Preference Shares:

According to Sec 85(1), of the Companies Act, 1956, a preference share is one, which carries the following two preferential rights:

(a)         The payment of dividend at fixed rate before paying dividend to equity shareholders.

(b)         The return of capital at the time of winding up of the company, before the payment to the equity shareholder.

Both the rights must exist to make any share a preference share and should be clearly mentioned in the Articles of Association.

Preference shareholders do not have any voting rights, but in the following conditions they can enjoy the voting rights:

(1)          In case of cumulative preference shares, if dividend is outstanding for more than two years.

(2)          In case of non-cumulative preference shares, if dividend is outstanding for more than three years.

(3)          On any resolution of winding up.

(4)          On any resolution of capital reduction.

Types of preference shares:

In addition to the aforesaid two rights, a preference shares may carry some other rights. On the basis of additional rights, preference shares can be classified as follows:

Cumulative Preference Shares: Cumulative preference shares are those shares on which the amount of divided if not paid in any year, due to loss or inadequate profits, then such unpaid divided will accumulate and will be paid in the subsequent years before any divided is paid to the equity share holders. Preference shares are always deemed to be cumulative unless any express provision is mentioned in the Articles.

1)             Non-Cumulative Preference Shares: Non-cumulative preference shares are those shares on which arrear of dividend do not accumulate. Therefore if divided is not paid on these shares in any year, the right receive the dividend lapses and as such, the arrear of divided is not paid out of the profits of the subsequent years.

2)             Participating Preference Shares: Participation preference shares are those shares, which, in addition to the basic preferential rights, also carry one or more of the following rights:

(a)         To receive dividend, out of surplus profit left after paying the dividend to equity shareholders.

(b)         To have share in surplus assets, which remains after the entire capital has been paid on winding up of the company.

4)             Non-Participating Preference Shares: Non-participation preference shares are those shares, which do not have the following rights:

(a)         To receive dividend, out of surplus profit left after paying the dividend to equity shareholders.

(b)         To have share in surplus assets, which remains after the entire capital has been paid on winding up of the company.

Preference shares are always deemed to be non-participating, if the Article of the company is silent.

5)             Convertible Preference Shares: Convertible preference shares are those shares, which can be converted into equity shares on or after the specified date according to terms mentioned in the prospectus.

6)             Non-Convertible Preference Shares: Non-convertible preference shares, which cannot be converted into equity shares. Preference shares are always being to be non-convertible, if the Article of the company is silent.

7)             Redeemable Preference Shares: Redeemable preference shares are those shares which can be redeemed by the company on or after the certain date after giving the prescribed notice. These shares are redeemed in accordance with the terms and sec. 80 of the Company’s Act 1956.

8)             Irredeemable Preference Shares: Irredeemable preference shares are those shares, which cannot be redeemed by the company during its life time, in other words it can be said that these shares can only be redeemed by the company at the time of winding up. But according to the sec. 80 (5A) of the Company’s (Amendment) Act 1988 no company can issue irredeemable preference shares.

Equity shares:

According to section 85 (2), of Companies Act, 1956, Equity share can be defined as the share, which is not preference shares. In other words equity shares are those shares, which do not have the following preferential rights:

(a)         Preference of dividend over others.

(b)         Preference for repayment of capital over others at the time of winding up of the company.

These shares are also known as ‘Risk Capital’, because they get dividend on the balance of profit if any, left after payment of dividend on preference shares and also at the time of winding up of the company, they are paid from the balance asset left after payment of other liabilities and preference share capital. Apart from this they have to claim dividend only, if the company in its A. G. M. declares the dividend. The rate of dividend on such shares is not pre-determined, but it depends on the profit earned by the company.

The equity shareholders have the right to vote on each and every resolution placed before the company and the holders of these shares are the real owners of the company.

Distinction between Preference Shares and Equity Shares:

Sub-division of share capital:

The word capital in connection with a company may mean any of the following divisions of capital:

1)                                                       Authorised capital: An authorised capital refers to that amount which is stated in the ‘Capital Clause’ of the Memorandum of Association as the share capital of the company. This is the maximum limit of the company which it is authorised to raise and beyond which company cannot raise unless the capital clause in the Memorandum is altered in accordance with the provisions of Sec. 94 of the Companies Act, 1956.

2)                                                       Issued capital: An issued capital refers to the nominal value of that part of authorised capital, which has been (1) subscribed for by the signatories to the Memorandum of Association, (2) allotted for cash or for consideration other than cash and (3) allotted as Bonus shares.

3)                                                       Subscribed capital: Subscribed capital refers to the paid-up value of the issued capital i.e. the total amount called by the company less calls-in-arrear. It is only the actual liability for the company hence it will be only be added while totalling the liability side.

Difference between Authorised Capital and Issued Capital:

Distinction between authorised capital and subscribed capital:

Meaning of reserve capital:

Under Section 99 of the Companies Act 1956, sometimes a company by means of special resolution decides that certain portion of its uncalled capital shall not be called up during its existence and it would by available as an additional security to its creditors in the event of its liquidation. Such a portion of uncalled capital is termed as ‘Reserve Capital’. It cannot be converted into ordinary uncalled capital without the leave (order) of the court and also it cannot be charged by the company.

Meaning of Capital Reserve:

Capital Reserve originates from sources other than the regular activities of the business. In other words, the reserve, which is created out of capital profit, is known as capital reserve. Dividend cannot e distributed out of this reserve but it can be used to meet capital losses or to declare a bonus share.  It is shown in the liability side of the Balance Sheet under the heading of ‘Reserve and Surplus’ Following are the principal sources of capital reserve:

(a)                                                   Profit on sale of a fixed asset.

(b)                                                   Profit on revaluation of assets and liabilities.

(c)                                                   Profit on forfeiture and re-issue of forfeited shares.

(d)                                                   Profit on redemption of debentures at a discount.

(e)                                                   Profit earned by a company prior to its incorporation.

Difference between Reserve capital and capital reserve:

Preliminary expenses:

Expenses incurred on the formation of a company are termed as ‘Preliminary Expenses’. These include the following:

(a)                                                   Expenses incurred on the preparation and printing of various documents needed for the registration of a company.

(b)                                                   Stamp duty and registration fees on these documents.

(c)                                                   Duty payable on authorised capital.

(d)                                                   Expenses incurred on the preparation, printing, and issue of prospectus.

(e)                                                   Underwriting commission.

(f)                                                      Cost of preliminary books and the common seal.

(g)                                                   In case the company has been formed to purchase a running business, the fees charged by accountant or valuer valuing the assets and liabilities of that business.

(h)                                                    This may be written off against Security Premium account, or against Capital Reserve, otherwise, these may be written off from Profit and Loss Account gradually over some period. The unwritten off portion of such expense is shown on the assets side of the Balance Sheet under the heading ‘Miscellaneous Expenditure’.

Procedure of issue of shares:

When company has been registered, the following procedure is adopted by the company to collect money from the public by issuing of shares:

1.             Issue of prospectus: When a Public company intends to raise capital by issuing its shares to the public, it invites the public to make an offer to buy its shares through a document called ‘Prospectus’. According to Section 60 (1), a copy of prospectus is required to be delivered to the Registrar for registration on or before the date of publication thereof. It contains the brief information about the company, its past record and of the project for which company is issuing share. It also includes the opening date and the closing date of the issue, amount payable with application, at the time of allotment and on calls, name of the bank in which the application money will be deposited, minimum number of shares for which application will be accepted, etc.

2.             To receive application: After reading the prospectus if the public is satisfied then they can apply to the company for purchase of its shares on a printed prescribed form. Each application form along with application money must be deposited by the public in a schedule bank and get a receipt for the same. The company cannot withdraw this money from the bank till the procedure of allotment has been completed (in case of first allotment, this amount cannot be withdrawn until the certificate to commence business is obtained and the amount of minimum subscripttion has been received). The amount payable on application for share shall not be less than 5% of the nominal amount of share.

3.             Allotments of shares: Allotments of shares means acceptance by the company of the offer made by the applicants to take up the shares applied for. The information of allotment is given to the shareholders by a letter known as ‘Allotment Letter’, informing the amount to be called at the time of allotment and the date fixed for payment of such money. It is on allotment that share come into existence. Thus, the application money on the share after allotment becomes a part of share capital. Decision to allot the share is taken by the Board of Directors in consultation with the stock exchange. After the closure of the subscripttion list, the bank sends all applications to the company. On receipt of applications, each application is carefully scrutinised to ascertain that the application form is properly filled up and signed and the money is deposited with the bank.

4.             To make calls on shares: The remaining amount left after application and allotment money due from shareholders may be demanded in ne or more parts which are termed as ‘First Call’ and ‘Second Call’ and so on. A word ‘Final’ word is added to the last call. The amount of call must not exceed 25% of the nominal value of the shares and at least 1 month have elapsed since the date which was fixed for the payment of the last preceding call, for which at least 14 days notice specifying the time and place must be given.

Modes of issue of shares:

A company can issue shares in two ways:

1.             For cash.

2.             For consideration other than cash.

Issue of shares for cash: When the shares are issued by the company in consideration for cash such issue of shares is known as issue of share for cash. In such a case shares can be issued at par or at a premium or at a discount. Such issue price may be payable either in lump sum along with application or in instalments at different stages (e.g. partly on application, partly on allotment, partly on call). Accounting procedure for the issue of shares for cash is given below:

Issue of shares at par: Shares are said to be issued at par when they are issued at a price equal to the face value. For example, if a share of Rs. 10 is issued at Rs. 10, it is said that the share has been issued at par.

Issue of shares at premium: When shares are issued at an amount more than the face value of share, they are said to be issued at premium. For example, if a share of Rs. 10 is issued at Rs. 15; such a condition of issue is known as issue of shares at premium. The difference between the issue price and the face value [i.e. Rs. 5 (Rs.15 – Rs.10)] of the shares is called premium. It is a capital profit for the company and will show credit balance; hence it will be shown in the liability side of the Balance Sheet under the heading ‘Reserves and Surplus’ in a separate account called ‘Security Premium Account’.

Shares of those companies can be issued at premium which offer attractive rate of dividend on their existing shares, having a good profit track for last few years and whose shares are in demand. The amount of premium depends upon the profitability and demand of shares of such company.

Note: The Company may collect the amount of security premium in lump sum or in instalments. Premium on shares may be collected by the company either with application money or with the allotment money or even with one of the calls. In absence of any information, the amount of the premium is to be recorded with allotment.

Utilisation of Security Premium Amount: According to Section 78 of the Companies Act 1956, the amount of security premium may be applied only for the following purposes:

(i)             To issue fully paid up bonus shares to the existing shareholders.

(ii)           To write off preliminary expenses of the company.

(iii)          To write off the expenses, or commission paid, discount allowed on issue of the shares or debentures of the company.

(iv)        To pay premium on the redemption of preference shares or debentures of the company.

(v)         To buy-back its own shares as per section 77A.

If the company wishes to use the premium amount for any other purpose, it will have to first obtain the sanction of the court for the same or it will be treated as reduction of capital.

Issue of shares at discount: Shares are said to be issued at a discount when they are issued at a price lower than the face value. For example if a share of Rs. 10 is issued at Rs. 9, it is said that the share has been issued at discount. The excess of the face value over the issue price [i.e. Re.1 (Rs. 10 – Rs. 9)] is called as the amount of discount.

Share discount account showing a debit balance denotes a loss to the company which is in the nature of capital loss. Therefore, it is desirable, but not compulsory, to write it off against any Capital Profit available or Profit and Loss Account as soon as possible,  and the unwritten off part of it is shown in the asset side of the Balance Sheet under the heading of ‘Miscellaneous Expenditure’ in a separate account called ‘Discount on issue of Shares Account’.

Conditions for issue of shares at discount: For issue of shares a discount the company has to satisfy the following conditions given in section 79 of the Companies Act 1956:

(i)             At least one year must have elapsed since the company became entitled to commence business. It means that a new company cannot issue shares at a discount at the very beginning.

(ii)           The company has already issued such types of shares.

(iii)          An ordinary resolution to issue the shares at a discount has been passed by the company in the General Meeting of shareholders and sanction of the Company Law Tribunal has been obtained.

(iv)        The resolution must specify the maximum rate of discount at which the shares are to be issued but the rate of discount must not exceed 10% of the face value of the shares. For more than this limit, sanction of the Company Law Tribunal is necessary.

(v)         The issue must be made within two months from the date of receiving the sanction of the Company Law Tribunal or within such extended time as the Company Law Tribunal may allow.

Accounting entries for issue of shares:

Joint Application and allotment account:

These days it is becoming a practice to open only one account in respect of application and allotment and not two separate accounts. This is based on the reasoning that allotment without application is impossible while application without allotment is meaningless so that the stages of the share capital transactions are closely interrelated, hence, form this point of view, Share Application and Share Allotment Account appear more logical. If combined account for application and allotment is opened, in such a case instead of passing first 4 entries following 3 eateries will be passed: