Accounting for Share Capital

Accounting for Share Capital — Comprehensive Chapter Notes

Features of a Company

**A company** is an artificial person created by law, distinct from its members (shareholders). It is a body corporate with separate legal entity status.

**Key distinguishing features:**

**Body Corporate**: Formed and registered under the Companies Act, 2013 (or earlier Acts). Banking and Insurance companies are regulated under separate laws.

**Separate Legal Entity**: A company can own property, enter into contracts, open bank accounts, and conduct business all in its own name, independent of its shareholders.

**Limited Liability**: Members' liability is restricted to the extent of unpaid amount on their shares. Fully paid shareholders have zero liability even if company debts exist. In guarantee companies, liability is limited to the guarantee amount.

**Perpetual Succession**: The company continues to exist irrespective of changes in membership (death, insanity, insolvency of shareholders). It can only be terminated through law.

**Common Seal**: Since a company cannot sign documents itself, it has an official common seal which serves as its signature. Documents lacking the seal are not binding on the company.

**Transferability of Shares**: Public company shares are freely transferable without requiring permission from the company or other shareholders, though Articles may regulate the manner of transfer.

**Right to Sue and Be Sued**: As a legal person, a company can enforce contractual rights and defend claims in its own name.

---

Kinds of Companies

Companies are classified in two ways:

**Classification Based on Liability of Members**

**Companies Limited by Shares**: Member liability is limited to the nominal (face) value of shares held. Once fully paid, shareholders have no further liability for company debts, even on winding up.

**Companies Limited by Guarantee**: Member liability arises only on winding up, limited to the guarantee amount they pledge. These are typically non-profit organizations.

**Unlimited Companies**: Members have unlimited personal liability; company creditors can claim against private property of members. Theoretically permitted in India but not found in practice.

**Classification Based on Number of Members**

**Public Company**: Not a private company; not a subsidiary of a private company. Can issue shares and debentures to the public.

**Private Company**: Restricts share transfer by Articles; has 2–200 members (excluding employees); cannot issue shares to the public.

**One Person Company (OPC)** (Sec. 2(62), Companies Act 2013): Single member company with following restrictions:

Only natural person, Indian citizen, resident in India can form OPC

Cannot engage in non-banking financial investment

Paid-up capital ≤ Rs. 50 lakhs

Average annual turnover (3-year) ≤ Rs. 2 crores

---

Share Capital of a Company

**Share Capital** is the total amount contributed by all shareholders, merged into a common account called **Share Capital Account**. Since thousands of shareholders exist, individual capital accounts are impractical.

**Categories of Share Capital (5 Progressive Levels)**

Understanding the flow from authorised to paid-up capital is crucial for Balance Sheet presentation.

**Authorised Capital** (Nominal/Registered Capital): Maximum amount the Memorandum of Association permits the company to issue. Cannot be exceeded without legal procedure. Example: Rs. 50 lakhs authorized may mean only Rs. 30 lakhs is actually issued.

**Issued Capital**: Portion of authorised capital actually offered to public subscription. The remaining is **unissued capital**, which can be offered later. Example: Out of Rs. 50 lakhs authorized, Rs. 30 lakhs is issued.

**Subscribed Capital**: Portion of issued capital actually subscribed by the public. In case of oversubscription, subscribed capital equals the issued amount (excess applications rejected). In undersubscription, subscribed equals actual amount applied for. Example: If Rs. 30 lakhs issued, but only Rs. 25 lakhs applied, subscribed capital is Rs. 25 lakhs.

**Called-up Capital**: Portion of subscribed capital the company has demanded payment for. A company may call Rs. 8 per share even if Rs. 10 is the face value. The remaining Rs. 2 is **uncalled capital**. Example: Rs. 25 lakhs subscribed, but only Rs. 18 lakhs called-up (Rs. 7 per share on Rs. 10 par value).

**Paid-up Capital**: Portion of called-up capital actually received from shareholders. Any called amount not received is **calls in arrears**. Formula:

**Paid-up Capital = Called-up Capital − Calls in Arrears**

**Uncalled Capital**: Subscribed capital not yet called. Available for future needs. Formula:

**Uncalled Capital = Subscribed Capital − Called-up Capital**

**Reserve Capital**: Portion of uncalled capital reserved for calling only during winding up. Available exclusively to creditors during liquidation.

**Example — Practical Application:**

Sunrise Company Ltd. shows in its Notes to Accounts:

| Category | Shares | Per Share | Amount (Rs.) |

|----------|--------|-----------|--------------|

| **Authorised** | 4,00,000 | Rs. 10 | 40,00,000 |

| **Issued** | 2,00,000 | Rs. 10 | 20,00,000 |

| **Subscribed & Called-up** | 2,00,000 | Rs. 8 | 16,00,000 |

| Less: Calls in Arrears | 2,000 shares × Rs. 8 | | (16,000) |

| **Paid-up Capital** | | | 15,84,000 |

Note: Final call of Rs. 2 per share not yet made; hence called-up is Rs. 8, not Rs. 10.

---

Nature and Classes of Shares

**Shares** are fractional units of the total share capital, representing ownership interest. The Memorandum prescribes the amount divided into shares; the Articles define the classes, rights, and obligations.

**Two Main Classes of Shares**

#### **1. Preference Shares (Sec. 43, Companies Act 2013)**

Preference shares carry **two fundamental rights**:

**Preferential Dividend**: Fixed dividend (e.g., 8% p.a.) paid before any equity dividend. Amount is fixed per share or percentage of nominal value.

**Preferential Capital Repayment**: On winding up, preference capital is repaid before equity shareholders receive anything.

**Sub-types of Preference Shares:**

**Cumulative vs. Non-cumulative**:

**Cumulative**: Unpaid dividends accumulate and must be paid from future profits before equity dividend.

**Non-cumulative**: Dividend is lost if not paid in that year; no arrears accumulate.

**Participating vs. Non-participating**:

**Participating**: Can share in surplus profits beyond the fixed rate after equity shareholders receive dividend equal to preference rate.

**Non-participating**: Limited strictly to fixed dividend; no participation in extra profits.

**Redeemable vs. Irredeemable**:

**Redeemable**: Company can repay the capital after specified period (e.g., after 10 years) at predetermined price.

**Irredeemable**: Can never be repaid; investor's stake is permanent, though preferential dividend continues.

**Convertible vs. Non-convertible**:

**Convertible**: At holder's option or company's option, can be converted into equity shares at predetermined ratio.

**Non-convertible**: Remain permanently as preference shares.

#### **2. Equity Shares (Ordinary Shares)**

**Definition (Sec. 43)**: Shares that are NOT preference shares; enjoy no preferential right in dividend or capital repayment.

**Characteristics:**

**Dividend** is not fixed; varies yearly based on available profits and Board decision.

**Ranking**: Equity shareholders receive dividend only after preference shareholders are fully satisfied.

**Capital Repayment**: On winding up, equity capital is repaid last, after all creditors and preference shareholders.

**Voting Rights**: Equity shareholders have voting rights in General Meetings (1 vote per share, generally).

**Types of Equity**:

With voting rights (standard)

With differential voting rights, dividend, or other rights as per Articles

**Example**: If a company declares 8% dividend and has 1,00,000 preference shares of Rs. 10 each (8% cumulative, non-participating) and 2,00,000 equity shares of Rs. 10 each:

Preference dividend: 1,00,000 × Rs. 10 × 8% = Rs. 80,000 (mandatory)

Equity dividend from remaining: Depends on profit available

---

Issue of Shares

The process of collecting share capital involves defined stages and legal requirements.

**Procedure Steps**

**1. Issue of Prospectus**

Prospectus is formal invitation to public announcing the new company and capital requirement.

Contains complete information: company's objects, management, financial projections, terms of issue.

Prospective investors study and apply.

**2. Receipt of Applications**

Applicants remit **application money** with share application form.

Money is deposited in a scheduled bank account designated in the prospectus.

Company must receive **minimum subscription** (as defined in SEBI guidelines) within **120 days** from prospectus date.

If minimum subscription not received within 120 days, application money must be refunded within 130 days with interest at 15% p.a. (Sec. 73(2), Companies Act 2013).

**Minimum Subscription Definition**: The minimum capital, in Board's opinion, needed to meet:

Cost of properties to be purchased (wholly or partly from issue proceeds)

Preliminary expenses and share issue commission

Repayment of borrowed funds for above

Working capital

Other essential business expenditure

**SEBI Requirement**: Minimum subscription cannot be less than **90%** of issued capital. If not met, entire subscription amount must be refunded immediately.

**3. Allotment of Shares**

After minimum subscription and legal compliance, company proceeds to allotment.

**Letters of Allotment** sent to successful applicants (now shareholders).

**Letters of Regret** sent to rejected applicants.

Allotment creates valid contract between company and allottee.

Oversubscription: Excess applications rejected; subscribed capital equals issued, not applications.

**Issue Price Categories**

**At Par**: Issue price = Nominal (face) value. Share of Rs. 10 issued at Rs. 10.

**At Premium**: Issue price > Nominal value. Share of Rs. 10 issued at Rs. 12. Excess Rs. 2 is **share premium**.

**Important Legal Rule (SEBI & Companies Act 2013, Sec. 52)**:

Securities premium (share premium) cannot exceed the nominal value of the share.

Example: Cannot issue Rs. 10 share at Rs. 25 premium (only up to Rs. 20 maximum).

Share premium account has **restricted use**: Can be used only for:

Writing off preliminary expenses

Issuing bonus shares

Redemption of preference shares/debentures

Cannot be distributed as dividend

---

Accounting Treatment of Share Issue

**On Application**

When application amounts are received, they are credited to **Share Application Account** (temporary account), not directly to Share Capital:

**Journal Entry:**

```

Bank A/c Dr.

To Share Application A/c

(Application money received for ____ shares @ Rs. ____ per share)

```

**Example**: 1,00,000 shares @ Rs. 10 par, Rs. 2 per share on application:

```

Bank A/c Dr. 2,00,000

To Share Application A/c 2,00,000

(Application for 1,00,000 shares @ Rs. 2 per share)

```

**Treatment**: Amount deposited with scheduled bank per prospectus. Share Application Account is a personal account (though plural in nature).

**On Allotment**

After minimum subscription confirmed and legal compliance done, allotment is made.

**Journal Entry (2-step process):**

**Step 1 — Close application account into Share Capital account:**

```

Share Application A/c Dr.

To Share Capital A/c

(Application money transferred on allotment of ____ shares)

```

**Step 2 — Record remaining amount due on allotment:**

```

Bank A/c (Allotment money received) Dr.

Share Allotment A/c (Balance due) Dr.

To Share Capital A/c

(Allotment of ____ shares @ Rs. ____ per share)

```

**Practical Example**:

1,00,000 shares issued @ Rs. 10 par

Rs. 2 on application (received)

Rs. 3 on allotment (to be called)

**On Allotment:**

```

Share Application A/c Dr. 2,00,000

Bank A/c (Allotment money received on 50,000 shares) Dr. 1,50,000

Share Allotment A/c (Balance on 50,000 shares) Dr. 1,50,000

To Share Capital A/c 5,00,000

```

Note: If applications exceed issued shares (1,00,000 shares offered but 1,50,000 applied), allotment is done pro-rata. Excess refunded with application money.

**On Calls (First Call, Second Call, Final Call)**

Subsequent instalments are called using similar entries.

**On First Call of Rs. 3 per share (on 1,00,000 shares = Rs. 3,00,000):**

```

Share First Call A/c Dr.

To Share Capital A/c

(First call of Rs. 3 per share on 1,00,000 shares)

Bank A/c Dr.

To Share First Call A/c

(First call money received: Rs. 3 per share on ____ shares)

```

**Calls in Advance** (if shareholder pays before call is made):

```

Bank A/c Dr.

To Share Calls in Advance A/c

(Advance payment received on shares)

Share Calls in Advance A/c Dr.

To Share Capital A/c

(Advance amount capitalized)

```

**Calls in Arrears** (if shareholder does not pay when called):

Arrears are shown as **receivable** in the Balance Sheet (deducted from Share Capital) until received or forfeiture action taken.

**Final Integration into Balance Sheet**

At Balance Sheet date, all temporary accounts (Application, Allotment, First Call, etc.) are closed into **Share Capital Account**, which then shows:

Share Capital (with detailed notes on authorized, issued, subscribed, called-up, paid-up)

Less: Calls in Arrears (if any)

---

Share Premium Account

**Treatment and Restrictions**

**Definition**: When shares are issued above nominal value, the excess is **share premium**.

**Example**: 1,00,000 shares of Rs. 10 par issued at Rs. 12 per share:

Share Capital: 1,00,000 × Rs. 10 = Rs. 10,00,000

Share Premium: 1,00,000 × Rs. 2 = Rs. 2,00,000

Cash received: Rs. 12,00,000

**Journal Entry on Issue at Premium:**

```

Bank A/c Dr. 12,00,000

To Share Capital A/c 10,00,000

To Share Premium A/c 2,00,000

(Issue of 1,00,000 shares @ Rs. 10 par, Rs. 12 issue price)

```

**SEBI Compliant Restrictions (Sec. 52, Companies Act 2013)**

Share Premium Account **cannot be used for**:

Distribution as dividend to shareholders

Writing off underwriting commission

Preliminary expenses (only if share premium itself was received from issue)

Share Premium Account **can be used for**:

Writing off discount on debentures

Issuing bonus shares (bonus capitalization)

Redemption of preference shares/debentures

Preliminary expenses (only in specific circumstances)

**Accounting Entry for Bonus Share Issue** (using share premium):

If company issues 20,000 bonus shares of Rs. 10 each using share premium:

```

Share Premium A/c Dr. 2,00,000

To Share Capital A/c 2,00,000

(Issue of 20,000 bonus shares @ Rs. 10 each)

```

---

Forfeiture of Shares

**Concept and Reason**

**Forfeiture** occurs when a shareholder fails to pay a call (or allotment or application money) when demanded, and the company exercises its right to seize the shares.

**When Forfeiture Occurs**:

Shareholder receives notice demanding payment

If not paid within specified period (typically 14-30 days)

Company Board passes resolution to forfeit shares

Shares are cancelled; shareholder loses all claims

**Effect**:

Shareholder loses ownership and all voting rights

Company retains the amount already paid on forfeited shares

Amount paid becomes capital profit, transferred to **Capital Reserve**

**Journal Entries for Forfeiture**

**On Forfeiture** (assume 500 shares forfeited; Rs. 7 per share already called and paid on Rs. 10 par shares; Rs. 3 still due):

**Step 1 — Cancel Share Capital Account:**

```

Share Capital A/c Dr. 5,000 (500 × Rs. 10)

To Share Forfeiture A/c 5,000

(Forfeiture of 500 shares of Rs. 10 each)

```

**Step 2 — Transfer Paid Amount to Capital Reserve:**

```

Share Forfeiture A/c Dr. 3,500 (500 × Rs. 7 paid)

To Capital Reserve A/c 3,500

(Amount paid on forfeited shares transferred)

```

**Combined Entry** (simplified):

```

Share Capital A/c Dr. 5,000

To Share Forfeiture A/c (Temp. account) 5,000

Share Forfeiture A/c Dr. 3,500

To Capital Reserve A/c 3,500

```

**Result**:

Share Capital reduced by Rs. 5,000 (nominal value of forfeited shares)

Capital Reserve increased by Rs. 3,500 (amount paid)

Rs. 1,500 (calls in arrears) written off

---

Reissue of Forfeited Shares

**Key Points**

Once forfeited shares are reissued, they must be treated as **new shares**. They can be reissued at **any price** — at par, at premium, or even at discount (with specific restrictions).

**Reissue at Par**

**Example**: 500 forfeited shares (Rs. 10 par, Rs. 7 paid = Rs. 3,500 retained in Capital Reserve) are reissued at Rs. 10:

**Journal Entry:**

```

Bank A/c Dr. 5,000

To Share Forfeiture A/c 5,000

(Reissue of 500 forfeited shares at Rs. 10 par)

```

**Capital Reserve remains unchanged** (Rs. 3,500 stays in reserve).

**Reissue at Premium**

**Example**: Same 500 shares reissued at Rs. 12 per share:

```

Bank A/c Dr. 6,000

To Share Forfeiture A/c 5,000

To Capital Reserve A/c 1,000

(Reissue of 500 forfeited shares at Rs. 12; premium Rs. 2 per share)

```

**Result**: Capital Reserve now Rs. 4,500 (Rs. 3,500 + Rs. 1,000 additional premium).

**Reissue at Discount**

**Rule**: Forfeited shares can be reissued at discount if:

1. Reissue price ≥ Amount forfeited (amount already paid on shares)

2. Discount does not create loss

**Example**: 500 shares (Rs. 7 paid) reissued at Rs. 8 (discount Rs. 2 from par):

```

Bank A/c Dr. 4,000

Capital Reserve A/c Dr. 1,500

To Share Forfeiture A/c 5,000

(Reissue of 500 forfeited shares at Rs. 8 per share)

```

**Explanation**:

Cash received: 500 × Rs. 8 = Rs. 4,000

Shortfall from nominal (Rs. 5,000): Rs. 1,000

This shortfall is covered from Capital Reserve (which holds Rs. 3,500)

Capital Reserve remains Rs. 2,500 (Rs. 3,500 − Rs. 1,000)

**Important Rule**: Discount on reissue **cannot exceed** the amount already received on forfeited shares. If it does, the entry is invalid, and reissue cannot proceed at that discount.

**Share Forfeiture Account Format (Ledger)**

```

Dr. Share Forfeiture A/c Cr.

─────────────────────────────────────────────────────────

To Share Capital A/c X | By Bank A/c (Reissue) Y

To Balance c/f Z |

──── |────

Total X+Z | Total Y+Z

```

**Treatment in Balance Sheet**: After all forfeiture and reissue transactions are complete, Share Forfeiture Account shows either a **debit balance** (loss, rare) or **credit balance** (transferred to Capital Reserve as profit).

---

Treatment of Oversubscription

**Concept**

**Oversubscription** occurs when applications exceed the number of shares offered. Company must:

1. Accept only up to offered shares (issued capital)

2. Reject excess applications

3. Refund excess application money

**Key Point**: Subscribed capital equals **issued capital**, not applications received. Oversubscription is not reflected in books.

**Accounting Treatment**

**Example**:

1,00,000 shares offered @ Rs. 10, Rs. 2 on application

Applications received: 1,50,000 shares

Money received: Rs. 3,00,000 (1,50,000 × Rs. 2)

**Step 1 — Receipt of Application:**

```

Bank A/c Dr. 3,00,000

To Share Application A/c 3,00,000

```

**Step 2 — Allotment (accept 1,00,000, reject 50,000):**

```

Share Application A/c Dr. 3,00,000

To Share Capital A/c 2,00,000 (1,00,000 × Rs. 2)

To Bank A/c (Refund) 1,00,000 (50,000 × Rs. 2)

```

Or in two entries:

```

Share Application A/c Dr. 3,00,000

To Share Capital A/c 2,00,000

To Share Application Refund a/c 1,00,000

Share Application Refund a/c Dr. 1,00,000

To Bank A/c 1,00,000

(Refund of excess application money)

```

---

Test Your Understanding — Solutions

**True/False Answers** (from chapter):

(a) **True** — A company is an artificial person created by law.

(b) **False** — Shareholders are NOT liable for acts of the company due to separate legal entity and limited liability.

(c) **False** — Every member is NOT entitled to participate in management; they elect Directors for that.

(d) **True** — Public company shares are freely transferable.

(e) **False** — Share Application Account is a **temporary account** (nominal), not personal.

(f) **False** — Directors are NOT required to be shareholders (though often are by practice).

(g) **False** — Paid-up capital **cannot exceed** called-up capital. Formula: Paid-up = Called-up − Arrears.

(h) **True** — Capital reserves are created from capital profits (e.g., share premium, forfeiture gains).

(i) **False** — There is NO fixed maximum rate for share premium. Premium can be any amount above nominal value, subject to SEBI guidelines on issue price.

(j) **True** — Reserve Capital is uncalled capital reserved for calling only on winding up.

---

Summary of Key Formulas & Journal Entries

**Share Capital Relationships:**

Paid-up Capital = Called-up Capital − Calls in Arrears

Uncalled Capital = Subscribed Capital − Called-up Capital

Called-up Capital = Subscribed Capital − Uncalled Capital

**Preference Share Dividend (if cumulative):**

Annual Dividend = Number of Preference Shares × Nominal Value × Dividend Rate (%)

**Forfeiture Profit to Capital Reserve:**

Amount Transferred = Amount Already Paid on Forfeited Shares

**Reissue Gain/Loss:**

If reissued at premium: Gain = (Reissue Price − Nominal Value) × Shares

Transferred additional to Capital Reserve

---

Board Exam Relevant Points

1. **MCQ Recognition**: Company features (artificial person, separate legal entity, limited liability, perpetual succession) frequently tested.

2. **Journal Entry Format**: Share application → allotment → calls (application, allotment, first call, second call, final call) sequence must be fluent.

3. **Balance Sheet Notes**: Present share capital with:

Authorised capital

Issued capital

Subscribed & called-up capital

Less: Calls in Arrears = Paid-up Capital

4. **Forfeiture Calculations**: When shares are forfeited, capital profit (amount paid) goes to Capital Reserve; this is a frequent 2-3 mark entry question.

5. **Premium Treatment Restrictions**: Share premium cannot be distributed as dividend; can only be used for specific purposes (Sec. 52 knowledge).

6. **Oversubscription Logic**: Understand that excess applications are rejected and refunded; subscribed = issued (not applications).

This chapter establishes the foundation for company accounting. Master the share issue procedure, forfeiture entries, and Balance Sheet presentation for full marks.