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SHARE CAPITAL

Total capital of the company is divided into units of small denominations; each one is
called a share. According to Sec 2(46) of the Companies Act 1956, share has been defined as
a share in the share capital of the company; and includes stock except where a distinction
between stock and share is expressed or implied.
Classes of Shares
A. Preference Shares
Shares which enjoy the preferential rights as to dividend and repayment of capital in
the event of winding up of the company over the equity shares are called preference shares.
The holder of preference shares will get a fixed rate o dividend.
B. Equity Shares
Equity shares are those which are not preference shares. Equity shares do not carry
any preferential gain in respect of dividend or repayment of capital. So these are known as
ordinary shares. There will be no fixed rate of dividend to be paid to the equity shareholders
and this rate may vary from year to year. In winding up, the equity capital is repaid last.
However, equity shareholder gets full voting power.
Issue of shares at premium
Shares are said to be issued at premium when a shareholder is required to pay more
than the face value to the company. The excess amount received over the face value is called
share premium. It is a capital receipt. The share premium shall be transferred to Securities
Premium A/c. It should be shown on the liability side of balance sheet under the head
Reserves and Surplus.
Issue of shares at discount
Shares are said to be issued at discount when the shareholder is required to pay less
amount than the face value to the company. Discount on issue of shares is a capital loss and it
should be debited to a separate account called Discount on issue of shares A/c. It is shown
on the assets side of balance sheet under Miscellaneous Expenditure. The rate of discount
should not exceed 10% of nominal value of shares. Generally the discount on issue is
recorded at the time of allotment. It is also noted that a newly registered company cannot
issue shares at discount.
Under subscription of shares
Sometimes the applications for shares received will be less than the number of shares
issued. This is called under subscription. In such a case, the allotment will be equal to the
number of shares subscribed and not to the shares issued.

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Over subscription of shares
Sometimes the applications for shares received will be more than the number of
shares issued. This is called over subscription. When there is over subscription, it is not
possible to issue shares to all applicants. In such a situation company shall reject some
applications altogether, allot in full on some applications and make a prorata allotment on
some applications. Prorata allotment means that allotment on every application is made in
the ratio which the number of shares allotted bears to number of shares applied. In case of
applications fully rejected will be returned to the applicants. In prorata allotment the excess
application will be adjusted either on allotment and or on calls. Any surplus left even after the
adjustment will be refunded to the applicants.
Calls in Arrears and Calls in Advance
Sometimes shareholders may fail to pay the allotment money and or call money. Such
dues are called calls in arrears. It is shown in the balance sheet as a deduction from the
calledup capital. Directors are authorized to charge interest on calls in arrears at a rate as per
Articles. In its absence, the interest does not exceed 5% pa. When a shareholder pays more
money than called up, the excess money is called calls in advance. The company must pay
interest on calls in advance at a rate prescribed by Articles. In its absence, the company is
liable to pay interest @6% pa. But the shareholder is not entitled to any dividend on calls in
advance.
Forfeiture of shares
The cancellation of shares due to nonpayment of allotment money or call money
within a specified period is called forfeiture of shares. It is the compulsory termination of
membership of the defaulting shareholders. He also losses whatever amount he has paid to
the company so far. A company can forfeit the shares only if it is authorized by its Articles.
The forfeiting is done only after giving 14 days notice to the defaulting shareholders. The
balance of forfeited shares A/c should be shown by way of an addition to called up capital on
the liability side of balance sheet till the shares are reissued.
REDEMPTION OF PREFERENCE SHARES
When the preference shares are issued it is to be paid back by the company to such
shareholders after the expiry of a stipulated period whether the company is to be wound up or
not.
As per Sec 80 of the Companies Act, a company limited by shares can redeem the
preference shares, subject to the following conditions.

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1. The shares to be redeemed must be fully paid up.
2. Such shares can be redeemed either out of profit or out of the proceeds of fresh issue of
shares. But these cannot be redeemed out of fresh issue of debentures or out of sale proceeds
of any property of the company.
3. Premium payable on redemption must be provided out of profits of company or out of
companys security premium account.
4. When shares are redeemed out of profit, a sum equal to the nominal amount of shares so
redeemed must be transferred out of profit to a reserve account namely Capital Redemption
Reserve A/c.
5. The Capital Redemption reserve A/c can be utilized only for the issue of fully paid up
bonus shares.
The preference shares can be redeemed either at par or at premium (but not at
discount). Premium on redemption is provided out of existing security premium account or
security premium on fresh issue. If they are not sufficient, the redemption premium should be
provided out of P&L A/c or General Reserve.
Capital Redemption Reserve
Capital Redemption Reserve is a reserve created out of the profit of the company, if
the preference shares are redeemed out of profit. The amount so credited will be equal to the
nominal value of the shares to be redeemed.
Profits available for capital redemption reserve
The revenue profits or the profits available for dividend can be used to create the cap
ital redemption reserve. They are
i) General Reserve
ii) Profit & Loss Account
iii) Dividend Equalization Fund
iv) Reserve Fund
v) Revenue portion of profit on sale of Investments
vi) Revenue portion of profit on sale of fixed assets
vii) Workmens Accident Compensation Fund
viii) Insurance Fund
Profits Not Available for capital redemption reserve
The capital profits or profits not available for dividend cannot be used for the purpose of
creating the capital redemption reserve. They are;
i) Capital Reserve

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ii) Capital Redemption Reserve
iii) Development Rebate Reserve
iv) Depreciation Reserve
v) Share Forfeited Account
vi) Profit prior to incorporation
vii) Profit on sale of fixed assets (capital portion)
viii) Share premium account
AMOUNT TO BE TRANSFERRED TO CAPITAL REDEMPTION RESERVE

Amount to be transferred to Capital Redemption Reserve =


Redeemable Preference shares of face value Face value of Fresh issue of shares
Methods of Redemption
There are three methods for redemption of preference shares. They are:
(a) Redemption out of fresh issue of shares
(b) Redemption out of profits
(c) Redemption partly out of fresh issue and partly out of profit.

DEBENTURES
The term debenture has been derived from the Latin word debere, which means to
borrow. Debenture is an instrument in writing given by a company acknowledging debt
received from the public.
The Companies Act defines debenture as debenture includes debenture stock, bonds
or any other securities of a company, whether constituting a charge on the assets of the
company or not.
Features of Debenture
1. It is an instrument of debt issued by company under its seal.
2. It carries fixed rate of interest.
3. Debenture is a part of borrowed capital.
4. It is repaid after a long period.
5. It is generally secured.

REDEMPTION OF DEBENTURES
Redemption of debentures refers to the discharge of liability on account of
debentures. It simply means repayment of debentures. As per Companies Act, the debentures
should be redeemed in accordance with the terms and conditions of issue.

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Sources of redemption of debentures
Debentures can be deemed out of the following sources
1. Redemption out of fresh issue.
A company may issue new shares or debentures or both for redeeming the existing
debentures.
2. Redemption out of Capital
If debentures are redeemed out of capital, no amount of divisible profit is kept aside
for Redeeming debentures. Redemption out of Capital reduces the liquid resources available
to the company. As per the guidelines issued by SEBI, a company has to create Debenture
Redemption Reserve (DRR) equivalent to 50% o the amount of debenture issue before
redemption of debentures commences. But the creation of DRR is not required in the
following cases
a. Debentures with maturity of 18 months or less
b. Fully convertible debentures.
3. Redemption out of profit
When sufficient profits are transferred from P & L Appropriation A/c to the
Debenture Redemption Reserve A/c at the time of redemption of debentures, such
redemption is said to be out of profits. It reduces the profits available for dividend.
As per guidelines of SEBI, creation of DRR (50% of amount of debentures issued) is
compulsory for debentures with maturity period of more than 18 months. On the completion
of redemption of all debentures, the DRR A/c is close by transferring it to general reserve.
4. Redemption by Sinking Fund
Under this method of redemption, every year a part of the profit (fixed amount) is set
aside and sinking fund (Debenture Redemption Fund) is created. Sinking fund I invested in
outside securities. The interest received o such investments along with the amount set aside
from profit will again be invested as usual. It continues till the date of redemption of
debenture. The investment will be sold and the cash thus realized will b used to repay the
debentures. Under this method, sinking fund A/c (Debenture Redemption Fund A/c) and
sinking fund investment A/c (Debenture Redemption Fund Investment A/c) will be opened.
After the redemption, balance of sinking fund A/c is transferred to general reserve.

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Valuation of shares

Valuation of shares involves the use of financial and accounting data based on the
objective and subjective consideration for a specific purpose. Hence, for ordinary
transactions in shares, the price prevailing in the stock exchange may be taken as the proper
value. But the transaction of a large block of companys shares and the non-availability of
market price for such shares necessitates the valuation of shares.

The necessity for valuation of shares arises inter alia in the following circumstances

(i) Assessments under the Wealth Tax Act


(ii) Purchase of a block of shares which may or may not give the holder thereof a
controlling interest in the company
(iii) Purchase of shares of employees of the company where the retention of such
shares is limited to the period of their employment
(iv) Formulation of schemes of amalgamation, absorption, etc.
(v) Acquisition of interest of dissenting shareholders under a scheme of
reconstruction
(vi) Compensating shareholders on the acquisition of their shares by the government
under a scheme of rationalisation
(vii) Conversion of shares, say, conversion of preference shares into equity.
(viii) Advancing a loan on the security of shares
(ix) Resolving a deadlock in the management of a private limited company on the
basis of the controlling block of shares being given to either of the parties.

Methods of valuation of shares

The following are the various methods for valuation of shares

(i) Net assets method


(ii) Yield basis method
(iii) Fair value method
(i) Net asset method
Under this method the net asset value of each share is arrived at by dividing the total
value of the net assets of the company by its total number of equity shares. This method aims
at finding out the possible value of the shares in the event of the company going into

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liquidation. This method is also known as break-up method or asset backing method or
intrinsic value method.



Net Asset value of each shares =

Net assets available for equity shareholders = Net Assets Preference Share
Capital

Net assets = Total realisable value of assets Total of External Liability

Assets available to equity shareholders may be calculated on the following basis:

Rs. Rs.
Assets at market value / book value: xxxx
Land and building xxxx
Plant and machinery xxxx
Cash xxxx
Bank xxxx
Debtors xxxx
Bills receivables xxxx
Stock xxxx
Other assets xxxx
Total realisable value of assets xxxx
Less: Outside Liabilities
Creditors xxxx
Bills Payable xxxx
Bank Overdraft xxxx
Debenture xxxx xxxx
Net Assets xxxx
Less: Amount Payable to Preference Shareholders xxxx
Net Assets available to equity shareholders xxxx

(ii) Yield basis method


Investors are interested in the income for their investment. Hence, the price they will be
prepared to pay will depend upon the yield or the size of the dividend that an investor gets out
of his holding. Under this method the value of share is obtained by comparing the expected
rate of return with normal rate of return.

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(iii) Fair value method
Fair value of share is the simple average of net assets value and yield value. Fair
value provides a better indication about the value of shares than the other methods.

Valuation of Goodwill

Meaning of Goodwill

An intangible asset that arises as a result of the acquisition of one company by another
for a premium value. The value of companys brand name, solid customer base, good
customer relations, and good employee relations and any patents or proprietary technology
represents goodwill. Goodwill is considered an intangible asset because it is not a physical
asset like buildings or equipment. The goodwill account can be found in the assets portion of
a companys balance sheet. Goodwill is a special type of intangible asset that represents that
portion of the entire business value that cannot be attributed to other income producing
business assets, tangible or intangible.

There are three methods of valuation of goodwill of the firm;

1. Average Profits Method

2. Super Profits Method

3. Capitalisation Method

1. Average Profits Method:

Under this method goodwill is calculated on the basis of the average of some agreed
number of past years. The average is then multiplied by the agreed number of years. This is
the simplest and the most commonly used method of the valuation of goodwill.

Goodwill = Average Profits X Number of years of Purchase

Before calculating the average profits the following adjustments should be made in the profits
of the firm:

a. Any abnormal profits should be deducted from the net profits of that year.

b. Any abnormal loss should be added back to the nat profits of that year.

c. Non operating incomes eg. income from investments etc should be deducted from
the net profits of that year.

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2. Super profits method:
Super Profits are the profits earned above the normal profits. Under this method
Goodwill is calculated on the basis of Super Profits i.e. the excess of actual profits over the
average profits. For examplle if the normal rate of return in a particular type of business is
20% and your investment in the business is $1,000,000 then your normal profits should be $
200,000. But if you earned a net profit of $ 230,000 then this excess of profits earned over the
normal profits i.e. $ 230,000 $ 200,000= Rs.30,000 are your super profits. For calculating
Goodwill, Super Profits are multiplied by the agreed number of years of purchase.

Steps for calculating Goodwill under this method are given below:

i) Normal Profits = Capital Invested X Normal rate of return/100

ii) Super Profits = Actual Profits Normal Profits

iii) Goodwill = Super Profits x No. of years purchased

3. Capitalisation Method:
There are two ways of calculating Goodwill under this method:

(i) Capitalisation of Average Profits Method

(ii) Capitalisation of Super Profits Method

(i) Capitalisation of Average Profits Method:


Under this method we calculate the average profits and then assess the capital needed
for earning such average profits on the basis of normal rate of return. Such capital is called
capitalised value of average profits. The formula is:-

Capitalised Value of Average Profits = Average Profits X (100 / Normal Rate of


Return)

Capital Employed = Assets Liabilities

Goodwill = Capitalised Value of Average Profits Capital Employed

(ii)Capitalisation of Super Profits:


Under this method first of all we calculate the Super Profits and then calculate the
capital needed for earning such super profits on the basis of normal rate of return. This
Capital is the value of our Goodwill. The formula is:-

Goodwill = Super Profits X (100/ Normal Rate of Return)

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