CHAPTER- 2

ISSUE AND REDEMPTION OF DEBENTURES

 Meaning of Debentures
Debentures are instruments to raise long-term debt, issued by a borrower company for
acknowledging debt. It is an instrument in writing that specifies the rate and time interval for
payment of interest and terms and condition for repayment of principle amount of the debt.
It includes debentures stock, bonds or any other instrument of a company.

 Difference between Shares and Debentures

Basis of Difference Shares Debentures

1. Owner or Creditor Share holders are the owners Debenture holder are Creditors
since shares forms a are part of since debentures are a part of
owned capital loan
2. Voting Rights Share holders have the voting Debenture holders do not have
rights any voting rights.
3. Returns Share holders are entitled for Debenture holders are entitled
returns in the form of dividend. for returns in the form of
interest.
4. Rate of Return The rate of dividend is not fixed The rate of interest is fixed and
and varies from year to year. do not vary from year to year.
5. Obligations of Return Dividend is appropriation of Interest is charged against
profit. Dividend will not be paid profit, interest is payable even
if losses are incurred by the if there is no profit.
company
6. Repayment of Amount The amount of share is not The amount of debenture is
returned during the life time of returned according to the term
the company of issue.
7. Issue As per Section 53 of Companies There are no such restrictions
Act 2013, shares cannot be issued for issuing debentures on
at discount, except sweat equity discount.
shares (as mentioned in Section
54 of 2013 Companies Act).
8. Conversion Shares cannot be converted into Debentures can be converted
debentures. into shares.
9. Risk Shares are more risky than If debentures are secured
debenture as these are unsecured. against asset, the risk involved
is the minimal.
 10. Repayment Priority Payment to the share holders is Payment to the debenture
made after settlement of all holders is made before the share
external liabilities, i.e. after holders.
debenture holders.

 Types of Debentures

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On the basis of Security
 Secured Debentures- Secured (Mortgaged) Debentures are those debentures that are
secured against asset/s of a company. In case the company fails to pay back the
principal amount of debenture or fails to meet its interest obligations on the due date,
then the debenture holders have the right to sell the mortgaged asset in order to realise
their amount due to the company.
 Unsecured Debentures- There debentures do not have charge against assets. They
are treated like other long-term debts which do not have charge against asset. These
debentures do not have any security.

On the basis of Tenure

 Redeemable Debentures- There debentures are issued for specific time period and
are payable after the expiry of the period.
 Non-Redeemable Debentures- These debentures cannot be repayable or redeemable by a
company during its life time. These are repayable only at the time of winding up of the
company. These are also known as Perpetual Debentures that means debentures having
indefinite life.

On the basis of Mode of Redemption

 Convertible Debentures- Debentures which can be converted into shares debentures
or other securities at the option after a specified period of time are called Convertible
Debentures. These debentures can be either fully convertible or partly convertible
debentures.
 Non-Convertible Debentures- Debentures which cannot be converted into new
debentures, shares, any other securities are called Non-Convertible Debentures.

On the basis of Coupon Rate

 Specific Coupon Rate Debentures- These debentures are issued with a specific rate of
interest which may either be fixed or floating rate.

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  Zero Coupon Debentures- Interest rates on these debentures are not specified. The
excess of the face-value over the issue price of the debentures is considered as the
interest amount.

On the basis of Registration

 Registered Debentures- While issuing such debentures, the company maintains a record
regarding name, address and number of holding of debentures in the Register of
Debenture Holders of the company.

 Bearer Debentures- When a company does not maintain any record of the debenture
holders and the debenture is transferable mere by delivery, then the type of the debenture
held by the holders is termed as Bearer Debenture. Interests on such debentures are paid
to the persons who produce the interest coupons that are attached with these debentures
in a specified bank.

ISSUE OF DEBENTURES

 Methods of Issue of Debentures

 Issue of Debentures for Cash- In Lump Sum

When a company calls the whole amount payable on debentures in one instalment application,
then it is called issue of debentures for cash in lump sum.

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 Issued at Par Issued at Premium Issued at Discount
Bank A/c Dr. Bank A/c Dr. Bank A/c Dr.
To Debenture Application To Debenture Application A/c To Debenture Application A/c
A/c
(Debentures Application (Debenture Application money (Debentures Application money
money received) received) received)

Debenture Application Dr. Debenture Application A/c Dr. Debenture Application A/c Dr.
A/c
To Debenture A/c To Debenture A/c Discount on issue of Dr.
Debenture A/c
To Securities Premium A/c To Debenture A/c
(Debentures Application (Debentures application money (Debentures application money
money transferred to transferred to Debentures transferred to Debentures
Debentures Account) Account) Account and allotment made at
discount)

 Issue of Debentures for Cash- In Instalments

Similar to Shares, a company may call the amount payable on the debentures in
instalments as- on application, on allotment, first call and so on.

Journal entries
1. For Application
(i) For receiving Application Money
Bank A/c Dr.
To Debenture Application A/c
(Debentures Application money received)

(ii) For transferring Application Money

 If Debentures are issued at Par
Debenture Application A/c Dr.
To Debentures A/c
(Debentures Application money transferred to
Debentures Account)

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  If Debentures are issued at Premium
Debenture Application A/c Dr.
To Debentures A/c
To Securities Premium A/c
(Debentures Application money transferred to
Debentures Account)

 If Debentures are issued at Discount

Debenture Allotment A/c Dr.
Discount on issue of Debenture A/c Dr.
To Debentures A/c
(Debentures allotment money due)

2. For Allotment
(i) For making Allotment Money Due
 If allotment does not include premium and discount
Debenture Allotment A/c Dr.
To Debentures A/c
(Debentures Allotment money due)

 If premium is included in Allotment

Debenture Allotment A/c Dr.
To Debentures A/c
To Securities Premium A/c
(Debentures Allotment money due)

 If discount is included in Allotment

Debenture Allotment A/c Dr.

Discount on issue of Debenture A/c Dr.
To Debentures A/c
(Debentures allotment due)

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 (ii) On Receiving Allotment Money
Bank A/c Dr.
To Debenture Allotment A/c
(Debentures Allotment money received)

3. For Various Calls

(i) For making Call Money Due
 If call does not include premium and discount
Debenture Call A/c Dr.
To Debentures A/c
(Debentures call due)

 If Premium is Included in Calls

Debenture Call A/c Dr.
To Debentures A/c
To Securities Premium A/c
(Debentures Call money due)

(ii) For receiving Call Money

Bank A/c Dr.
To Debenture Call A/c
(Debentures Call money received)

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 Over Subscription of Debentures

 When Debentures are Issued for Consideration Other than Cash (for purchasing Assets)

Issue at Par Issue at Premium Issue at Discount

Asset A/c Dr. Asset A/c Dr. Assets A/c Dr.
To Vendor To Vendor To Vendor
(Assets purchased) (Assets purchased) (Assets purchased)
Vendor Dr. Vendor Dr. Vendor A/c Dr.
To Debenture A/c To Debenture A/c Discount on Issue of Dr.
Debenture A/c
To Securities Premium A/c To Debenture A/c
(Debentures issued to (Debentures issued to vendor at (Debentures issued to vendor at
vendor) premium) discount)
Number of Debentures Number of Debentures Issued Number of Debentures Issued
Issued Amount Payable Amount Payable
= (Face value+Premium) per Debenture = (Face valueDiscount) per Debenture
Amount Payable
= Face valueper
Debenture

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 When Debentures are Issued for Consideration Other than Cash (for acquiring Business)
Issue at Par Issue at Premium Issue at Discount
Sundry Assets A/c Dr. Assets A/c Dr. Assets A/c Dr.
Goodwill A/c  Dr. Goodwill A/c  Dr. Goodwill A/c  Dr.
To Liabilities A/c To Liabilities A/c To Liabilities A/c
To Vendor * To Vendor * To Vendor *
To Capital Reserve  To Capital Reserve  To Capital Reserve 
(Business purchased) (Business purchased) (Business purchased)
Vendor Dr. Vendor Dr. Vendor A/c Dr.
To Debenture A/c To Debenture A/c Discount on Issue of Dr.
Debentures A/c
To Securities Premium A/c To Debenture A/c
(Debentures issued to (Debentures issued to vendor at (Debentures issued to vendor at
vendor at par) premium) discount)
Number of Debentures Number of Debentures Issued Number of Debentures Issued
Issued Amount Payable Amount Payable
= (Face value+Premium) per Debenture = (Face valueDiscount) per Debenture
Amount Payable
= Face valueper
Debenture

Note
 If the Net Assets (Sundry Assets – Sundry Liabilities) < Purchase Consideration, then
Goodwill A/c is Debited with the difference amount
Or,
 If the Net Assets (Sundry Assets – Sundry Liabilities) > Purchase Consideration, then
Capital Reserve is Credited with the difference amount
* Vendor A/c is credited with the amount of Purchase Consideration. If it is not given
in the question, then it is equal to the difference between the Sundry Assets and
Sundry Liabilities.
Important Notes
 In case, if the Vendor is being paid some amount of purchase consideration in Cash,
then Cash A/c will be credited with the amount paid in cash.

 In case, while calculating the Number of Debentures Issued, if the Number appears in
fraction (or decimal), then that part multiplied by the issue price of the debenture will
be paid in Cash to the Vendor (round-off).

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 Issue of Debentures as Collateral Security
When Debentures are issued as security against a loan to a lender in addition to the primary
security, then debentures are said to be issued as collateral security.

 Accounting Treatment of Issue of Debentures as Collateral Security

 When a Company do not record its debentures in its books of accounts separately
No Entry is required
As no liability has been created so no entry is recorded in the books of account. In fact, as
per the Schedule III of the Companies Act, the issue of debenture as collateral security is
shown in the Notes to Accounts of Long-Term Borrowings. The final balance is shown
on the Equity and Liabilities side of the Company's Balance Sheet under the main head of
Non-Current Liabilities.

Example
Balance Sheet
Amount
Particulars Note No.
(Rs)
I. Equity and Liabilities
1. Shareholders’ Fund
2. Non-Current Liabilities
a. Long-Term Borrowings 1 4,00,000
3. Current Liabilities
Total 4,00,000
II. Assets
1. Non-Current Assets

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 2. Current Assets
a. Cash and Cash Equivalents
Total

NOTES TO ACCOUNTS
Note Amount
Particulars
No. (Rs)

1 Long-Term Borrowings
Bank Loan (Secured by 10% 4,000 debentures of Rs 100 as
collateral security) 4,00,000

 When a Company records its debentures in its books of accounts separately

By Making Entry
In order to record the issue of debentures as collateral security, the following necessary
Journal entry is passed in the books of account.
At the time of Issue of Debentures as Collateral Security
Debenture Suspense A/c Dr.
To Debenture A/c
(Debentures issued as collateral security)

As per the Schedule III of the Companies Act, the issue of debenture as collateral security
is shown in the Notes to Accounts of Long-Term Borrowings and Debenture Suspense
Account is deducted from the debentures so issued as Collateral Security. The final
balance of this is shown on the Equity and Liabilities side of the Company's Balance
Sheet under the main head of Non-Current Liabilities.
When these debentures are redeemed after repayment of the loan so taken, the following
entry is recorded in the books.

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At the time of taking back the Debentures
Debenture A/c Dr.
To Debentures Suspense A/c
(Debenture released and loan repaid)

Example: Company issued 10% Debentures of Rs 5,00,000 as collateral security for a

loan of Rs 4,50,000 from PNB.

At the time of Issue of Debentures as Collateral Security

Debenture Suspense A/c Dr. 5,00,000
To Debenture A/c 5,00,000
(Debentures issued as collateral security)

Balance Sheet
Amount
Particulars Note No.
(Rs)
I. Equity and Liabilities
1. Shareholders’ Fund
2. Non-Current Liabilities
a. Long-Term Borrowings 1 4,50,000
3. Current Liabilities
Total 4,50,000

II. Assets
1. Non-Current Assets
2. Current Assets
a. Cash and Cash Equivalents 2 4,50,000
Total 4,50,000

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 NOTES TO ACCOUNTS
Note Amount
Particulars
No. (Rs)

1 Long-Term Borrowings
Secured:
Bank Loan 4,50,000
10% Debenture (Secured against issue of 5,00,000
Debentures of Rs 5,00,000)
Less: Debenture Suspense Account (5,00,000) -
4,50,000
2 Cash & Cash Equivalents
Bank 4,50,000

 Journal Entries for Issue of Debentures from Redemption point of view

Issue and Redemption of
Journal Entries
Debentures
Bank A/c (with the amount received) Dr.
To Debenture Application A/c (face value)
When debentures are issued
at par and redeemable at par Debenture Application A/c Dr.
To Debentures A/c

Bank A/c Dr.

To Debenture Application A/c
When debentures are issued
at premium and redeemable
Debenture Application A/c Dr.
at par
To Debenture A/c
To Securities Premium A/c

Bank A/c Dr.

To Debenture Application A/c
When debentures are issued
at discount and redeemable Debenture Application A/c Dr.
at par Discount on Issue of Debenture A/c Dr.
To Debenture A/c

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 Bank A/c Dr.
To Debenture Application A/c

Debenture Application A/c Dr.

When debenture are issued Loss on Issue of Debenture A/c Dr.
at par and redeemable at (with the amount of premium on
premium redemption)
To Debenture A/c (with the face-value)
To Premium on Redemption A/c (with the amount of
premium on redemption)

Bank A/c Dr.

To Debenture Application A/c

Debenture Application A/c Dr.

Loss on Issue of Debenture A/c Dr.
When debentures are issued (with the amount of premium on
at premium and redeemable redemption)
at premium To Debenture A/c (with the face-value)
To Securities Premium A/c (with the amount of
premium on issue)
To Premium on Redemption A/c
(with the amount of premium on redemption)

Bank A/c Dr.

To Debenture Application A/c

Debenture Application A/c Dr.

When debentures are issued Loss on Issue of Debenture A/c (with the Dr.
at discount and redeemable amount of discount on issue plus amount of
at premium premium on redemption)
To Debenture A/c (with the face-value)
To Premium on Redemption A/c (with the amount of
premium on redemption)

 Interest on Debentures
Interest is paid on the outstanding balance of debentures at the prescribed rate at regular
interval until the debentures are repaid. Interest on debentures is an obligation which is to be
paid even if the company incurs loss. As per the Income Tax Act, before paying the interest
on debentures to the debentureholders, the company is required to deduct income tax at the

14
 prescribed rate from the amount of interest. This income tax is to be payable to the
Government.

Journal Entries
When Income Tax is Deducted When Income Tax is Not Deducted
Interest on Debentures A/c Dr. Interest on Debentures A/c Dr.
To Debentureholders’ A/c To Debentureholder’s A/c
To Income Tax Payable A/c (Interest due)
(Interest due)
Debentureholders’ A/c Dr.
Debentureholders’ A/c Dr. To Bank A/c
To Bank A/c (Interest paid to debentureholders)
(Interest paid to debentureholders)

Income Tax Payable A/c Dr.

To Bank A/c
(Income tax on interest on debentures paid)

Statement of Profit and Loss Dr. Statement of Profit and Loss Dr.
To Interest on Debenture A/c To Interest on Debentures A/c
(Interest transferred to Statement of Profit and (Interest transferred to Statement of Profit and
Loss) Loss)

REDEMPTION OF DEBENTURES

 Redemption of Debentures- It refers to repayment of the outstanding amount on

debentures. The debentures can be redeemed as per the terms stated in the company’s
prospectus.

 Funds for Redemption of Debentures

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 Debenture Redemption Reserve (DRR)
As per Section 71 (4) of the Companies Act, 2013, every company issuing debentures is
required to create a debenture redemption reserve account out of the profits of the company
available for payment of dividend and the amount credited to such account shall not be
utilised by the company except for the redemption of debenture.

Various conditions and the amount to be set aside for DRR has been specified in the
Companies (Share Capital and Debentures) Rules, 2014, which states that
 Every company (except All India Financial Institutions (AIFIs) regulated by Reserve
Bank of India and Banking Companies) is required to create DRR equal to the 25% of
the value of debentures.
 Creation of DRR is applicable only for Non-Convertible Debentures and for Non-
Convertible part of Partly Convertible Debentures.

 Exception from the Creation of DRR

As per Rule 18(7) of the Companies Rule 2014, the following companies are exempted from
the creation of DRR.
 Debentures issued by All India Financial Institutions regulated by RBI
 Banking Companies

Journal Entries
For Creation of DRR
Statement of Profit and Loss A/c Dr.
To DRR A/c

Closing of DRR after redemption of all debentures

DRR A/c Dr.
To General Reserve A/c

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Issue and Redemption of Debentures

Disclosure of DRR in Company's Balance Sheet

DRR is shown in the Notes to Account of Reserves and Surplus and the final balance is
shown on the Equity and Liabilities Side of the Balance Sheet as per the Schedule III of
Companies Act 2013. It is closed by transferring its balance to General Reserve Account at
the end, when all the debentures are redeemed.

Debenture Redemption Investment

In addition to above specified rules, Rule 18 (7) of the Companies (Share Capital and
Debentures) Rules, 2014 requires every company required to create DRR shall on or before
30th April in each year, invest or deposit in specified securities, a sum of at least equal to
fifteen percent of the amount of debentures maturing for payment during the year ended
31st March of the next year. Also, the amount invested or deposited shall not be used for any
purpose other than redemption of debentures maturing during the year ending 31st March of
next year.
The specified securities for Investment are:
(i) in deposits with any Scheduled Banks, free from any charge;
(ii) in unencumbered securities of Central Government or any State Government;
(iii) in unencumbered securities mentioned in sub-clause (a) to (d) and (ee) of Section 20
of the Indian Trust Act, 1882 and

17
 (iv) in unencumbered bonds issued by any other company which is notified under sub-
clause (f) of Section 20 of the Indian Trust Act, 1882.

 Methods of Redemption of Debentures

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 Process of Redemption

 Method I (Redemption in Lump Sum)- When all the debentures are repaid (redeemed)
in one single payment, then it is called redemption of debenture in lump sum. Debentures
can be redeemed out of profits or out of capital.

19
20
21
 Important Note for Students’
Unless otherwise specified in the question,
 Journalise the transactions related to redemption only
 Interest entries are not mandatory

 Method II (Redemption by Draw of Lots)- Under this method, the debentures are
redeemed in lots (instalments). The number of debentures to be redeemed along with
their time of redemption is specified beforehand. This method is also known as
redemption of debentures in instalments.
Here, DRR is created only once (on March 31, a year preceding the redemption) while DRI
is created every year (of redemption) on April 30. Subsequently, DRI is encashed every year
when the redemption falls due.
The following are the journal entries to be passed in this method.

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23
 Redemption of Debentures by Purchase in Open Market- Under this method, the
company purchases its own debentures from the open market. The following are the
two main purposes behind the purchase of own debentures.

i. For immediate cancellation

ii. With the motive of investment (For resale or cancellation)

Motive 1: When Own Debentures are Purchased for Immediate Cancellation

The Journal entries for immediate cancellation of own debentures are presented in the below
diagram.

24
25
26
 Debenture Redemption Reserve and Debenture Redemption Investment

Motive 2: Purchase of Own Debentures for Investment Purposes (Resale &

Cancellation)

The Journal entries for investment purposes of own debentures are presented in the below
diagram.

27
28
Interest on Own Debentures and its Accounting Treatment

For Interest Due on Debentures

Interest on Debentures A/c Dr. (with total interest)
To Debentureholders' A/c (with interest payable to outsiders)
To Interest on Own Debentures A/c (with interest on own debentures)
(Interest on debentures became due)

For Payment of Interest to Debentureholders

Debentureholders' A/c Dr. (with amount paid to the outsiders)
To Bank A/c
(Interest paid to the outside
debentureholders)

29
 For Transfer of Interest on own Debentures to Statement of Profit and Loss
Interest on Own Debentures A/c Dr. (with interest on own debentures)
To Statement of Profit and Loss A/c
(Interest on own debentures transferred to
Statement of Profit and Loss)
For Transfer of Interest on Debentures to Statement of Profit and Loss
Statement of Profit and Loss A/c Dr. (with total interest on debentures)
To Interest on Debentures A/c
(Interest on debentures transferred to
Statement of Profit and Loss)

Disclosure of Own Debentures in Balance Sheet

30
 CHAPTER- 1
ACCOUNTING FOR SHARE CAPITAL

 Meaning of Company
Company is an artificial person that has a separate legal entity and existence from its
members. A company is formed and registered under the Companies Act.

 Features of Company
 It is separate from its members
 It comes into existence after incorporation.
 Company’s life is not affected by the death or retirement of its directors.
 It has its own common seal.
 The shares of a company are transferrable.

 Types of Company
There are two types of company
 Public Company
 Private Company
 One Person Company

 Public Company
A public company is defined as a company that offers a part of its ownership in the form
of shares, debentures, bonds, securities to the general public through stock market.
There must be at least seven members to form a public company. There are two types of
public company:
 Listed Company (Quota Company) - A company whose shares are listed and
traded in the stock exchange like, Tata Motors, Reliance, etc. are called Listed
Company.
 Unlisted Company- A company whose shares are not listed in the stock exchange
and thereby these shares cannot be traded in the stock exchange are called Unlisted
Company.

1
 Private Company
A private limited company is defined as a company that has a minimum paid-up share
capital of Rs 1,00,000. There must be at least two and a maximum of 50 members
(excluding current and former employees) to form a private company. These companies
can neither invite application from the general public to subscribe its shares and
debentures nor these companies can accept deposits from persons other its members.

 One Person Company

A company formed with only one person as its member; with minimum paid-up capital of
not more than Rs 50,00,000 is defined as one person company. Their average annual
turnover should not exceed Rs 2 crores. These companies can be formed only by a citizen
and resident of India. Such companies cannot conduct non-banking financial investment
activities. Moreover, they cannot indulge in investments of securities of any other entity.

 Meaning of Share
Share is a unit of capital of a public company. Each share (unit) has equal denomination in
terms of money.

 Shares Capital- The amount to be invested by issuing capital in the form of shares
is known as Share Capital.

 Classification of Share Capital

The Share Capital of a company consists of the following components:

 Authorised Capital- It is an amount which is stated in the Memorandum of

Association. It is the maximum amount that the company can raise by issuing shares.

 Issued Capital- It is a part of authorised capital which is offered by the company to

the general public for subscription. For example, if the authorised capital of a
company is Rs 1,00,000 divided into Rs 10 per share, then the issued capital cannot
be more than Rs 1,00,000.

 Unissued Capital- It is a part of authorised capital that has not been offered till now
but can be offered to the general public in the future. In the above example, if the
issued capital is Rs 80,000, then the unissued capital is Rs 20,000

 Subscribed Capital- It is a part of issued capital that is actually subscribed by the

general public. For example, if the company has issued 8,000 shares of Rs 10 per
share and public has subscribed for 7,500 shares, then the subscribed share capital of
the company amounts to Rs 75,000.

 Unsubscribed Capital- It is that part of the issued capital that is not subscribed by
the public. For example, in the above example, 500 shares were left unsubscribed,
making an unsubscribed share capital of Rs 5,000.

 Called-up Capital- It is a part of subscribed capital that is called up by the Directors

from the shareholders of a company to pay. For example, if the Directors call up Rs
6 out of Rs 10 (i.e. the face value of the share) from the shareholders of 10,000 to
pay, then Rs 60,000 is regarded as called up share capital.

 Uncalled-up Capital- It is that part of subscribed capital which is not called up till
now but can be called up in future as per the need of the company. For example, in
the above example, Rs 4 were left uncalled from shareholders holding 10,000
shares, so Rs 40,000 is uncalled up share capital.
  Paid-up Capital- It is that part of called up share capital which is actually received
from the shareholders. If the entire called up money of Rs 4 on 1,000 shares has been
received except from a shareholder holding 300 shares, then the paid up share capital
is Rs 2,800 (Rs 4,000 – Rs 1,200). The amount of Rs 1,200 is called Call in Arrears
that has been called up but is unpaid.

 Reserved Capital- A limited company may call up any portion of uncalled share
capital in the event of winding up of the company to pay its creditors. This amount
of uncalled share capital is reserved for paying back the creditors that is why; such
portion of share capital is called reserve capital.

 Kinds of Shares

 Preference Shares- Preference Shares entitle its holder the right to receive dividend
at a fixed rate or fixed amount. The Preference Shareholders enjoy preferential right
to receive repayment of the capital invested before the equity shareholder at the
time of winding-up of the company.

 Equity Shares- Shares which are not Preference Shares are called Equity Shares.
The rate of dividend is not fixed on these shares and varies from year to year,
depending on the amount of profit available for distribution.

 Types of Preference Shares

The Preference Shares can be classified into the following categories.
On the basis of Dividend:
 Cumulative Preference Shares- The Preference Shares whose dividend can be forwarded
to the next accounting period and have a right to received arrears of dividend before the
payment of dividend to equity shares holders are called Cumulative Preference Shares.

 Non-Cumulative Preference Shares- The Preference Shares whose dividend can be

curtailed or cancelled when the company has insufficient profit to declare dividend are
called Non-Cumulative Preference Shares. The holders of these shares do not enjoy
the right to receive arrears of dividend.

On the basis of Participation:

 Participating Preference Shares- These preference shares carry the right to participate in
the surplus profit (in addition to the fixed rate of dividend) that is left after the payment
of dividend on the equity shares.
  Non-Participating Preference Shares- These preference shares do not carry the right to
participate in the residual profit after paying dividend to equity shareholders. The
holders of these shares receive only a fixed rate of dividend every year.

On the basis of Convertibility:

 Convertible Preference Shares- The holders of these shares have the right to convert
their holdings into new securities according to the term of issue.
 Non-Convertible Preference Shares- The holders of these shares do not have the right of
converting their holdings into new securities.

On the basis of Redemption:

 Redeemable Preference Shares- The holders of these shares are repaid by the company
after a certain specified period as per the term specified in the Companies Act of 2013.
 Non-Redeemable Preference Shares- The holders of these shares are repaid only at the
time of the winding-up of the company.

 Some Important Terms

 Private Placement of Shares- It means offering and allotting shares to a selected
group such as, banks, other financial institutions, etc. without any public invitation.
 Preferential Allotment- It means issue of shares on preferential basis to pre-identified
persons that include promoters and other strategic shareholders who own control and
belong to the management of the company.
 Sweat Equity- It means issue of shares to the directors and other employees at
discount or in consideration of their valuable efforts to the company.

 Issue of Shares
In order to raise share capital, a public company invites subscription from the general public.

 Methods of Issuing Shares

The shares can be issued either for cash or for consideration other than cash (such as, for
acquiring machinery and other assets).
 Journal Entries for Issue of Shares
 When the amount of shares are received in Lump Sum

Issue at Par Issue at Premium

Bank A/c Dr. Bank A/c Dr.
To Share Application A/c To Share Application A/c
(Application money received) (Application money received)

Share Application A/c Dr. Share Application A/c Dr.

To Share Capital A/c To Share Capital A/c
To Securities Premium A/c
(Application money transferred) (Transfer of application to share
capital and premium)

 When amount of share are received in instalments

Bank A/c Dr.
To Share Application A/c
(Money Received)

Share Application A/c Dr.

To Share capital
(Money transferred to capital)

If premium is received on application

Share Application A/c Dr.
To Share Capital A/c
To Securities Premium A/c
(Application money transferred to capital and premium)
 Share Allotment A/c Dr.
To Share Capital A/c
(Allotment money due)

If Calls include Premium

Share Call A/c Dr.
To Share Capital A/c
To Securities Premium A/c
( Call due including premium)

Bank A/c Dr.

To Share Call A/c Dr.
(Share call money received)

 When Shares are Issued for Consideration Other than Cash (for purchasing Assets)

Issue at Par Issue at Premium

Asset A/c Dr. Asset A/c Dr.
To Vendor To Vendor
(Assets purchased) (Assets purchased)
Vendor Dr. Vendor Dr.
To Share Capital A/c To Share Capital A/c
To Securities Premium A/c
(Shares issued to vendor) (Shares issued to vendor at premium)
Number of Shares Issued Number of Shares Issued
Amount Payable Amount Payable
= Face valueper = (Face value+Premium) pershare
share

 When Shares are Issued for Consideration Other than Cash (for acquiring Business)

Issue at Par Issue at Premium

Sundry Assets A/c Dr. Asset A/c Dr.
Goodwill A/c  Dr. Goodwill A/c  Dr.
To Liabilities A/c To Liabilities A/c
To Vendor * To Vendor *
 To Capital Reserve  To Capital Reserve 
(Business purchased) (Business purchased)
Vendor Dr. Vendor Dr.
To Share Capital A/c To Share Capital A/c
To Securities Premium A/c
(Shares issued to vendor at par) (Shares issued to vendor at premium)
Number of Shares Issued Number of Shares Issued
Amount Payable Amount Payable
= Face valuepershare = (Face value+Premium) pershare

Note
 If the Net Assets (Sundry Assets – Sundry Liabilities) < Purchase Consideration, then
Goodwill A/c is Debited with the difference amount
Or,
 If the Net Assets (Sundry Assets – Sundry Liabilities) > Purchase Consideration, then
Capital Reserve is Credited with the difference amount
* Vendor A/c is credited with the amount of Purchase Consideration. If it is not given in the
question, then it is equal to the difference between the Sundry Assets and Sundry
Liabilities.

Important Notes
 In case, if the Vendor is being paid some amount of purchase consideration in Cash,
then Cash A/c will be credited with the amount paid in cash.

 In case, while calculating the Number of Shares Issued, if the Number appears in
fraction (or decimal), then that part multiplied by the issue price of the share will be
paid in Cash to the Vendor.
 Under Subscription- It refers to a situation when the number of shares applied is less than
number of shares offered for subscription. That is, when the number of Share Application
received is less than the number of Share Application invited.

Example: A public company invited application for 10,000 shares of Rs 10 each from the
general public. Public applied only for 9,500 shares. This situation is known as Under
Subscription of shares.

 Minimum Subscription- It refers to the minimum amount that must be subscribed by the
general public so that the company can allot shares to the applicants. As per Section 39 of the
Companies Act, 2013, “No allotment of any securities of a company offered to the public for
subscription shall be made unless the amount stated in the prospectus as the minimum
amount has been subscribed and the sum payable on application for the amount stated have
been paid to and received by the company by cheque or other instrument”. However, the
Companies Act of 2013 does not specify the quantum of minimum subscription needed in
case of public issues (for both equity and debt). Accordingly, as per SEBI guidelines no
allotment shall be made of any share capital if minimum subscription of 90% of issue size is
not received as per Section 69 of Companies Act, 1956.

 Over Subscription- It refers to a situation when number of shares applied is more than
the number of shares offered for subscription.
Example: A public company invited application for 10,000 shares of Rs 10 each from the
general public. Public applied only for 25,000 shares. This situation is known as Over
Subscription of shares.

 Allotment of Shares- Over Subscription

There can be three ways of allotment of shares in case of oversubscription.
 Case-I: Rejecting excess application and money returned

Example: A Ltd. issued 10,000 shares @ Rs 10 per share. Applicants received for
25,000. The company rejected the excess application of 15,000 shares and made
allotment to rest of the applicants. Amount is payable Rs 2 on application, Rs 5 on
allotment, Rs 3 on first and final call.
Bank A/c Dr. 50,000
To Share Application A/c 50,000
(Application money received for 25,000 shares)

Share Application A/c Dr. 50,000

To Share Capital A/c 20,000
To Bank A/c 30,000
(Application money transferred to Share Capital Account and
the excess money returned)

 Case-II: Allotting on Pro-rata basis and excess application money adjusted on

subsequent calls

Example: A Ltd. issued 10,000 shares @ Rs 10 per share. Applicants received for 25,000.
The company made allotment on pro-rata basis and excess application money was
adjusted on subsequent calls. Amount is payable Rs 2 on application, Rs 5 on allotment,
Rs 3 on first and final call.

Bank A/c Dr. 50,000

To Share Application A/c 50,000
(Application money received for 25,000 shares)
 Share Application A/c Dr. 50,000
To Share Capital A/c 20,000
To Share Allotment A/c 30,000
(Application money transferred to Share Capital Account and the
balance amount is transferred to Share Allotment Account)

Share Allotment A/c Dr. 50,000

To Share Capital A/c 50,000
(Amount due on allotment of 10,000 shares @ Rs 5 per share)

Bank A/c Dr. 20,000

To Share Allotment 20,000
(Allotment money received, Rs 50,000 – Rs 30,000)

 Case-III: Pro-rata allotment and refund of money

Example: A Ltd. issued 10,000 shares @ Rs 10 per share. Applicants received for 25,000.
The company made allotment on pro-rata basis to 20,000 and rejected 5,000 shares. The
money of rejected applications was refunded immediately. Amount is payable Rs 2 on
application, Rs 5 on allotment, Rs 3 on first and final call.

Bank A/c Dr. 50,000

To Share Application A/c 50,000
(Application money received for 25,000 shares)

Share Application A/c Dr. 50,000

To Share Capital A/c (10,000 × 2) 20,000
To Share Allotment A/c (10,000 × 2) 20,000
To Bank (Money of rejected shares) (5,000 × 2) 10,000
(Application money transferred to Share Capital Account and the
balance amount is transferred to Share Allotment Account)

Share Allotment A/c Dr. 50,000

To Share Capital A/c 50,000
(Amount due on allotment of 10,000 shares @ Rs 5 per share)
 Bank A/c Dr. 30,000
To Share Allotment 30,000
(Allotment money received, Rs 50,000 – Rs 20,000)

 Securities Premium
When shares are issued more than its face-value, then the excess amount over the face-value
is called Securities Premium.

 Utilisation of Securities Premium

As per the Section 52(2) of the Companies Act, 2013, the amount available in securities
premium account will be utilised only for the following purposes.
 For issuing fully paid bonus shares to the members.
 For writing-off preliminary expenses, discount on securities and debentures, expenses
relating to issue of shares.
 For premium payable on redeemable preference shares and debentures.
 For buy back of its own shares.

 Buy Back of Shares

Buy-back of shares means repurchasing of its own shares by a company from the market for
reducing the number of shares in the open market. As per the Section 68 of the Companies
Act, 2013, a company can Buy-back its own shares and debentures on the account of
following reasons:
 To improve EPS (Earnings Per Share)
 To return surplus cash to the shareholders that is not required by the business
 To support value of its shares
 To facilitate capital restructuring of the company.
 To prevent take-over bid.

 Calls-in-Arrears
When a shareholder fails to pay the amount due on allotment or any subsequent calls, then it
is termed as Calls-in-Arrears.
 Journal Entry: If calls in arrears account are opened.
Calls-in-Arrears A/c Dr.
To Share Allotment, First Call, so on A/c

 Calls-in-Advance
When a shareholder pays the whole amount or a part of the amount in advance, i.e. before
the company calls, then it is termed as Calls-in-Advance.
Journal Entries:
for receiving
Bank A/c Dr.
To Calls-in-Advance A/c

for adjustment
Calls-in-Advance A/c Dr.
To Share Call A/c

 Ascertaining the Amount Due from the Defaulters

Generally, the question specifies one or two defaulters who fail to pay either the allotment,
first call or other calls. The calculation of the amount not received from such defaulters
involves the calculation of the numbers of shares held by them (or number of shares applied
by them). Usually, the question mentions either of the two, i.e. either the number of shares
allotted to the defaulters or the number of shares applied by them.

If number of shares applied by the defaulter is given, then

Number of Shares Alloted Shares Allotted

=  No. of Shares Applied by the
Defaulter Shares Applied
If number of shares alloted to the defaulter is given, then

Number of Shares Applied Shares Applied

=  No. of Shares Allotted to the Defaulter
Shares Allotted

Example,
If Mr. A (belonging to the category which applied for 20,000 shares and were allotted 5,000
shares) holding (allotted) 250 shares failed to pay allotment money, then in order to ascertain
the amount unpaid by him, we need to calculate the number of shares applied by him, that is,
 Number of Shares Applied Shares Applied
 No. of Shares Allotted to Mr. A
Shares Allotted
= Number of Shares 20,000
 250 = 1,000 shares
5,000
Applied =

Example,
If Mr. A (belonging to the category which applied for 20,000 shares and were allotted 5,000
shares) applied for 300 shares failed to pay allotment money, then in order to ascertain the
amount unpaid by him, we need to calculate the number of shares allotted to him, that is,

Shares Alloted
Number of Shares Allotted  No. of Shares Applied by Mr.
A Shares Applied
5, 000
= Number of Shares  300 = 75 shares
20,000
Allotted =

 Forfeiture of Shares
If a shareholder fails to pay the allotment money and/or any subsequent calls, then the
company has the right to forfeit his/her shares by giving a proper notice.

Journal Entries for forfeiture of Shares

Issued at Par
Share Capital A/c (called-up) Dr.
To Share Forfeiture A/c (paid-up)
To Calls-in-Arrears A/c (unpaid)
Or
To Unpaid Calls A/c (unpaid)

(Shares forfeited)
 Issued at Premium Issued at Premium
when premium is due and received when premium due but not received
Share Capital A/c (called-up minus premium) Dr. Share Capital A/c (called-up minus premium) Dr.
To Share Forfeiture A/c (paid-up) Securities Premium A/c (premium) Dr.
To Calls-in-Arrears A/c (unpaid minus premium) To Share Forfeiture A/c (paid-up)
Or To Calls-in-Arrears A/c (unpaid plus premium)
To Name of Unpaid Call A/c (unpaid minus premium) Or
To Name of Unpaid Calls A/c (unpaid plus premium)
(Shares forfeited) (Shares forfeited)

 Re-issue of Forfeited Shares

The director of the company can re-issue the forfeited shares either at par, at premium or at
discount. If the shares are re-issued at discount (or loss), then the face-value of the share must
not exceed the amount of Share Forfeiture per share.

Re-issue of Shares Originally Issued at Par Re-issue of Shares Originally Issued at Premium
Bank A/c Dr. Bank A/c Dr.
(Amount received of equal to paid up) (Amount received)
To Share Capital A/c (Paid up) To Share Capital A/c (Paid up)
To Securities Premium A/c (Amount over paid up)

 Transfer to Capital Reserve

After the forfeiture and re-issue of shares, the last step is to transfer the profit to the Capital
Reserve Account. In order to calculate the amount of profit that is to be transferred to the
Capital Reserve, we need to ascertain the difference between the Share Forfeiture Account
(in the forfeiture entry) and Forfeited Shares Account (in the re-issue entry).

Generally, we encounter the following two cases while calculating the amount of Capital
Reserve:
 When all the Shares Forfeited are Reissued

Journal Entry:
Forfeited Shares A/c Dr.
To Capital Reserve A/c

 When all the Shares Forfeited are not Reissued

If in case, the question specifies that not all the shares that were forfeited are not reissued,
then we need to calculate the Share Forfeiture Amount (in the forfeited entry)
proportionately.

Example
Ram who applied and allotted 500 shares, issued at par of Rs 10 failed to pay the
allotment money of Rs 4 per share consequently; his shares were forfeited immediately
after the allotment. Out of these 300 forfeited shares, only 200 shares were reissued at Rs
9 per share as fully paid. The amount payable as Rs 3 on application and Rs 4 on
allotment.

Share Capital A/c (300 × 7) Dr. 2,100

To Share Forfeiture A/c (300 × 3) 900
To Share Allotment A/c (300 × 4) 1,200
(300 shares of Ram forfeited )

Bank A/c (200 × 9 ) Dr. 1,800

Forfeited Shares A/c (200 × 1) Dr. 200
To Share Capital A/c (200 × 10) 2,000
(200 shares re-issued at Rs 8 per
share as fully paid)

Forfeited Shares A/c Dr. 400

To Capital Reserve A/c 400
(Transfer of profit on re-issue)
 Working Notes:

Forfeiture Amount on 300 shares = Rs 900

Forfeiture Amount on 1 share = 900

Rs
300
Forfeiture Amount on 200 shares = 900
 200  Rs 600
Rs 300

Amount of Capital Reserve

Proportionate Amount of Share Forfeiture Account minus Forfeited Shares
= Rs 600 – Rs 200 = Rs 400

 Presentation of Share Capital in the Balance Sheet as per Schedule III of the Companies
Act, 2013

Example 1
Q Ltd. is registered with a capital of Rs 7,00,000 divided in 70,000 shares of Rs 10 each. Out
of these, 50,000 shares were offered to the public for subscription. All the shares were fully
subscribed by the public and all the money was received. Show the share capital in the
Company’s Balance Sheet as per Schedule III of the Companies Act, 2013.

Solution
Q Ltd.
Balance Sheet
Note Amount
Particulars
No. (Rs)
I. Equity and Liabilities
1. Shareholders’ Funds
a. Share Capital 1 5,00,000
2. Non-Current Liabilities
3. Current Liabilities
Total 5,00,000

II. Assets
1. Non-Current Assets
2. Current Assets
a. Cash and Cash Equivalents 2 5,00,000
Total 5,00,000
NOTES TO ACCOUNTS
Amount
Note No. Particulars
(Rs)
1 Share Capital
Authorised Share Capital
70,000 shares of Rs 10 each 7,00,000
Issued Share Capital
50,000 shares of Rs 10 each 5,00,000
Subscribed, Called-up and Paid-up Share Capital
50,000 shares of Rs 10 each 5,00,000

2 Cash and Cash Equivalents

Cash at Bank 5,00,000

Example 2
RS Ltd. has an authorised capital of Rs 1,00,000 divided in 10,000 shares of Rs 10 each. Out
of these, 7,000 shares were offered to the public at a premium of Rs 3. Company received
the applications only for 5,000 shares. All the money was duly received. Show the relevant
items in the Company’s Balance Sheet as per Schedule III of the Companies Act, 2013.

Solution

RS Ltd.
Balance Sheet
Amount
Particulars Note No.
(Rs)
I. Equity and Liabilities
1. Shareholders’ Funds
a. Share Capital 1 50,000
b. Reserves and Surplus 2 15,000
2. Non-Current Liabilities
3. Current Liabilities
Total 65,000

II. Assets
1. Non-Current Assets
2. Current Assets
a. Cash and Cash Equivalents 3 65,000
Total 65,000
NOTES TO ACCOUNTS
Amount
Note No. Particulars
(Rs)
1 Share Capital
Authorised Share Capital
10,000 shares of Rs 10 each 1,00,000
Issued Share Capital
7,000 shares of Rs 10 each 70,000
Subscribed, Called-up and Paid-up Share Capital
5,000 shares of Rs 10 each 50,000

2 Reserves and Surplus

Securities Premium 15,000

3 Cash and Cash Equivalents

Cash at Bank 65,000

Example 4
SK Ltd. is registered with a capital of Rs 20,00,000 divided into equity shares of Rs 100
each. Out of these 5,000 shares were issued to the vendor as fully paid purchase
consideration for a machinery purchased. Remaining shares were offered to the general
public. All the calls were made and duly received except the first and final call of Rs 30 per
share on 1,200 shares. Out of these shares, 700 shares were forfeited by the company for
the non-payment of the call money. Show how Share Capital will appear in the Company’s
Balance Sheet as per Schedule III of the Companies Act, 2013.

Solution

SK Ltd.
Balance Sheet
Amount
Particulars Note No.
(Rs)
I. Equity and Liabilities
1. Shareholders’ Funds
a. Share Capital 1 19,64,000
2. Non-Current Liabilities
3. Current Liabilities
Total 19,64,000
II. Assets
1. Non-Current Assets
a. Fixed Assets
i. Tangible Assets 2 5,00,000
2. Current Assets
a. Cash and Cash Equivalents 3 14,64,000
Total 19,64,000

NOTES TO ACCOUNTS
Amount
Note No. Particulars
(Rs)
1 Share Capital
Authorised Share Capital
20,000 shares of Rs 100 each 20,00,000
Issued Share Capital
20,000 shares of Rs 100 each 20,00,000
Subscribed, Called-up and Paid-up Share Capital
5,000 shares of Rs 100 each issued to the vendor 5,00,000
14,300 shares of Rs 100 each 14,30,000
Less: Calls-in-Arrears (500 × 30) (15,000)
Add: Share Forfeiture (700 × 70) 49,000 14,64,000
19,64,000

2 Tangible Assets
Machinery 5,00,000

3 Cash and Cash Equivalents

Cash at Bank 14,64,000
 Chapter- 3
Financial Statements of a Company

 Meaning of Financial Statements

The Financial Statements are those statements that express the performance and position of
an organisation in financial terms to various users of accounting information such as,
creditors, management, employees, etc.

 Nature of Financial Statements

The nature of the financial statements depends upon the following aspects like recorded
facts, conventions, concepts, and personal judgment
 Recorded facts- As the items are recorded in the financial statements at their original cost
(i.e. the cost at which they were acquired), therefore, the financial statements fail to
reveal the current market price and fail to capture the inflation effects.
 Conventions- The adherence of accounting conventions for preparation of financial
statements such as, Prudence Convention, Materiality Convention, Matching Concept,
makes the financial statements easy to understand, comparable and reflect the true and
fair financial position of a company.
 Accounting Assumptions- The adherence of postulates (accounting assumptions) such as,
Going Concern Concept, Money Measurement Concept, Realisation Concept, etc reflects
the nature of such postulates in the nature of the financial statements.
 Personal Judgments- Different value judgments are attached to different practices of
recording transactions in the financial statements. For example, provision on various
assets, method of charging depreciation, period related to writing-off intangible assets
depends on personal judgment.

 Objectives of Financial Statements

 To know the performance and position of enterprise in financial terms.
 To judge the efficiency of management.
 To provide information about expenses incurred and revenues from various activities.
  To use the information for drafting policies and plans by conducting inter-firm and intra-
firm comparisons.
 To disclose important changes in the accounting methods, practices and accounting
process of the company, so that the financial statements are simple, true and enables
different accounting users to understand without any ambiguity

 Annual Reports
 Meaning and Components of Annual Reports
 The Annual Reports of a company provide information about various affairs
and financial statements of the company.
 Annual Reports comprise of Directors’ Report, Auditors’ Reports, Cash Flow
Statements, Segment Reports, Financial Statements- Income Statements and Balance
Sheets. Besides these, the Annual Reports also consist of notes regarding adaption of
accounting policies, explanatory notes and other notes disclosing information that are
required as per the Schedule III of the Companies Act.

 Which companies need to prepare Annual Reports?

 All the companies that are listed on the recognised Stock Exchanges,
 Enterprises having a turnover of more than Rs 50 crores, and
 Companies having accepted Rs 10 crores of Public Deposits

 Financial Statements of a Company

As per the Schedule III of the Companies Act, 2013, the financial statements of a company
consist of:
 Statement of Profit and Loss
 Balance Sheet
 Cash Flow Statement
 Statement of Changes in Equity (if applicable)
 Any explanatory notes or Notes to Accounts annexed to or forming part of any of
the documents listed above
 Statement of Profit and Loss- Purpose
 These are prepared to ascertain profit earned (or loss incurred) by a company during an
accounting period
 The Statement of Profit and Loss also present a concise version (summary) of revenues
earned and expenses incurred to earn revenues.

 Presentation of Statement of Profit and Loss

As per the Schedule III of the Companies Act, 2013, the format for preparing the Statement of
Profit and Loss is given below as:

Statement of Profit and Loss

for year ended...
Figures for Figures for
Note
S. No. Particulars the Current the Previous
No.
Year Year
I Revenue from Operation
II Other Income
III Total Revenue (I + II) Expenses:
IV Cost of Material Consumed
Purchase of Stock-in-Trade
Changes in inventories of finished goods
Work-in-progress and Stock-in-Trade
Employee Benefit Expenses
Finance Cost
Depreciation and amortisation expenses
Other Expenses
Total Expenses

V Profit before exceptional and extraordinary

items and tax (III – IV)
VI Exceptional items
VIIProfit before extraordinary item and tax (V–VI)
VIIIExtraordinary Items
IX Profit Before Tax (VII – VIII)
X Tax Expenses
(1) Current Tax
(2) Deferred Tax
 XI Profit/(Loss) for period from continuing
operations (IX – X)
XII Profit/ (Loss) from discontinuing operations
XIII Tax expenses of discontinuing operations
XIV Profit/(Loss) from discontinuing operations
(after Tax (XII – XIII)
XV Profit (Loss) for the period (XI + XIV)
XVI Earning Per Equity Shares
(1) Basic
(2) Diluted

 Balance Sheet- Meaning

It refers to a statement that shows the financial position of an organisation in the form of
assets and liabilities on a particular date.

 Presentation of Balance Sheet

Company Balance Sheet is prepared by following the general principles of accounting. As
per the Schedule III of the Companies Act 2013, the Company’s Balance Sheet is prepared
in the following manner.
Balance Sheet
as at...
Figures at Figures at the
Note the end of end of the
Particulars
No. the Current Previous
Year Year
I. Equity and Liabilities
1. Share holder’s Funds
a. Share Capital
b. Reserves and Surplus
c. Money received against Share Warrants

2. Share Application Money Pending Allotment

3. Non-Current Liabilities
a. Long-Term Borrowings
b. Deferred Tax Liabilities
 c. Other Long-Term Liabilities
d. Long-Term Provisions

4. Current Liabilities
a. Short-Term Borrowings
b. Trade Payables
c. Other Current Liabilities
d. Short-Term Provisions
Total

II. Assets
1. Non-Current Assets
a. Fixed Assets
i. Tangible Assets
ii. Intangible Assets
iii. Capital Work-in-Progress
iv. Intangible Assets under Development
b. Non-Current Investments
c. Deferred Tax Assets
d. Long-Term Loans and Advances
e. Other Non-Current Assets

2. Current Assets
a. Current Investments
b. Inventories
c. Trade Receivables
d. Cash and Cash Equivalents
e. Short-Term Loans and Advances
f. Other Current Assets
Total

 Cash Flow Statement

It refers to a statement that records inflows and outflows of cash and cash equivalents during
a particular period.
 Statement of Changes in Equity
It provides the details of the change in owners’ equity over an accounting period. Statement
of changes in Equity includes few of the following items such as Net profit or loss, change in
share capital reserves, dividend payments to shareholders, change in accounting policies, etc.

 Notes to Accounts
It provides the details regarding the items mentioned in the Balance Sheet and Statement of
Profit and Loss. Additional disclosures specified in the Accounting Standards are made by
the way of notes to accounts or by the way of additional statement unless required to be
disclosed on the face of the Financial Statements.

 Importance/Advantages of Financial Statements

 Provides Information- Financial statements provide information to various accounting
users both internal as well as external users.
 Cash Flow- Financial statements provide information about the cash flows of the
company. The financial statements help the creditors and other investors in
determining solvency of company.
 Effectiveness of Management- The comparability feature of the financial statements
enables management to undertake comparisons- inter-firm and intra-firm comparisons.
This not only helps in assessing the viability and performance of the business but also
helps in designing policies and drafting policies, thereby enhances the effectiveness and
efficacy of the management.
 Disclosure of Accounting Policies- Financial Statements disclose vital information
regarding various policies, important changes in the methods, practices and process of
accounting by the company, which makes it simpler, true and comprehend without any
ambiguity.
 Policy Formation by Government- Financial Statements provide various information to
the government to determine national income, GDP, industrial growth, etc and also to
formulate various policy measures to address economic problems such as, employment,
poverty, etc.
  Attracts Investors and Potential Investors- The financial statements attract investors by
enabling them to assess the viability and prospectus of their investment in the company.

 Limitations/Disadvantages of Financial Statements

 Historical Data- As the items recorded in the Financial Statements reflect their original
cost and the current market price, so the financial statements fail to capture the
inflation effects.
 Ignorance of Qualitative Aspect- Financial Statements does not reveal the qualitative
aspects such as, colour, size, employees’ capabilities and market position.
 Biased- Financial statements are based on the personal judgments the concerned
accountants and clerks regarding the use of methods of recording.
 Inter- firm Comparisons- Usually, it is difficult to compare the financial statements of
two companies because of the difference in the methods and practices followed by
their respective accountants.
 Window dressing- The possibility of window dressing is probable. This might be
because of the motive of the company to overstate or understate the assets and liabilities
to attract more investors. A recent example of this practice can be traced to the case of
Satyam Industries.
 Difficulty in Forecasting- Since the Financial Statements fail to reflect the effect of
inflation, so forecasting and policy designing is difficult on the basis of the historical
cost.
 Chapter- 4

Analysis of Financial Statements

 Meaning of Analysis of Financial Statements

 It means studying and comparing the data contained in financial statements.

 The purpose of analysing is to understand the cause and effect relationship between the
items of the financial statements and also to conduct a meaningful comparison of data
of two or more financial statements.
 The analysis of financial statements helps in exercising various effective
controls, drafting effective and efficient plans.
 The major emphasis of the analysis of financial statements is to make the financial
data user-friendly, so that it can be understood and interpreted by various accounting
users such as, managers, creditors and customers in an easy and unambiguous manner.

 Objectives of Financial Analysis

 It enables conduct of meaningful comparisons of financial data. It provides better
and easy understanding of changes in the financial data overtime.
 It helps in designing effective plans and better execution of plans by enabling control and
checks over the use of financial resources.
 It helps in analysing the profit-earning ability of an enterprise.
 It also helps in assessing the Solvency position of the business.

 Limitations of Financial Statements Analysis

 It ignores the qualitative and non-monetary aspects

 It ignores changes in the price level. It may result in wrong interpretation
when statements of comparisons are prepared by using diverse accounting
policies.
 The analysis may involve personal biasness It cannot provide accurate analysis
because some items of financial statement such as depreciation, provisions, etc. are
recorded on the past experiences and estimates.

 Tools of Financial Analysis

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  Comparative Statements: These financial statements enable comparisons of data of
financial statements of two or more periods of a same enterprise or financial statements
of two or more enterprises. These statements express the absolute change and
percentage change in the financial items over a period of time. The following are the
commonly prepared Comparative Financial Statements.
 Comparative Balance Sheet
 Comparative Income Statement (Statement of Profit and Loss)

 Common Size Statements: These statements depict the relationship between various
items of financial statements and some common items (like Revenue from Operations
and the Total of Balance Sheet) in percentage terms. In other words, various items of
Statement of Profit and Loss such as, Cost of Materials Consumed, Purchase of Stock-in-
Trade, Finance Costs, Other Expenses, etc. are expressed in terms of percentage of
Revenue from Operations. On the other hand, different items of Balance Sheet such as,
Non-Current Assets, Current Assets, Shareholders’ Funds, Non-Current Liabilities, etc.
are expressed in terms of percentage of Total of the Balance Sheet. The following are the
commonly prepared Common Size Financial Statements.
 Common Size Balance Sheet
 Common Size Income Statement (Statement of Profit and Loss)

 Trend Percentage Analysis: This analysis undertakes the study of trend in the
financial positions and the operating performance of a business over a series of
successive years. In this technique, a particular year is assumed to be the base year and
the figures of all other years are expressed in percentage terms of the base year’s
figures.

 Ratio Analysis: This technique is used to express the relationship between two
accounting variable in terms of ratio. It helps in ascertaining the profitability,
operational efficiency, solvency, etc of a firm. The analysis expresses financial items in
terms of percentage, fraction, proportion and as number of times. It enables budgetary
controls by assessing the qualitative relationship among different financial variables.

 Cash Flow Analysis: It refers to analysis of inflows and outflows of cash and cash
equivalents from operating activities, investing activities and financing activities of
an enterprise during a particular period of time.

 Parties Interested in the Analysis of Financial Statements

2
 Parties Reasons for their interest
To know solvency, profitability, liquidity, turnover of the
Owners
business
To conduct and assess overall financial viability of the
Management
business
To assess the solvency and profitability of the business to
Long-term lender
judge the safety of their funds
To assess the liquidity and profitability of the business to
Creditors
judge the safety of their funds
To assess the profitability of the business and bargain for the
Employees
wage-hike

 Comparative Balance Sheet

Comparative Balance Sheet
as on…..
Absolute Percentage
Change Change
Previous Current
Particulars (Increase/ (Increase/
Year Year
Decrease) Decrease)
(Rs) (%)
I. Equity and Liabilities
1. Shareholder’s Funds
a. Equity Share Capital
b. Preference Share Capital
c. Reserves and Surplus
2. Non-Current Liabilities
a. Long-Term Borrowings
i. Secured Loans
ii. Unsecured Loans
b. Other Long-Term Liabilities
3. Current Liabilities
a. Short-Term Borrowings
b. Trade Payables
c. Other Current Liabilities
d. Short-Term Provisions

Total

II. Assets
1. Non-Current Assets
a. Fixed Assets
i. Tangible Assets
ii. Intangible Assts
b. Non-Current Investments
c. Long-Term Loans and Advances
d. Other Non-Current Assets

3
 2. Current Assets
a. Inventories
b. Trade Receivables
c. Cash and Cash Equivalents
d. Short-Term Loans and Advances
e. Other Current Assets
Total

Example
Following are the Balance Sheets of Kranti Flour Mills Ltd. for the year ended March 31,
2011 and 2012.
Balance Sheet
2011 2012
Note
Particulars Amount Amount
No.
(Rs) (Rs)
I. Equity and Liabilities
1. Shareholders’ Funds
a. Equity Share Capital 3,00,000 5,10,000
b. Reserves and Surplus 1,00,000 80,000
2. Non-Current Liabilities
a. Long-Term Borrowings (12% Debentures) 70,000 1,00,000
3. Current Liabilities
a. Trade Payables (Sundry Creditors) 30,000 60,000
Total 5,00,000 7,50,000

II. Assets
1. Non-Current Assets
a. Fixed Assets 3,50,000 4,50,000
b. Non- Current Investments 70,000 1,40,000
2. Current Assets
a. Trade Receivables (Sundry Debtors) 80,000 1,60,000
Total 5,00,000 7,50,000

Prepare a Comparative Balance Sheet of Kranti Flour Mills Ltd.

Solution
Comparative Balance Sheet
as on March 31, 2011 and 2012
Absolute Percentage
Particulars 2011 2012 Change Change
(Rs) (%)
I. Equity and Liabilities
1. Shareholders’ Funds
a. Equity Share Capital 3,00,000 5,10,000 2,10,000 70
4
 b. Reserve and Surplus 1,00,000 80,000 (20,000) (20)
2. Non-Current Liabilities
a. Long-Term Borrowings (12% Debentures) 70,000 1,00,000 30,000 42.86
3. Current Liabilities
a. Trade Payables (Sundry Creditors) 30,000 60,000 30,000 100
Total 5,00,000 7,50,000 2,50,000 50

II. Assets
1. Non-Current Assets
a. Fixed Assets 3,50,000 4,50,000 1,00,000 28.57
b. Non- Current Investments 70,000 1,40,000 70,000 100
2. Current Assets
a. Trade Receivables (Sundry Debtors) 80,000 1,60,000 80,000 100
Total 5,00,000 7,50,000 2,50,000 50

Absolute Increase or Decrease = Current Years’ Figures – Previous Years’ Figures

Percentage Increase or Decrease Absolute Increase or Decrease

 100
Previous Years' Absolute
Figure

 Common Size Balance Sheet

Common Size Balance Sheet

as on…..
Percentage of Balance
Absolute Amount
Sheet Total
Note
Particulars Previous Current Previous Current
No.
Year Year Year Year
(Rs) (Rs) (%) (%)
I. Equity and Liabilities
1. Shareholders’ Funds
a. Equity Share Capital
b. Preference Share Capital
c. Reserves and Surplus
2. Non-Current Liabilities
a. Long-Term Borrowings
i. Secured Loans
ii. Unsecured Loans
b. Other Long-Term Liabilities
3. Current Liabilities
a. Short-Term Borrowings
b. Trade Payables
c. Other Current Liabilities
d. Short-Term provisions
5
Total

6
 II. Assets
1. Non-Current Assets
a. Fixed Assets
i. Tangible Assets
ii. Intangible Assts
b. Non-Current Investments
c. Long-Term Loans and Advances
d. Other Non-Current Assets
2. Current Assets
a. Inventories
b. Trade Receivables
c. Cash and Cash Equivalents
d. Short-Term Loans and Advances
e. Other Current Assets
Total

Using the above example of Kranti Flour Mills Ltd., prepare the Common Size Balance
Sheet.

Solution
Common Size Balance Sheet
as on year ended 2012 and 2013
Percentage of
Absolute Amount
Balance Sheet Total
Particulars (Rs)
(%)
2011 2012 2011 2012
I. Equity and Liabilities
1. Shareholders’ Funds
a. Equity Share Capital 3,00,000 5,10,000 60 68
b. Reserves and Surplus 1,00,000 80,000 20 10.67
2. Non-Current Liabilities
a. Long-Term Borrowings (12% Debentures) 70,000 1,00,000 14 13.33
3. Current Liabilities
a. Trade Payables (Sundry Creditors) 30,000 60,000 6 8
Total 5,00,000 7,50,000 100 100

II. Assets
1. Non-Current Assets
a. Fixed Assets 3,50,000 4,50,000 70 60
b. Non-Current Investments 70,000 1,40,000 14 18.67
2. Current Assets
a. Trade Receivables (Sundry Debtors) 80,000 1,60,000 16 21.33
Total 5,00,000 7,50,000 100 100

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 Previous Year Percentage Previous Years' Absolute Figure
100
= Total of Balance Sheet of Previous
Year
Current Year Percentage Current Years' Absolute Figure
100
= Total of Balance Sheet of Current
Year
 Comparative Statement of Profit and Loss
Comparative Statement of Profit and Loss
Absolute Percentage
Previous Current
Particulars Change Change
Year Year
(Rs) (%)
I. Revenue from Operations
II. Other Incomes
Total Revenue (I +
II)
Less: Expenses
Cost of Material Consumed
Purchase of Stock-in-Trade
Changes in Inventories of Finished
Goods Work-in-Progress and Stock-in-
Trade Employees Benefit Expenses
Finance Costs
Depreciation and Amortisation Expenses
Other Expenses
Profit Before Tax
Less: Tax
Profit After Tax

Example
Following data related to income and expenditure of Prakash Lites Ltd. as on March 31, 2011
and 2012.
Particulars 2011 2012
Revenue from Operations 8,00,000 9,00,000
Cost of Material Consumed 40% of Revenue 50% of Revenue
Other Expenses 5% of Revenue 5% of Revenue
Income Tax 40% of Profit before Tax 40% of Profit before Tax

Solution
Comparative Statement of Profit and Loss
Absolute Percentage
Particulars 2012 2013 Change Change
(Rs) (%)
I. Revenue from operations 8,00,000 9,00,000 1,00,000 12.5
Less: Expenses

8
 Cost of Material Consumed 3,20,000 4,50,000 1,30,000 40.63
Other Expenses 40,000 45,000 5,000 12.50
Profit before Income Tax 4,40,000 4,05,000 (35,000) (7.95)
Less: Income Tax @ 40% 1,76,000 1,62,000 (14,000) (7.95)
Profit after Income Tax 2,64,000 2,43,000 (21,000) (7.95)

Absolute Increase or Decrease = Current Years’ Figure – Previous Years’ Figure

Percentage Change % Absolute Change

100
= Previous Years'
Figure

 Common Size Statement of Profit and Loss

Common Size Statement of Profit and Loss
for the year ended...
Percentage of Revenue
Absolute Amount
from Operations
Particulars Previous Current Previous Current
Year Year Year Year
(Rs) (Rs) (%) (%)
I. Revenue from Operations
II. Other Income
Total Revenue (I +
II)
Less: Expenses
Cost of Material Consumed
Purchase of Stock-in-Trade
Changes in Inventories of Finished
Goods, Work-in-Progress and Stock-in-
Trade Employees Benefit Expenses
Finance Costs
Depreciation and Amortisation Expenses
Other Expenses
Profit before Tax
Less: Tax
Profit after Tax

Example:
Using the data related to income and expenditure of Prakash Lites Ltd.
Common Size Income Statement
for the year ended 2011 and 2012
Percentage of Revenue
Absolute Amount
from Operations
Particulars (Rs)
(%)
2011 2012 2011 2012

9
I. Revenue from Operations 8,00,000 9,00,000 100 100
Less: Expenses
Cost of Material Consumed 3,20,000 4,50,000 40 50
Other Expenses 40,000 45,000 5 5

10
 Profit before Income Tax 4,40,000 4,05,000 55 45
Less: Income Tax @ 40% 1,76,000 1,62,000 22 18
Profit after Income Tax 2,64,000 2,43,000 33 27

Previous Year Percentage Previous Years' Absolute Figure

100
= Revenue from Operations of Previous
Year
Current Year Percentage Current Years' Absolute Figure
100
= Revenue from Operations of Current
Year

 Advantages of Comparative Statements

 The side-by-side presentation of financial items not only makes the presentation clear
but also enables easy comparisons (both intra-firm and inter-firm) conclusive.
 The presentation of comparative statement is so effective that it enables the analyst
to draw conclusion quickly and easily and that too without any ambiguity
 The comparative analysis of profitability and operational efficiency of a business over
a period of time enables the management to forecast and draft various future plans.
 The comparative analysis not only enables the management in locating the problems but
also helps them to put various budgetary controls and corrective measures to check
whether the current performance is aligned with that of the planned targets.

 Disadvantages of Comparative Statements

 The most important disadvantage of Comparative Statements is that they fail to
capture the effects of price change.
 Further, these statements lead to misleading conclusions in case of changes in
the accounting policies and accounting practices over the period of study.
 As these statements record the financial items at their original cost and not at their
current market price, so they may lead to wrong and misleading conclusions regarding
the profitability and efficiency of the business

 Advantages of Common Size Statements

 It helps in ascertaining the ratio of each item to a common item (Net Sales and Total
of Balance Sheet) of the financial statements in terms of percentage.
 It also helps in analysing the impact of each item on the operation and efficiency of
the business.
 It enables comparisons such as, inter-firm and intra-firm comparisons of
liquidity, solvency and efficiency.

 Disadvantages of Common Size Statements

 These statements determine the proportion of each item to a common item rather
than comparing the figures of the same item over a period of time.
 These statements enable only cross-sectional analysis of financial data.

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 Advantages of Trend Analysis
 As the trends are expressed in percentage figures, so it is the most popular financial
analysis to analyse the financial performance and operational efficiency of the
company.
 Analysing the percentage figures of trends is easy and also less time consuming.
 Trend Analysis helps the accounting users to forecast the future trend of the business.
 One need not to have an in-depth and sophisticated knowledge of accounting in order
to analyse these percentage trends.
 Generally, companies prefer to present their financial data for a period of 5 or 10 years
in forms of percentage trends, whereas the other techniques of Financial Analysis lack
this popularity.

 Disadvantages of Trend Analysis

 Trend analysis can lead to meaningful conclusion only over a long period of time, say
10 to 15 years.
 Selection of base year involves personal biasness.
 Comparison in terms of the base year may be meaningless if the base year happens to be
an extraordinary year. For example, it may happen that in the base year the company may
have earned either supernormal profits or supernormal losses.
 It only highlights the change in the relative terms of the base year’s and not in
relative terms of the previous or next year.

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