
Example - 5
Solution
Step 1: Money Received in the Bank for Share Applications
Step 2: Once the Shares are allotted, the money which is there in the
Share Application A/c corresponding to Allotted shares shall be
transferred to the Share Capital A/c
Step 3: Refund for Rejected Applications No Refund
Step 4: Amount Due on Allotment
Example - 5
Solution
Step 5: Adjustment of Excess Application Money for Allotment No adjustment
Step 6: : Receipt of Amount after adjustment of Application
Money to be paid by the Parties for Share Allotment
Due of First Call
Example - 5
Solution
Receipt of First call Amount with Arrears and Calls in Advance
We have combined the entry for Payment of First call and
consolidating the Unpaid calls in Arrears and Calls Paid in advance
Payment of First Call Call in Arrears A/c Calls Paid in Advance
Bank A/c Dr. 59200 Calls in Arrears A/c Dr. 800 Bank A/C Dr. 600
To Share First Call A/c 59200 To Share First Call A/c 800 To Calls in Advance A/c 600
Concept Check
Max Interest on calls in arrears is charged according to “Table F” at :
(i) 10%
(ii) 6%
(iii) 8%
(iv) 11%
Ans: Option 1
Money received in advance from shareholders before it is actually called-up by the directors is :
(i) debited to calls in advance account
(ii) credited to calls in advance account
(iii) debited to calls account
(iv) none of the above
Ans: Option 2
Concept Check
A Ltd. proposed to issue 6,000 equity shares of `100 Face value at issue price of 120. The minimum amount of application
money to be collected per share as per the Companies Act, 2013
(i) 5
(ii) 6
(iii) 7
Ans: Option 1
As per the SEBI guidelines, on issue of shares, the application money should not be less than
(a) 2.5% of the nominal value of shares
(b) 2.5% of the issue price of shares
(c) 25.0% of the issue price of shares
Ans: Option 3
Concept Check
Which of the following will define, when appropriation of a certain number of shares is made to an applicant in response
to his application?
(A) Share allotment
(B) Share forfeiture
(C) Share trading
(D) Share Purchase
Ans: Option A
According to Companies Act, Minimum Subscription has been fixed at ……….. of the issued amount.
(A) 25%
(B) 50%
(C) 90%
(D) 100%
Ans: Option C
Concept Check
One of the conditions, in addition to others, for allotment of shares is :
(A) Resolution in General Meeting
(B) Receiving Minimum Subscription
(C) Full Subscription by Public
(D)Approval by SEBI
Ans: Option B
Amount of Calls in Advance is
(A) Added to Share Capital
(B) Deducted from Share Capital
(C) Shown on the Assets side
(D) Shown on the Equity & Liabilities side
Ans: Option D
Concept Check
Following amounts were payable on issue of shares by a Company : ₹3 on application, ₹3 on allotment. ₹2 on first call and
₹2 on final call. Final call has been made. X holding 500 shares paid only application and allotment money whereas Y
holding 400 shares did not pay final call. Amount of calls in arrear will be :
(A) ₹3,800
(B) ₹2,800
(C) ₹1,800
(D) ₹6,200
Ans: Option B
The subscribed capital of a company is 80,00,000 and the nominal value of the share is 100 each. There were no calls in
arrear till the final call was made. The final call made was paid on 77,500 shares only. The balance in the calls in arrear
amounted to 62,500. Calculate the final call on share.
(A) ₹7
(B) ₹20
(C) ₹22
(D) ₹25
Ans: Option D
Concept Check
A shareholder holding 600 shares paid the amount of call @ ₹5 per share on 1st November 2018 whereas the call was due
on 1st March 2019. Max Interest on calls in advance as per Table F will be :
(A) ₹45
(B) ₹60
(C) ₹50
(D) ₹120
Ans: Option D
Next Video – Over Subscription and Undersubscription of Shares
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Oversubscription and Undersubscription
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Over Subscription and Undersubscription of Shares
Scenario 1
Company wants to issue 100 Shares
People applied for 250 Shares 100 Shares were
worth Rs. 10 each to Public
allotted/Subscribed finally
Issued Capital = 10,000 Over Subscription of Shares Subscribed Capital = 10,000
Scenario 2
Company wants to issue 100 Shares
People applied for 95 Shares 95 Shares were
worth Rs. 10 each to Public
allotted/Subscribed finally
Issued Capital = 10,000 Under subscription of Shares Subscribed Capital = 9500
Over Subscription of Shares
How do you decide whom gets how many shares?
Suppose
Ram Applied for 50 shares
Sham Applied for 50 Shares
Varun applied for 50 Shares
Arun Applied for 50 Shares
Manoj applied for 50 Shares
Over Subscription of Shares
First Alternative
Total 100 Shares to be allocated
Three
Alternatives
Directors decide to fully accept some applications
Suppose
and totally reject the others, the application money
Ram Applied for 50 shares
received on rejected applications is fully refunded.
Sham Applied for 50 Shares
Varun applied for 50 Shares
Arun Applied for 50 Shares
Manoj applied for 50 Shares
Suppose
Ram Applied for 50 shares - 50 shares given
In this case the money for fully rejected applications shall be Sham Applied for 50 Shares – 50 Shares given
refunded Varun applied for 50 Shares - Rejected
Arun Applied for 50 Shares – Rejected
No adjustment required for Fully Accepted shares i.e. no Manoj applied for 50 Shares - Rejected
money needs to be moved from Share Application A/c to
Share Allotment a/c corresponding to these fully accepted
applications
Over Subscription of Shares
Second Alternative
Total 200 Shares to be allocated
Three
Alternatives
When the directors opt to make a proportionate
Suppose
allotment to all applicants (called ‘pro-rata’
Ram Applied for 50 shares
allotment).
Sham Applied for 50 Shares
Varun applied for 50 Shares
Arun Applied for 50 Shares
Manoj applied for 50 Shares
Ratio of Applied to Allotted = 250/100 = 2.5:1
Nothing is to be refunded for Fully rejected applications as no
Suppose
application is rejected
Ram Applied for 50 shares - 20 shares given
Sham Applied for 50 Shares – 20 Shares given
Excess Application Money needs to be adjusted for Partial
Varun applied for 50 Shares - 20 Shares given
Allotment
Arun Applied for 50 Shares – 20 Shares given
Manoj applied for 50 Shares – 20 Shares given
There might be refund from Partial Allotment
Over Subscription of Shares
Third Alternative (Mixture of First 2 Alternatives)
Total 200 Shares to be allocated
Three
Alternatives
Suppose When the application for some shares are
Ram Applied for 50 shares rejected/accepted outrightly; and pro-rata
Sham Applied for 50 Shares allotment is made to the remaining applicants
Varun applied for 50 Shares
Arun Applied for 50 Shares
Manoj Applied for 50 Shares
Manoj’s Application Rejected
Ratio of Applied to Allotted = 200/100 = 2:1
Refund for Fully Rejected Applications
Suppose
Excess Application Money needs to be adjusted for Partial Ram Applied for 50 shares - 25 shares given
Allottment Sham Applied for 50 Shares – 25 Shares given
Varun applied for 50 Shares - 25 Shares given
There might be refund from Partial Allotment Arun Applied for 50 Shares – 25 shares given
Manoj Applied for 50 Shares - Rejected
How to decide how much to Refund or adjust from Application Money
Till now we have discussed questions only on first scenario where some people are given full shares and some people
are given nothing. Things become little complex in 2nd and 3rd alternative
Suppose
Ram Applied for 50 shares - 50 shares given
First Alternative Sham Applied for 50 Shares – 50 Shares given
Varun applied for 50 Shares - Rejected
Arun Applied for 50 Shares – Rejected
Manoj applied for 50 Shares - Rejected
Suppose
Ram Applied for 50 shares - 20 shares given
Second Alternative Sham Applied for 50 Shares – 20 Shares given
Varun applied for 50 Shares - 20 Shares given
Arun Applied for 50 Shares – 20 Shares given
Manoj applied for 50 Shares – 20 Shares given
Suppose
Ram Applied for 50 shares - 25 shares given
Third Alternative (Mixture of First 2 Sham Applied for 50 Shares – 25 Shares given
Alternatives) Varun applied for 50 Shares - 25 Shares given
Arun Applied for 50 Shares – 25 shares given
Manoj Applied for 50 Shares - Rejected
How to decide how much to Refund or adjust from Application Money?
Total 100 shares were to be issued at 10 each. 250 shares were applied for. Application Money was 4, Allottment money
was Rs. 2 and rest were to be paid through calls
Suppose
Ram Applied for 50 shares - 50 shares given
First Alternative Sham Applied for 50 Shares – 50 Shares given
Varun applied for 50 Shares - Rejected
Arun Applied for 50 Shares – Rejected
Manoj applied for 50 Shares - Rejected
Fully Accepted Fully Refunded Partially
Accepted
No.of Shares 100 150 0
Application Money (A) 400 600
Application Money Transferred to Share Capital A/c (B) 400 0 0
Application Money Adjusted for Allotment ( C ) 0 0 0
Refund A – (B + C) 0 600 0
Allotment Money Due ( D ) 200 0 0
Money to Paid After Adjustment from Application Money for Allotment ( D – C) 200 0 0
How to decide how much to Refund or adjust from Application Money
Total 100 shares were to be issued at 10 each. 250 shares were applied for. Application Money was 4, Allottment money
was Rs. 2 and rest were to be paid through calls
Suppose
Ram Applied for 50 shares - 20 shares given
Second Alternative Sham Applied for 50 Shares – 20 Shares given
Varun applied for 50 Shares - 20 Shares given
Arun Applied for 50 Shares – 20 Shares given
Manoj applied for 50 Shares – 20 Shares given
Fully Accepted Fully Refunded Partially Accepted
No.of Shares 0 0 250 (100)
Application Money (A) 0 0 1000
Application Money Transferred to Share Capital A/c (B) 0 0 400 (100*4)
Application Money Adjusted for Allotment ( C ) 0 0 200 (100*2)
Refund A – (B + C) 0 0 400
Allotment Money Due ( D ) 0 0 200
Money to Paid After Adjustment from Application Money for Allotment ( D – C) 0 0 0
How to decide how much to Refund or adjust from Application Money
Total 100 shares were to be issued at 10 each. 250 shares were applied for. Application Money was 3, Allottment money
was Rs. 6 and rest were to be paid through calls
Suppose
Ram Applied for 50 shares - 20 shares given
Sham Applied for 50 Shares – 20 Shares given
Second Alternative Varun applied for 50 Shares - 20 Shares given
Arun Applied for 50 Shares – 20 Shares given
Manoj applied for 50 Shares – 20 Shares given
Fully Accepted Fully Refunded Partially Accepted
No.of Shares 0 0 250 (100)
Application Money (A) 0 0 750
Application Money Transferred to Share Capital A/c (B) 0 0 300 (100*3)
Application Money Adjusted for Allotment ( C ) 0 0 450
Refund A – (B + C) 0 0 0
Allotment Money Due ( D ) 0 0 600
Money to Paid After Adjustment from Application Money for Allotment ( D – C) 0 0 150
How to decide how much to Refund or adjust from Application Money
Total 100 shares were to be issued at 10 each. 250 shares were applied for. Application Money was 4, Allottment money
was Rs. 2 and rest were to be paid through calls
Suppose
Ram Applied for 50 shares - 25 shares given
Third Alternative Sham Applied for 50 Shares – 25 Shares given
Varun applied for 50 Shares - 25 Shares given
Arun Applied for 50 Shares – 25 shares given
Manoj Applied for 50 Shares - Rejected
Fully Accepted Fully Refunded Partially
Accepted
No.of Shares 0 50 200 (100)
Application Money (A) 200 800
Application Money Transferred to Share Capital A/c (B) 0 0 400 (100*4)
Application Money Adjusted for Allotment ( C ) 0 0 200 (100*2)
Refund A – (B + C) 0 200 200
Allotment Money Due ( D ) 0 0 200
Money to Paid After Adjustment from Application Money for Allotment ( D – C) 0 0 0
How to decide how much to Refund or adjust from Application Money
Total 100 shares were to be issued at 10 each. 250 shares were applied for. Application Money was 2, Allottment money
was Rs. 6 and rest were to be paid through calls
Suppose
Ram Applied for 50 shares - 25 shares given
Sham Applied for 50 Shares – 25 Shares given Third Alternative
Varun applied for 50 Shares - 25 Shares given
Arun Applied for 50 Shares – 25 shares given
Manoj Applied for 50 Shares - Rejected
Fully Accepted Fully Refunded Partially Accepted
No.of Shares 0 50 200 (100)
Application Money (A) 100 400
Application Money Transferred to Share Capital A/c (B) 0 0 200 (100*2)
Application Money Adjusted for Allotment ( C ) 0 0 200 (100*2)
Refund A – (B + C) 0 200 0
Total Allotment money Due ( D ) 0 0 600(100*6)
Money to be paid after adjusting Application money for Allotment ( D – C) 400
Example - 6
Solution (Point 1)
Fully Fully Refunded Partially
Accepted Accepted
No.of Shares 100000 300000 0
Application Money (A) 500000 1500000 0
Application Money Transferred to Share Capital A/c (B) 500000 0 0
Application Money Adjusted for Allotment ( C ) 0 0 0
Refund A – (B + C) 0 1500000 0
Total Allotment money Due ( D ) 7500000 0 0
Money to be paid after adjusting Application money for Allotment ( D – C) 7500000 0 0
Example - 6
Solution (Point 1)
Step 1: Money Received in the Bank for Share Applications
Step 2: Once the Shares are allotted, the money which is there in the
Share Application A/c corresponding to Allotted shares shall be
transferred to the Share Capital A/c
Equity Share App a/c Dr. 5,00000
To Equity Share Capital a/c 5,00000
Step 3: Refund for Rejected Applications
Equity Share App a/c Dr. 15,00000
To Bank a/c 15,00000
Example - 6
Solution (Point 1)
Step 4: Amount Due on Allotment
Equity Share Allotment A/c Dr. 750000
To Equity Share Capital A/c 750000
Step 5: Adjustment of Excess Application Money for Allotment
No Adjustment
Step 6: : Receipt of Amount after adjustment of Application
Money to be paid by the Parties for Share Allotment
Bank A/c Dr. 750000
To Equity Share Allotment A/c 750000
Example - 6
Solution (Point 1)
First Call Due
Receipt
\ of Payment for First Call
Example - 6
Solution (Point 1)
Second Call Due
Receipt of Payment for Second Call
Solution (Point 2)
Fully Fully Refunded Partially
Accepted Accepted
No.of Shares 0 0 400000 (100000)
Application Money (A) 0 0 2000000
Application Money Transferred to Share Capital A/c (B) 0 0 500000
Application Money Adjusted for Allotment ( C ) 0 0 750000
Refund A – (B + C) 0 0 750000
Total Allotment money Due ( D ) 0 0 750000
Money to be paid after adjusting Application money for Allotment ( D – C) 0 0 0
Example - 6
Solution (Point 2)
Step 1: Money Received in the Bank for Share Applications
Step 2: Once the Shares are allotted, the money which is there in the
Share Application A/c corresponding to Allotted shares shall be
transferred to the Share Capital A/c
Equity Share App a/c Dr. 5,00000
To Equity Share Capital a/c 5,00000
Step 3: Refund for Rejected Applications (Shares not
allotted)
Equity Share App a/c Dr. 750000
To Bank a/c 750000
Example - 6
Solution (Point 2)
Step 4: Amount Due on Allotment
Step 5: Adjustment of Excess Application Money for Allotment
Equity Share App A/c Dr. 750000
To Equity Share Allotment A/c 750000
Step 6: : Receipt of Amount after adjustment of Application
Money to be paid by the Parties for Share Allotment
No Receipt Required as all the money for allotment has been
adjusted through Share Application Account
Example - 6
Solution (Point 2)
The entries regarding the two calls would be the same as
given in preceding method.
Solution (Point 3)
Fully Fully Refunded Partially
Accepted Accepted
No.of Shares 80000 200000 1,20000 (20000)
Application Money (A) 400000 1000000 600000
Application Money Transferred to Share Capital A/c (B) 400000 0 100000
Application Money Adjusted for Allotment ( C ) 0 0 150000
Refund A – (B + C) 0 1000000 350000
Total Allotment money Due ( D ) 600000 0 150000
Money to be paid after adjusting Application money for Allotment ( D – C) 600000 0 0
Example - 6
Solution (Point 3)
Step 1: Money Received in the Bank for Share Applications
Step 2: Once the Shares are allotted, the money which is there in the
Share Application A/c corresponding to Allotted shares shall be
transferred to the Share Capital A/c
Equity Share App a/c Dr. 5,00000
To Equity Share Capital a/c 5,00000
Step 3: Refund for Rejected Applications (Shares not
allotted)
Equity Share App a/c Dr. 1350000
To Bank a/c 1350000
Example - 6
Solution (Point 3)
Step 4: Amount Due on Allotment
Step 5: Adjustment of Excess Application Money for Allotment
Equity Share App a/c Dr. 150000
To Equity Share Allot/c 150000
Step 6: : Receipt of Amount after adjustment of Application
Money to be paid by the Parties for Share Allotment
Bank a/c Dr. 600000
To Equity Share Allot/c 600000
Example - 6
Solution (Point 3)
The entries regarding the two calls would be the same as
given in preceding method.
Concept Check
Pro-rata allotment of shares is made when there is :
(A) Under subscription
(B) Oversubscription
(C) Equal subscription
(D) As and when desired by directors
Ans: Option B
Authorized capital of a Company is divided into 5,00,000 shares of ₹10 each. It issued 3,00,000 shares. Public applied for
3,60,000 shares. Amount of issued capital will be :
(A) ₹30,00,000
(B) ₹36,00,000
(C) ₹50,00,000
(D) ₹6,00,000
Ans: Option A
Concept Check
A Company invited applications for 1,00,000 shares and it received applications for 1,50,000 shares. Applications for
30,000 shares were rejected and the remaining were allotted shares on prorata basis. How many shares an applicant for
3,000 shares will be allotted :
(A) 2,500 Shares
(B) 3,600 Shares
(C) 4,500 Shares
(D) 2,000 Shares
Ans: Option A
E Ltd. had allotted 10,000 shares to the applicants of 14,000 shares on pro-rata basis. The amount payable on application
was ₹2. F applied for 420 shares. The number of shares allotted and the amount carried forward for adjustment against
allotment money due from F will be :
(A) 60 shares; ₹120
(B) 340 shares; ₹160
(C) 320 shares, ₹200
(D) 300 shares; ₹240
Ans: Option D
Concept Check
If applicants for 80,000 shares were allotted 60,000 shares on prorata basis, the shareholder who was allotted 1,200 shares
must have applied for :
(A) 900 Shares
(B) 3,600 Shares
(C) 1,600 Shares
(D) 4,800 Shares
Ans: Option C
A Company offered 50,000 shares of 10 each at par payable as to 3 on applications, 5 on allotment and the balance on
final call. Applications were received for 60,000 shares and the allotment was made pro-rata. The excess application
money was to be adjusted on allotment and call. How much amount will be transferred from Share Application A/c to
Share Allotment A/c?
(A) ₹1,80,000
(B) ₹30,000
(C) ₹1,50,000
(D) ₹50,000
Ans: Option B
Concept Check
A company issued 4,000 equity shares of ₹10 each at par payable as under : On application ₹3; on allotment ₹2; on first call ₹4 and on
final call ₹1 per share.
Applications were received for 13,000 shares. Applications for 3,000 shares were rejected and pro-rata allotment was made to the
applicants for 10,000 shares. How much amount will be received in cash on first call? Excess application money is adjusted towards
amount due on allotment and calls.
(A) ₹6,000
(B) Nil
(C) ₹16,000
(D) ₹10,000
Ans: Option A
Fully Fully Refunded Partially
Accepted Accepted
No.of Shares 0 3000 10000(4000)
Application Money (A) 0 9000 30000
Application Money Transferred to Share Capital A/c (B) 0 0 12000
Application Money Adjusted for Allotment ( C ) 0 0 8000
Refund A – (B + C) 0 90000 10000
Will be adjusted in Call money
Total call money -> 16000
After Adjustment -> 6000
Concept Check
A company issued 4,000 equity shares of ₹10 each at par payable as under : On application ₹3; on allotment ₹2; on first
call ₹4 and on final call 1 per share.
Applications were received for 13,000 shares. 3000 shares were rejected and Allotment was made pro-rata. How much
amount will be received in cash on allotment?
(A) ₹8,000
(B) ₹12,000
(C) Nil
(D) None
Ans: Option C
Fully Fully Refunded Partially
Accepted Accepted
No.of Shares 0 3000 10000(4000)
Application Money (A) 0 9000 30000
Application Money Transferred to Share Capital A/c (B) 0 0 12000
Application Money Adjusted for Allotment ( C ) 0 0 8000
Refund A – (B + C) 0 90000 10000
Money Due on Allotment 0 0 8000
Money to be paid for Allotment after Adjusting excess Application Money 0 0 0
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Accounting for Share Capital Transactions
Issues of Shares at Premium and discount
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Issue of Shares at Premium or at Discount
Company A issues 100 Shares at Face
Share Capital at Nominal Value = 1000
value of 10 (All fully Paid up)
Also called issued at par
Company A issues 100 shares with Share Capital at Nominal Value = 100*10 = 1000
face value of 10 issued at price of 50
(All Fully Paid up) Here premium is 400%
(Price of 50 for Re 10) Share Capital Premium = 100* 40 = 4000
Company A issues 100 shares with Share Capital at Nominal Value = 100*10 = 1000
face value of 10 issued at price of 5 Here Discount is 50%
(All fully Paid up after discount) (Price of 5 for Re 10)
Share Capital Discount = 100* 5 = 500
Issue of Shares at Premium
Company A issues 100 shares with Share Capital at Nominal Value = 100*10 = 1000
face value of 10 issued at price of 50
(All Fully Paid up) Here premium is 400%
(Price of 50 for Re 10) Share Capital Premium = 100* 40 = 4000
Liabilities Assets
Share Capital -> 1000 Cash -> 5000
Share Capital Premium
(Securities Premium) -> 4000
Liabilities Assets
Share Capital -> 1000 Cash -> 5000
Reserves and Surplus
Securities Premium -> 4000
Use of Securities Premium A/c or Reserve
Securities Premium can only be used for
(a) to issue fully paid bonus shares to the extent not exceeding unissued share capital of the company;
(b) to write-off preliminary expenses of the company;
(c) to write-off the expenses of, or commission paid, or discount allowed on any securities of the company; and
(d) to pay premium on the redemption of preference shares or debentures of the company
(e) Purchase of its own shares (i.e., buy back of shares).
Cannot be used for Dividends
Accounting Treatment - Issue of Shares at Premium
Till now the examples we have discussed all of them were related to shares being issued at Face value
Now we shall discuss some scenarios where shares are issued at premium or at Discount
Irrespective of the fact that shares are issued at par or at a premium, the share capital of a company as stated earlier,
may be collected in instalments payable at different stages.
Accounting Treatment – Premium Shares
Suppose Company issued 100 Shares of Face value 10 and Rs. 100. Premium would be 90 in this case
Break up of Face Value 10 i.e. these money
Application Money -> 2
types are used to collect face value
Allotment money -> 5
First Call -> 2
Premium Amount is collected through Premium
Second and Final Call -> 1
Money
Premium Money is the term used to collect
Premium Money -> 90 money towards premium
Premium Money can be collected either with
Allotment money or Call money or Application
Money
Accounting Treatment – Premium Shares
Step 1: Money Received in the Bank for Share
Applications
If Premium Money was received with
Application Money
Step 2: Once the Shares are allotted, the money
which is there in the Share Application A/c
corresponding to Allotted shares shall be transferred
to the Share Capital A/c
Step 3: Refund for Rejected Applications
If Premium Money was received with
Allotment Money
Step 4: Amount Due on Allotment
Step 5: Adjustment of Excess Application Money for
Allotment
Step 6: : Receipt of Amount after adjustment of
Application Money to be paid by the Parties for
Share Allotment
Accounting Treatment – Premium Shares
If Premium Money was received with Call
Money
Share Call A/c
On First Call Due Date
For Receipt of First Call Amount
Example - 7
Solution
Step 1: Money Received in the Bank for Share
Applications
Step 2: Once the Shares are allotted, the money
which is there in the Share Application A/c
corresponding to Allotted shares shall be transferred
to the Share Capital A/c
Step 3: Refund for Rejected Applications No Refund
Example - 7
Solution
Step 4: Amount Due on Allotment
Step 5: Adjustment of Excess Application Money for No Adjustment
Allotment
Step 6: : Receipt of Amount after adjustment of
Application Money to be paid by the Parties for
Share Allotment
Example - 7
Solution
On First Call Due Date
For Receipt of First Call Amount
Accounting Treatment – Discount Shares
We shall not be discussing this
Concept Check
The excess Price received over par value of shares should be credited to
1) Calls-in-advance account
2) Share Capital Account
3) Securities Premium Account
Ans: Option 3
The Securities Premium amount may be utilized by a company for __________.
(a) Writing off any loss on sale of fixed asset
(b) Writing off any loss of revenue nature
(c) Writing off the expenses/discount on the issue of debentures
Ans: C
Concept Check
Maximum limit of Premium on shares is:
(A) 5%
(B) 10%
(C) No Limit
(D) 100%
Ans: Option 3
When a company issues shares at a premium, the amount of premium should be received by the company :
(A) Along with application money
(B) Along with allotment money
(C) Along with calls
(D) Along with any of the above
Ans: Option D
Concept Check
Amount of securities premium can be utilized for :
(A) Writing off the preliminary expenses of the company
(B) Issuing bonus shares to the shareholders of the company
(C) Buy-back of its own shares
(D) All of the above .
Ans: Option D
For what purpose securities premium reserve account cannot be utilized?
(A) Amortization of preliminary expenses
(B) Distribution of dividend
(C) Issue of fully paid bonus shares
(D) Buy Back of own shares
Ans: Option 2
Concept Check
Premium on the issue of shares should be shown :
(A) On the Assets side of balance sheet
(B) On the Equity & Liabilities side of balance sheet
(C) In profit & loss Statement
(D) None of the Above
Ans: Option B
A Company issued 50,000 shares of ₹20 each at 5% premium. ₹10 were payable on application and balance on allotment.
What will be the allotment amount?
(A) ₹5,00,000
(B) ₹4,75,000
(C) ₹5,50,000
(D) ₹5,25,000
Ans: Option C
Concept Check
From which account, expenses on issue of shares will be written off first of all:
(A) Statement of Profit and Loss
(B) Miscellaneous Expenditure Account
(C) Share Issue Expenses Account
(D) Securities Premium Reserve Account
Ans: Option D
Concept Check
Company issued 100 Shares of Face value 10 each at price of 12. Only 90 Shares were subscribed for and paid up fully,
then tell the following
Issued Capital
Subscribed Capital
Paid up Capital
Share Capital
Securities Premium
Company issued 100 Shares of Face value 10 each at price of 12. Only 90 Shares were subscribed for and paid up fully,
then tell the following
Solution
Issued Capital -> 1000
Subscribed Capital -> 900
Paid up Capital -> 900
Share Capital-> 900
Securities Premium -> 180
Next Video – Forfeiture of Shares
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Accounting for Share Capital Transactions
Forfeiture of Shares
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Forfeiture of Shares
Suppose Company issued 100 shares of face value 10 as price of 12 (Premium 2)
Application Money -> 2
Allotment Money -> 6 (Including Premium)
First Call Money -> 4
Now suppose Person X has been allocated 10 Shares. He did not pay the full amount. There can be various scenarios
1) He Paid Only Application
2) He Paid only Application Money and allotment Money
3) He paid only application Money and Allotment Money including Premium
4) He Paid only application Money and Allotment Money including Premium and First Call Money
In all these scenarios the Shares would be forfeited (they would no longer be part of Subsribed Capital of the company)
Accounting Treatment for Forfeiture of Shares
Shares Issued at Par Shares Issued at Premium
Accounting Treatment for Forfeiture of Shares
Shares Issued at Par Share Capital A/c..........(Called up amount) Dr.
To Share Forfeiture A/c...........(Paid up amount)
To Share Allotment A/c
To Share Calls A/c (individually)
On First Call Due Date
Step 4: Amount Due on Allotment
Share Forfeiture A/c is liability Account indicating the that this is liability of company towards people who have applied for
the shares but not paid the full Amount
Accounting Treatment for Forfeiture of Shares
Shares Issued at Par Share Capital A/c..........(Called up amount) Dr.
To Share Forfeiture A/c...........(Paid up amount)
To Share Allotment A/c
To Share Calls A/c (individually)
Illustration 1
Suppose Company issued 100 shares of face value 10 at price of 10
Application Money -> 2
Allotment Money -> 4
First Call Money -> 4
Suppose Call Money of 4 was called up but not paid on 10 Shares then make out journal entry for forfeiture of Shares
Solution
Called up Share Capital Corresponding to 10 Shares which
Share Capital A/c 100 Dr.
need to be forfeited -> 10* 10 = 100
To Share Forfeiture A/c 60
Unpaid Amount in Calls -> 10* 4 = 40
To Share First Call A/c (individually) 40
Paid Amount for Face value ->10* 6 = 60
Accounting Treatment for Forfeiture of Shares
Shares Issued at Par Share Capital A/c..........(Called up amount) Dr.
To Share Forfeiture A/c...........(Paid up amount)
To Share Allotment A/c
Illustration 2 To Share Calls A/c (individually)
Suppose Company issued 100 shares of face value 10 at price of 10
Application Money -> 2
Allotment Money -> 4
First Call Money -> 4
Suppose Allottment Money of 4 was called up but not paid on 10 Shares then make out journal entry for forfeiture of
Shares
Solution
Called up Share Capital Corresponding to 10 Shares which
need to be forfeited -> 6* 10 = 60 Share Capital A/c 60 Dr.
Unpaid Amount in Allotment -> 10* 4 = 40 To Share Forfeiture A/c 20
Paid Amount for Face Value ->10* 2 = 20 To Share Allotment A/c 40
Example 8- Accounting Treatment for Forfeiture of Shares
Solution
Step 1: Money Received in the Bank for Share
Applications
Step 2: Once the Shares are allotted, the money
which is there in the Share Application A/c
corresponding to Allotted shares shall be transferred
to the Share Capital A/c
Step 3: Refund for Rejected Applications No Refund
Example 8 - Accounting Treatment for Forfeiture of Shares
Solution
Step 4: Amount Due on Allotment
Step 5: Adjustment of Excess Application Money for No Adjustment
Allotment
Step 6: : Receipt of Amount after adjustment of
Application Money to be paid by the Parties for
Share Allotment
Example 8 - Accounting Treatment for Forfeiture of Shares
Solution
On First Call Due Date
For Receipt of First Call Amount
On Second Call Due Date
For Receipt of Second Call Amount
Example 8 - Accounting Treatment for Forfeiture of Shares
Solution
On Forfeiture
Called up Share Capital Corresponding to 300 Shares which need to be forfeited -> 300* 100 = 30,000
Unpaid amount in First Call -> 300* 20 = 6000
Unpaid amount in Second and Final Call -> 300* 30 = 9000
Paid Amount for Face Value -> 300* 50 = 15000
Accounting Treatment for Forfeiture of Shares
Shares Issued at Par Shares Issued at Premium
Accounting Treatment for Forfeiture of Shares
Shares Issued at Premium
Premium Amount has not been Called Up Premium Amount has been Called Up
Journal Entry will be same as journal entry for
Shares Issues at par
Accounting Treatment for Forfeiture of Shares
Share Capital A/c..........(Called up amount) Dr.
Shares Issued at Premium but Premium
To Share Forfeiture A/c...........(Paid up amount)
Amount has not been called up
Same as To Share Allotment A/c
Illustration3 issued at Par To Share Calls A/c (individually)
Suppose Company issued 100 shares of face value 10 at price of 12 (2 as Premium)
Application Money -> 2
Allotment Money -> 4
First Call Money -> 6 (Including Premium)
Suppose Allotment money called up but not paid on 10 shares and these 10 shares were forfeited. Give journal entries
Solution
Called up Share Capital Corresponding to 10 Shares which
need to be forfeited -> 6* 10 = 60 Share Capital A/c 60 Dr.
Unpaid Amount in Allotment -> 10* 4 = 40 To Share Forfeiture A/c 20
Paid Amount for Face Value -> 10* 2 = 20 To Share Allotment A/c 40
Accounting Treatment for Forfeiture of Shares
Shares Issued at Premium
Premium Amount has not been Called Up Premium Amount has been Called Up
Journal Entry will be same as journal entry for Shares where Premium Amount has been Fully
Shares Issues at par Paid
Shares where Premium Amount has not been
Fully Paid or Partially Paid
Example 9
Sahil, a share holder, failed to pay the money for second and final call of Rs. 20 on 1,000 shares issued to him at Rs. 120
(face value of Rs. 100 per share). His shares were forfeited after the second and final call. Give the necessary journal
entry for forfeiture of the shares.
Solution
Share Capital A/c..........(Called up amount) Dr.
To Share Forfeiture A/c...........(Paid up amount)
To Share Allotment A/c
To Share Calls A/c (individually)
Called up Share Capital Corresponding to 1000 Shares which
need to be forfeited -> 1000* 100 = 100000
Unpaid Amount in Second Call -> 1000* 20 = 20000
Paid Amount for Face Value -> 1000*80 = 80000
Ignore the Premium amount
Accounting Treatment for Forfeiture of Shares
Shares Issued at Premium
Premium Amount has not been Called Up Premium Amount has been Called Up
Shares where Premium Amount has been Fully
Paid
Shares where Premium Amount has not been
Fully Paid or Partially Paid
Securities Premium A/c will be debited only for the
Unpaid Amount
Example 10
Sunena, a shareholder holding 500 shares of Rs. 10 each, did not pay the allotment money of Rs. 4 per share (including a
premium of Rs. 2) and the first and final call of Rs. 3. Her shares were forfeited after the first and final call. Give journal entry
for forfeiture of the shares
Solution
Called up Share Capital Corresponding to 500 Shares which need to be forfeited -> 500* 10 = 5000
Securities Premium for 500 shares not paid -> 500* 2 -> 1000
Unpaid amount in Allotment -> 500* 4 -> 2000
Unpaid Amount in First and Final Call -> 500*3 = 1500
Paid Amount for face Value -> 500 * 5 = 2500
Example 10 A
Sunena, a shareholder holding 500 shares of Rs. 10 each. The premium is Re. 2. She did not pay the allotment money of Rs. 4
per share (including a premium of Rs. 1) and the first and final call of Rs. 3. Her shares were forfeited after the first and final
call. Give journal entry for forfeiture of the shares
Solution
Share Capital A/c Dr. 5000
Securities Premium A/c Dr. 500
To Share Allotment A/c 2000
To Share First and Final Call A/c 1500
To Share Forfeitures A/c 2000
Called up Share Capital Corresponding to 500 Shares which need to be forfeited -> 500* 10 = 5000
Securities Premium for 500 shares not paid -> 500* 1 -> 500
Unpaid amount in Allotment -> 500* 4 -> 2000
Unpaid Amount in First and Final Call -> 500*3 = 1500
Paid Amount Corresponding to Face Value-> 500 * 4 = 2000
Example 11
Solution
Fully Accepted Fully Refunded Partially Accepted
No.of Shares 0 0 400000 (300000)
Application Money (A) 0 0 1200000
Application Money Transferred to Share Capital A/c (B) 0 0 900000 (300000*3)
Application Money Adjusted for Allotment ( C ) 0 0 300000
Refund A – (B + C) 0 600 0
Allotment Money Due ( D ) 0 0 1500000
Money to Paid After Adjustment from Application Money for Allotment ( D – C) 0 0 1200000
Example 11
Solution
Step 1: Money Received in the Bank for Share
Applications
Step 2: Once the Shares are allotted, the money
which is there in the Share Application A/c Equity Share Application A/c Dr. 900000
corresponding to Allotted shares shall be transferred To Share Capital A/c 900000
to the Share Capital A/c
Step 3: Refund for Rejected Applications No Refund
Example 11
Solution
Step 4: Amount Due on Allotment
Step 5: Adjustment of Excess Application Money for Equity Share Application A/c Dr. 300000
Allotment To Share Allotment A/c 300000
Step 6: : Receipt of Amount after adjustment of
Application Money to be paid by the Parties for
Share Allotment
Example 11
Solution
On First Call Due Date
For Receipt of First Call Amount
On Second Call Due Date
For Receipt of Second Call Amount
Example 11
Solution
On Forfeiture (issued at premium but
premium amount is paid)
Called up Share Capital Corresponding to 800 Shares which need to be forfeited -> 800* 10 = 8000
Unpaid Amount in First and Final Call -> 800*2 = 1600
Unpaid amount in Second Call -> 800* 2= 1600
Paid Amount corresponding to Face Value -> 800* 6 = 4800
Example 11
Solution
Balance of Forfeiture Account is show
under Share Capital in the Balance
sheet
Example 12
Solution
Make Journal Entries for Forfeiture of Shares of
Rohan
Fully Accepted Fully Refunded Partially Accepted
No.of Shares 0 0 700 (600)
Application Money (A) 0 200000 28000
Application Money Transferred to Share Capital A/c or Securities Premium A/c(B) 0 0 24000
Application Money Adjusted for Allotment ( C ) 0 0 4000
Refund A – (B + C) 0 600 0
Allotment Money Due ( D ) 0 0 18000
Money to Paid After Adjustment from Application Money for Allotment ( D – C) 0 0 14000
Example 12
Solution
Make Journal Entries for Forfeiture of Shares of
Rohan
Share Capital A/c Dr. 30000
On Forfeiture (issued at premium but Securities Premium A/c Dr. 6000
premium amount is not fully paid) To Share Allotment A/c 14000
To Share Forfeitures A/c 22000
Called up Share Capital Corresponding to 600 Shares which need to be forfeited -> 600* 50 = 30000
Unpaid Amount in Securities Premium = 600*10 = 6000
Unpaid Amount in Allotment = 14000
Paid Amount corresponding to Face Value = 28000 -6000 = 22000
Next Video – Reissue of Forfeiture of Shares
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Accounting for Share Capital Transactions
Reissue of Forfeiture of Shares
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Re-Issue of Forfeiture of Shares
Shares Forfeited can be re-issued to a different Party
Discount can be given but up to maximum of Forfeited Amount
For example, when a company forfeits 200 shares of Rs. 10 each on which Rs. 600 had been received, it can allow a
maximum discount of Rs. 600 on their reissue
I.e. The shares worth Rs. 2000 can be reissued at a minimum price of 1400
Re-Issue of Forfeiture of Shares
For example, when a company forfeits 200 shares of Rs. 10 each on which Rs. 600 had been received, it can allow a
maximum discount of Rs. 600 on their reissue
I.e. The shares worth Rs. 2000 can be reissued at a minimum price of 1400
If the company reissues these shares for Rs. 1,800 as fully paid, the necessary journal entry will be:
What will happen to the rest 400 Forfeited Amount
for these 200 shares?
Re-Issue of Forfeiture of Shares
Liabilities Assets
Share Capital -> 1000
Reserves and Surplus
Securities Premium -> 4000 This is different from Reserve Capital which is uncalled capital
Capital Reserve -> 400
only called in case of winding up of the company
Retained Earnings -> Value X
General Reserve -> Value Y
Capital Redemption Reserve – Value X
Capital Reserve: It contains the capital generated out of the following
1. The upward revaluation of assets to reflect their current market value
2. Reissue of forfeited shares
3. Profit generated by selling of Assets
4. Transfer from Retained Earnings Reserve
This reserve cannot be used to issue dividends. This can be used for making capital investments
Retained Earnings are the profits accumulated over the years. When money is transferred from Retained Earnings to other Reserves
then money in Retained Earnings account gets decreased
Re-Issue of Forfeiture of Shares
Liabilities Assets
Share Capital -> 1000
Reserves and Surplus
Securities Premium -> 4000 This is different from Reserve Capital which is uncalled capital
Capital Reserve -> 400
only called in case of winding up of the company
Retained Earnings -> Value X
General Reserve -> Value Y
Capital Redemption Reserve – Value X
General Reserves are free reserves which can be used for anything. The money in General Reserves is also transferred
from the Retained Earnings.
Capital Redemption Reserves are reserves which can be used for issuing bonus shares or redeeming the Preference
Shares of the company. The money in Capital Redemption Reserves is transferred from the Retained Earnings.
Concept Check
If a Share of Rs. 10 on which Rs. 8 is called-up and Rs. 6 is paid as forfeited. State with what amount the Share Capital
account will be debited.
1) 8
2) 6
3) 4
4) 10
Ans: Option 1
If a Share of Rs. 10 on which Rs. 6 has been paid is forfeited, at what minimum price it can be reissued
1) 6
2) 4
3) 10
4) 2
Ans: Option 2
Concept Check
Shares can be forfeited :
(i) for non-payment of call money
(ii) for failure to attend meetings
(iii) for failure to repay the loan to the bank
(iv) for which shares are pledged as a security
Ans: Option 1
The Profit on reissue of forfeited shares is transferred to :
(i) general reserve
(ii) capital redemption reserve
(iii) capital reserve
(iv) revenue reserve
Ans: Option 3
Concept Check
When shares are forfeited, the share capital account is debited with ________ and the share forfeiture account is credited
with __________.
(a) Paid-up capital of shares forfeited; Called up capital of shares forfeited
(b) Called up capital of shares forfeited; Calls in arrear of shares forfeited
(c) Called up capital of shares forfeited; Amount received on shares forfeited
Ans: Option 3
Balance of share forfeiture account is shown in the balance sheet under the item :
(i) current liabilities and provisions
(ii) reserves and surpluses
(iii) share capital
(iv) unsecured loans
Ans: Option 3
Concept Check
Reserve Capital is also known by :
(A) Capital Reserve
(B) Called up Capital
(C) Subscribed Capital
(D) None of the above
Ans: Option D
____ is transferred to Capital Reserve.
(A) Profit from sale of fixed assets
(B) Face value of shares
(C) Profit on forfeiture of shares
(D) A and C
Ans: Option D
Concept Check
Forfeiture of shares results in the reduction of:
(A) Subscribed Capital
(B) Authorized Capital
(C) Reserve Capital
(D) Fixed Assets
Ans: Option A
At the time of forfeiture of shares the share capital account is debited with
(A) Face value
(B) Called up value
(C) Paid up value
(D) Issued value
Ans: Option B
Concept Check
Voluntary return of shares for cancellation by the shareholders is called
(A) Cancellation of shares
(B) Forfeiture
(C) Surrender of shares
(D) None of these
Ans: Option C
If the Premium on the forfeited shares has already been received, then Securities Premium A/c should be
(A) Credited
(B) Debited
(C) No treatment
(D) None of these
Ans: Option C
Concept Check
Balance of share forfeiture account is shown in the balance sheet under the head
(A) Share Capital Account
(B) Reserve and Surplus
(C) Current Liabilities and Provisions
(D) Unsecured Loans
Ans: Option A
If a share of ₹10 issued at a premium of ₹3 on which the full amount has been called and ₹8 (including premium) paid is
forfeited the capital account should be debited with:
(A) ₹5
(B) ₹8
(C) ₹10
(D) ₹13
Ans: Option C
Concept Check
If a share of ₹10 issued at a premium of 1 on which ₹9 (including premium) have been called and ₹7 including premium is
paid is forfeited, the capital account should be debited by :
(A) ₹10
(B) ₹7
(C) ₹8
(D) ₹9
Ans: Option C
600 shares of ₹10 each were forfeited for non-payment of ₹2 per share on first call and ₹5 per share on final call. Share
Forfeiture Account will be credited with:
(A) ₹1,200
(B) ₹1,800
(C) ₹3,000
(D) ₹4,200
Ans: Option B
Concept Check
800 shares of ₹10 each issued at 20% premium were forfeited for non-payment of allotment money of ₹5 (including
premium) and first & final Call of 3 per share. Share Forfeiture Account will be credited with :
(A) ₹1,600
(B) ₹2,400
(C) ₹3,200
(D) ₹4,800
Ans: Option C
The amount of discount on reissue of forfeited shares cannot exceed :
(A) 5% of the face value
(B) 10% of the face value
(C) The amount received on forfeited shares
(D) The amount not received on forfeited shares
Ans: Option C
Concept Check
If 500 shares of ₹10 issued at a premium of ₹1 on which ₹9 (including premium) have been called and ₹7 including
premium have been paid are forfeited, the forfeiture account should be credited by :
(A) ₹3,000
(B) ₹3,500
(C) ₹4,000
(D) ₹4,500
Ans: Option A
If 400 shares of ₹10 issued at a premium of ₹3 on which the full amount has been called and ₹8 (including premium) have
been received are forfeited, the forfeiture account should be credited with :
(A) ₹3,200
(B) ₹2,000
(C) ₹1,200
(D) ₹2,800
Ans: Option B
Concept Check
A Ltd. forfeited 500 shares of ₹10 each fully called up for non-payment of final call of ₹3 per share. 300 of these shares
were reissued at 9 per share, fully paid up. What is the amount to be transferred to Capital Reserve Account?
(A) ₹3,500
(B) ₹2,100
(C) ₹3,200
(D) ₹1,800
Ans: Option D
Concept Check
400 shares of ₹10, on which 8 has been called and 5 has been paid, are forfeited. Out of these, 300 shares are re-issued for
9 as fully paid. What is the amount to be transferred to. Capital Reserve Account?
(A) ₹1,200
(B) ₹1,600
(C) ₹2,000
(D) ₹1,700
Ans: Option A
Concept Check
If a share of 100 on which 60 has been paid, is forfeited, it can be re-issued at the minimum price of:
(A) ₹60
(B) ₹100
(C) ₹40
(D) ₹140
Ans: Option C
Concept Check
Madhu Ltd. forfeited 800 shares of ₹10 each issued at 10% premium to Shyam (₹10 called up including premium ) on
which he did not pay ₹3 of allotment (including premium) and first call of ₹2. Out of these, 600 shares were re-issued to
Ram as fully paid up for ₹9 per share. What is to amount to be transferred to capital Reserve?
(A) ₹2,400
(B) ₹1,800
(C) ₹3,000
(D) ₹3,600
Ans: Option A
Paid Amount for Face value -> 600*5 = 3000
Debit in Share Forfeiture Account due to Reissue at 9 -> 600
Remaining Value in Forfeiture Accounts -> 3000 – 600 = 2400
Concept Check
Ans: Option C
Concept Check
Ram applied for 1000 shares, but he got allotted only 500 shares under pro-rata allotment. The shares were issued at face value of 10. The application money
was 4 and allotment money was 5. Ram was not able to pay the allotment money and shares were forfeited. What would be money debited in Share Capital
A/c and money credited in Share Allotment A/c.
(A) 4500, 1500
(B) 4500, 500
(C) 5500, 500
(D) 5500, 1500
Ans: Option B
Called up Share Capital = 9* 500 = 4500
Unpaid Allotment Money = 500
Paid Amount for Face Value = 4000
Concept Check
Ram applied for 1000 shares, but he got allotted only 500 shares under pro-rata allotment. The shares were issued at premium of 10% on face value of 10.
The application money was 4 and allotment money was 5 (including Premium) . Ram was not able to pay the allotment money and shares were forfeited.
What would be money debited in Share Capital A/c and money credited in Share Allotment A/c.
(A) 4000, 1500
(B) 4000, 500
(C) 4500, 500
(D) 4500, 1500
Ans: Option B
Called up Share Capital = 8* 500 = 4000
Securities Premium unpaid = 500
Unpaid Allotment Money = 500
Paid Amount for Face Value = 4000
Next Video -> Issue of Shares for Consideration other than Cash
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Accounting for Share Capital Transactions
Issuing of Shares for Consideration other than Cash
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Issuing of Shares for Consideration other than Cash
There are instances where a company enters an arrangement with the vendors from whom it has purchased assets,
whereby the latter agrees to accept, the payment in the form of fully paid shares of the company issued to them
Rahul Limited purchased building from Handa
Handa Limited
Limited for Rs.5,40,000
Rahul Limited Pays Handa by issuing Shares of
Handa Limited
Face Value 100
Number of Shares to be issued if they are issues at face value of 100 = 540000/100 = 5400
Number of Shares to be issued if they are issues at premium of 20% (120) = 540000/120 = 4500
Issuing of Shares for Consideration other than Cash
Journal Entries
When Issued at Par
When Issued at Premium
Concept Check
Ahluwalia Ltd. issued 1,000 equity shares of Rs. 100 each as fully paid-up in consideration of the purchase of plant and
machinery worth Rs. 1,00,000. What entry will be recorded in company’s journal
Plant A/c Dr. 100000
Vendor A/c 100000
Concept Check
G Ltd. acquired assets worth `7,50,000 from H Ltd. by issue of shares of `100 at a premium of 25%. The number of shares
to be issued by G Ltd. to settle the purchase consideration = ?
(i) 6000
(ii) 7000
(iii) 9375
Ans: Option 1
If vendors are issued fully paid shares of ₹1,25,000 in consideration of net assets of 1,50,000, the balance of ₹25,000 will
be credited to :
(A) Statement of Profit & Loss
(B) Goodwill Account
(C) Security Premium Reserve Account
(D) Capital Reserve Account
Ans: Option 3
Concept Check
A Company purchased a building for ₹3,60,000 and issued as payment equity shares at 20% premium. Journal Entry will be
Ans: Option C
Let's Assume face value = 100, premium = 20
Number of Shares = 360000/120 = 3000
Concept Check
If shares of ₹4,00,000 are issued for purchase of assets of ₹5,00,000, ₹1,00,000 will be treated as ……………………. :
(A) Discount
(B) Premium
(C) Profit
(D) Loss
Ans: Option B
A Building was purchased for ₹9,00,000 and payment was made in 100 shares at 20% premium. Securities Premium
Reserve A/c will be ……………….
(A) Debited by ₹1,50,000
(B) Credited by ₹1,50,000
(C) Debited by ₹1,80,000
(D) Credited by ₹1,80,000
Ans: Option B
Price of Issue = 900000/100 = 9000
X * 1.2 = 9000 -> x = 7500, so premium would be 20% of 7500 = 1500 per share
Thank You Very Much
Accounting for Bonus Shares and Rights Issue
Basics of Bonus Issue
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What are Bonus Issue or Shares?
Bonus issue means an issue of free additional shares to existing shareholders
Bonus shares are issued according to each shareholder’s stake in the company
Bonus Issue of 1:1 means that company would given one additional share for already existing one share
Bonus issue of 1:5 means that company would given one additional share for already existing 5 shares
Bonus issue of X:Y means that company would given X additional shares for already existing Y shares
What are Bonus Issue or Shares?
Example: What would be bonus shares allocated if a bonus issue is a 3:2 and number of shares held by share
holder are 1000
Solution:
3:2 means 3 more shares for every 2 shares held
So it means 1500 more share would be allocated for already held 1000 shares
Example: What would be total number of shares issued in the books of company if a bonus issue is a 3:2 and
number of shares issued before the Bonus issue are 1000
Solution:
3:2 means 3 more shares for every 2 shares held
So it means 1500 more share would be allocated for already held 1000 shares
So total number of share after the bonus issue = 1500+1000 = 2500
Concept Check
Company has issued total of 300 Shares and they are only issued to Ram and Sham. Ram and Sham currently
hold 100 Shares and 200 shares respectively. After the Bonus issue of 1:5, what would be Impact on % of shares
held by Ram
1) Increase by 5%
2) Increase by 20%
3) Decrease by 1%
4) Decrease by 20%
5) No Change in % of shares held
Ans: Option 5
Sol:
Before Bonus issue % of Shares held By Ram = 100/300 = 1/3 = 33.33%
After Bonus issue Shares held by Ram = 100 + 20 (Bonus shares) = 120
After Bonus issue shares held by Sham = 200 + 40 (Bonus Shares) = 240
After Bonus issue % of Shares held By Ram = 120/360 = 1/3 = 33.33%
Although the total number of issued shares increases, the ratio of number of shares held by each shareholder
remains constant.
From Where does Bonus Issue Gets Funded? Changes in Balance Sheet
Suppose Company has issued 100 shares at face value 10 and premium of 40.
Liabilities Assets
Share Capital -> 1000 Cash -> 10,000
Reserves and Surplus
Securities Premium -> 4000
Capital Reserves -> 1000
Retained Earnings -> 1000
General Reserves -> 1000
Capital Redemption Reserve -> 2000
A bonus can be given out of
1. Free Reserves (Retained Earnings Reserve or General Reserves)
2. Securities Premium Reserves
3. Capital Redemption Reserves
A bonus Cannot be given out of
1. Revaluation Reserves which are part of Capital Reserves
From Where does Bonus Issue Gets Funded? Changes in Balance Sheet
Suppose Company gives bonus of 1:1 from Free
Reserves (General Reserve or Retained Earning
Reserve)
It means Bonus Shares of 100
Now in books of Company there would be 200
shares at face value of 10
Liabilities Assets
Share Capital -> 2000 Cash -> 10,000
Share Capital increases Reserves and Surplus
Corresponding Reserves come Securities Premium -> 4000
down Capital Reserves -> 1000
Retained Earnings -> 1000
General Reserves -> 0
Capital Redemption Reserve -> 2000
From Where does Bonus Issue Gets Funded? Changes in Balance Sheet
Suppose Company gives bonus of 1:1 from
Capital Redemption Reserve
It means Bonus Shares of 100
Now in books of Company there would be 200
shares at face value of 10
Liabilities Assets
Share Capital -> 2000 Cash -> 10,000
Share Capital increases Reserves and Surplus
Corresponding Reserves come Securities Premium -> 4000
down Capital Reserves -> 1000
Retained Earnings -> 1000
General Reserves -> 1000
Capital Redemption Reserve -> 1000
From Where does Bonus Issue Gets Funded? Changes in Balance Sheet
Suppose Company gives bonus of 2:1 from
Securities Premium Reserve
It means Bonus Shares of 200
Now in books of Company there would be 300
shares at face value of 10
Liabilities Assets
Share Capital -> 3000 Cash -> 10,000
Share Capital increases Reserves and Surplus
Corresponding Reserves come Securities Premium -> 2000
down Capital Reserves -> 1000
Retained Earnings -> 1000
General Reserves -> 1000
Capital Redemption Reserve -> 2000
Impact of Bonus Shares on Face Value of Shares
Before Bonus After Bonus
Liabilities Assets Liabilities Assets
Share Capital -> 1000 Cash -> 10,000 Share Capital -> 3000 Cash -> 10,000
Reserves and Surplus Reserves and Surplus
Securities Premium -> 4000 Securities Premium -> 2000
Capital Reserves -> 1000 Capital Reserves -> 1000
Retained Earnings -> 1000 Retained Earnings -> 1000
General Reserves -> 1000 General (Free)Reserves -> 1000
Capital Redemption Reserve -> 2000 Capital Redemption Reserve -> 2000
No Change in the Face Value
Impact of Bonus Shares on Cash of the Company
In all the 3 scenario you see, Cash of the Company remains
Unchanged
Issuing bonus shares does not involve cash flow for the company,
so company can issue them without any impact on their Cash
Bonus issue is also known as ‘capitalization of profits’.
Capitalization of profits refers to the process of converting profits
or reserves into paid up capital
Impact of Bonus Shares on Cash of the Company
In all the 3 scenario you see, Cash of the Company remains Unchanged
Issuing bonus shares does not involve cash flow for the company, so company can issue them without any impact on
their Cash
Bonus issue would be used by Company
Bonus issue would be used by Company
when it has Cash but it wants to use that
when it is short of Cash
for further expansion of the company
Impact of Bonus Shares on Net worth of Company
Before Bonus After Bonus
Liabilities Assets Liabilities Assets
Share Capital -> 1000 Cash -> 10,000 Share Capital -> 3000 Cash -> 10,000
Reserves and Surplus Reserves and Surplus
Securities Premium -> 4000 Securities Premium -> 2000
Capital Reserves -> 1000 Capital Reserves -> 1000
Retained Earnings -> 1000 Retained Earnings -> 1000
General Reserves -> 1000 General Reserves -> 1000
Capital Redemption Reserve -> 2000 Capital Redemption Reserve -> 2000
Shareholder Capital or Net Worth = 10,000 Shareholder Capital or Net Worth = 10,000
Whenever we issue Bonus Shares, there is no change in the Net worth of the company
Impact of Bonus Shares on Market Price
Market Price adjusts in such a way that Market Capitalization remains the same before and after the issue
Market Capitalization = Total Shares * Market Price
Illustration 1
Suppose Company had earlier issued 100 Shares of face value 10. The market price was 30 before the Bonus issue of
1:1. What will be the market price after bonus issue
Sol:
Market Capitalization before Bonus issue = 100* 30 = 3000
Number of Shares After Bonus Issue = 100+ 100 (Bonus) = 200
Market Capitalization after Bonus issue will remain the same as that before = 100* 30 = 3000
200* Market Price = 3000
Market Price = 15
Impact of Bonus Shares on Market Price
Market Price adjusts in such a way that Market Capitalization remains the same before and after the issue
Market Capitalization = Total Shares * Market Price
Illustration 2
Suppose Company had earlier issued 100 Shares of face value 10. The market price was 30 before the Bonus issue of
1:4. What will be the market price after bonus issue
Sol:
Market Capitalization before Bonus issue = 100* 30 = 3000
Number of Shares After Bonus Issue = 100+ 25 (Bonus) = 125
Market Capitalization after Bonus issue will remain the same as that before = 100* 30 = 3000
125* Market Price = 3000
Market Price = 24
Impact of Bonus Shares on Market Price
Market Price adjusts in such a way that Market Capitalization remains the same before and after the issue
Market Capitalization = Total Shares * Market Price
Illustration 3
Suppose Company had earlier issued 100 Shares of face value 10. The market price was 30 before the Bonus issue of 2:1
. What will be the market price after bonus issue
Sol:
2:1 is also possible where 2 more shares are given for existing 1 share
Market Capitalization before Bonus issue = 100* 30 = 3000
Number of Shares After Bonus Issue = 100+ 200 (Bonus) = 300
Market Capitalization after Bonus issue will remain the same as that before = 100* 30 = 3000
300* Market Price = 3000
Market Price = 10
Impact of Bonus Shares on Earnings Per Share
EPS = Profit/Number of Shares
Profit will not change due to Bonus shares, but Number of Shares will increase
Hence EPS will reduce
Impact of Bonus Shares on Market Sentiments
Generally Bonus is taken as Positive step by markets because Company is kind of distributing reserves to shareholders
If Issued Capital becomes > Authorized Capital due to Bonus Issue
Company has Authorized Capital of 1500
Suppose Company has issued 100 shares of face value 10 at a value of 12 and all of it is subscribed
So total Issued Capital is 100*10 = 1000
Now suppose that a company comes out with a Bonus issue of 1:1
So total shares issued by company would become 200
Total issued capital would become = 200*10 = 2000
Issued Capital has become more than authorized Capital
A resolution shall be passed by the company at its general body meeting for increasing the authorized capital.
A return of bonus issue along with a copy of resolution authorizing the issue of bonus shares is also required to be filed
with the Registrar of Companies.
If Issued Capital becomes > Authorized Capital due to Bonus Issue
Company has Authorized Capital of 1500
Suppose Company has issued 100 shares of face value 10 at a value of 12 and all of it is subscribed
So total Issued Capital is 100*10 = 1000
Now suppose now a company comes out with a Bonus issue of 1:1
So total shares issued by company would become 200
Total issued capital would become = 2000*10 = 2000
2 Methods to increase Authorized Capital
Increase in Authorized Capital = Amount of Bonus Issue Increase in Authorized Capital = Amount of Bonus Issue – Unused Auth. Capital
The authorized capital will be increased by the The authorized capital will be increased by the Shortfall only
amount of bonus issue. (Amount of bonus issue-unused Authorized Capital
In our example the authorized Capital would be In our example the authorized Capital would be increased by
increased by 100*10 = 1000 1000 – 500 = 500
New Auth. Capital = 1500+1000 =2500 New Auth. Capital = 1500+500 =2000
Concept Check
Which of the following cannot be used for issue of bonus shares as per the Companies Act?
(a) Securities premium account
(b) Revaluation reserve
(c) Capital redemption reserve
Ans: Option B
Which of the following statements is true about declaring and issuing of Bonus Shares?
(a) Assets are transferred from the company to the shareholders.
(b) A Bonus issue results in decrease in reserves and surplus.
(c) A Bonus issue is same as declaration of dividends.
Ans: Option B
Concept Check
When issued capital becomes > Authorized Capital due to Bonus issue then how do we increase the Authorized Capital?
(a) Increase Authorized Capital by the amount of value of Bonus Shares
(b) Increase Authorized Capital by the amount = Value of Bonus Shares – Value of Unused Authorized Capital
(c) Either A or B
Ans: Option C
Which of the following Decrease after Bonus issue?
(a) Net worth
(b) EPS
(c) Market Capitalization
(d) Cash
Ans: Option B
Concept Check
The market price before Bonus issue is 100. What would be the % reduction in market price after bonus issue of 2:1
(a) 50%
(b) 33.3%
(c) 66.6%
(d) 75%
Ans: Option C
Sol:
Let X be the number of shares
Market Capitalization before Bonus issue = 100 X
After Bonus number of shares will be 3X
Market Capitalization after Bonus issue will remain = 100 X
3X * Market Price = 100 X
Market Price = 33.33
Reduction from 100 to 33.33, hence it is 66.6%
Next Video - Regulations Related to Bonus Issue under Company Law and SEBI Regulations
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Accounting for Bonus Shares and Rights Issue
Regulations Related to Bonus Issue under Company Law and SEBI Regulations
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Provisions Under Companies Act
Section 63 (1)
Can be issued
through
1. Free Reserves (General Reserves or Retained Earnings Reserve
Bonus Issue 2. Securities Premium Reserves
3. Capital Redemption Reserves
Cannot be
issued through
1. Revaluation Reserves
Bonus Issue
Provisions Under Companies Act
Section 63 (2)
Following Conditions must be met for a Company to come out with Bonus Issue
1. Authorized by Articles of the company
2. Board has recommended the Bonus Issue and same has been approved in the general meeting of the
company
3. Company has not defaulted in payment of interest or principal in respect of fixed deposits or debt securities
issued by it
4. Company has not defaulted in respect of the payment of statutory dues of the employees, such as,
contribution to provident fund, gratuity and bonus
5. Any Partly Paid up shares shall be made fully Paid up
The company which has once announced the decision of its Board recommending a bonus issue, shall not
subsequently withdraw the same
Provisions Under Companies Act
Section 63 (2)
Any Partly Paid up shares shall be made fully Paid up
Suppose if some money is still unpaid and Company wants to call them later
Does this mean, a company with partly paid up shares can not come out with Bonus issue till then?
Table F under Schedule I to the Companies Act, 2013 allows use of free reserves for paying up amounts unpaid on
shares held by existing shareholders
It can be said that free reserves may be used for paying up amounts unpaid on shares held by existing shareholders
(though securities premium account and capital redemption reserve cannot be used).
So companies by themselves can convert partly paid up shares into fully paid up shares
SEBI Regulations
SEBI Regulations related to Bonus shares
ICDR Regulations -> Regulation 293 (Conditions for Bonus Issue)
Following Conditions must be met for a Company to come out with Bonus Issue
Same as mentioned in Companies Act
1. Authorized by Articles of the company (If not authorized by Articles of Association then issuer shall pass a resolution
at its general body meeting making provisions in the articles of associations for capitalization of reserve)
2. Company has not defaulted in payment of interest or principal in respect of fixed deposits or debt securities issued
by it
3. Company has not defaulted in respect of the payment of statutory dues of the employees, such as, contribution to
provident fund, gratuity and bonus
4. Any Partly Paid up shares shall be made fully Paid up
Extra from what is mentioned in Companies Act
1. Any of its promoters or directors is not a fugitive economic offender.
SEBI Regulations related to Bonus shares
ICDR Regulations -> Regulation 294 (Restrictions on Bous Issue)
Bonus to holders of Convertible Debt Instruments
Bonus Equity shares must be reserved for them and
If there are some parties who hold Convertible shall be issued at time of conversion of debt into
Debt Instruments equity later
Sources of Bonus Issue 1. Free or General Reserves
2. Securities Premium Reserves
Bonus issue shall be made only out of 3. Capital Redemption Reserves
Revaluation Reserves shall not be used
Superior Voting Rights
Any bonus issue on the SR equity shares shall carry the
Bonus issue on SVR’s to have same ratio of voting same ratio of voting rights compared to ordinary
rights shares
SEBI Regulations related to Bonus shares
ICDR Regulations -> Regulation 295 (Completion of Bous Issue)
1. Authorized by Articles of the company (If not authorized by Articles of Association then issuer shall pass a resolution
at its general body meeting making provisions in the articles of associations for capitalization of reserve)
If there is no Authorization by Articles of
If already there is Authorization by Articles of
Company to Capitalize Reserves for Bonus
Company to Capitalize Reserves for Bonus
issue and Resolution needs to be passed for
issue
making provisions in articles of association for
capitalizing reserves to issued Bonus shares
Company Shall implement the bonus issue Company Shall implement the bonus issue
within fifteen days from the date of within 2 months from the date of
approval of the issue by its board of approval of the issue by its board of
directors directors
SEBI Regulations related to Bonus shares
ICDR Regulations -> Regulation 295 (Completion of Bous Issue)
2. A bonus issue, once announced, shall not be withdrawn.
Concept Check
Which of the following statement is true in case of bonus issue?
(a) Convertible debenture holders will get bonus shares in same proportion as to the existing shareholders.
(b) Bonus shares shall be issued to convertible debenture holders at the time of conversion of such debentures into shares.
(c) Both (a) and (b)
Ans: Option C
Bonus issue is also known as
(a) Scrip issue.
(b) Capitalization issue.
(c) Both (a) and (b)
Ans: Option C
Concept Check
The bonus issue is not made unless
(a) Partly paid shares are made fully paid up.
(b) It is provided in its articles of association
(c) Both (a) and (b).
Ans: Option C
If there is no Authorization by Articles of Company to Capitalize Reserves for Bonus issue and Resolution needs to be
passed for making provisions in articles of association for capitalizing reserves to issued Bonus shares then Company Shall
implement the bonus issue with in how many days from the date of approval of the issue by its board of directors
(a) 15
(b) 30
(c) 60
(d) 90
Ans: Option C
Concept Check
As per SEBI regulations, which of the following condition must be met by the company for the bonus issue?
1. Capitalization of Reserves must be Authorized by Articles of the company or if not authorized by Articles of Association
then issuer shall pass a resolution at its general body meeting making provisions in the articles of associations for
capitalization of reserve)
2. Company has not defaulted in payment of interest or principal in respect of fixed deposits or debt securities issued by
it
3. Company has not defaulted in respect of the payment of statutory dues of the employees, such as, contribution to
provident fund, gratuity and bonus
4. Any Partly Paid up shares shall be made fully Paid up
5. All the above
Ans: Option 5
Accounting for Bonus Shares (Journal Entries)
Journal Entries for Bonus Shares
Event 1 Event 2
Upon the sanction of an issue of bonus shares Upon issue of bonus shares
A) Debit Capital Redemption Reserve Account A) Debit Bonus to Shareholders Account
Debit Securities Premium Account
Debit General Reserve Account B) Credit Share Capital Account.
Debit Profit & Loss Account (Retained Earnings)
B) Credit Bonus to Shareholders Account.
Example 1 – Bonus Shares
Solution
Minimum Reduction in Free Reserves means that first money
should be used from Capital Redemption Reserve or Securities
Premium Reserve
Upon the sanction of an issue of bonus shares
Upon issue of bonus shares
Example 1 – Bonus Shares
Solution
Minimum Reduction in Free Reserves means that first money
should be used from Capital Redemption Reserve or Securities
Premium Reserve
Upon the sanction of an issue of bonus shares
Upon issue of bonus shares
Example 2 – Bonus Shares
Solution
Journal Entries when call becomes due and Receipt for call
money is received
Call becomes Due
Receipt of Call Money
Example 2 – Bonus Shares
Solution
When Bonus issue is sanctioned and Bonus shares are issued
1:4 bonus shares issue means, bonus shares issued will be
90000/4 = 22500 and their value would be 22500*10 = 225000
Upon the sanction of an issue of bonus shares
s
Upon issue of bonus shares
Example 2 – Bonus Shares
Solution
Balance Sheet
After Call, the share Capital would be
80,000 +7,20,000 + 1,80,000 (Called Money) = 9,80,000
After Bonus the share Capital would be
9,80,000
s + 225000 = 12,05,000
Reserves and Surplus would reduce during the Bonus Issue
Example 2 – Bonus Shares
Solution
Balance Sheet
The issued capital after Bonus issue will become more that Authorized Capital for
Equity Shares, So Authorized Capital will also be increased. In this example we have
increased Authorized Capital by Shortfall only
Notes to Balance Sheet
s
Example -3 Bonus Shares
Solution
Journal Entries when call becomes due and Receipt for call
money is received
Call becomes Due
On 1st April, 20X1, the Company has made final call @ ` 2 each
on 1,35,000 equity shares. The call money was received by 20th
April, 20X1. Thereafter, the company decided to capitalize its Receipt of Call Money
reserves by way of bonus at the rate of one share for every four
shares held.
Show necessary journal entries in the books of the company and
prepare the extract of the balance sheet as on 30th April, 20X1
after bonus issue.
Example -3 Bonus Shares
Solution
When Bonus issue is sanctioned and Bonus shares are issued
1:4 bonus shares issue means, bonus shares issued will be
135000/4 = 33750 and their value would be 33750*10 = 337500
Upon the sanction of an issue of bonus shares
On 1st April, 20X1, the Company has made final call @ ` 2 each
on 1,35,000 equity shares. The call money was received by 20th
April, 20X1. Thereafter, the company decided to capitalize its
reserves by way of bonus at the rate of one share for every four
shares held.
Upon issue of bonus shares
Show necessary journal entries in the books of the company and
prepare the extract of the balance sheet as on 30th April, 20X1
after bonus issue.
Example -3 Bonus Shares
Solution
Extract of Balance Sheet
The issued capital after Bonus issue will become more that
Authorized Capital for Equity Shares, So Authorized Capital will
also be increased. In this example we have increased Authorized
Capital by Amount equal to Bonus Issue
Notes to Balance Sheet
On 1st April, 20X1, the Company has made final call @ ` 2
each on 1,35,000 equity shares. The call money was received
by 20th April, 20X1. Thereafter, the company decided to
capitalize its reserves by way of bonus at the rate of one
share for every four shares held.
Show necessary journal entries in the books of the company
and prepare the extract of the balance sheet as on 30th
April, 20X1 after bonus issue.
Example 4 - Bonus Shares
Solution
Concept Check
Which of the following Account should be credited when bonus shares are approved by board
(a) Securities Premium Account
(b) Capital Redemption Account
(c) Retained Earnings Account
(d) Bonus to Shareholders A/c
Ans: Option D
A company has issued 100 shares of face value 10. The company has now bonus issued of 1:4. Company has Rs. 100 in
securities premium account, Rs. 100 in Capital Redemption Reserve account, Rs. 100 in General Reserves and no amount
in Profit and Loss Account. How much Could be the minimum amount debited from General Reserves?
(a) 100
(b) 40
(c) 50
(d) 150
Ans: Option C
Concept Check
A company has issued 100 shares of face value 10. The company has now bonus issued of 1:4. Company authorized capital
of 1250. How much is the minimum increase required in Authorized Capital?
(a) 250
(b) 500
(c) 0
(d) 500
Ans: Option C
Next Video – Rights Issue
Thanks
Accounting for Bonus Shares and Rights Issue
Basics of Rights Issue
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Basics of Rights Issue
Has earlier Issued 100 to
Ram and Sham in equal
proportion
Company 100 Shares of face value 10
Share Capital = 1000
Ram’s Share = 500 (50%)
Issued 100 Additional Sham’s Share = 500 (50%)
Shares in market to Arun
and Varun in equal
proportion
200 Shares of face value 10
Share Capital = 2000
Ram’s Share = 500 (25%)
Company Sham’s Share = 500 (25%)
Arun’s Share = 500 (25%)
Varun’s Share = 500 (25%)
We can see the % of Shareholding of Ram and Sham has decreased. This is called dilution of Shareholding
Rights Issue
To prevent Dilution of Shareholding, the Company’s Act requires that a company which wants to raise more capital
through an issue of shares must first offer them to the existing shareholders.
Such an offer of shares is called a rights issue
This is right and not an obligation.
During Rights issue, an investor may not use his right and may not buy the shares because of any reason like he feels
company is not good or he has no money to buy the additional shares offered in rights issue
Basics of Rights Issue
In Rights Issue, shares are offered in proportion to existing shares held by the shareholders.
For example, 1:1 Rights issue means 1 for 1 i.e. 1 share would be issued in Rights issue for every 1 share held by the
investor
Example
If company has 100 shares and Ram and Sham has 50 shares each out of these 100 shares.
Rights issue of 2:10, would means 2 shares would be offered under Rights issue for every 10 shares held
Total shares issued by company during Right issue would be 20
Total shares after the rights issue (Including the previous one also) = 100 + 20 = 120
Assuming Ram and Sham subscribe to the Rights issue
Total Shares with Ram after rights issue would be = 50 + 10 = 60
Total Shares with Sham after rights issue would be = 50+10 = 60
You can see that after the rights issue, the % shareholding of Ram and Sham remains the same as that of earlier which
was 50%
Basics of Rights Issue
In our earlier example it would be like this as shown below
Has earlier Issued 100 to
Ram and Sham in equal
proportion
Company 100 Shares of face value 10
Share Capital = 1000
Ram’s Share = 500 (50%)
Assuming they Sham’s Share = 500 (50%)
Offers 1:1 Rights Issue, so 50 shares
accept the offer would be offered to Ram and Sham
and buy the shares
After the offer 200 Shares of face value 10
Share Capital = 2000
Company Ram’s Share in Share Capital = 1000 (50%)
100 Shares with Ram Sham’s Share in Share Capital = 1000 (50%)
100 Shares with Sham
No Dilution happening here
Concept Check
Company makes a right issue of 10,000 shares when its existing issued and subscribed capital is 100,000 shares. How
many shares will be offered to an existing shareholder holding 1000 shares.
A) 100
B) 1000
C) 10000
D) 10
Ans: Option A
Concept Check
Company has issued 100 shares of face value 10. Now company announces the rights issue of 1:5. What would be
increase in number of shares of the company
A) 20
B) 100
C) 50
D) 10
Ans: Option A
Financial Impact of Rights Issue on Company
Impact of Rights issue on Balance Sheet
Suppose Company has issued 100 shares at face value 10 and premium of 40. Market Value before Rights issue is say 60
Shares under Rights issue Shares under Rights issue Shares under Rights issue
offered at Face Value offered at Premium to Face offered at Discount
Value but Less than Market
In our example Rs. 10 Value In our example Rs. 5
In our example Rs. 55
Most Common Case
Impact of Rights issue on Balance Sheet
Suppose Company has issued 100 shares at face value 10 and premium of 40.
Liabilities Assets
Share Capital -> 1000 Cash -> 10,000
Reserves and Surplus
Securities Premium -> 4000
Capital Reserves -> 1000
Retained Earnings -> 1000
General Reserves -> 1000
Market Value before Capital Redemption Reserve -> 2000
Rights issue is say 60
Now Suppose there is Rights issue of 1:1
Normally shares are offered at discount to market price, so at market price of 60 let's suppose they are offered at price of 55
Liabilities Assets
Share Capital -> 2000 Cash -> 15500
Reserves and Surplus
Share Capital Increases and Securities Premium -> 8500
Securities Premium Increases here Capital Reserves -> 1000
Retained Earnings -> 1000
General Reserves -> 1000
Capital Redemption Reserve -> 2000
Impact of Rights issue on Face Value
Before Rights After Rights
Liabilities Assets Liabilities Assets
Share Capital -> 1000 Cash -> 10,000 Share Capital -> 2000 Cash -> 15500
Reserves and Surplus Reserves and Surplus
Securities Premium -> 4000 Securities Premium -> 8500
Capital Reserves -> 1000 Capital Reserves -> 1000
Retained Earnings -> 1000 Retained Earnings -> 1000
General Reserves -> 1000 General Reserves -> 1000
Capital Redemption Reserve -> 2000 Capital Redemption Reserve -> 2000
No Change in Face Value of share during Rights Issue
Impact of Rights issue on Cash
Before Rights After Rights
Liabilities Assets Liabilities Assets
Share Capital -> 1000 Cash -> 10,000 Share Capital -> 2000 Cash -> 15500
Reserves and Surplus Reserves and Surplus
Securities Premium -> 4000 Securities Premium -> 8500
Capital Reserves -> 1000 Capital Reserves -> 1000
Retained Earnings -> 1000 Retained Earnings -> 1000
General Reserves -> 1000 General Reserves -> 1000
Capital Redemption Reserve -> 2000 Capital Redemption Reserve -> 2000
The Cash of the company increases after the rights issue
Impact of Rights issue on Net Worth
Before Rights After Rights
Liabilities Assets Liabilities Assets
Share Capital -> 1000 Cash -> 10,000 Share Capital -> 2000 Cash -> 15500
Reserves and Surplus Reserves and Surplus
Securities Premium -> 4000 Securities Premium -> 8500
Capital Reserves -> 1000 Capital Reserves -> 1000
Retained Earnings -> 1000 Retained Earnings -> 1000
General Reserves -> 1000 General Reserves -> 1000
Capital Redemption Reserve -> 2000 Capital Redemption Reserve -> 2000
Shareholder Capital or Shareholder Capital or
Net Worth = 10,000 Net Worth = 15,500
The net worth of the company increases after the Rights Issue
Impact of Rights issue on EPS
EPS = Profit/Number of Shares
Profit will not change due to Rights shares, but Number of Shares will increase
Hence EPS will reduce
Concept Check
Company has issued 100 shares of face value 10. Now company announces the rights issue of 1:5. What would be
increase in share capital of the company
A) 100
B) 200
C) 250
D) 100
Ans: Option B
When shares of Company of face value 10 are offered in rights issue at a value of 30. Then which of the following will
increase
A) Share Capital
B) Share Premium
C) Cash
D) All the above
Ans: Option D
Financial Impact of Rights Issue on Shareholder
Various Scenarios Possible For Shareholder
1
The rights offer is accepted. The shareholder pays for it and gets the shares issued
2
The rights are sold to somebody else at a price by the shareholder. This is called renunciation of Rights.
Renunciation of Rights will be only possible if that are not prohibited by Articles of Association
3
Nothing done with the rights
Example
Let's say you own 1,000 shares in Wobble Telecom, Scenario 1 – Accept the offer
each of which is worth 5.50. The company is in a bit of
financial trouble and sorely needs to raise cash to
cover its debt obligations. Wobble therefore Cum Rights Market Price -> 5.50
announces a rights offering, in which it plans to raise
30 million by issuing 10 million shares to existing
investors at a price of 3 each. The issue is a three-for- Share price that will result after the rights issue is
10 (3:10) rights issue. In other words, for every 10 calculated as shown below
shares you hold, Wobble is offering you another three
shares.
Discuss the Implications on the shareholder in all the 3
scenarios of handling the Rights issue?
Ex- Rights Market Price -> 4.923
Value of Right = 5.50 – 4.923 = .577 per share So here after the rights issue the price will drop
Example
Let's say you own 1,000 shares in Wobble Telecom, Scenario 2 – Sell (Renunciate) the Rights
each of which is worth 5.50. The company is in a bit of
financial trouble and sorely needs to raise cash to
cover its debt obligations. Wobble therefore
The price at which rights can be sold for buyer to buy one share
announces a rights offering, in which it plans to raise
= value of stock post the issue - the rights issue price
30 million by issuing 10 million shares to existing
investors at a price of 3 each. The issue is a three-for-
10 (3:10) rights issue. In other words, for every 10
shares you hold, Wobble is offering you another three Selling Price of right for buyer to buy one share= 4.924 – 3 = 1.924
shares.
Discuss the Implications on the shareholder in all the 3
scenarios of handling the Rights issue? Since you have got rights for buying 300 shares, so the
total value becomes 1.923 * 300 = 577
This can also be calculated as
Total worth of your shares before Rights issue – Total worth of your shares after rights issue
1000* (5.5) - 1000* (4.924)
= 5500 – 4923 = 577
Example
Scenario 2 – Sell (Renunciate) the Rights
What is here for the buyer
Buyer basically will pay 1.923 to you
Rest 3 he will pay to company
So he will pay 4.923 to buy the shares and this
price is equal to Ex-rights price of 4.923
So to gain something the buyer will try to bargain
with the seller of the rights and instead of paying
him 1.923 he might pay say 1.50 and keeping
0.423 as his profit
Example
Let's say you own 1,000 shares in Wobble Telecom, Scenario 3 – Ignore the Issue
each of which is worth 5.50. The company is in a bit of
financial trouble and sorely needs to raise cash to
cover its debt obligations. Wobble therefore You may not have the 900 to purchase the additional 300
announces a rights offering, in which it plans to raise shares at 3 each, so you can always let your rights expire.
30 million by issuing 10 million shares to existing But this is not normally recommended. If you choose to
investors at a price of 3 each. The issue is a three-for- do nothing, your shareholding will be diluted thanks to
10 (3:10) rights issue. In other words, for every 10 the extra shares issued
shares you hold, Wobble is offering you another three
shares.
Discuss the Implications on the shareholder in all the 3
scenarios of handling the Rights issue?
Example 2
Mr. Narain has 100 shares of Prosperous Company Scenario 1 – Accepts the Right
before rights issue. The market value of share is 25.
Companies come out with Rights issue of 1:10 where Cum Rights Market Price -> 25
company is issuing shares at 14 each
Share price that will result after the rights issue is
Consider the Impact on Narain in the below 2
scenarios? 100 existing shares at 25 -> 2500
1) He Accepts the offer 10 new shares at 14 -> 140
2) He sells the rights to Murthy at a price as per Value of 110 shares -> 2640
theoretical calculations Ex Rights Value -> 24
Ex- Rights Market Price -> 24
Value of Right = 25-24 = 1
Example 2
Mr. Narain has 100 shares of Prosperous Company Scenario 2 – Sell (Renunciate) the Rights
before rights issue. The market value of share is 25.
Companies come out with Rights issue of 1:10 where
The price at which rights can be sold for buyer to buy one share
company is issuing shares at 14 each
= value of stock post the issue - the rights issue price
Consider the Impact on Narain in the below 2
scenarios?
1) He Accepts the offer Selling price of Right for buyer to buy one share = 24 – 14 = 10
2) He sells the rights to Murthy at a price as per
theoretical calculations
Since narain have got rights for 10 shares, so the total
value becomes 10 * 10 = 100
This can also be calculated as
Total worth of your shares before Rights issue – Total worth of your shares after rights issue
100* (25) - 100* (24)
= 2500 – 2400 = 100
Example 3
A company offers new shares of 100 face value each at 25% premium to existing shareholders on one for four bases. The
cum-right market price of a share is ` 150 and company has issued 100 shares in total. Calculate the value of a right. What
should be the ex-right market price of a share?
Cum Rights Market Price -> 150
Share price that will result after the rights issue is
100 existing shares at 150 -> 15000
Selling price of Right to buy one share= 145 – 125
25 new shares at 125 -> 3125
= 20
Value of 125 shares -> 18125
Ex Rights Value -> 145
Ex Rights Market Price -> 145
Value of Right = 150 – 145 = 5 per Share
Impact of Rights issue on Market Price
Let's say you own 1,000 shares in Wobble Telecom,
each of which is worth 5.50. The company is in a bit of Share price that will result after the rights issue is
financial trouble and sorely needs to raise cash to calculated as shown below
cover its debt obligations. Wobble therefore
announces a rights offering, in which it plans to raise
30 million by issuing 10 million shares to existing
investors at a price of 3 each. The issue is a three-for-
10 (3:10) rights issue. In other words, for every 10
shares you hold, Wobble is offering you another three
shares.
Discuss the Implications on the shareholder in all the 3
scenarios of handling the Rights issue?
We have already discussed in earlier example how Market Price gets adjusted after Rights Issue.
Concept Check
A company’s share’s face value is 10, book value is 20, Right issue price is 30 and Market price is 40, while recording the
issue of right share, the securities premium will be credited with
(a) 10
(b) 20
(c) 30
Ans: Option B
Concept Check
A. Right shares enable existing shareholders to maintain their proportional holding in the company.
B. Right share issue does not cause dilution in the market value of the share.
Which of the option is correct:
(a) A-Correct; B Correct
(b) A – Incorrect; B Correct
(c) A Correct; B – Incorrect
Ans: Option C
Company has issued 100 shares of face value 10. The market price before the rights issue is 20. Company offers shares in
rights issue of 1:10 at a value of 15.What is the approx. value of the right per share?
a) .10
b) .50
c) .60
d) 70
Ans: Option B
Sol: Ex-Eight Value (2000+150)/110 = 19.54
Concept Check
Company has issued 100 shares of face value 10. The market price before the rights issue is 20. Company offers shares in
rights issue of 1:10 at a value of 15.What is the approx. value of the selling price of right to buy a share
a) 15
b) 4.50
c) 9
d) 7.59
Ans: Option B
Sol: 19.50 (Ex-Right Value) – 15 (Offer Price in Rights Issue) = 4.50
Concept Check
A company has decided to increase its existing share capital by making rights issue to its existing shareholders. The
company is offering one new share for every two shares held by the shareholder. The market value of the share is 240
and the company is offering share of 120 each. Calculate the value of a right.
a) 50
b) 40
c) 60
d) 80
Ans: Option B
Sol: Let there be 2 shares before Rights Issue
Ex Rights Price = (480+120)/3 = 600/3 = 200
Value of Right per share = 240 -200 = 40
Next Video – Regulations Related to Rights Issue and Journal Entries
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Accounting for Bonus Shares and Rights Issue
Regulation for Rights Issue and Journal Entries
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Regulations for Rights Issues
A company desirous of issuing new shares has to offer, as per Section 62(1) (a) of Companies Act 2013, the shares to
existing equity shareholders through a letter of offer subject to the following conditions, namely:
1
The Shareholder can do any of the following with the offer
1) He can accept the offer which means shares would be bought by paying the money
2) He can sell his rights (renunciate) to anybody else to buy the shares. When he sells his right, he will get some money
from the buyer
3) He can simply do nothing with those rights
2
The company shall send a notice specifying number of shares offered
The shareholder shall be given not less than 15 days and not more than 30 days to accept the offer and if the offer is not
accepted with in that period then the offer will be assumed to be declined
3
If the offer is declined, then Board of Directors can dispose (sell) them to other parties
Regulations for Rights Issues
Exceptions to Rights Issue: As per section 62, there are four situations under which the further shares are to be issued by a
company, but they need not be offered to the existing shareholders i.e. company can instead of coming out with rights issue
can offer new shares to other people
Exception 1
Shares issued under ESOP Scheme: Company can issue shares to employees under a scheme of employees’ stock option
subject to certain specified conditions
Exception 2
Shares issued using Valuation Report: Shares can be issued to any persons, either for cash or for a consideration other than
cash, if the price
of such shares is determined by the valuation report of a registered valuer
Exception 3
Shares issued under Convertible Debt Plan: Sometimes companies borrow money through debentures / loans and give the
creditor an option to buy equity shares of a company when there is maturity of debt. The shares can be issued when
creditor converts the debt into shares
Regulations for Rights Issues
Exceptions to Rights Issue: As per section 62, there are four situations under which the further shares are to be issued by a
company, but they need not be offered to the existing shareholders i.e. company can instead of coming out with rights issue
can offer new shares to other people
Exception 4
Shares issued under Conversion of Debt into Shares by Government: If company has taken non-convertible debt or
debentures from government company, then Government considers it necessary in the public interest so to do, it may, by
order, direct that such debentures or loans or any part thereof shall be converted into shares in the company
If company is not happy with the terms and conditions of such conversion, then it can approach NCLT within sixty days from
the date of communication of such order
If the government order results in issued capital increasing beyond the authorized capital, then the Memorandum of
Association of company would automatically stand altered and Authorized Capital will increase by an amount equal to the
amount of the value of shares which such debentures or loans or part thereof has been converted into
Concept Check
Under which of the following conditions, the company can issue shares to new shareholders without coming out with
Rights issue
a) Shares allocated to Foreign nationals
b) Share allocated under ESOP Scheme
c) Shares allotted for Green Shoe Option
d) All the above
Ans: Option B
During Rights issue shareholder shall be given not less than ____days and not more than ___ days to accept the offer and
if the offer is not accepted with in that period then the offer will be assumed to be declined
a) 15,20
b) 15,60
c) 15,30
d) NOTA
Ans: Option C
Journal Entries
Journal Entries
Share issued at Face Value in Rights issue
Share issued at Premium in Rights issue
Example
Solution
Example
A company having 100,000 shares of 10 each as its issued share capital, and having a market value of 46, issues rights
shares in the ratio of 1:10 at an issue price of 10.
Solution
Bank A/c Dr. 100000
To Equity Share Capital A/c 100000
Concept Check
10 Shares under rights issue are allotted at premium of 50% with face value of 10. How much would be credit in
securities premium A/c
a) 10
b) 20
c) 50
d) 100
Ans: Option C
Thanks
Buyback of Shares
Basics of Buyback of Shares and Regulations under Companies Act
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What is Buyback of Shares?
As per Section 68 (1) of the Companies Act 2013, buy back of shares can be Shareholders
made out of: its free reserves; or the securities premium account; or the
proceeds of any shares or other specified securities.
Buy back is when company purchases the shares/securities back from its
shareholders
Securities in the context of buyback means ESOPs
What is Buyback of Shares?
When shares are bought back by a company, they
must be cancelled by the company
As per Section 68 (1) of the Companies Act 2013, buy back of shares can be
made out of: its free reserves; or the securities premium account; or the
proceeds of any shares or other specified securities.
The Paid-up share Capital of the Company would
decrease
When does a company goes for Buyback of Shares?
Companies usually goes for Buyback when they have
extra cash lying idle
As per Section 68 (1) of the Companies Act 2013, buy back of shares can be
made out of: its free reserves; or the securities premium account; or the
proceeds of any shares or other specified securities.
How to Fund Buyback of Shares?
Suppose Company has issued 100 Equity shares at face value 10 and premium of 40.
Suppose Company also issued 100 Preference shares of face value 10 at premium of 40
Liabilities Assets
Share Capital -> 2000 Cash -> 15000
Reserves and Surplus
Securities Premium -> 8000
As per Section 68 (1) of the Companies
Capital Reserves Act 2013, buy back of shares can be
-> 1000
Retained Earnings
made out of: its free reserves; -> 1000account; or the
or the securities premium
proceeds of any shares General Reserves
or other specified securities.-> 1000
Capital Redemption Reserve -> 2000
As per section 68(1) of Companies Act, Buyback can be
funded from However, Buy-back of any kind of shares or other
1. Free reserves (General Reserves and Retained specified securities cannot be made from the
Earnings Reserves) proceeds of the earlier issue of same kind of shares or
2. Securities premium account same kind of other specified securities
3. Proceeds of the issue of any shares or other specified
securities For example, if equity shares are to be bought-back,
Note: Revaluation Reserves cannot be used then, preference shares may be used for the purpose
Implications of Buyback on Balance Sheet
Suppose company bought back 50 equity shares at
price of 50, then Impact on balance sheet would
be
Assuming Security Premium
Reserves created by are used
Cash
As per Section 68 (1) of the Companies Act 2013, buy back of shares canwould
be reduce by = 50* 50 = 2500
made out of: its free reserves; or the securities premium account;Share
or theCapital would reduce by = 50* 10 = 500
proceeds of any shares or other specified securities. Securities Premium Reserves would reduce by 50*40 = 2000
Liabilities Assets
Share Capital -> 1500 Cash -> 12500
Share Capital will decrease
Reserves and Surplus
Reserves will decrease
Securities Premium -> 6000
Cash will Decrease
Capital Reserves -> 1000
Retained Earnings -> 1000
General Reserves -> 1000
Capital Redemption Reserve -> 2000
Implications of Buyback on Balance Sheet
Suppose company bought back 50 equity shares at
price of 50, then Impact on balance sheet would
be
Assuming First free reserves are used and
then Security Premium Reserves are used
As per Section 68 (1) of the Companies Act 2013, buy back of shares can be
Cash would reduce by = 50* 50 = 2500
made out of: its free reserves; or the securities premium account; or the
Share Capital would reduce by = 50* 10 = 500
proceeds of any shares or other specified securities.
Free Reserves will reduce by 50*40 = 2000
Liabilities Assets
Share Capital will decrease Share Capital -> 1500 Cash -> 12500
Reserves will decrease
Reserves and Surplus
Cash will Decrease Securities Premium -> 8000
Capital Reserves -> 1000
Retained Earnings -> 0
General Reserves -> 0
Capital Redemption Reserve -> 2000
Implications of Buyback on Some other Areas
Cash Flow of Company
Cash flow of company will decrease as company will pay for the shares during Buyback
Face Value
NoSection
As per Change68in(1)
theofFace
the Value of shares
Companies Act 2013, buy back of shares can be
made out free reserves; or the securities premium account; or the
proceeds
Net of any shares or other specified securities.
Worth
Net worth of the company is Share Capital + Reserves which will decrease
Other Reasons/Implications of Buyback
To increase earning per share assuming earnings remain Constant
EPS = Earnings / Number of Shares
After Buyback, the number of shares will reduce and hence the EPS will increase
As per Section 68 (1) of the Companies Act 2013, buy back of shares can be
made out of: its free reserves; or the securities premium account; or the
To increase
proceeds of anypromoters
shares or holding as the shares
other specified which are bought back are cancelled
securities.
Example: if Promoter earlier had 200 shares out of total 1000 shares then holding of promoter was 200/1000 = 20%
Suppose 500 shares are cancelled through buyback so the Promoter shareholding will be 200/500 = 40%
To discourage others to make hostile bid to take over the company as the buy back will increase the promoters holding
Other Implications of Buyback
To support the share price on the stock exchanges when the share price, in the opinion of company management, is
less than its worth
When company buybacks the shares then it gives a confidence to investors that if company is buying back then it
means the company is positive about the future
As per Section 68 (1) of the Companies Act 2013, buy back of shares can be
To pay surplus
madreeserves; cashsecurities
or the to shareholders
premiumwhen the company
account; or the does not need it for business
proceeds of shares or other specified securities.
Provisions Related to Buyback in Companies Act
As per Section 68 (1) of the Companies Act 2013, buy back of shares can be
; or the securities premium account; or the
proceeds of shares or other specified securities.
Provisions Related to Buyback in Companies Act
Section 68(1) of Companies Act
Buyback can be funded from However, Buy-back of any kind of shares or other
1. Free reserves (General Reserves and Retained specified securities cannot be made from the
As per Section 68 (1) of the Companies Act 2013, buy back of shares ds of shares or other specified securities.
Earnings Reserves) proceeds of the earlier issue of same kind of shares or
2. Securities premium account same kind of other specified securities
3. Proceeds of the issue of any shares or other specified
securities For example, if equity shares are to be bought-back,
then, preference shares may be used for the purpose
Provisions Related to Buyback in Companies Act
Section 68 (2) of Companies Act
Resource Test
Buyback should be <= 25% of (Paid Up Capital + Free Reserves)
As per Section 68 (1) of the Companies Act 2013, buy back of shares ds of shares or other specified securities.
Provisions Related to Buyback in Companies Act
Section 68 (2) of Companies Act
Buyback is <= 10% of (Paid Up Capital + Free Reserves) Buyback is > 10% of (Paid Up Capital + Free Reserves)
AsAuthorized
per Section 68
by (1)
a ofboard
the Companies
resolutionActpassed
2013, buy
at back of shares ds of shares or other specified securities.
a duly The buy-back is authorized by its articles
convened meeting of the directors
A special resolution has been passed in general meeting
of the company authorizing the buy-back
Provisions Related to Buyback in Companies Act
Section 68 (2) of Companies Act
Debt-Equity Ratio Test
Ratio of the debt owed by the company (both secured and unsecured) after such buy-back is not more than twice the total
of its paid-up capital and its free reserves
NoteSection
As per 1: Debt68here should
(1) of include both
the Companies Actlong term
2013, buydebt
backasofwell as short
shares ds ofterm debt
shares or other specified securities.
Note 2: Central Government may prescribe a higher ratio of the debt
Provisions Related to Buyback in Companies Act
Section 68 (2) of Companies Act
All the shares or other specified securities for buy-back are fully paid up
As per Section
Buyback 68 (1)
should beofinthe
lineCompanies Act 2013, stipulated
with the conditions buy back ofbyshares
SEBI ds of shares or other specified securities.
No offer of buy back under this sub section shall be made within a period of one year from the date of closure of a
previous offer of buy back if any
Provisions Related to Buyback in Companies Act
Section 68 (3) of Companies Act
The notice of meeting at which special resolution is
supposed to be passed must be accompanied by an
explanatory statement stating
1. A full and complete disclosure of all material
As per Section 68 (1) of the Companies Act 2013, buy back of shares ds of shares or other specified securities.
facts
2. The necessity of the buy-back
3. The class of security intended to be purchased
under the buy-back
4. The amount to be invested under the buy-back
5. The time limit for completion of the buy-back
Provisions Related to Buyback in Companies Act
Section 68 (4) of Companies Act
Every buy-back shall be completed within twelve
As per Section 68 (1) of the Companies Act 2013, buy back of shares ds of shares
monthsor other
from specified
the datesecurities.
of passing the special
resolution, or the resolution passed by the board of
directors
Provisions Related to Buyback in Companies Act
Section 68 (5) of Companies Act
The buyback can be done using any of the methods below
1. from the existing security holders on a proportionate basis
2. from the open market
3. by purchasing the securities issued to employees of the company pursuant to a scheme of stock option or sweat
As per Section 68 (1) of the Companies Act 2013, buy back of shares ds of shares or other specified securities.
equity.
Provisions Related to Buyback in Companies Act
Section 68 (6) of Companies Act
Company intending to Must file Declaration of Solvency with Registrar and SEBI in form SH.8
buyback , once the Note: Unlisted company need not file declaration with SEBI
resolution has been passed
As per by
Section
the 68 (1) oforthea Companies
Board special Act 2013, buy back of shares ds of shares or other specified securities.
resolution has been passed
at general meeting It must be accompanied with an Affidavit by the Board of Directors
that Board of directors feel company is capable of meetings its
liabilities and will not be rendered solvent within a period of one
year of the date of declaration adopted by the Board of Directors
This must be signed by 2 Board of directors including the managing
director
Provisions Related to Buyback in Companies Act
Section 68 (6) of Companies Act – Timelines of Buyback
Company intending to buyback , once the Must file Declaration of Solvency with Registrar and SEBI in form SH.8
resolution has been passed by the Board or a Note: Unlisted company need not file declaration with SEBI
special resolution has been passed at general
meeting
Offer for buy-back shall remain open for a period of not less than
Asfifteen days and68
per Section not(1)
exceeding thirty days from
of the Companies Actthe date buy
2013, of dispatch
back ofof shares The letter
ds of of offer
shares or shall
other bespecified
dispatchedsecurities.
to the shareholders immediately
the letter of offer. after filing the same with the Registrar of Companies but not later than
twenty days from its filing with the Registrar of Companies.
Exception: If all members agree then buyback can remain open for less
than 15 days also
With in 7 days of acceptance or rejection of shares offered by
The company shall complete the verifications of the offers received shareholders, the company shall
within fifteen days from the date of closure of the offer 1) make payment of consideration in cash to those shareholders or
The offer is assumed to be accepted unless communication of rejection security holders whose securities have been accepted
is made within twenty-one days from the date of closure of the offer. 2) return the share certificates to the shareholders or security holders
whose securities have not been accepted
Provisions Related to Buyback in Companies Act
Section 68 (6) of Companies Act
As per Section 68 (1) of the Companies Act 2013, buy back of shares ds of shares or other specified securities.
The company shall not issue any new shares including by
As per 68(4), the whole process shall be completed with in way of bonus shares from the date of passing of special
12 months resolution authorizing the buy-back till the date of the
closure of the offer
Provisions Related to Buyback in Companies Act
Section 68 (7) of Companies Act
Company shall extinguish and physically destroy the securities so bought-back within seven days of the last date of
Ascompletion
per Sectionof68 (1) of the Companies Act 2013, buy back of shares ds of shares or other specified securities.
buy-back
Provisions Related to Buyback in Companies Act
Section 68 (8) of Companies Act
After the Buyback of shares or any specified It shall not make a further issue of the same kind of shares or
Security has been completed other securities including allotment of new shares in Rights
Issue for 6 months
As per Section 68 (1) of the Companies Act 2013, buy back of shares ds of shares or other specified securities.
Exception
Shares can still be issued
1. Conversion of Warrants into shares
2. Stock Option Scheme
3. Sweat Equity Conversion
4. Conversion of Preference Shares and Debentures into
shares
5. Bonus issue
Provisions Related to Buyback in Companies Act
Section 68 (9) and 68 (10) of Companies Act
Details of Shares/Securities Bought back
Company shall maintain a register for details Consideration Paid for buyback
related to buyback using form SH10 Date of Cancellation of Shares/Securities
Date of extinguishing and physically destroying the shares or
As per Section 68 (1) of the Companies Act 2013, buy back ofsecurities
shares ds of shares or other specified securities.
A company must file these details with the Registrar and the Securities and Exchange Board relating to the buy-
back within thirty days of such completion using Form SH11
Note: Details will not be filed with SEBI in case of unlisted company
Along with this return in SH11, a separate Form SH15 should also be submitted signed by at least 2 directors
including the managing director certifying that the buy-back of securities has been made in compliance with the
provisions of the Act
Provisions Related to Buyback in Companies Act
Section 68 (11)
Company Defaulting in any of the provision mentioned in this section or any of the regulations made by SEBI
As per Section 68 (1) of the Companies Act 2013, buy back of shares ds of shares or other specified securities.
Company
Minimum fine of 1 lakh rupees but which can be extended to 3 lakh rupees
Officer of Company in Default
Imprisonment for a term which may extend to three years or
Fine which shall not be less than one lakh rupees, but which may extend to three lakh rupees or
with Both
Provisions Related to Buyback in Companies Act
Some More Rules related to Buy Back
The company shall not withdraw the offer once it has announced the offer to the shareholders
The company shall not utilize any money borrowed from banks or financial institutions for the purpose of buying
back its shares
As per Section 68 (1) of the Companies Act 2013, buy back of shares ds of shares or other specified securities.
Provisions Related to Buyback in Companies Act
69 (1) Companies Act
When a company purchases its own shares out of the free reserves or securities premium account, a sum equal to the
nominal value of shares so purchased shall be transferred to the Capital Redemption Reserve Account
Amount Transferred to Capital Redemption
Reserve from General Reserve -> 50*10 = 500
As per Section 68 (1) of the Companies Act 2013, buy back of shares ds of shares or other specified securities.
Liabilities Assets
Share Capital -> 1500 Cash -> 12500
Reserves and Surplus
Securities Premium -> 6000
Capital Reserves -> 1000
Retained Earnings -> 1000
General Reserves -> 500
Capital Redemption Reserve > 2500
Provisions Related to Buyback in Companies Act
Section 70 of Companies Act
No company shall buy its own shares through subsidiaries companies or Investment companies
No company shall buy its own shares if there has been default by the company in the past on interest payment on
loans, bonds etc. or on redemption of bonds, debentures etc.
As per Section 68 (1) of the Companies Act 2013, buy back of shares ds of shares or other specified securities.
Exception: Once the default is made the company can become eligible again for buyback only if the company settles
that default and 3 years have passed since settling of default
Concept Check
As per section 68(1) of the Companies Act, buy back of own shares by the company, shall not exceed
(a) 25% of the total paid-up capital and free reserves of the company
(b) 20% of the total paid-up capital and free reserves of the company
(c) 15% of the total paid-up capital and free reserves of the company
Ans: Option A
As per Section 68 (1) of the Companies Act 2013, buy back of shares can be
; orThe
thecompanies
securities premium account;
are permitted or the
to buy back their own shares out of
proceeds
(a) Freeofreserves
shares or other
and specified
Securities securities.
premium
(b) Proceeds of the issue of any shares of different kind
(c) Both (a) and (b)
Ans: Option C
Concept Check
When a company purchases its own shares out of free reserves; a sum equal to nominal value of shares so purchased shall
be transferred to
(a) Revenue redemption reserve.
(b) Capital redemption reserve.
(c) Buyback reserve
Ans: Option B
As per Section 68 (1) of the Companies Act 2013, buy back of shares can be
; or the securities premium account; or the
proceeds
Which of shares or other
the following specified
Reserves securities.
cannot be used for buyback?
A) Revaluation Reserve
B) Securities Premium Reserve
C) General Reserve
Ans: Option A
Concept Check
In which of the following issue, the cash flow of the company will not be changed
(a) Buyback of shares
(b) Bonus shares
(c) Rights Issue
(d) ESOPS
Ans: Option B
As per Section 68 (1) of the Companies Act 2013, buy back of shares can be
; or the securities premium account; or the
proceeds of sharesremain
If the earnings or other specified
constant securities.
then after buyback the EPS will
A) Increase
B) Decrease
C) Remains same
Ans: Option A
Concept Check
If the buyback is less than equal to 10% of (Paid Up Capital and Free Reserves) then it needs to be authorized by
(a) Board of Directors
(b) Articles of Association
(c) Members in general meeting with special Resolution
(d) All of the above
Ans: Option A
As per Section 68 (1) of the Companies Act 2013, buy back of shares can be
; or the securities premium account; or the
proceeds of shares
The minimum orbetween
gap other specified securities.
2 buybacks should be
A) 1 year
B) 2 year
C) 3 year
D) NOTA
Ans: Option A
Concept Check
The letter of offer shall be dispatched to the shareholders immediately after filing the same with the Registrar of
Companies but not later than _________ days from its filing with the Registrar of Companies
(a) 40
(b) 30
(c) 20
(d) NOTA
Ans: Option C
As per Section 68 (1) of the Companies Act 2013, buy back of shares can be
; or the securities premium account; or the
proceeds of shares
After the Buybackorof
other specified
shares or any securities.
specified Security has been completed, company shall not make a further issue of the
same kind of shares or other securities including allotment of new shares in Rights Issue for ______ months
(a) 9
(b) 6
(c) 3
(d) 12
Ans: Option B
Next Video -> Provisions Related to Buyback in SEBI Regulations
As per Section 68 (1) of the Companies Act 2013, buy back of shares can be
; or the securities premium account; or the
proceeds of shares or other specified securities.
Thanks
Buyback of Shares
SEBI Regulations
www.edutap.co.in
SEBI Regulations for Buyback of Shares
Securities and Exchange Board of India (Buy Back of Securities) Regulations, 2018
As per Section 68 (1) of the Companies Act 2013, buy back of shares can be
made out of: its free reserves; or the securities premium account; or the
th
proceeds of any shares or other specified securities. Notified on 11 September 2018
SEBI Regulations for Buyback and Companies Act
SEBI Regulations mostly are in line with Companies Act and many regulations have been directly picked up from the
Companies Act
But at some places more details are given
As per Section 68 (1) of the Companies Act 2013, buy back of shares can be
made outf: its free reserves; or the securities premium account; or the
proceeds of any shares or other specified securities.
Conditions of Buyback under SEBI Regulations for Buyback of Shares
Maximum Buyback Allowed
Buyback should be <= 25% of (Paid Up Capital + Free Reserves)
As per Section 68 (1) of the Companies Act 2013, buy back of shares can be
its free reserves; or the securities premium account; or the
proceeds of any shares or other specified securities.
Conditions of Buyback under SEBI Regulations for Buyback of Shares
Debt to Equity Ratio
Company not having any subsidiary company which is NBFC or Housing Finance Company
Ratio of the debt owed by the company (both secured and unsecured) after such buy-back is not more than twice the total
of its paid-up capital and its free reserves
As per Section 68 (1) of the Companies Act 2013, buy back of shares can be
its free reserves; or the securities premium account; or the
proceeds of any shares or other specified securities.
Company having any subsidiary company or Companies which is NBFC or Housing Finance Company
Ratio of the debt owed by the company (both secured and unsecured) after such buy-back is not more than twice the total
of its paid-up capital and its free reserves after excluding financial statements of all subsidiaries that are nonbanking
financial companies and housing finance companies
Provided that buyback of securities shall be permitted only if all such excluded subsidiaries have their ratio of aggregate of
secured and unsecured debts to the paid up capital and free reserves of not more than 6:1 on standalone basis
Conditions of Buyback under SEBI Regulations for Buyback of Shares
Other Conditions
All the shares or other specified securities for buy-back are fully paid up
As per Section shall
A company 68 (1)not
of buy
the Companies Act or
back its shares 2013, buyspecified
other back of securities
shares canso
beas to delist its shares or other specified securities
its free
fromreserves;
the stockorexchange
the securities premium account; or the
proceeds of any shares or other specified securities.
No offer of buy back under this sub section shall be made within a period of one year from the date of closure of a
previous offer of buy back if any
Conditions of Buyback under SEBI Regulations for Buyback of Shares
Other Conditions
No company shall buy its own shares through subsidiaries companies or Investment companies
No company shall buy its own shares if there has been default by the company in the past on interest payment on
loans, bonds etc. or on redemption of bonds, debentures etc.
As per Section 68 (1) of the Companies Act 2013, buy back of shares ds of shares or other specified securities.
Exception: Once the default is made the company can become eligible again for buyback only if the company settles
that default and 3 years have passed since settling of default
Conditions of Buyback under SEBI Regulations for Buyback of Shares
Sources of Buyback
Buyback can be funded from However, Buy-back of any kind of shares or other
1. Free reserves (General Reserves and Retained specified securities cannot be made from the
Earnings Reserves)
As per Section 68 (1) of the Companies Act 2013, buy back of shares canproceeds
be of the earlier issue of same kind of shares or
2. Securities premium account same kind of other specified securities
its free reserves; or the securities premium account; or the
3. Proceeds of the issue of any shares or other specified
proceeds of any shares or other specified securities.
securities For example, if equity shares are to be bought-back,
Note: Revaluation Reserves cannot be used then, preference shares may be used for the purpose
General Compliance
As per Section 68 (1) of the Companies Act 2013, buy back of shares can be
made out of: its free reserves; or the securities premium account; or the
proceeds of any shares or other specified securities.
General Compliance for Buyback as per SEBI Regulations for Buyback
General Compliance
Buyback is <= 10% of (Paid Up Capital + Free Reserves) Buyback is > 10% of (Paid Up Capital + Free Reserves)
As per Section 68 (1) of the Companies Act 2013, buy back of shares can be
made out of: itsbyfree
Authorized a reserves; or the securities
board resolution passed premium
at a account;
duly or the
The buy-back is authorized by its articles
proceeds of any shares or other
convened meeting of the directorsspecified securities.
A special resolution has been passed in general meeting
of the company authorizing the buy-back
General Compliance for Buyback as per SEBI Regulations for Buyback
General Compliance
The notice of meeting at which special resolution is
supposed to be passed must be accompanied by an
explanatory statement stating
1. A full and complete disclosure of all material facts
As per Section 68 (1) of the Companies Act 2013, buy back of shares ds of2.shares
The necessity of the buy-back
or other specified securities.
3. The class of security intended to be purchased
under the buy-back
4. The amount to be invested under the buy-back
5. The time limit for completion of the buy-back
6. The maximum price at which shares would be
bought back
General Compliance for Buyback as per SEBI Regulations for Buyback
General Compliance
As per Section 68 (1) of the Companies Act 2013, buy back of shares ds of shares or other specified securities.
A copy of the resolution passed by the board of directors A copy of the resolution passed at the general meeting
shall be filed with the Board and the stock exchanges shall be filed with the Board and the stock exchanges
where the shares of the company are listed, within two where the shares of the company are listed, within
days from the date of passing of the resolution. seven days from the date of passing of the resolution.
General Compliance for Buyback as per SEBI Regulations for Buyback
General Compliance
Every buy-back shall be completed within twelve months from the date of passing the special resolution, or the
resolution passed by the board of directors
As per Section 68 (1) of the Companies Act 2013, buy back of shares can be
The company shall, after expiry of the buy back period file with the Registrar of Companies and the Board, a return
made out : its free reserves; or the securities premium account; or the
containing such relating to the buy back within thirty days of such expiry
proceeds of any shares or other specified securities.
Date of Passing the Resolution to Issue Date on which the payment of consideration to
the shares shareholders who have accepted the buyback offer is
made
Buyback Period
Concept Check
Every buy-back shall be completed within _____ months from the date of passing the special resolution, or the resolution
passed by the board of directors
(a) 10 months
(b) 12 months
(c) 15 months
(d) 20 months
As Ans:
per Section
Option68B (1) of the Companies Act 2013, buy back of shares can be
; or the securities premium account; or the
proceeds of shares
If Buyback or other
is <= 10% specified
of (Paid securities.
Up Capital + Free Reserves) then it must be authorized by
(a) Board of Directors
(b) Articles of Association
(c) Special Resolution in General Meeting
(d) B and C
Ans: Option A
Methods of Buyback
As per Section 68 (1) of the Companies Act 2013, buy back of shares can be
its free reserves; or the securities premium account; or the
proceeds of any shares or other specified securities.
Methods of Buyback
A company may buy back its shares or other specified securities by any one of the following methods
1. From the existing shareholders or other specified securities holders on a proportionate basis through the tender offer
2. From Odd Lot Holders
3. from the open market through (Must be less than 15% of paid up capital and Free reserves of company)
As per Section 68 (1) of the Companies Act 2013, buy back of shares can specified securities.
i) Book building process
ii) Stock exchange
Odd Lot shares means shares which are smaller than such marketable lots, as may be specified by the stock exchange
Foe example stock exchange says lot size is 100 but shareholder is holding 75 shares then it would be odd lot offer
Buyback through Tender Offer
From the existing shareholders or other specified securities holders on a proportionate basis through the tender offer
Provided the below condition is met
Provided that fifteen per cent of the number of shares which the company proposes to buy back or number of securities
entitled as per their shareholding, whichever is higher, shall be reserved for small shareholders
As per Section
What are 68 (1) shareholders?
small of the Companies Act 2013, buy back of shares can specified securities.
Small shareholder’ means a shareholder of a company
The market value of whose share based on closing price of shares, as on record date is <= 2 Lakh
What is Record Date?
The record date, or date of record, is the cut-off date established by a company in order to determine which shareholders
are eligible for Corporate Action
Example: if record date for buyback is 10th Jan, then all the shareholders on the books of the company shall be
considered for buyback
Buyback through Tender Offer
From the existing shareholders or other specified securities holders on a proportionate basis through the tender offer
Shares to be bought back shall be
categorized as below
Shares to be bought back from Small Shares to be bought back from Other
Shareholders
As per Section Shareholders
68 (1) of the Companies Act 2013, buy back of shares can specified securities.
Buyback through Tender Offer
Company intending to buyback , once the resolution has been With in 2 days of resolution being passed
passed by the Board or a special resolution has been passed at Company shall make a public announcement for Buyback and send the
general meeting copy of Public Announcement to SEBI
With in 7 days of receipt of Draft Letter of Offer buy the Board With in 5 days of public announcement,
Board shall give comments on the same Company shall file draft Letter of offer with the board
The closure of comments can take further time in case changes are Declaration of solvency that company can meet its obligations for next 1
required
As per Section 68 (1) of the Companies Act 2013, buy back of shares yearcan specified securities.
With in 5 days of receipt of Comments from Board
The company shall announce the record date The letter of Offer shall be dispatched to shareholders which can be
physical or electronic form but if shareholder insists for physical form
then it must be provided
The date of the opening of the offer shall be not later than five working
Before Opening the offer, the company shall deposit amount in
days from the date of dispatch of the letter of offer
escrow account
25% up to 100 crore of offer and after that 10% on remaining Offer
The offer for buy back shall remain open for a period of ten working days
Buyback through Tender Offer
After the closure of offer period, company shall
with in 7 days complete the verification process
and make payment to those shareholders whose
shares have been accepted
With in 7 days of buyback period the shares
which have been bought back shall be destroyed
As per Section 68 (1) of the Companies Act 2013, buy back of shares can specified securities.
With in 7 days of destroying the certificates
1. The Company shall give certificate signed by 2
directors and one of them being managing
director certifying that process was followed
in destroying of share certificates
2. The details of share certificates destroyed
shall be sent to stock exchange
Concept Check
As per SEBI Regulations for buyback of shares the offer to tender shares by existing shareholders shall be open for
(a) 7 days
(b) 10 days
(c) 12 days
(d) 15 days
Ans: Option B
As per Section 68 (1) of the Companies Act 2013, buy back of shares can be
; orThe
theminimum
securitiesnumber
premiumofaccount; or the
shares earmarked to be bought back through tender offer from small shareholder is
proceeds
(a) 5% of shares or other specified securities.
(b) 10%
(c) 15%
(d) 25%
Ans: Option C
Methods of Buyback
A company may buy back its shares or other specified securities by any one of the following methods
1. From the existing shareholders or other specified securities holders on a proportionate basis through the tender offer
2. From Odd Lot Holders
3. from the open market through (Must be less than 15% of paid up capital and Free reserves of company)
As per Section 68 (1) of the Companies Act 2013, buy back of shares can specified securities.
i) Book building process
ii) Stock exchange
Odd Lot shares means shares which are smaller than such marketable lots, as may be specified by the stock exchange
Foe example stock exchange says lot size is 100 but shareholder is holding 75 shares then it would be odd lot offer
Buyback through Odd Lot
All the shareholders having odd lot of shares shall be eligible for buyback by the company under this process
The process remains the same as discussed in process followed when buyback is done from existing shareholders using
Tender Offer
As per Section 68 (1) of the Companies Act 2013, buy back of shares can specified securities.
Methods of Buyback
A company may buy back its shares or other specified securities by any one of the following methods
1. From the existing shareholders or other specified securities holders on a proportionate basis through the tender offer
2. From Odd Lot Holders
3. from the open market through (Must be less than 15% of paid up capital and Free reserves of company)
As per Section 68 (1) of the Companies Act 2013, buy back of shares can specified securities.
i) Book building process
ii) Stock exchange
Odd Lot shares means shares which are smaller than such marketable lots, as may be specified by the stock exchange
Foe example stock exchange says lot size is 100 but shareholder is holding 75 shares then it would be odd lot offer
Buyback Open Market
Buyback from Open Market can be through any of the following Process
1. Through Stock Exchange
2. Through Book Building
As perThe
Section 68 (1)shall
company of the Companies
ensure that at Act 2013,
least fiftybuy
per back
cent of shares can specified
the amount earmarkedsecurities.
for buy back, as specified in the resolution
of the board of directors or the special resolution, is utilized for buying back shares or other specified securities
Buyback Open Market (Stock Exchange)
Buyback from Open Market can be through Stock Exchange
Company (Buyer in Sellers (Shareholders)
Buyback)
As per Section 68 (1) of the Companies Act 2013, buy back of shares can specified securities.
Stock Exchange
Buyback Open Market (Stock Exchange)
Company intending to buyback , once the resolution has been With in 2 days of resolution being passed
passed by the Board or a special resolution has been passed at Company shall make a public announcement for Buyback and send the
general meeting copy of Public Announcement to SEBI
No offer Letter Required
The date of the opening of the offer shall be not later than seven working The company shall, before opening of the offer, create an escrow
days from the date of public announcement and shall close with in 6 account and deposit in escrow account 25 per cent of the amount
Asmonths from the68
per Section date
(1)ofofopening of offer
the Companies earmarked
Act 2013, buy back of shares can for the
specified buyback
securities.
The identity of the company as a purchaser shall appear on the electronic
screen when the order is placed The money is paid once the orders are executed
The company shall extinguish and physically destroy the securities certificates with in 7 days of completion of buyback period
Buyback Open Market (Stock Exchange)
With in 7 days of destroying the certificates
1. The Company shall give certificate signed by 2
directors and one of them being managing
director certifying that process was followed
in destroying of share certificates
2. The details of share certificates destroyed
As per Section 68 (1) of the Companies Act 2013, buy back of shares can specifiedshall
securities.
be sent to stock exchange
Buyback Open Market
Buyback from Open Market can be through any of the following Process
1. Through Stock Exchange
2. Through Book Building
As perThe
Section 68 (1)shall
company of the Companies
ensure that at Act 2013,
least fiftybuy
per back
cent of shares can specified
the amount earmarkedsecurities.
for buy back, as specified in the resolution
of the board of directors or the special resolution, is utilized for buying back shares or other specified securities
Buyback Open Market (Book Building)
In book building process no fixed price is there but instead a price range of 20% is given
in which investors can offer their shares for buyback
For example: Company XYZ wants to buyback 10 shares from the public in price range
of 100-120. Following are the Ask made by people
As per Section 68 (1) of the Companies Act 2013, buy back of shares can specified securities.
Price Number of Shares Total Shares Ask
Ask at the Price till that Price
120 8 40 Price Discovery
115 2 32
110 10 30
100 20 20
Buyback Open Market (Book Building)
In book building process no fixed price is there but instead a price range of 20% is given
in which investors can offer their shares for buyback
For example: Company XYZ wants to buyback 10 shares from the public in price range
of 100-120. Following are the Ask made by people
As per Section 68 (1) of the Companies Act 2013, buy back of shares can specified securities.
Price Number of Shares Total Shares Ask
Ask at the Price till that Price
120 10 40 Price Discovery
115 20 30
110 2 10
100 8 8
Buyback Open Market (Book Building)
Company intending to buyback , once the resolution has been Before 7 days of opening of Offer period
passed by the Board or a special resolution has been passed at Company shall make a public announcement for Buyback and send the
general meeting copy of Public Announcement to SEBI with in 2 days of announcement
No offer Letter Required
The offer for buy back shall remain open to the securities holders for a
period not less than fifteen days and not exceeding thirty days
As per Section 68 (1) of the Companies Act 2013, buy back of shares can specified securities.
Buyback Open Market (Book Building)
After the closure of offer period, company shall
with in 7 days complete the verification process
and make payment to those shareholders whose
shares have been accepted
With in 7 days of the end of buyback period the
shares which have been bought back shall be
destroyed
As per Section 68 (1) of the Companies Act 2013, buy back of shares can specified securities.
With in 7 days of destroying the certificates
1. The Company shall give certificate signed by 2
directors and one of them being managing
director certifying that process was followed
in destroying of share certificates
2. The details of share certificates destroyed
shall be sent to stock exchange
Concept Check
The buyback from open market can be maximum of
(a) 25% of Paid up Capital and Free Reserves
(b) 15% of Paid up Capital and Free Reserves
(c) 30% of Paid up Capital and Free Reserves
(d) 50% of paid up Capital and Free Reserves
Ans: Option B
As per Section 68 (1) of the Companies Act 2013, buy back of shares can be
; or the securities premium account; or the
In the buyback
proceeds of sharesfrom openspecified
or other market using stock exchange, all the share certificates bough back must be destroyed with in
securities.
(a) 2 days of buyback period
(b) 9 days of buyback period
(c) 7 days of buyback period
(d) 15 days of buyback period
Ans: Option C
Concept Check
In the buyback from open market using stock exchange, the offer period is
(a) 3 months
(b) 10 days
(c) 6 months
(d) 15 days
Ans: Option C
As per Section 68 (1) of the Companies Act 2013, buy back of shares can be
; or
In the
the securities premium
buyback from openaccount; or thebook building, the offer period is
market using
proceeds
(a) Max of
of shares
30 daysorand
other
minspecified securities.
of 15 days
(b) Max of 30 days and min of 10 days
(c) Max of 45days and min of 15 days
(d) Max of 60 days and min of 50 days
Ans: Option A
Thanks
As per Section 68 (1) of the Companies Act 2013, buy back of shares can specified securities.
Accounting For Buyback of Shares
Journal Entries
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Steps in Journal Entries for Buyback
When Investments are sold to arrange money for buyback
Cancellation of Shares bought back
As per Section 68 (1) of the Companies Act 2013, buy back of shares can be
; or the securities premium account; or the
proceeds of shares or other specified securities. Equity Shareholder A/c is a liability A/C
Sometimes we also mention it as
Equity shares buy back A/c
On Payment of money to Shareholders
Transfer of Face Value of shares bought back to Capital General Reserve DR.
Redemption Reserve To Capital Redemption Reserve
Example 1
Solution
20% of shares would be bough back
So 20% of 300000 = 60,000 shares would be bought back
Company collected cash by selling investments worth 30 lakh
at 20 lakh
Bank A/c Dr. 25,00000
As per Section 68 (1) of the Companies Act 2013, buy back of shares can be
P/L A/c 5,00000
; or the securities premium account; or the
To Investments 30,00000
proceeds of shares or other specified securities.
Equity Share Capital A/c Dr. 6,00000
Securities Premium A/c 3,00000
To Equity Shareholders A/c 9,00000
Equity Shareholders A/c Dr. 9,00000
The company passed a resolution to buy back 20% of its equity To Bank A/c 9,00000
capital @ 15 per share. For this purpose, it sold its investments
of 30 lakhs for 25 lakhs.
Revenue Reserve A/c Dr. 600000
You are required to pass necessary Journal entries Assuming To Capital Redemption Reserve A/c 6,00000
Securities Premium A/c was used
Example 2
Solution
Equity Share Capital A/c Dr. 50000000
Securities Premium A/c 200000000
To Equity Shareholders A/c 250000000
As per Section 68 (1) of the Companies Act 2013, buy back of shares can be
; or the securities premium account; or the Equity Shareholders A/c Dr. 250000000
proceeds of shares or other specified securities. To Bank A/c 250000000
Revenue Reserve A/c Dr. 50000000
To Capital Redemption Reserve A/c 50000000
The company bought back 50 lakhs equity
shares of ` 10 each at ` 50 per share using
security premium reserves
The payments for the above were made out
of the huge bank balances, which appeared
as a part of current assets
Example 3
Solution
Bank A/c Dr. 2200000
Profit and Loss A/c 800000
To Investments 3000000
As per Section 68 (1) of the Companies Act 2013, buy back Equity
of shares canCapital
Share be A/c Dr. 500000
; or the securities premium account; or the Securities Premium A/c 2000000
proceeds of shares or other specified securities. To Equity Shareholders A/c 2500000
Equity Shareholders A/c Dr. 2500000
The company bought back 50 lakhs equity To Bank A/c 2500000
shares of ` 10 each at ` 50 per share using
security premium reserve
Revenue Reserve A/c Dr. 500000
The company passed a resolution to buy back 20% of its equity
To Capital Redemption Reserve A/c 500000
capital @ ` 50 per share. For this purpose, it sold all of its
investment for ` 22,00,000. You are required to pass necessary
journal entries
Example 4
X’ Co. Ltd., buys back its own 1, 50,000 equity
shares of Rs. 10 each, at par. The company has Solution
sufficient profits otherwise available for dividend
besides general reserve. No fresh issue of shares
is made for this purpose. The shares are fully Equity Share Capital A/c Dr. 1500000
paid up. Journalize the transactions Securities Premium A/c 0
To Equity Shareholders A/c 1500000
As per Section 68 (1) of the Companies Act 2013, buy back of shares can be
; or the securities premium account; or the
proceeds of shares or other specified securities. Equity Shareholders A/c Dr. 1500000
To Bank A/c 1500000
General Reserve A/c Dr. 1500000
To Capital Redemption Reserve A/c 1500000
Example 5
The Evergreen Co. Ltd., resolved by a special Solution
resolution, to buy-back 1,00,000 of its equity
shares of the face value of Rs. 10 each, on which
Rs. 8 has been paid up. The general balance of
the company stood at Rs. 25,000 and no fresh
issue of shares was made. Journalize the
transactions.
As per Section 68 (1) of the Companies Act 2013, buy back of shares can be
; or the securities premium account; or the
proceeds of shares or other specified securities.
Equity Share Capital A/c Dr. 1000000
Securities Premium A/c 0
To Equity Shareholders A/c 1000000
Equity Shareholders A/c Dr. 1000000
To Bank A/c 1000000
General Reserve A/c Dr. 1000000
To Capital Redemption Reserve A/c 1000000
Thanks
As per Section 68 (1) of the Companies Act 2013, buy back of shares can be
; or the securities premium account; or the
proceeds of shares or other specified securities.
Accounting Standards
Introduction to Accounting Standards
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Introduction to Accounting Standards
Idea of accounting standards is centered around standardization of accounting policies and practices followed by different
business entities
Example:
As per Section 68 (1) of the Companies Act 2013, buy back of shares can be
Theout:
made costfree
of car is 2 lakh
reserves; or the securities premium account; or the
proceeds of any shares or other specified securities.
How much the depreciation be considered each year? 10%, 20% ?
Objective of Accounting Standards
Provide a set of standard accounting policies 1. Eliminate the non-comparability of financial Statements
and Disclosure Requirements
As per Section 68 (1) of the Companies Act 2013, buy back of shares can be the reliability of financial statements
2. Improving
made out: free reserves; or the securities premium account; or the
proceeds of any shares or other specified securities. 3. Improving the Transparency
4. Requirements o Additional disclosures
5. Reduction in scope of creative accounting
Creative Accounting is twisting of accounting policies to produce financial statements
favorable to a particular interest group
Process in Formulation of Accounting Standards
ICAI
Accounting Standards Board (ASB) in 1977
(The Institute of Chartered Accountants of India)
As per Section 68 (1) of the Companies Act 2013, buy back of shares can be
The composition of ASB includes,
made out: free reserves; or the securities premium account; or the
representatives of industries (namely,
proceeds of any shares or other specified securities.
ASSOCHAM, CII, FICCI), regulators,
academicians, government departments
Although ASB is a body constituted by the Council of the ICAI, it (ASB) is independent in the formulation of
accounting standards and Council of the ICAI is not empowered to make any modifications in the draft accounting
standards formulated by ASB without consulting ASB
Process in Formulation of Accounting Standards
Circulation of draft of accounting standard (after revision by ASB) to the Council members of the ICAI
and specified outside bodies such as Department of Company Affairs (DCA), Securities and Exchange
Board of India (SEBI), Comptroller and Auditor General of India (C&AG), Central Board of Direct Taxes
(CBDT), Standing Conference of Public Enterprises (SCOPE), etc. for comments
As per Section 68 (1) of the Companies Act 2013, buy back of shares can be
Views of different Bodies are gathered
made out: free reserves; or the securities premium account; or the
proceeds of any shares or other specified securities.
Consideration of the final draft of the proposed standard by the Council of the ICAI, and
if found necessary, modification of the draft in consultation with the ASB is done
The accounting standard on the relevant subject (for non-corporate entities) is then
issued by the ICAI. For corporate entities, the accounting standards are issued by the
Central Government of India through MCA
Who Makes/Issues Accounting Standards
Under section 210A of Companies Act, 1956 , Accounting Standards were
Accounting Issued by MCA on recommendation of NACAS (National Advisory
Standards Committee on Accounting Standards)
As per Section 68 (1) of the Companies Act 2013, buyAccounting Standards
back of shares are prepared under the supervision and control of
can be
made out: free reserves; or the securities premiumAccounting
account; orStandards
the Board (ASB) of ICAI
proceeds of any shares or other specified securities.
Section 132 of the Companies Act, 2013 provides that a National Financial
Reporting Authority (NFRA) will be constituted and Accounting Standards
will be notified by the Central Government (MCA) in consultation with
National Financial Reporting Authority in place of NACAS.
List of Accounting Standards in India
These standards are named as Accounting Standards (AS)
Important
As per Section 68 (1) of the Companies Act 2013, buy back of shares Point
can be
made out: free reserves; or the securities premium account; orAS6
the has been withdrawn and now is part of AS10 (Property,
proceeds of any shares or other specified securities. Plant and Equipment)
Enforcement of Accounting Standards
Accounting Standards are developed by the Accounting Standards Board (ASB) of the Institute of Chartered Accountants of
India
ASB or ICAI is not legal body which can enforce these standards. These need to be enforced by some law
As per Section 68 (1) of the Companies Act 2013, buy back of shares can be
made out: free reserves; or the securities premium account; or the
proceeds of any shares or other specified securities.
Section 133 of the Companies Act had notified 27 of these standards shown on previous slide, hence it becomes mandatory
Section 129(1) of the companies Act requires companies to present their financial statements in accordance with the
accounting standards notified under Section 133
As per section 129(5) of the companies Act, If the financial statements of a company do not comply with the accounting
standards, the reasons for such deviation shall be disclosed in the financial Statement
MCQs
Accounting Standards for Non-Corporate entities in India are issued by
(a) Central Govt.
(b) State Govt.
(c) Institute of Chartered Accountants of India.
(d) Reserve Bank of India.
Ans: Option C
As per Section 68 (1) of the Companies Act 2013, buy back of shares can be
made out: free reserves; or the securities premium account; or the
proceeds of any shares or other specified securities.
Accounting Standards
(a) Harmonise accounting policies.
(b) Eliminate the non-comparability of financial statements.
(c) Improve the reliability of financial statements.
(d) All the three.
Ans: Option D
MCQs
It is essential to standardize the accounting principles and policies in order to ensure
(a) Transparency. (b) Consistency.
(c) Comparability. (d) All the three.
Ans: Option D
As per Section 68 (1) of the Companies Act 2013, buy back of shares can be
made out:committee
Which free reserves; or the securities
is responsible premium
for approval account; orstandards
of accounting the and recommending the same to MCA for the purpose
proceeds of any shares
of applicability or other specified securities.
to companies?
(a) NFRA.
(b) Central Government Advisory Committee.
(c) Advisory Committee for approval of Accounting Standards
Ans: Option A
Applicability of Accounting Standards
As per Section 68 (1) of the Companies Act 2013, buy back of shares can be
made out: free reserves; or the securities premium account; or the
proceeds of any shares or other specified securities.
Applicability of Accounting Standards
For Applicability of Accounting Standards, entities are classified into 2 categories
Non-Corporate Entities Corporate Entities
As per Section 68 (1) of the Companies Act 2013, buy back of shares can be
made out: free reserves; or the securities premium account; or the
proceeds of any shares or other specified securities.
Other than companies such as Partnership
Entities Registered as Companies
Firms, Sole Proprietorship Firms
Non-Corporate Entities
Level 1 Level 2 (SME’s) Level 3 (SME’s)
Entities whose equity or debt Entities not in Level 1 and following Not there in Level 1 or Level 2
securities are listed or are in the any of the below condition
process of listing on any stock
exchange, whether in India or outside Entities having turnover between 10
AsIndia or
per Section crorebuy
68 (1) of the Companies Act 2013, andback
50 of
crores or can be
shares
made out: free reserves; or the securities premium account; or the
Banks (including
proceeds co-operative
of any shares banks), securities.
or other specified
financial institutions or entity carrying Entities having borrowing between 1
on insurance business or crore and 10 crore or
Entities having turnover > 50 crores or Holding and subsidiary entities of any
one of the above
Entities having borrowing > 10 crore
or
Note: Level 2 and Level 3 are also called SMEs
Holding and subsidiary entities of any
one of the above
Applicability of Accounting Standards for Non-Corporate Entities
Accounting Standards applicable to all Non- Accounting Standards not applicable to Non-corporate Entities
corporate Entities in their entirety (Level I, Level II falling in Level II in their entirety
and Level III)
Accounting Standards not applicable to Non-corporate Entities
falling in Level III in their entirety:
As per Section 68 (1) of the Companies Act 2013, buy back of shares can be
made out: free reserves; or the securities premium account; or the
proceeds of any shares or other specified securities.
Accounting Standards not applicable to all Non-corporate Entities
since the relevant Regulators require compliance with them only
by certain Level I entities
Applicability of Accounting Standards for Non-Corporate Entities
Accounting Standards in respect of which relaxations from certain requirements have been given to Non-corporate Entities
falling in Level II and Level III (SMEs):
1. AS 15 (Employee Benefits) – Partial Exemption
2. AS 19 (Leases) - Partial Exemption
3. AS 20 (Earning Per Share) - Partial Exemption
4. AS 28 (Impairment of Assets) - Partial Exemption
As per Section 68 (1) of the Companies Act 2013, buy back of shares can be
5. AS 29 (Provisions, Contingent Liabilities and Contingent Assets) - Partial Exemption
made out: free reserves; or the securities premium account; or the
6. AS 25 (Interim Financial Reporting) – Partial Exemption
proceeds of any shares or other specified securities.
Applicability of Accounting Standards
For Applicability of Accounting Standards, entities are classified into 2 categories
Non-Corporate Entities Corporate Entities
As per Section 68 (1) of the Companies Act 2013, buy back of shares can be
made out: free reserves; or the securities premium account; or the
proceeds of any shares or other specified securities.
Other than companies such as Partnership
Entities Registered as Companies
Firms, Sole Proprietorship Firms
Corporate Entities
SMCs Non-SMC
whose equity or debt securities are
not listed or are not in the process of Companies not falling within the
listing on any stock exchange, whether definition of SMC are considered as
in India or outside India Banks Non-SMCs
(including co-operative banks),
Asfinancial
per Section 68 (1) of or
institutions theentity
Companies Act 2013, buy back of shares can be
carrying
made out: free reserves;
on insurance or the securities premium account; or the
business and
proceeds of any shares or other specified securities.
which is not a bank, financial
institution or an insurance company
and
Turnover < 50 crore and
Borrowings < 10 crore and
Not a subsidiary company of non-smc
company
Applicability of Accounting Standards for Corporate Entities
Accounting Standards applicable to all companies Accounting Standards not applicable to SMCs
in their entirety for accounting periods
commencing on or after 7th December 2006
Accounting Standards not applicable to SMCs and Non-SMCs since
the relevant Regulations require compliance with them only by
As per Section 68 (1) of the Companies Act 2013, buy back of shares can be
certain Non-SMCs
made out: free reserves; or the securities premium account; or the
proceeds of any shares or other specified securities.
Applicability of Accounting Standards for Corporate Entities
Accounting Standards in respect of which relaxations from certain requirements have been given to SMCs
1. AS 15 (Employee Benefits) – Partial Exemption
2. AS 19 (Leases) - Partial Exemption
3. AS 20 (Earning Per Share) - Partial Exemption
4. AS 28 (Impairment of Assets) - Partial Exemption
As per Section 68 (1) of the Companies Act 2013, buy back of shares can be
5. AS 29 (Provisions, Contingent Liabilities and Contingent Assets) - Partial Exemption
made out: free reserves; or the securities premium account; or the
6. AS 25 (Interim Financial Reporting) – Partial Exemption
proceeds of any shares or other specified securities.
MCQs
AS 17 is applicable to
(a) Level 1 Non-Corporate Entities and SMC
(b) Level 2 Non -Corporate Entities and SMCs
(c) Level 1 Non-Corporate Entities and Non-SMCs
(d) None of the above
Ans: Option C
As per Section 68 (1) of the Companies Act 2013, buy back of shares can be
made out: free reserves; or the securities premium account; or the
proceeds of any shares or other specified securities.
Next Video -> (IND AS) and IFRS
Thankscan be
As per Section 68 (1) of the Companies Act 2013, buy back of shares
made out: free reserves; or the securities premium account; or the
proceeds of any shares or other specified securities.
Accounting Standards
IND AS and IFRS
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Indian Accounting Standards (IND AS) and International Accounting Standard (IFRS)
IFRS International Accounting Standards
International Accounting Standards Committee (IASC)
As per Section 68 (1) of the Companies Act 2013, buy back of shares can be London based
made out: free reserves; or the securities premium account; or the
proceeds of any shares or other specified securities.
The IASC comprises the professional accountancy bodies of
over 75 countries (including the Institute of Chartered
Accountants of India
IASC is now named as International Accounting Standards
Board (IASB).
Indian Accounting Standards (IND AS) and International Accounting Standard (IFRS)
As per Section 68 (1) of the Companies Act 2013, buy back of shares can be
made out: free reserves; or the securities premium account; or the
These standards are not in compliance with international
proceeds of any shares or other specified securities.
standards
The Globalization these days make it necessary that these
standards shall be in compliance with the international
standards
Indian Accounting Standards (IND AS) and International Accounting Standard (IFRS)
IFRS
International Accounting Standards
International Financial
Reporting Standards
Understand IFRS
When they invest money in India, it becomes very difficult
forcanthem
As per Section 68 (1) of the Companies Act 2013, buy back of shares be to compare the results in India with other
made out: free reserves; or the securities premium account; or thecountries since accounting standards are different
proceeds of any shares or other specified securities.
The Globalization these days make it necessary that Accounting standards in India shall follow the international accounting
standards
Steps towards Convergence of Indian Accounting Standards (IND AS) and International Accounting Standards (IFRS)
ICAI Initiated the process of moving towards the International
Financial Reporting Standards issued by IASB
The Government of India in consultation with the ICAI decided
As per Section 68 (1) of the Companies Act 2013, buy back of shares can be
to converge and not to adopt IFRSs issued by the IASB
made out: free reserves; or the securities premium account; or the
proceeds of any shares or other specified securities.
Converge means Adapt as per Indian needs
The standards which converged with IFRS were named as Ind As
While formulating IND As efforts have been made to keep these Standards, as far as possible, in line with the
corresponding IFRS and departures have been made where considered essential.
Departures has been made depending on economic environment and terminologies used in Indian law
Steps towards Convergence of Indian Accounting Standards (IND AS) and International Accounting Standards (IFRS)
Various terminology related changes have been made
Statement of profit and loss’ in place of statement of comprehensive income
Balance sheet’ in place of ‘statement of financial position’.
As per Section 68 (1) of the Companies Act 2013, buy back of shares can be
made out: free reserves; or the securities premium account; or the
proceeds of any shares or other specified securities.
Steps towards Convergence of Indian Accounting Standards (IND AS) and International Accounting Standards (IFRS)
What are Carve Out and Carve Ins
As per Section 68 (1) of the Companies Act 2013, buy back of shares can be
made out: free reserves; or the securities premium account; or the
proceeds of any shares or other specified securities.
List of IND AS
As per Section 68 (1) of the Companies Act 2013, buy back of shares can be
made out: free reserves; or the securities premium account; or the
proceeds of any shares or other specified securities.
List of IND AS
As per Section 68 (1) of the Companies Act 2013, buy back of shares can be
made out: free reserves; or the securities premium account; or the
proceeds of any shares or other specified securities.
Total of 41 Ind As have been notified by MCA
MCQS
Global Standards facilitate
(a) Cross border flow of money. (b) Global listing in different bourses.
(c) Comparability of financial statements. (d) All the three.
Ans: Option D
As per Section 68 (1) of the Companies Act 2013, buy back of shares can be
made out: free reserves; or the securities premium account; or the
The Government
proceeds of any sharesoforIndia
otherinspecified
consultation with the ICAI decided to
securities.
(a) Adapt with IFRS. (b) Converge with IFRS.
(c) apply IFRS in India. (d) notify IFRS in India.
Ans: Option B
MCQS
Convergence with IFRSs
(a) Simplifies the process of preparing the financial statements.
(b) Reduces the costs of preparing the financial statements.
(c) Both (a) and (b).
(d) Facilitates global investors’ understanding and confidence in high quality financial statements.
Ans: Option D
As per Section 68 (1) of the Companies Act 2013, buy back of shares can be
made out: free reserves; or the securities premium account; or the
proceeds of any shares or other specified securities.
As per Section 68 (1) of the Companies Act 2013, buy back
INDof
ASshares can
Rollout be
(Timelines)
made out: free reserves; or the securities premium account; or the
proceeds of any shares or other specified securities.
IND AS Rollout (Timelines)
For Companies other than Insurance/Banking or NBFCs For Companies which are Insurance/Banking or NBFCs
As per Section 68 (1) of the Companies Act 2013, buy back of shares can be
made out: free reserves; or the securities premium account; or the
proceeds of any shares or other specified securities.
Commitment of Government of India to IND AS (Timelines)
For Companies other than Insurance/Banking or NBFC
1st April 2016: Mandatory Basis Phase II: 1st April 2017: Mandatory Basis
Companies listed/in process of listing on Stock
Exchanges in India or Outside India having net worth of All companies which are listed/or in process of listing inside or
INR 500 crore or more outside India on Stock Exchanges not covered in Phase I (other
than companies listed on SME Exchanges);
AsCompanies
per Section Unlisted Companies
68 (1) of the having
Companies net worth
Act 2013, of of shares can be
buy back
INR out:
made 500 crore or more or the securities premium account; orUnlisted
free reserves; the
companies having net worth of INR 250 crore or more
but less than INR 500 crore;
proceeds of any shares or other specified securities.
Parent, Subsidiary, Associate and JV of above.
Parent, Subsidiary, Associate and JV of above
Special Points
1. Companies listed on SME exchange are not required to apply Ind AS
2. Once Ind AS are applicable, an entity shall be required to follow the Ind AS for all the subsequent financial statements.
3. Companies not covered by the above roadmap shall continue to apply Accounting Standards
Commitment of Government of India to IND AS (Timelines)
For Scheduled Commercial Banks (Excluding RRBs), Insurers/Insurance Companies and Non-Banking Financial Companies (NBFC’s)
As per Section 68 (1) of the Companies Act 2013, buy back of shares can be
made out: free reserves; or the securities premium account; or the
proceeds of any shares or other specified securities.
MCQs
Which bank is not required to apply IND AS
(a) Cooperative Banks
(b) Regional Rural banks
(c) NBFC
(d) Private Banks
(e) A and B
Ans: Option E
As per Section 68 (1) of the Companies Act 2013, buy back of shares can be
made out: free reserves; or the securities premium account; or the
Companies
proceeds other than
of any shares Banks,
or other NBFCssecurities.
specified and Insurance companies having net worth of INR 500 crore or more are required
to implement IND AS by 1st April 2016. This apply to
1) Listed Companies
2) Unlisted Companies
3) Both Listed and Unlisted Companies
4) NOTA
Ans: Option C
MCQs
NBFCs having net worth of 500 crore are required to implement IND AS by
(a) 1st April 2018
(b) 1st April 2017
(c) 1st April 2019
(d) 1st April 2020
(e) NOTA
Ans: Option A
As per Section 68 (1) of the Companies Act 2013, buy back of shares can be
made out: free reserves; or the securities premium account; or the
Insurance
proceeds of anycompanies are required
shares or other tosecurities.
specified implement IND AS by
(a) 1st April 2019
(b) 1st April 2020
(c) 1st April 2021
(d) 1st April 2022
Ans: Option C
Thanks
As per Section 68 (1) of the Companies Act 2013, buy back of shares can be
; or the securities premium account; or the
proceeds of shares or other specified securities.
Types of Accounts
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Types of Accounts
Types of Accounts
Partnership is a relationship between persons who have agreed to share profits and losses of business carried on by all or any of them acting for all.
Real Account Personal Account Nominal Account
There are 3 golden rules of accounting.
Types of Accounts
Real Account
• Real accounts are related to asset account which can be touched & felt.
• Any kind of assets which is either tangible (for example: land, stock, building, etc.) or intangible
(for example: goodwill, copyrights, patents, etc.) are categorized into Real Account.
Partnership is a relationship between persons who have agreed to share profits and losses of business carried on by all or any of them acting for all.
Rule No. 1 - Debit what comes in
Credit what goes out
Types of Accounts
Real Account
• Illustration :- Ravi purchased furniture of Rs.75,000/- for cash.
Partnership is a relationship between persons who have agreed to share profits and losses of business carried on by all or any of them acting for all.
Furniture A/c Dr. 75000
To Cash A/c 75000
Types of Accounts
Personal Account
• Personal accounts are related to persons , institutions companies
• Personal accounts are sub-divided into natural persons and artificial persons.
• Natural persons are individuals or human .
• Where isare
Partnership artificial
a relationship persons
between are
persons whothe
haveorganizations created
agreed to share profits byof law
and losses like
business companies,
carried trusts,
on by all or any of themfirms etc
acting for all.
Rule No. 2 - Debit the receiver
Credit the giver
Types of Accounts
Personal Account
• Illustration :- Ram paid Rs.45,000/- to Reliance Private Limited Company by cheque.
Partnership is a relationship between persons who have agreed to share profits and losses of business carried on by all or any of them acting for all.
Reliance Private Limited A/c Dr. 45000
To Bank A/c 45000
Types of Accounts
Nominal Account
• Those accounts which are associated with income, gains, losses or expenses are known as Nominal
Account.
• At the end remaining balances of nominal accounts are then posted to capital account.
For examples-
• Partnership salaries,
is a relationship betweenrent,
personssales, purchases
who have etc.
agreed to share profits and losses of business carried on by all or any of them acting for all.
Rule No. 3 - Debit all expenses and losses
Credit all incomes and gains
Types of Accounts
Nominal Account
• Illustration :- Jasmine purchase goods worth Rs. 10000 for cash.
Partnership is a relationship between persons who have agreed to share profits and losses of business carried on by all or any of them acting for all.
Purchase A/c Dr. 10000
To Cash A/c 10000
Types of Accounts
Identify the type of accounts
1) Ibrahim a sole proprietor Commenced business with a capital of 2,00,000
2) Bought Furniture for cash 20,000.
3) Paid Rent to the shop owner Mr. Murugan 5,000.
4) Paid cash into bank 1,50,00
5) Bought Goods for cash 10,000 from M/s Shamir Jain & Co.,
6) Bought Goods on credit from M/s Ramdas & Bros. for 10,000.
7) Partnership
Sold goods for cashbetween
is a relationship 12,000 to Mr.
persons Naryan
who have agreedTiwari
to share profits and losses of business carried on by all or any of them acting for all.
8) Bought Machinery from M/s Boolani Machinery and paid by cheque 25,000.
9) Sold goods on credit to Mr. Natekar for 8,000
10) Paid weekly wages to workers 5,000
11) Paid M/s Ramdas and Brothers by cheque 5,000
12) Received from Mr. Natekar 2,000
13) Received commission from M/s Orion Traders for giving a trade lead 500.
Types of Accounts
Identify the type of accounts
Commenced Business with a Capital of 2,00,000
Cash A/c Dr.
To Capital A/c
Partnership is a relationship between persons who have agreed to share profits and losses of business carried on by all or any of them acting for all.
Real A/c Personal A/c
Types of Accounts
Identify the type of accounts
Bought Furniture for cash 20,000.
Furniture A/c Dr.
To Cash A/c
Partnership is a relationship between persons who have agreed to share profits and losses of business carried on by all or any of them acting for all.
Real A/c Real A/c
Types of Accounts
Identify the type of accounts
Paid Rent to the shop owner Mr. Murugan 5,000.
Rent paid A/c Dr.
To cash A/c
Partnership is a relationship between persons who have agreed to share profits and losses of business carried on by all or any of them acting for all.
Nominal A/c Real A/c
Types of Accounts
Identify the type of accounts
Paid cash into bank 1,50,000
Bank A/c Dr.
To cash A/c
Partnership is a relationship between persons who have agreed to share profits and losses of business carried on by all or any of them acting for all.
Real A/c Real A/c
Types of Accounts
Identify the type of accounts
Bought Goods for cash 10,000 from M/s Shamir Jain & Co.,
Purchases A/c Dr.
To cash A/c
Partnership is a relationship between persons who have agreed to share profits and losses of business carried on by all or any of them acting for all.
Nominal A/c Real A/c
Types of Accounts
Identify the type of accounts
Bought Goods on credit from M/s Ramdas & Bros. for 10,000.
Purchases A/c Dr.
To M/s Ramdas & Bros. A/c
Partnership is a relationship between persons who have agreed to share profits and losses of business carried on by all or any of them acting for all.
Nominal A/c Personal A/c
Types of Accounts
Identify the type of accounts
Sold goods for cash 12,000 to Mr. Naryan Tiwari.
Cash A/c Dr.
To sales A/c
Partnership is a relationship between persons who have agreed to share profits and losses of business carried on by all or any of them acting for all.
Real A/c Nominal A/c
Types of Accounts
Identify the type of accounts
Bought Machinery from M/s Boolani Machinery and paid by cheque 25,000.
Machinery A/c Dr.
To Bank
Partnership is a relationship between persons who have agreed to share profits and losses of business carried on by all or any of them acting for all.
Real A/c Real A/c
Types of Accounts
Identify the type of accounts
Sold goods on credit to Mr. Natekar for 8,000.
Mr. Natekar A/c Dr.
To sales A/c
Partnership is a relationship between persons who have agreed to share profits and losses of business carried on by all or any of them acting for all.
Personal A/c Nominal A/c
Types of Accounts
Identify the type of accounts
Paid weekly wages to workers 5,000
Wages A/c Dr.
To cash A/c
Partnership is a relationship between persons who have agreed to share profits and losses of business carried on by all or any of them acting for all.
Nominal A/c Real A/c
Types of Accounts
Identify the type of accounts
Paid M/s Ramdas and Brothers by cheque 5,000
M/s. Ramdas & Bros. A/c Dr.
To bank A/c
Partnership is a relationship between persons who have agreed to share profits and losses of business carried on by all or any of them acting for all.
Personal A/c Real A/c
Types of Accounts
Identify the type of accounts
Received from Mr. Natekar 2,000
Cash A/c Dr.
To Mr. Natekar A/c
Partnership is a relationship between persons who have agreed to share profits and losses of business carried on by all or any of them acting for all.
Real A/c Personal A/c
Types of Accounts
Identify the type of accounts
Received commission from M/s Orion Traders for giving a trade lead 500.
Cash A/c Dr.
To Commission received A/c
Partnership is a relationship between persons who have agreed to share profits and losses of business carried on by all or any of them acting for all.
Real A/c Nominal A/c
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Video 1 –Joint Venture
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Joint Venture
Indian Bank Foreign Company
The joint venture is for a specific project of the
companies i.e. insurance business in India.
Had a customer base in India Wanted to expand insurance
Joint Venture Company business to India
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Joint Venture
• A joint venture is an arrangement in which two or more parties agree to pool their resources for the
purpose of a specific task or transaction.
• This task may be a fresh project or any other business activity.
• In a joint venture, each of the members is responsible for profits, losses and costs associated with it.
• The venture is an entity separate from its participants.
• Some examples of Joint Ventures-
• Sony Ericsson
• Hero Honda
• Maruti Suzuki
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Joint Venture
Features
• Duration: It is formed for a short period of time and thus, may be termed as a temporary partnership.
• Parties: The persons who come together to run a joint venture are the Co-venturers.
• Funds: The co-venturers bring the funds for the joint venture account
• Sharing of profits or losses: The co-venturers share profits or losses are as per the agreement between
them. In the absence of an agreement, they will share it equally.
• Computation of profits or losses: Usually, the co-venturers compute the profit or loss of the venture on
its completion.
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Joint Venture
Advantages
• Risks and rewards can be shared
• Synergies can be achieved.
• Economies of scale
• Access to new markets and distribution networks
• Access to technology and innovation
• Brand Name
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Joint Venture
Difference between Joint Venture and Partnership
Basis for Joint Venture Partnership
comparison
Meaning Joint Venture is a business formed by two or A business arrangement where two or more
more than two persons for a limited period persons agree to carry on business and have
and a specific purpose. mutual share in the profits and losses, is
known as Partnership.
Status of minor A minor cannot become a co-venturer. A minor can become a partner to the benefits
of the firms.
Ascertainment of At the end of the venture or on interim basis Annually
profits as the case may be.
Maintenance of Not necessary Mandatory
separate set of books
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Joint Venture
Accounting of Joint Venture
One of the Venturers keeps Separate Books of account are Separate Books of account are not
accounts maintained maintained
Joint Bank Account Joint Venture Account Co-venturers account
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Joint Venture
Accounting of Joint Venture
One of the Venturers keeps accounts
If one of the co-venturers is appointed to manage the joint venture, he is awarded an extra commission or
remuneration out of the profit for his services.
Journal Entries
Particulars Entry
When share of investment received Cash/Bank A/cDr
from other co-venturers To Co-venturers A/c
Joint Venture A/cDr
To Cash A/c (in case of cash purchase)
When goods are purchased
Or
To Creditors A/c (for credit purchase)
Joint Venture A/cDr
When expenses incurred
To Cash A/c
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Joint Venture
One of the Venturers keeps accounts
Particulars Entry
Cash A/c Dr
Or
When goods are sold
Debtors A/c Dr
To Joint Venture A/c
Joint Venture A/c Dr
When commission allowed to working co-venturer
To Commission A/c
In case of Profit balance of joint venture, account will Joint Venture A/c Dr
be transferred to profit & Loss (own share of working To Profit & Loss A/c
co-venturer) and other co-venture’s personal accounts To Co-venturers personal A/c
Profit & Loss A/c Dr
In case of Loss
To Joint Venture A/c
All other Co-venturer A/c Dr
On settlement of accounts
To Cash/Bank A/c
Joint Venture
One of the Venturers keeps accounts
PNB is maintaining the books of PNB Metlife (JV).
Co-venturers
Joint Venture Co-venturers
1. Metlife contributed its share of investment Rs. 50 Lacs.
Bank A/c Dr.
To Metlife
2. Goods are purchased by PNB Metlife
PNB Met life A/c Dr.
To Bank
3. Expenses incurred of PNB Metlife
PNB Metlife A/c Dr.
To Bank
4. Goods are sold by PNB Metlife
Bank A/c Dr.
To PNB Metlife
Joint Venture
One of the Venturers keeps accounts
5. When commission allowed to PNB
PNB Metlife A/c Dr.
To Commisssion
6. Profit of PNB Metlife
PNB Metlife A/c Dr.
To profit & loss(share of PNB)
To Metlife(share of Metlife)
7. Loss of PNB Metlife
Profit & Loss A/c Dr.
Metlife A/c Dr.
To PNB Metlife
8. On settlement of accounts
MetlifeA/c Dr.
To Bank
Joint Venture
Practice Questions
Which account will be credited when joint venture company sells goods?
A. Sales
B. Joint Venture
C. Co- Venturer
D. Profit & Loss
B. Joint Venture
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Video 2 –Joint Venture
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Joint Venture
When separate set of books of account are maintained
Joint Bank Account
• The co-venturers open a separate bank account for the venture transactions.
• They make initial contributions to this account.
• Expenses are met from this Joint Bank Account.
• Sales or collections from transactions are deposited into this account.
• However, if any co-venturers make direct payments and direct collections; in such a case their Personal Accounts will be
credited/ debited for the transactions done.
• On completion of the venture, the Joint Bank Account is closed by paying the balance to co-venturers.
Joint Venture
When separate set of books of account are maintained
Joint Venture Account
• This account is prepared for measurement of venture profit.
• This account is debited with all venture expenses and credited with all sales or collections.
• The excess balance of credit side over the debit side shows the profit on joint venture and vice versa.
• Profit /Loss are transferred to co-venturers’ accounts in the profit-sharing ratio.
Joint Venture
When separate set of books of account are maintained
Co – Venturer’s Account
• Personal accounts of the venturers are maintained to keep a record of their contributions of cash, goods.
• Expenditure directly paid and payments directly received by co-venturers are also recorded in this account.
• The profit or loss so made on the venture is transferred to this account in the agreed profit sharing ratio.
• This account is also closed on completion of the venture.
Joint Venture
When separate set of books of account are maintained
Journal Entries
Joint Bank A/c Dr.
Initial contribution made by Co- Venturers
To Co- venturers A/c
Joint Venture A/c Dr.
Expenses paid out of joint bank a/c To Joint Bank A/c
Expenses directly paid by co-venturers/ Goods Joint Venture A/c Dr.
brought to the Joint Venture by co- venturers To Co- Venturers A/c
Joint Venture
When separate set of books of account are maintained
Journal Entries
If the stock of Joint Venture gets lost or destroyed No entry
Joint Bank A/c Dr.
Insurance claim received for such goods To Joint Venture A/c
Joint Bank A/c Dr.
Entry for sale of goods/ receipt of contract price To Joint Venture A/c
Joint Venture
When separate set of books of account are maintained
Journal Entries
Payment made to creditors Creditors A/c Dr.
To Joint Bank A/c
Joint Bank A/c Dr.
Payment received from debtors To Debtors A/c
Joint Venture
When separate set of books of account are maintained
Journal Entries
Depreciation on assets of Joint Venture (here we No entry
are assuming that joint venture is for a specific
period of time)
Entry for unsold goods/ unutilized assets taken over Co- Venturers’ A/c Dr.
by co-venturers To Joint Venture A/c
Profit of Joint Venture Joint Venture A/c Dr.
To Co- Venturers’ A/c
Joint Venture
When separate set of books of account are maintained
Journal Entries
Loss of joint Venture Co – Venturers’ A/c Dr.
To Joint Venture
Final settlement of joint venture Co- Venturers’ A/c Dr.
To Joint Bank A/c
Joint Venture
When separate set of books of account are maintained
Example
• A and B enter a joint venture to produce some goods for the Government.
• A contributes Rs.20000 and B contributes Rs.30000.
• The Government agrees to pay Rs.200,000 for the product out of which it paid 150000 Rs. in advance.
• These amounts are deposited into a Joint Bank Account. Payments made out of the joint bank account were:
a) Purchase of equipment- 12000
b) Hire of equipment- 10000
c) Wages- 90000
d) Material- 20000
e) Office expenses- 10000
• A paid Rs.4000 as licensing fee. On completion, the goods was found defective and the government made a deduction
of 20000.
• The equipment was taken over by B at a valuation of 4000.
• Separate books of account were maintained for the joint venture accounting whose profits were divided in the ratio of
A- 2/5 and B- 3/5.
• Pass Journal Entries.
Joint Venture
When separate set of books of account are maintained
Journal Entries
Joint Bank A/c Dr. 50000
A contributes Rs.20000 and B contributes Rs.30000. To A ’s A/c 20000
To B ’s A/c 30000
Government paid advance Joint bank A/c Dr. 150000
To Joint venture A/c 150000
Expenses done by Joint Venture
a) Purchase of equipment- 12000
b) Hire of equipment- 10000 Joint Venture A/c Dr. 142000
c) Wages- 90000 To Joint Bank A/c 142000
d) Material- 20000
e) Office expenses- 10000
Joint Venture
When separate set of books of account are maintained
Journal Entries
Joint venture A/c Dr. 4000
A paid Rs.4000 as licensing fee To A’s A/c 4000
On completion, the goods was found defective Joint bank A/c Dr. 30000
and the government made a deduction of 20000. To Joint venture A/c 30000
(Out of 200000 payment, 150000 was paid in
advance and Rs.20000 is deducted)
The equipment was taken over by B at a B’s A/c Dr. 4000
valuation of 4000. To Joint Venture 4000
Joint Venture
When separate set of books of account are maintained
Journal Entries
After making all the entries, the profit earned by the Joint Venture is Rs.38000. It will be distributed among the
venturers’ in the ratio decided.
Profits were divided in the ratio of A- 2/5 and B- Joint venture A/c Dr. 38000
3/5. To A’s A/c 15200
To B’s A/c 22800
• Calculation of profit =
• Balancing figure of Joint Venture A/c =
180000-142000+4000-4000 = 38000
Joint Venture
When separate set of books of account are maintained
Journal Entries
Final Settlements of accounts
A A/c Dr. 39200 (20000+4000+15200)
B A/c Dr. 48800 (30000+22800-4000)
To Joint Bank A/c 88000
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Video 3 –Joint Venture
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Joint Venture
When no separate set of books of account are maintained
When each co-venturer keeps records of ALL When each co-venturer keeps records of OWN
transactions transactions only
Joint Venture with Co- Memorandum Joint
venturer’s A/c Venture A/c
Joint Venture
When no separate set of books of account are maintained
When each co-venturer keeps records of ALL transactions
Journal Entries
Goods supplied to Joint venture out of own stock Joint Venture A/c Dr.
of Co- Venture To Purchases A/c
Expenses made by Joint Venture/ Purchases Joint Venture A/c Dr.
made by Joint Venture To Bank/ Creditors A/c
Other co-venturers’ incurs expenses or supply Joint Venture A/c Dr.
goods to Joint Venture To Co- Venturer’s A/c
Joint Venture
When no separate set of books of account are maintained
When each co-venturer keeps records of ALL transactions
Journal Entries
Sale made by Joint Venture Bank/ Debtors A/c Dr.
To Joint Venture A/c
Venture sale made by the co-venturer Co-venturer’s A/c Dr.
To Joint Venture A/c
Profit of venture Joint Venture A/c Dr.
To Profit & Loss A/c (own share)
To Co- Venturer’s A/c (their share)
Joint Venture
When no separate set of books of account are maintained
When each co-venturer keeps records of ALL transactions
Journal Entries
Venture Loss Profit & Loss A/c Dr. (own share)
Co-venturers’ A/c Dr. ( their share)
To Joint Venture A/c
Settlement of claim Co-venturer A/c Dr.
To Bank
Joint Venture
When no separate set of books of account are maintained
When each co-venturer keeps records of OWN transactions only
Journal Entries
Goods supplied to Joint venture out of own stock Joint Venture with Co- Venturers’ A/c Dr.
of Co- Venture To Purchases A/c
Expenses made by Joint Venture/ Purchases Joint Venture with Co- Venturers’ A/c Dr.
made by Joint Venture To Bank/ Creditors A/c
Sale made by Joint Venture Bank/ Debtors A/c Dr.
To Joint Venture with Co- Venturer’s A/c
Joint Venture
When no separate set of books of account are maintained
When each co-venturer keeps records of OWN transactions only
Journal Entries
Profit of venture Joint Venture with Co- Venturers’ A/c Dr.
To Profit & Loss A/c (own share)
To Co- Venturer’s A/c (their share)
Venture Loss Profit & Loss A/c Dr. (own share)
Co-venturers’ A/c Dr. ( their share)
To Joint Venture with Co- Venturers’ A/c
Settlement of claim Joint Venture with Co-venturers’ A/c Dr.
To Bank
Joint Venture
When no separate set of books of account are maintained
When each co-venturer keeps records of OWN transactions only
• Each Co-Venturer then prepares a Memorandum Joint Venture Account in order to ascertain the amount of profit or
loss in Joint Venture.
• The account resembles a profit and loss account wherein all the expenses and losses are debited and all incomes and
gains are credited.
• But it does not form part of the double entry books.
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Video 1 –Consignment
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Consignment
❑ Consignment refers to handing over of goods belonging to one person to another person without transferring ownership.
❑ Consignment, in simple words, means one person/firm sending goods to another person/firm for selling them on behalf
of the former. The owner of the goods only transfers possession of the goods, he retains ownership over them.
❑ The purpose of a consignment transaction is to facilitate delivery or transport of goods.
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Consignment
• Consignment is a system where one person sends the goods to another so that the
latter can sell those goods on behalf of the person who sends it in the first place.
• Risk related to goods will be on the part of the consignor.
Sale to customer
Consignor Consignee
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Consignment
There are two parties in a consignment.
1.The person sending the goods is the consignor.
2.The person receiving the goods is the consignee.
Consignor Consignee
• The relationship between consignor and consignee is that of the principal and the agent.
• So entire profit or loss belongs to the consignor and consignee receives the commission as his remuneration.
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Consignment
Procedure of Consignment
• Consignor and Consignee enter into agreement.
• They agree upon terms of their agreement and the commission payable.
• The consignor hands over possession of goods to the consignee along with a
proforma invoice.
• This document contains details about the goods transferred. Consignee
Consignor
• The consignor transfers only possession of goods and not ownership over
them.
• The consignee sends a statement called Account Sales to the consignor.
• This document contains details like sales made by the consignee, the expenses he incurred and
commission payable to him.
• The consignor now pays commission to the consignee for his services at agreed rates.
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Consignment
Difference between Consignment and Sale
Consignment Sale
Ownership of goods remains with the consignor until Ownership of goods is transferred from the seller to
the consignee sells them to a third party. the buyer immediately upon sale.
The consignor and consignee have a principal-agent The buyer and seller have a creditor-debtor
relationship. relationship.
The consignee can return all unsold goods to the Ownership gets transferred upon sale, so the buyer
consignor. cannot return goods unless the seller agrees.
Expenses incurred by the consignee are borne by the Goods once sold become the buyer’s responsibility
consignor unless they agree otherwise. and the seller is not responsible for any further
expenses.
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Consignment
Commission
Commission is the remuneration paid by the consignor to the consignee for the services rendered to the former for
selling the consigned goods.
Ordinary Commission Del credere commission Over-riding commission
• It is based on fixed percentage of • To increase the sales and • It is an extra commission allowed
the gross sales proceeds made by encourage the consignee to make by the consignor to the consignee
the consignee. credit sales, the consignor to promote sales at higher price
• It is given by the consignor provides an additional than specified or to encourage
regardless of whether the commission generally known as the consignee to put hard work in
consignee is making credit sales del-credere commission. introducing new product in the
or not. • It is a type of commission which a market.
• This type of commission does not consignor offers to the consignee • It is calculated on total sales or on
give any protection to the who guarantees the collection of the difference between actual
consignor from bad debts and is payment from credit customers. sales and sales at invoice price.
provided on total sales.
Consignment
Valuation of unsold consignment
Consignor Consignee
Stock lying with consignee on the date of
closing books of entry will be valued at
Lower Of
• COST
• MARKET PRICE
The cost price will be valued at −
• Proportionate cost price and
• Proportionate direct expenses.
Here, proportionate direct expenses mean — all expenses incurred by the consignor and the expenses of consignee, which
are incurred by him till the goods reach the warehouse.
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Consignment
Invoicing Goods Higher than Cost
• Under this method, goods are charged at the cost + profit and the pro-forma invoice also shows this higher price of
such goods.
• To know the actual profit, at the end of an accounting period, consignment account will be credited with excess price so
charged.
Main reason to adopt this policy by consignor is −
➢ To hide actual profit from consignee.
➢ Valuation of a stock at the consignor’s warehouse is comparatively easy in this case.
➢ In this case, consignor usually directs consignee to sale goods on invoice price only. It prevents different sale price to
different customers.
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Consignment
Loss of Goods
Normal Loss :-
• Normal loss may occur due to inherent Abnormal Loss :-
characteristics of goods like evaporation, drying up • An abnormal loss may occur due to any
of goods, etc. accidental reason.
• It is not separately shown in the consignment • It is credited to the consignment account to
account, but included in the cost of goods sold and calculate actual profitability.
the closing stock by inflating the rate per unit.
• Value of closing stock =
Total value of goods sent . x Unsold Quantity Valuation of closing stock = Proportionate
Net Quantity received by consignee cost + proportionate direct expenses
Where Net Quantity received = Goods consigned – Normal loss
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Video 2 –Consignment
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Consignment
Accounting treatment in the Books of Consignor and Consignee
Consignor Consignee
When goods are sent to consignee
Consignment A/c Dr. No Entry
To Goods Sent on consignment
Expenses incurred by consignor
Consignment A/c Dr. Not Applicable
To Cash/ Bank
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Consignment
Accounting treatment in the Books of Consignor and Consignee
Consignor Consignee
Advance given by consignee
Cash/ Bank A/c Dr. Consignor’s A/c Dr.
To Consignee’s A/c To Cash/ Bank
Expenses incurred by consignee
Consignment A/c Dr. Consignor’s A/c Dr.
To Consignee A/c To Cash/ Bank
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Consignment
Accounting treatment in the Books of Consignor and Consignee
Consignor Consignee
Sale by consignee
Cash A/c Dr.(Cash sales)
Consignee A/c Dr. Debtors A/c Dr.(Credit sales)
To Consignment A/c To Consignor A/c
Commission due to consignee
Consignment A/c Dr. Consignor’s A/c Dr.
To Consignee A/c To Commission
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Consignment
Accounting treatment in the Books of Consignor and Consignee
Consignor Consignee
Remittance from consignee
Cash/ Bank A/c Dr. Consignor A/c Dr.
To Consignee A/c To Cash/ Bank A/c
Entry for loss on consignment
Profit & Loss A/c Dr. Not Applicable
To Consignment A/c
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Consignment
Accounting treatment in the Books of Consignor and Consignee
Consignor Consignee
Profit on Consignment
Consignment A/c Dr.
Not Applicable
To Profit & Loss A/c
Entry to deduct loading included in stock in hand on closing
date(in case goods are sent at invoice price)
Consignment A/c Dr.
To Stock Reserve No Entry
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Consignment
Accounting treatment in the Books of Consignor and Consignee in case of loss
Normal Loss on Consignment
➢ To ascertain the cost per unit after the normal loss, we use the following formula:
Cost per unit=Total cost + Expenses incurred
Total quantity–Normal loss
Note: No entry is recorded for normal loss in the books
• For example: Suppose, 10,000 apples were sent to the consignee at ₹30 per kg and freight of ₹60,000. It is known that
there would be a normal loss of 10%.
• Cost per kg=300000+60000
10000 x 90%
=₹40 per kg
If the unsold quantity is 500 its value will be(500×40=20000).
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Consignment
Accounting treatment in the Books of Consignor and Consignee in case of loss
Abnormal Loss on Consignment
➢ Some losses are accidental or can be caused by carelessness.
➢ Example: by theft or loss by fire, flood, earthquake, war, accidents in transit, etc.
➢ Suppose a part of goods is stolen, now this will reduce the value of stock and therefore profit on consignment.
➢ Some businessmen also take an insurance policy in respect of goods sent or received.
➢ Such a policy is obtained only in respect of abnormal loss caused to goods.
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Consignment
Accounting treatment in the Books of Consignor and Consignee
Consignor Consignee
When the loss is irrecoverable
Abnormal Loss A/c Dr.
Not Applicable
To Consignment A/c
Abnormal loss transferred to P& L
Profit & Loss A/c Dr. Not Applicable
To Abnormal Loss
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Consignment
Accounting treatment in the Books of Consignor and Consignee
Consignor Consignee
When the loss is insured and is recoverable
Abnormal Loss A/c Dr.
Not Applicable
To Consignment A/c
Abnormal loss transferred to insurance company
Insurance Company Dr. Not Applicable
To Abnormal Loss
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Video 1 – Partnership
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Partnership
1) Partnership is a relationship between persons who have agreed to share profits and losses of business carried on by
all or any of them acting for all.
2) The Indian Partnership Act, 1932 - It is an Act that governs the partnership firms. In case, Partnership Deed is silent
on any issue, provisions of the Act apply
3) Capital is the amount in credit of Partner’s Capital Account. It may be contributed by the partners in the firm
and/or credited
Partnership by waybetween
is a relationship of hispersons
or herwho
share
haveof profit,
agreed salary,
to share commission
profits and interest
and losses of business onbycapital.
carried on all or any Capitals of the
of them acting for all.
partners may be fixed or fluctuating.
Partnership
Features of partnership
1) Two or More Persons - The minimum number of partners in a partnership firm can be two.
Maximum number of partners in a partnership firm can be fifty.
2) Agreement - The partnership is an agreement between two or more persons who decide to do business and share its
profits and losses. To have a legal relationship between the partners, the partnership agreement becomes the basis.
The agreement can be in written form or oral form. An oral agreement is equally valid. But, preferably the partners
should have a written agreement, in order to avoid disputes in future.
3) Legal Business
Partnership – The business
is a relationship to be carried
between persons who have out should
agreed to sharebe legal.
profits and losses of business carried on by all or any of them acting for all.
4) Sharing of Profit - The agreement between partners must be to share profits and losses of a business. Sharing of
profits and losses is important. The partnership is not for the purpose of some charitable activity.
5) Liability of Partnership - Each partner is liable jointly with all the other partners. And also when is a partner,
severally liable to the third party for all the acts done by the firm. Liability of the partner is not limited. This implies
that for paying off the firm’s debts, his private assets can also be used
6) Mutual Agency - The business of a partnership firm may be carried on by all the partners or any of them acting for
all. Each partner carrying on the business is the principal as well as the agent. He can bind other partners by his
acts.
Partnership
PARTNERSHIP DEED
➢ The Partnership Act does not require that the agreement must be in writing.
➢ But when the agreement is in written form, it is called ‘Partnership Deed’.
➢ Partnership deed should be duly signed by the partners, stamped & registered.
Partnership is a relationship between persons who have agreed to share profits and losses of business carried on by all or any of them acting for all.
Partnership
TERMINOLOGIES
➢ Profit sharing ratio – The ratio in which profit will be shared by the partners.
➢ Capital Ratio – The ratio in which capital has been contributed b the partners.
Partnership is a relationship between persons who have agreed to share profits and losses of business carried on by all or any of them acting for all.
Partnership
Distribution of Profits Among Partners
As we know a partnership is where two or more persons work together and distribute among themselves all profits and
losses. But how exactly will this distribution of profit take place? Let us see the accounting entries and effects of the
distribution of profit.
Profit sharing among
As agreed
Partnership is a relationship between persons who have per to share
partnership
profits and losses of business carried on by all or any of them acting for all.
partners
deed
If partnership deed is Sharing of profits & losses
silent or no partnership equally among partners
deed irrespective of the capital.
Partnership
Provisions of Partnership Act relevant for Accounting
The important provisions affecting partnership accounts are as follows:
a) Profit Sharing Ratio: If the partnership deed is silent about the profit sharing ratio, the profits and losses of the firm
are to be shared equally by partners, irrespective of their capital contribution in the firm.
b) Interest on Capital: No partner is entitled to claim any interest on the amount of capital contributed by him in the
firm as a matter of right. However, interest can be allowed when it is expressly agreed to by the partners. Thus, no
interest on capital is payable if the partnership deed is silent on the issue.
Partnership is a relationship between persons who have agreed to share profits and losses of business carried on by all or any of them acting for all.
c) Interest on Drawings: No interest is to be charged on the drawings made by the partners, if there is no mention in
the Deed.
d) Interest on Loan: If any partner has advanced loan to the firm for the purpose of business, he/she shall be entitled to
get an interest on the loan amount at the rate of 6 per cent per annum.
e) Remuneration for Firm’s Work: No partner is entitled to get salary or other remuneration for taking part in the
conduct of the business of the firm unless there is a provision for the same in the Partnership Deed.
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Video 2 – Partnership
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Partnership
Distinction between Fixed and Fluctuating Capital Accounts
Basis of Fixed Capital Account Fluctuating Capital Account
Distinction
Number of Under this method, two separate accounts are Each partner has one account, i.e.
accounts maintained for each partner viz. ‘capital account’ and capital account, under this method.
‘current account’
Adjustments Allbetween
Partnership is a relationship adjustments for
persons who havedrawings, salary,
agreed to share interest
profits and losses of on Allcarried
business adjustments forofdrawings,
on by all or any salary,
them acting for all.
capital etc. are made in the current accounts and not interest on capital etc. are made in
in the capital accounts. the capital accounts.
Fixed Balance The capital accounts balance remain unchanged The balance of the capital account
unless there is addition to or withdrawal of capital fluctuates from year to year.
Credit balance The capital accounts always show a credit balance. The capital account may sometimes
show a debit balance.
Partnership
Profit and Loss Appropriation Account
• Profit and Loss Appropriation Account is merely an extension of the Profit and Loss Account of the firm.
• It shows how the profits are appropriated or distributed among the partners.
• All adjustments in respect of partner’s salary, partner’s commission, interest on capital, interest on
drawings, etc. are made through this account.
Partnership is a relationship between persons who have agreed to share profits and losses of business carried on by all or any of them acting for all.
• It starts with the net profit/net loss as per Profit and Loss Account.
Partnership
Journal entries for preparation of Profit and Loss Appropriation Account
Transfer of the balance of Profit and Loss Account to Profit and Loss Appropriation Account
Net Profit Net Loss
Profit and Loss A/c Dr. Profit and Loss Appropriation A/c Dr.
To Profit and Loss Appropriation A/c To Profit and Loss A/c
Interest on Capital
Interest on capital transferred to P & L
For Allowing interest on capital
Appropriation Account
Interest on Capital A/c Dr. Profit and Loss Appropriation A/c Dr.
To Partner’s Capital/Current A/cs To Interest on Capital A/c
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Partnership
Journal entries for preparation of Profit and Loss Appropriation Account
Interest on Drawings
For charging interest on drawings to Transferring interest on drawings to P & L
partners’ capital accounts Appropriation Account
Partners Capital/Current A/c’s Dr. Interest on Drawings A/c Dr.
To Interest on Drawings To Profit and Loss Appropriation A/c
Partner’s Salary
Allowing partner’s salary to Transferring partner’s salary to P & L
partner’s capital account Appropriation Account
Salary to Partner A/c Dr. Profit and Loss Appropriation A/c Dr.
To Partner’s Capital/Current A/c’s To Salary to Partner’s A/c
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Partnership
Journal entries for preparation of Profit and Loss Appropriation Account
Partner’s Commission
Crediting commission allowed to a Transferring commission allowed to partners
partner to P & L Appropriation Account
Commission to Partner A/c Dr. Profit and Loss Appropriation A/c Dr.
To Partner’s Capital A/c’s To Commission to Partners A/c
Share of Profit or Loss after appropriations
If Profit If Loss
Profit and Loss Appropriation A/c Dr. Partner’s Capital/Current A/c (individually)
To Partner’s Capital A/c’s To Profit and Loss Appropriation A/c
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Partnership
Treatment of guarantee of minimum profit to a partner
Sometimes, a partner may be guaranteed a minimum amount by way of his share in profits.
If, in any year, the share of profits as calculated according to his profit sharing ratio is less than the
guaranteed amount, the deficiency is made good by the guaranteeing partners’ in the agreed ratio
which usually is the profit sharing ratio.
Partnership is a relationship between persons who have agreed to share profits and losses of business carried on by all or any of them acting for all.
If, however, such guarantee has been given by any of them, he or they alone shall bear the amount of
deficiency.
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Video 1 – Branch Accounts
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Branch Accounts
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Need for Branch Accounting
a) To ascertain the profit or loss of each branch so that if any of them is not yielding the desired profits,
corrective measures can be undertaken.
b) To ascertain the financial position of each branch separately at the end of the accounting period.
c) To exercise a proper degree of control on the operations of the branch.
d) To ascertain the requirements of stock and cash for each branch.
e) To coordinate the operations of various branches.
f) To incorporate the profit or loss made by branch and its assets and liabilities in the head office’s final
accounts
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Classification of Branches
Classification of
Branches
Inland Branches Foreign Branches
Dependent
Branches
Independent
Branches
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Branch Accounts
Dependent Branches
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Method of charging goods to Branches
Invoiced Invoiced
at cost at Invoice
price price
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Video 2 – Branch Accounts
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Branch Accounts
• This method of accounting is suitable for small sized branches.
• Under this method, head office opens only one account for each branch called “Branch Account”.
• All transactions relating to that branch are recorded in this account.
• This account is a nominal account and is prepared to ascertain profit or loss made by the branch.
• A branch is assumed to be a debtor of head office and it records only the transactions that take place
between itself (H.O) and its branch.
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Branch Accounts
For recording opening balances of assets & liabilities at branch
ASSETS
LIABILITIES
Branch Account Dr
To Branch Stock A/C (At cost price) Branch Liabilities (individually) A/C Dr.
To Branch Debtors A/C To Branch Account
To Branch Cash A/C
Goods are supplied by Head Office to branch/ by another branch to Branch
Branch Account Dr
To Goods Sent to Branch A/C (At cost price)
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Branch Accounts
Return of goods by branch to head office/ branch customers directly to Head Office
Goods Sent to Branch Account Dr
To Branch Account
Expenses are met by the head office or for remittance of Cash/ cheque to branch for expenses
Branch A/C Dr
To Cash/Bank A/C
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Branch Accounts
Cash/cheque received by the Head Office from Branch (cash sales plus collection from debtors) Or Branch customers directly
Cash/Bank A/C Dr
To Branch A/C
Recording closing Balances of assets’ at branch
Branch Assets account Dr
To Branch Account
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Branch Accounts
Recording ‘closing Balances of liabilities’ at the branch
Branch A/C Dr
To Liabilities (Individual) Account
No entry for credit sales, normal loss and goods returned by customers to Branch
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Branch Accounts
For abnormal loss
Abnormal Loss A/C Dr
To Branch A/C
Branch expenses paid by branch; bad debts; discount allowed to debtors
No entry
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Branch Accounts
When remittances are sent by the Branch but not received by the Head Office till the end of the accounting year
Cash-in- transit A/C Dr.
To Branch A/C
Goods are supplied by the Head Office but not received by the Branch till the end of accounting year
Goods-in-transit A/C Dr.
To Branch A/C
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Branch Accounts
Branch account discloses a profit
Branch Account Dr.
To General P&L A/C
Branch account discloses a loss
General P & L A/C Dr.
To Branch Account
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Branch Accounts
Goods sent to Branch A/c
Goods Sent to Branch A/C Dr.
To Trading A/C or Purchases A/C
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Branch Accounts
The items mentioned below are not recorded in Branch Accounts under this method
1) Petty Expenses paid by the Branch: Petty expenses paid by the branch are not shown in the Branch Account. The
Branch Account is debited with the opening balance of petty cash and the amount of petty cash sent by the Head
office and is credited with the closing balance of petty cash. For calculating closing balance of petty cash, all petty
expenses paid by the branch are taken into consideration. Therefore, these should not be shown separately in the
Branch Account.
2) Credit sales, sales returns, bad debts, discount allowed etc. are not shown in the Branch Account. These items
are related to Debtors Account. For calculating closing balance of debtors all these items are taken into
consideration. Thus, there is no need to show them separately in Branch Account.
3) Depreciation, Profit /Loss on sale of fixed assets: Branch Account shows the opening and closing balances of
fixed assets which automatically take care of depreciation, profit /loss on sale of fixed assets. Moreover, if an asset is
sold for cash, the Branch Account will be credited with the remittances. If it is sold on credit, the Branch account
will be credited with the Debtor for sale of an asset. Therefore, at the time of preparing Branch Account, these items
are not shown separately.
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Branch Accounts
• Sometimes the head office sends goods to the branch at a higher price than cost (termed as invoice
price).
• The invoice price method is adopted where the goods generally would be sold at a fixed price by the
branch.
• It is suitable for dealers where goods are of standard type and unlikely to fluctuate in price.
• The goods may also be invoiced at selling price to keep the margin of profit a secret from the branch
manager.
• Under this method, the preparation of Branch Account is same as in the cost price method, except that
all journal entries relating to the goods (stock) such as opening stock, goods sent to branch, goods
returned to head office by Branch and closing stock are made at invoice price and proper adjustments
for loading (difference between cost price and invoice price) are made by passing some additional
entries
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Branch Accounts
Adjustment of excess price of the opening stock
Stock Reserve A/c Dr. (with difference in cost price and invoice price)
To Branch A/C
Adjustment of excess price of goods sent to branch
Branch A/c Dr. (with difference in cost price and invoice price)
To Stock Reserve A/c
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Branch Accounts
Goods returned by Branch to H.O. is deducted out of the goods sent to Branch
Adjustment of excess price of closing stock
Branch A/c Dr. (with difference in cost price and invoice price)
To Stock Reserve
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Video 3 – Branch Accounts
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Branch Accounts
Stock and Debtors Method
• Stock and debtors system is generally applied if the head office desires to exercise a greater control
over the working of a branch.
• Goods are generally sent to the branch at an invoice price and the size of the branch is large.
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Branch Accounts
Stock and Debtors Method
Accounts maintained by the Head Office for each branch
Branch Stock A/c Branch Debtors A/c Branch cash A/c Branch Profit &
Loss A/c
Branch Expenses A/c Branch Fixed Assets Branch Stock Goods sent to
A/c Adjustment A/c Branch A/c
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Branch Accounts
Stock and Debtors Method
Journal Entries in the books of the Head Office
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Branch Accounts
Stock and Debtors Method
Journal Entries in the books of the Head Office
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Branch Accounts
Stock and Debtors Method
Journal Entries in the books of the Head Office
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Branch Accounts
Stock and Debtors Method
Journal Entries in the books of the Head Office
Branch Accounts
Stock and Debtors Method
Journal Entries in the books of the Head Office
Branch Accounts
Stock and Debtors Method
Accounts made in this method
Branch Stock Account
• It is always prepared at invoice price.
• Being a real account (an asset), it takes the rule of debit what comes in and credit what goes out.
Important features of Branch Stock Account are as under:
1) It controls branch stock
2) It is maintained at invoice price
3) Actual stock with the branch is shown as the closing balance in this account.
Branch Adjustment Account
• This account is prepared with a view to ascertain the gross profit of the branch. In this account all loading (profit
margin) entries are summarized.
• It is credited with the “stock reserve” on opening stock; loading on net goods sent to branch.
• This account is debited with the loading on shortage in stock; spoilage; pilferage; loss by fire; loss in transit and
‘stock reserve’ on closing stock.
• The Balance of this account is transferred to branch profit & loss account.
Branch Accounts
Stock and Debtors Method
Accounts made in this method
Branch Profit & Loss Account
• This account is prepared to determine the net profit or loss of the branch.
• The gross profit or gross loss is transferred from “Branch Adjustment Account” to Branch Profit &
Loss Account.
• It is debited with branch expenses; cost of shortage in stock, pilferage theft etc.
Branch Expenses Account
• This account records all cash as well as non cash expenses of the branch.
• The Balance of this account is transferred to ‘Branch Profit and Loss Account’ and thereby closed.
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Video 4 – Branch Accounts
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Branch Accounts
Final Accounts Method
a) It is not a separate system of maintaining accounts, but the head office may also prepare a
memorandum trading and profit and loss account to find out the profit or loss of a branch, apart from
preparing branch account.
b) Under this method, the trading and profit and loss figures are at cost price.
Important features of this system are
i. All stock items (opening stock; Goods sent to Branch; Goods returned to H.O; closing stock etc) are to
be converted into cost price. (if these are given at invoice price)
ii. A Branch Account is also prepared which is of a ‘Personal Account’ in nature. It will show only the
mutual transactions between head office and branch. The Balance of Branch Account is nothing but net
assets of the branch at the end of the accounting year.
iii. Branch Trading and Profit and Loss Account is merely a memorandum account and therefore the
entries made therein do not form part of double entry system. The only object of this account is to
disclose profit/loss incurred by the branch.
Branch Accounts
For your knowledge
i. Branch account under Final Accounts Method is a personal account.
ii. Branch account under Debtors Method and Stock and Debtors Method is a nominal account.
• Branch account under (i) and (ii) are different.
Branch Accounts
Wholesale Branch System
• Manufacturing concerns usually sell their goods through agents or middlemen or intermediaries, known
as wholesalers and/or retailers.
• At times they operate through their own retail outlets.
• These retail outlets are supplied with goods at the price at which they are sent to the middlemen, that is,
the wholesaler.
• Such price is cost plus a percentage of profit, and is known as wholesale price.
• The branch is expected to sell the goods at retail prices that are higher than the wholesale price.
• The real profit earned by the branch is the excess of the final selling price (also called as retail price) over
the wholesale price.
• For example, the cost price of an article is Rs. 100, the whole sale price is Rs. 125 and the retail price is Rs.
160. If an article sold by the branch, the actual profit is Rs 160-Rs100=Rs 60 but the branch’s real profit is
Rs160 – Rs120=Rs 35.
Branch Accounts
Wholesale Branch System
Wholesale price - 125 Rs.
Retail price - 160 Rs.
Cost price - 100 Rs.
Branch Accounts
Wholesale Branch System
Creation of reserve for unrealized profit on unsold stock at the branch
The head office must create suitable reserve on closing stock at the branch at the end of the year because
this stock is valued at wholesale price and profit on it is still unrealized.
Entry for creation of stock reserve
Profit & Loss A/c (of head office) Dr. (difference between wholesale price and cost price)
To Stock Reserve Account
Branch Accounts
Accounting Treatment of Independent Branches
o Independent branches maintain separate set of books of accounts and keep a full system of accounting.
o In other words, the branch carries on business as independent unit; records all the transactions in its
own books; extracts its own trial Balance and prepare its own Trading and Profit and Loss Account.
o Apart from receiving goods from the head office, the branch is allowed to make purchases from the open
market. From the amount received from cash sales or debtors, it can incur expenses and can operate the
bank account in its own name.
o The profit and loss of the branch ultimately belongs to the head office.
o The head office maintains one ledger account for each such branch, where in all transactions between
the head office and the branch are recorded.
o Similarly, the branch opens a ‘Head Office Account’ where in the same transactions between the branch
and head office are recorded and the balance is the amount due to or due from the head office.
Branch Accounts
Accounting Treatment of Independent Branches
After receiving the trial Balance and financial statements from the branch, the head office reconciles the
two Balances – Branch account in books of head office with ‘Head Office Account’ as would appear in the
books of the branch. The reasons for differences, if any, are looked into and adjustments entries are made
in the head office books to reconcile the two Balances. Some of the reasons are-
Cash In Transit Goods In Transit Items of income or Inter branch
payments or expenses transactions
relating to branch
transacted by the head
office directly
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INSURANCE CLAIMS FOR LOSS ON STOCK &
LOSS OF PROFIT
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Insurance Accounts
Meaning of FIRE
For purposes of insurance, fire means:
i. Fire
ii. Lightning
iii. Explosion
Usually, fire policies covering stock or other assets do not cover explosion of boilers used for domestic purposes or other
boilers or economizers in the premises but policies in respect of profit cover such explosions.
Insurance is covered for fire and other damage if caused by storm or tempest, flood, escape of water, impact
and breakdown of machinery, etc., again by agreement with the insurer.
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Insurance Accounts
Introduction
• Business enterprises get insured against the loss of stock on the happening of certain events such as fire,
flood, theft, earthquake etc.
• Insurance being a contract of indemnity, the claim for loss is restricted to the actual loss of assets.
• Sometimes an enterprise also gets itself insured against consequential loss of profit due to decreased
turnover, increased expenses etc.
• If loss consequential to the loss of stock is also insured, the policy is known as loss of profit or
consequential loss policy.
• Insurance claim can be studied under two parts as under:-
a. Claim for loss of stock
b. Claim for loss of profit
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Insurance Accounts
Claim for loss on stock
Insurance company has the right over
the destroyed and scrapped goods
Insurance company pays the
claim to the insured enterprise
Insured Insurer
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Insurance Accounts
Claim for loss on stock
Claim is lodged for lower of the two
i. Amount of loss
ii. Insured value
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Insurance Accounts
Claim for loss on stock – Total Loss
• Total Loss: If the goods are totally destroyed, the amount of claim is equal to the actual loss, provided the
goods are fully insured. However, in case of under insurance (i.e. value of stock insured is more than the
sum insured),the amount of claim is restricted to the policy amount.
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Insurance Accounts
Claim for loss on stock – Total Loss
EXAMPLE –
• Stock on the date of fire Rs, 3,00,000
• Stock fully destroyed by fire (no salvage)
Amount of policy in case (1) Rs. 4,00,000 and in case (2) Rs. 2,50,000.
SOLUTION –
1) In case (1), claim can be lodged for actual amount of loss i.e. Rs. 3,00,000, as it is not exceeding the policy
value.
2) In case (2), claim amount cannot exceed policy amount and it will be for Rs. 2,50,000.
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Insurance Accounts
Claim for loss on stock – Partial Loss
Partial Loss :
a) If the goods are partially destroyed, the amount of claim is equal to the actual loss provided the goods are
fully insured.
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Insurance Accounts
Claim for loss on stock – Partial Loss – Without Average clause
Partial Loss :
b) In case of under insurance, the amount of claim will depend upon the nature of insurance policy as
follows –
i. Without Average clause: Claim is equal to the lower of actual loss or the sum insured.
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Insurance Accounts
Claim for loss on stock – Partial Loss – Without Average clause
• Stock on the date of fire Rs. 3,00,000
• Goods saved from fire (i.e. salvage) Rs. 1,20,000
Compute the amount of claim if amount of policy (without average clause) is
1) Rs. 1,00,000
2) Rs. 2,00,000
SOLUTION –
• Stock on the date of fire Rs. 3,00,000
• Less: Salvage (Rs. 1,20,000)
----> Loss of Stock Rs. 1,80,000
Amount of claim is as under:
1) Rs. 1,00,000 (restricted to amount of policy, although loss is of Rs. 1,80,000 only)
2) Rs. 1,80,000 (restricted to amount of loss)
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Insurance Accounts
Claim for loss on stock – Partial Loss – With Average clause
Partial Loss :
c) In case of under insurance, the amount of claim will depend upon the nature of insurance policy as
follows –
With Average clause:
Amount of claim = Loss of stock × sum insured / Insurable amount (Total Cost)
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Insurance Accounts
Claim for loss on stock – Partial Loss – With Average clause
• Stock on the date of fire Rs. 60,000
• Amount of policy for loss of stock Rs. 15,000
• Salvage Value (residual value) Rs. 50,000
• Loss of stock Rs. 10,000
Find out claim which should be paid by an insurance company
SOLUTION –
• Usually, students think that loss of Rs.10,000 is lower than amount of policy of Rs.15,000. So full loss is
recoverable by insurance claim.
• But in reality, as only 25% of the stock was insured (Rs.15,000/Rs.60,000X100) and remaining 75% is
uninsured.
• Hence, claim should be restricted to 25% of the loss of Rs. 10,000 i.e. Rs. 2,500 only.
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Insurance Accounts
Claim for loss on stock - Points to remember
i. Where the stock records are maintained and such records are not destroyed by fire, the value of the
stock as at the date of the fire can be easily arrived at.
ii. Where either the stock records are not available or where they are destroyed by the fire, the value of
stock at the date of the fire has to be estimated. The usual method of arriving at this value is to build up a
Trading Account as from the date of last accounting year. After allowing for the usual gross profit, the
figure of closing stock on the date of the fire can be ascertained as the balancing item.
iii. After the insurance company makes payment for total loss, it has the same rights which the insured had
over the damaged stock. These are subrogated to the insurance company. The insurance company will
sell the scrap stock after refurbishing in the market.
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Insurance Accounts
SUMMARY CHART
Amount of claim in case of Under Insurance
Total Loss Partial Loss
Restricted to policy amount Without average clause With average clause
Lower of Actual loss or (Loss of stock x sum
Sum Insured insured)/ Insurable amount
THANK YOU
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INSURANCE CLAIMS FOR LOSS ON STOCK &
LOSS OF PROFIT
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Insurance Accounts
Claim for loss of profit
• When a fire occurs, apart from the direct loss on account of stock or other assets destroyed, there is also a
consequential loss because, for some time, the business is disorganized or has to be discontinued, and
during that period, the standing expenses of the business like rent, salaries etc. continue.
• Moreover, there is loss of profits which the business would have earned during the period. This loss can be
insured against by a "Loss of Profit" or "Consequential Loss" policy.
• There must be a separate policy in respect of the consequential loss but claim will be admitted in
respect of the policy only when the claim on account of fire is also admitted under other policies.
• The Loss of Profit Policy normally covers the following items
a) Loss of net profit
b) Any increased cost of working.
c) Standing charges
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Insurance Accounts
Claim for loss of profit
Loss of profit policy
Loss of net profit Standing charges Increased cost of working
Loss of business due Interest on Renting of
to interruptions and debentures, other temporary premises
damage of premises. finance costs etc.
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Insurance Accounts
Some Important Terms
1. Indemnity Period:
• Indemnity period means the period which commences on the date of damage by fire and ends on the date
when normality is restored.
• The indemnity period is generally stipulated in the insurance policy.
• This period is selected by the insured himself.
• The policy is taken generally for a period of one year and can be renewed annually, whereas the indemnity
period commences on the day on which the accident takes place and runs up to a period of twelve or more
months.
• It is necessary that the policy must be in force at the time of fire accident.
2. Standard Turnover:
It is the turnover during the period in the twelve months immediately preceding the date of the hazard which
corresponds with the indemnity period.
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Insurance Accounts
Some Important Terms
Suppose the fire brock out on 1st April 2021 and it took business 6 months to restore into normal.
The indemnity period is 1st April 2021 – 30th September 2021
➢ The standard turnover would be the turnover of the business from 1st April 2020 to 30th September
2020. (i.e. the sales/ production of the enterprise for the same period in the preceding year)
Suppose th fi
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Insurance Accounts
Some Important Terms
3. Short Sales:
• The term “Short Sales” refers to the loss of sales due to the dislocation of business.
• That is, short sale is the difference between standard turnover and actual turnover during the period of
fire.
4. Standing Charges:
• Standing charges refer to those fixed expenses which are incurred irrespective of the reduction in
turnover.
• Examples of standing charges are salaries to permanent staff, rent, rates, taxes, insurance premium,
interest on bank overdraft, debentures etc.
• Only those standing charges, which are insured, can be claimed.
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Insurance Accounts
Some Important Terms
5. Increased Cost of Working:
• The insured may have to incur some additional or special expenses in order to keep the business, during
the post-fire period and to avoid reduction in sales.
• Expenses in excess of what is essentially required may be unreasonable expenditure.
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Insurance Accounts
Some Important Terms
Increased working expenses will be allowed subject to the limit which is lower of the two figures calculated as
follows :
Net profit+Insured standing charges
a) x Increased cost of working
Net profit+All standing charges
b) Short sales avoided through increased cost of working x Rate of gross Profit
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Insurance Accounts
Illustration
Calculate from the following the amount of permissible increased working expenses
Rs.
Net profit 10000
Short sales 8000
Rate of gross profit 15%
Increased working expenses 500
Insured standing charges 4000
Uninsured standing charges 2000
Short sales avoided through increased cost of working 3000
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Insurance Accounts
Illustration
The amount of increased working expenses will be lower of the two. They are
Net profit+Insured standing charges
i. Net profit+All standing charges
x Increased cost of working
10000+4000
x 500
10000+6000
= Rs.437.50
i. Short sales avoided through increased cost of working x Rate of Gross profit
3000 x 15/100 = Rs.450
The increased working expenses allowed will be Rs.437.50/-
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Insurance Accounts
Some Important Terms
6. Rate of Gross Profit
• The term “Gross Profit” has got a different meaning when it is calculated for loss of profit policy and is
different from the normal rate of Gross Profit as described under “Loss of Stock”.
• The rate of Gross Profit is calculated by taking previous year’s figures.
• Loss due to reduction in turnover is calculated by applying the gross profit rate to reduction in turnover.
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Insurance Accounts
Claim for loss of profit
Some important Formulas
Net profit+Insured Standing charges
Gross profit Rate = x 100
Turnover
Net profit = Net trading profit of the business after depreciation
Insured standing charges =
Interest on Debentures & Loans + Rent, Rates and Taxes + Salaries of Permanent Staff and Wages to
Skilled Employees + Boarding and Lodging of resident Directors and Manager + Directors’ Fees +
Unspecified Standing Charges [not exceeding 5% (five per cent) of the amount recoverable in respect of
Specified Standing Charges].
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Insurance Accounts
Some Important Terms
7. Annual Turnover
• It is the value of sales and services during the twelve months immediately preceding the hazard, subject to
adjustment for any change in the volume of sales.
8. Average Clause:
• Average clause is applicable in respect of loss of profit insurance.
• If there is an increase in the turnover of business, the sum insured should also be proportionately
increased.
• If not, it amounts to under-insurance.
• Under-insurance may also occur if all the standing charges are not covered by the policy.
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Insurance Accounts
Steps to ascertain the amount of claim under Loss of profit policy
Step 1:
Ascertain the short sale (i.e. excess of standard turnover over actual turnover) during the period of
dislocation.
Step 2:
Find out the rate of Gross Profit.
Step 3:
Calculate the Loss of Profit by applying the rate of Gross Profit ( Short sales x gross profit rate)
Step 4:
Add thereto (Step 3) the net increased cost of working on account of short sales.
Step 5:
Any savings in expenses are deducted (from Step 4).
Step 6:
The result of Step 5 is the amount of gross claim.
Step 7:
Finally, the amount calculated will be adjusted, by applying average clause, if necessary. The figure so
calculated will be the amount of claim for loss of profit to be lodged with the insurance company
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Insurance Accounts
Illustration 1 – For understanding and not exam purpose
• A fire broke out in a Company on 1st April 2005 and short sales remained for a period of six months: total
sales during this period amounted to Rs 80,000, while in previous year from 1st April 2004 to 30th
September 2004 were of Rs 2, 00,000.
• Sales have increased by 10% in 2005 in the period from 1st January 2005 to 1st April 2005. Find out the
short sales during this period of six months of 2005.
Solution
Sales during 6 months (2004) = 2,00,000
Add : Increase expected is 10% = 20,000
= 2,20,000
Less : Sales of this period of 2005 = (80,000)
Short sales = 1,40,000
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Insurance Accounts
Illustration 2 – For understanding and not exam purpose
The following are the details relating to a Company for the year ended 2004.
(Rs.)
Total Variable expenses = 350000
Total fixed expenses = 120000
Non operation income = 60000
Net profit = 90000
The Company took a decision to arrange for a Loss of Profits Insurance for the year 2005. It is expected that
the turnover might increase by 15% and all the fixed standing expenses will remain constant. Ascertain the
extent to which the Company should finalize the amount to be insured under Loss of Profits Policy
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Insurance Accounts
Solution
• Sales for 2004 = Total variable expenses + Total fixed expenses + Net profit – Non operating income
= 350000+120000+90000-60000
= 500000
Gross profit (2004) = Sales – variable expenses
= 500000-350000
= Rs. 150000
• Gross profit (2005) =
Gross profit for 2004 = 150000
Add : Increased trend @ 15% = 22500
= 172500
The Gross Profit expected in 2005, Rs. 1, 72,500, should be insured under Loss of Profit Policy.
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