UNIT 1
Accounting principles
Accounting concepts defines the assumption on the basis of which financial statement of a business entity is prepared. Concepts are those basic assumption and condition which for the basis upon which the accountancy has been laid.
Accounting principles
- They should be based on real assumption
- They must be simple, understandable and explanatory
- They must be followed consistently
- They should be able to reflect future predictions
- They should be informational to users
Accounting convention emerges out of accounting practices, commonly known as accounting principle, adopted by various organizations over a period of time. Accounting bodies may change any of the convention to improve the quality of accounting information.
Accounting concepts
- Entity concept – Entity concept states that the business enterprise and its owner are two separate independent entities. Thus, the business and personal transaction of its owner are separate.
For example, when owner invests money in the business, it is recorded as liability of the business to the owner. Similarly, when owner takes money from business for personal use, it is not treated as business expenses.
2. Money measurement concept – This concept assumes that all business transaction must be in terms of money. Thus transactions expressed in terms of money are recorded in the books of account.
For example – sale of good, rent paid are expressed in money so recorded in books of account. Whereas sincerity, loyalty are not recorded in books of account because they cannot be measured in monetary terms.
3. Going concern concept - This concept states that a business firm will continue to carry on its activities for an indefinite period of time. It means every business entity has continuity of life and will not be resolved in the near future.
4. Accounting period concept –All transaction are recorded in the books of account on the assumption that profits on these transaction are to be ascertained for a specific period. Thus, this concept states that a balance sheet and profit and loss account should be prepared at regular interval
5. Accounting cost concept – It states that all assets are recorded in the books of account at their purchase price which include cost of acquisition, transportation and installation and not at its market price.
For example – fixed assets like building, machinery are recorded at purchase price
6. Dual aspect concept – dual aspect is the basic principle of accounting. It provides the basis of recording accounting transactions. For every credit, a corresponding debit is made. Therefore the transaction should be recorded in two places.
7. Matching concept – this concept states that revenue and expenses incurred to earn profit must belong to the same accounting period. So once the revenue is realized, the next step is to allocate it to the relevant accounting period. It is very helpful for the investors to know the exact amount of profit and loss in the business
8. Realization concept – the concept states that, revenue is realized at the time when goods and services are actually delivered. An advance or fee paid is not considered a profit until the goods or services are delivered to the buyer.
9. Accrual concept – accrual concept means the amount of money is yet to be paid or received at the end of the accounting period. It means cash received or not and expenses paid or not, both the transaction will be recorded in the books of account in that accounting period
Accounting convention
- Consistency – consistency means same accounting principles should be uses year after year, so that same standards are applied to calculate profit and loss. While comparing over a period of time a meaningful conclusion can be drawn. If a different accounting principles are used , then it cannot be comparable
2. Full disclosure – It includes all material and relevant facts concerning financial statements should be fully disclosed. Full disclosure means full, fair, adequate disclosure of accounting information. Parties like investor, lender, etc are interested in the financial information, so the business entity should disclose full and fair information.
3. Materiality – it means all material fact should be recorded in accounting. Accountant should record important data and leave insignificant data. Material fact influence the decision of the users.
4. Conservatism – the conservatism is based on the principle that “Anticipate no profit, but provide all the possible losses”. The main objective is to show minimum profit. Profit should not be over estimated. It is an unfair convention, it will lead to reduction in the capital of an enterprise
Key takeaways:
- Accounting rules are guidelines that help companies determine how to record business transactions that are not yet fully covered by accounting standards.
- They are generally accepted by accounting institutions, but are not legally binding.
- Accounting rules no longer apply if the supervisory body has guidelines that address the same topics as accounting rules.
- There are four widely recognized accounting rules. Conservatism, consistency, full disclosure, and importance.
- Accounting policies are the procedures that a company uses to prepare financial statements. Unlike accounting principles, which are rules, accounting policies are the basis for following those rules.
- Accounting policies may be used to legally manipulate revenue.
- The choice of a company in its accounting policy indicates whether management is willing or conservative in reporting its revenue.
- Accounting policies should still adhere to generally accepted accounting principles (GAAP).
AS - 1
The information presented in the financial statements of an organisation is of its financial position. The profit or loss can be affected to a large degree by the accounting policies followed. The accounting policies followed vary from organisation to organisation. It is important to disclose significant accounting policies followed to make the financial statements understandable. The disclosure is required by law in certain cases.
Fundamental Accounting Assumptions
Certain assumptions are used in the preparation of financial statements. They are usually not specifically stated because they are assumed to be followed. Disclosure is necessary only if they are not followed.
The following have been generally accepted as fundamental accounting assumptions:
Going Concern
An entity is considered to be in business unless there is evidence of opposition. Because companies are relatively permanent, financial accounting is designed with the assumption that the business will survive indefinitely in the future.
Consistency
It is assumed that accounting policies are consistently followed from one period to another. No frequent changes are expected.
Accrual
Revenues and costs are recorded when they are earned or incurred (and not as money is received or paid) in the periods to which they relate.
Considerations in the Selection of Accounting Policies
The major considerations governing the selection and application of accounting policies are:
Prudence
In view of the uncertainty of future events, profits are not anticipated but recognised only when earned, though not necessarily in cash. However, provision is made for all known liabilities and losses even though the amount cannot be determined with certainty and represents only an estimate.
Substance over Form
The accounting treatment and presentation of transactions and events in financial statements should be governed by their substance and not merely by the legal form.
Materiality
Financial statements should disclose all “material” items, i.e. items, the knowledge of which might influence the decisions of the user of the financial statements.
Accounting standard 9 – revenue recognition
Revenue refers to measurement of the amount charged to the clients for the sale of goods and services. in the case of the agency relationship, the revenue are measured by the amount charged for commission and not on the gross inflow of the cash, receivables or other consideration.
As per the AS 9 Revenue Recognition issued by ICAI “Revenue is the gross inflow of cash, receivables or other consideration arising in the course of the ordinary activities of an enterprise from the sale of goods, rendering of services & from various other sources like interest, royalties & dividends”.
Applicability of AS 9 Revenue Recognition
This accounting standard was issued by ICAI in the year 1985. In the initial years, it was for only Level I enterprises and but from April 01, 1993 it was made mandatory for all other enterprises.
As per ICAI, “Enterprise means a company as defined in section 3 of the Companies Act, 1956”.
Level I enterprises are those enterprises whose turnover for the immediately preceding accounting year exceeds 50 crores. The turnover here does not include other income and is applicable for holding as well as subsidiary companies.
Sale of goods
Sale of good is one of the key elements to recognise the revenue which involves for a consideration the seller has transferred the property in the goods to the buyer. The property in the goods means the transfer of the significant risks and rewards in ownership of the goods.
In case when the sale is assured under government guarantee or a forward contract or where the market exists and there is a negligible risk of failure to sell, the goods involved are often valued at the net realizable value (NRV).
Rendering of services
Service Revenue are recognised depends as the service is performed. This is further divided into two ways:
- Proportionate Completion Method: under his method revenue are recognised with the degree of completion of each service proportionately in the statement of profit & loss.
- Completed Service Contract Method: under this method revenue are recognised only when the rendering of services under a contract is completed or substantially completed in the statement of profit & loss.
Interest, royalties & dividends
- Interest: Revenue is recognized on the time proportion basis after taking into account the amount outstanding and the rate applicable.
For Example: If the interest on FD is due on 30th June and 31st Dec. On 31st March when the books will be closed, though the interest for the period of Jan-March will be received in June, still we have to recognize the revenue in March itself.
- Royalties: The charge for the use of patents, know-how, trademarks, and copyrights refers to royalties. On the basis of accrual basis and in accordance with the relevant agreement revenue has to be recognized.
For Example: If the royalty is payable based on the number of copies of the book, then it has to be recognized on that basis only.
Dividends: Revenue has to be recognized when the owner’s right to receive payment is established. This happens when the company declare the dividends on the shares to their shareholders
Issue of shares
Definition
A “share” has been defined by the Indian Companies Act, as “A share is the share in the Capital of the Company”.
Types of shares
A Company can issue two types of shares – Equity and Preference.
- Equity Shares: Equity shares means that part of the share capital which is not a Preference share capital. It means all such shares which are not Preference shares. Equity shares are also called as Ordinary Shares.
- Preference Shares: Preference shares are those shares which fulfill both the following two conditions:
(i) They carry preferential share right in respect of dividend at a fixed rate,
(ii) They also carry preferential right in regard to payment of capital on winding up of the company.
Preference shares can be further classified as follows:
1) Cumulative and Non – Cumulative : If in any year the profits are insufficient to pay the preference dividend then in case of cumulative preference shares this dividend can be paid in the subsequent year before any other dividend is paid. In other words the right to receive the dividend goes on accumulating till it is paid. In case of Non – cumulative preference shares the dividend can be paid only in that year. If there are insufficient profits then such preference shareholders do not get any dividend for that year.
2) Participating & Non-Participating Preference Shares: Participating preference shares are entitled to participate in the surplus profits remaining after the payment of (a) Fixed dividend to Preference shareholders and (b) Dividend to the equity shareholders. They are also entitled to participate in the surplus funds remaining at the time of winding of the company after payment of (a) Preference share capital & (b) Equity Share Capital. Non – participating preference share are not entitled to participate in the surplus profits or surplus funds left over at the time of winding off.
Procedure for issue of shares
- Issue of Prospectus: Whenever shares are to be issued to the public the company must issue a prospectus. Prospectus means an open invitation to the public to take up the shares of the company thus a private company need not issue prospectus. Even a Public Company issuing it’s shares privately need not issue a prospectus. However, it is required to file a “Statement in lieu of Prospectus” with the register of companies. The Prospectus contains relevant information like names of Directors, terms of issue, etc. It also states the opening date of subscription list, amount payable on application, on allotment & the earliest closing date of the subscription list.
- Application of Shares: A person intending to subscribe to the share capital of a company has to submit an application for shares in the prescribed form, to the company along with the application money before the last date of the subscription mentioned in the prospectus.
Over Subscription: If the no. of shares applied for is more than the no. of shares offered to the public then that is called as over Subscription.
Under Subscription: If the no. of shares applied for is less then the no. of shares offered to the public then it is called as Under Subscription.
3. Allotment of Shares: After the last date of the receipt of applications is over, the Directors, Proceed with the allotment work. However, a company cannot allot the shares unless the minimum subscription amount mentioned in the prospectus is collected within a stipulated period. The Directors pass resolution in the board meeting for allotment of shares indicating clearly the class & no. of shares allotted with the distinctive numbers. Then Letters of Allotment are sent to the concerned applicants. Letters of Regret are sent to those who are not allotted any shares & application money is refunded to them.
Partial Allotment: In partial allotment the company rejects some application totally, refunds their application money & allots the shares to the remaining applicants.
Pro-rata Allotment: When a company makes a pro-rata allotment, it allots shares to all applicants but allots lesser shares then applied for E.g. If a person has applied for three hundred shares he may get two hundred shares.
4. Calls on Shares: The remaining amount of shares may be collected in installments as laid down in the prospectus. Such installments are called calls on Shares. They may be termed as “Allotment amount, First Call, Second Call, etc.”
5. Calls–in–Arrears: some shareholders may not pay the money due from them. The outstanding amounts are transferred to an account called up as “Calls-in-Arrears” account. The Balance of calls-in-arrears account is deducted from the Called-up capital in the Balance Sheet.
6. Calls–in–Arrears: some shareholders may not pay the money due from them. The outstanding amounts are transferred to an account called up as “Calls-in-Arrears” account. The Balance of calls-in-arrears account is deducted from the Called-up capital in the Balance Sheet.
Terms of issue of shares
A limited company may issue the shares on following different terms.
(a) Issue of Shares for Consideration other than cash or for cash or on capitalization of reserves.
(b) Issue of Shares at par i.e. at face value or at nominal value.
(c) Issue of Shares at a Premium i.e. at more than face value.
(d) Issue of Shares at a Discount i.e. at less than the face value.(omitted in Companies Act,2013)
Accounting entries
For receipt of application money
Bank A/c………………………………Dr.
To Share Application A/c
On Allotment
1) Transfer of Application money to Share Capital
Share Application A/c..………….. Dr.
To Share Capital A/c
2) Amount due to on Allotment
Share Allotment A/c………………Dr.
To Share Capital A/c
To Securities Premium Account (if any)
Refund of excess Application money on rejected application
Share Application A/c……………..Dr.
To Bank A/c
Adjustment of excess application money towards allotment money due.
Share Application A/c…………….Dr.
To Share Allotment A/c
Receipt of Allotment money.
Bank A/c…………………………….Dr.
To Share Allotment A/c
For making First Call
Share First Call A/c……………………..Dr.
To Share Capital A/c
For receipt of First Call Money
Bank A/c…………………………………Dr.
To Share First Call A/c
For calls in arrears
Calls in Arrears A/c……………………..Dr.
To Share First Call A/c
For receipt if calls in advance
Bank A/c…………………………………Dr.
To Calls in Advance A/c
Issue of shares to vendors for consideration other than cash
A Company may take over a running business i.e. assets & liabilities of another business. The Sellers of the business are known as Vendors. The company may offer shares to the Vendors in settlement of the purchase price of the business. The buying company does not receive any cash for shares offered to them.
The following entries are passed in case of such takeover of the business:
(a) For recording takeover of the business
Sundry Assets A/c Dr
To Sundry liabilities A/c
To Vendor A/c
(b) For issue of shares to Vendor
Vendor A/c Dr.
To Share Capital A/c
To Securities Premium A/c (if any)
Issue of right shares
Under Companies Act, A company can issue additional shares at any time by passing an ordinary resolution at its General Meeting. However, under Sec. 81 of that, such additional shares must be first offered to the existing equity shareholders in the proportion of the shares already held by them. Such additional shares are called “Rights Shares”. Following legal provisions are pertinent in this regard.
a) The issue should be within the limits of the authorized capital, if not so, then the authorized capital must be increased first suitably.
b) The issue is to be made after two years from the formation of the company or after one year from the first allotment of shares.
c) The shares should be offered to the equity shareholders in proportion to the capital paid-up on their shares.
d) The offer should be made by a written notice specifying the no. of shares offered & the time limit for acceptance which should be at least 15 days from the date of offer.
e) Unless prohibited by the Articles, the offer should include & specify the power of the shareholder to renounce (sale) the right shares to others.
f) The shares not taken up by the shareholders can be sold by the Board of Directors in a manner most beneficial to the company.
g) Such right offer need not be made to the existing shareholders, if
i) A special resolution to that effect is passed by the shareholder in the General Meeting or
ii) An ordinary resolution to that effect is passed and approved from the Central Govt. is obtained for issue of shares to persons other than the existing shareholders.
Key takeaways –
- Revenue refers to measurement of the amount charged to the clients for the sale of goods and services.
- A company can issue additional shares at any time by passing an ordinary resolution at its General Meeting
The provisions regulating buy back of shares are contained in Section 77A, 77AA and 77B of the Companies Act,1956. These were inserted by the Companies (Amendment) Act,1999. The Securities and Exchange Board of India (SEBI) framed the SEBI(Buy Back of Securities) Regulations,1999 and the Department of Company Affairs framed the Private Limited Company and Unlisted Public company (Buy Back of Securities) rules,1999 pursuant to Section 77A(2)(f) and (g) respectively.
Objectives of buybacks
- To increase promoters holding
- Increase earnings per share
- Rationalize the capital structure by writing off capital not represented by available assets.
- Support share value
- To thwart takeover bid
- To pay surplus cash not required by business
Reasons of buybacks
A Company can purchase its own shares from
- free reserves; Where a company purchases its own shares out of free reserves, then a sum equal to the nominal value of the share so purchased shall be transferred to the capital redemption reserve and details of such transfer shall be disclosed in the balance-sheet or
- securities premium account; or
- proceeds of any shares or other specified securities. A Company cannot buyback its shares or other specified securities out of the proceeds of an earlier issue of the same kind of shares or specified securities.
Procedure for buybacks
- Where a company proposes to buy back its shares, it shall, after passing of the special/Board resolution make a public announcement at least one English National Daily, one Hindi National daily and Regional Language Daily at the place where the registered office of the company is situated.
- The public announcement shall specify a date, which shall be "specified date" for the purpose of determining the names of shareholders to whom the letter of offer has to be sent.
- A public notice shall be given containing disclosures as specified in Schedule I of the SEBI regulations.
- A draft letter of offer shall be filed with SEBI through a merchant Banker. The letter of offer shall then be dispatched to the members of the company.
- A copy of the Board resolution authorizing the buyback shall be filed with the SEBI and stock exchanges.
- The date of opening of the offer shall not be earlier than seven days or later than 30 days after the specified date
- The buy back offer shall remain open for a period of not less than 15 days and not more than 30 days.
- A company opting for buy back through the public offer or tender offer shall open an escrow Account
Key takeaways –
- A buyback occurs when the issuing company pays shareholders the market value per share and re-absorbs that portion of its ownership that was previously distributed among public and private investors
Preference shares cannot be redeemed unless they are fully paid up. In other words partly paid-up shares cannot be redeemed. Preference shares can be redeemed in two ways- one is profits which would be available for dividend. The other one is out of the proceeds of a fresh issue of shares made with the object of redemption.
When Preference shares are redeemed out of profits available for distribution as dividend, a sum equal to the nominal amount of the shares so redeemed must be transferred out of profits to a reserve account to be called ‘Capital Redemption Reserve Account’. Such reserve can be used for issuing fully paid bonus shares to the shareholders.
Conditions for redemption of preference shares
Before going for redemption, the company must follow the following conditions
- There must be a provision in the Articles of Association regarding the redemption of preference shares.
- The redeemable preference shares must be fully paid up. If there is any partly paid share, it should be converted in to fully paid shares before redemption
- The redeemable preference shareholders should be paid out of undistributed profit/ distributable profit or out of fresh issue of shares for the purpose of redemption.
- If the shares are redeemed at a premium, it should be should be provided out of securities premium or profit and loss account or general reserve account.
- The proceeds from fresh issue of debentures cannot be utilized for redemption.
- The amount of capital reserve cannot be used for redemption of preference shares.
- If the shares are redeemed out of undistributed profit , the nominal value of share capital, so redeemed should be transferred to Capital Redemption Reserve Account. This is also known as capitalization profit.
The redeemable preference shares can be redeemed by a) the proceeds of a fresh issue of equity shares/ preference shares, b) the capitalization of undistributed profit i.e. creating capital redemption reserve account, or c) a combination of both (a) and (b).
Accounting entries required for redemption of preference shares.
When new shares are issued at par:
Bank A/c …………………Dr.
To Share Capital A/c.
When new shares are issued at premium:
Bank A/c ……………………..Dr.
To Share Capital A/c
To Share Premium A/c
When new shares are issued at a discount:
Bank A/c ………………Dr.
Discount on Issue of Share Capital………..Dr.
To Share Capital A/c.
Conversion of partly paid shares into fully paid shares:
a) Share Call A/c ………..Dr.
To Share Capital A/c
b) Bank A/c ……………..Dr.
To Share Call A/c.
When preference shares are redeemed at par:
Redeemable Preference Share Capital A/c ………………Dr.
To Preference shareholders A/c.
When preference shares are redeemed at a premium:
Redeemable Preference Share Capital A/c ………………Dr
Premium of Redemption Preference Share Capital A/c….Dr.
To Preference shareholders A/c.
Adjustment of premium on redemption:
Profit and Loss A/c………………..Dr.
Share Premium A/c ……………….Dr.
To Premium of Redemption Preference Share Capital A/c
Transferring the amount to Capital Redemption Reserve Account:
General Reserve A/c …………….Dr.
Profit and Loss A/c …………….Dr.
To Capital Redemption Reserve A/c
Expenses on issue of shares:
Expenses on Issue of shares A/c…………….Dr.
To Bank A/c.
When payment is made to preference shareholders:
Preference Shareholders A/c ……………Dr.
To Bank A/c.
When the fully paid bonus shares are issued:
Capital Redemption Reserve A/c …………….Dr.
General Reserve A/c …………………………..Dr.
Share Premium A/c ……………………………Dr.
Profit & Loss A/c …………………………….. Dr.
To Bonus to Shareholders A/c
Capitalization of profit:
Bonus to Shareholders A/c ………………Dr.
To Equity share capital A/c
Key takeaways –
- Preference shares can be redeemed in two ways- one is profits which would be available for dividend. The other one is out of the proceeds of a fresh issue of shares made with the object of redemption.
Sources
- Corporate accounting by BS Raman
- Corporate accounting by Dr. S.M. Shukla, Dr. K.L. Gupta
- Corporate accounting by V RAJASEKARAN and R LALITA
UNIT 1
Accounting principles
Accounting concepts defines the assumption on the basis of which financial statement of a business entity is prepared. Concepts are those basic assumption and condition which for the basis upon which the accountancy has been laid.
Accounting principles
- They should be based on real assumption
- They must be simple, understandable and explanatory
- They must be followed consistently
- They should be able to reflect future predictions
- They should be informational to users
Accounting convention emerges out of accounting practices, commonly known as accounting principle, adopted by various organizations over a period of time. Accounting bodies may change any of the convention to improve the quality of accounting information.
Accounting concepts
- Entity concept – Entity concept states that the business enterprise and its owner are two separate independent entities. Thus, the business and personal transaction of its owner are separate.
For example, when owner invests money in the business, it is recorded as liability of the business to the owner. Similarly, when owner takes money from business for personal use, it is not treated as business expenses.
2. Money measurement concept – This concept assumes that all business transaction must be in terms of money. Thus transactions expressed in terms of money are recorded in the books of account.
For example – sale of good, rent paid are expressed in money so recorded in books of account. Whereas sincerity, loyalty are not recorded in books of account because they cannot be measured in monetary terms.
3. Going concern concept - This concept states that a business firm will continue to carry on its activities for an indefinite period of time. It means every business entity has continuity of life and will not be resolved in the near future.
4. Accounting period concept –All transaction are recorded in the books of account on the assumption that profits on these transaction are to be ascertained for a specific period. Thus, this concept states that a balance sheet and profit and loss account should be prepared at regular interval
5. Accounting cost concept – It states that all assets are recorded in the books of account at their purchase price which include cost of acquisition, transportation and installation and not at its market price.
For example – fixed assets like building, machinery are recorded at purchase price
6. Dual aspect concept – dual aspect is the basic principle of accounting. It provides the basis of recording accounting transactions. For every credit, a corresponding debit is made. Therefore the transaction should be recorded in two places.
7. Matching concept – this concept states that revenue and expenses incurred to earn profit must belong to the same accounting period. So once the revenue is realized, the next step is to allocate it to the relevant accounting period. It is very helpful for the investors to know the exact amount of profit and loss in the business
8. Realization concept – the concept states that, revenue is realized at the time when goods and services are actually delivered. An advance or fee paid is not considered a profit until the goods or services are delivered to the buyer.
9. Accrual concept – accrual concept means the amount of money is yet to be paid or received at the end of the accounting period. It means cash received or not and expenses paid or not, both the transaction will be recorded in the books of account in that accounting period
Accounting convention
- Consistency – consistency means same accounting principles should be uses year after year, so that same standards are applied to calculate profit and loss. While comparing over a period of time a meaningful conclusion can be drawn. If a different accounting principles are used , then it cannot be comparable
2. Full disclosure – It includes all material and relevant facts concerning financial statements should be fully disclosed. Full disclosure means full, fair, adequate disclosure of accounting information. Parties like investor, lender, etc are interested in the financial information, so the business entity should disclose full and fair information.
3. Materiality – it means all material fact should be recorded in accounting. Accountant should record important data and leave insignificant data. Material fact influence the decision of the users.
4. Conservatism – the conservatism is based on the principle that “Anticipate no profit, but provide all the possible losses”. The main objective is to show minimum profit. Profit should not be over estimated. It is an unfair convention, it will lead to reduction in the capital of an enterprise
Key takeaways:
- Accounting rules are guidelines that help companies determine how to record business transactions that are not yet fully covered by accounting standards.
- They are generally accepted by accounting institutions, but are not legally binding.
- Accounting rules no longer apply if the supervisory body has guidelines that address the same topics as accounting rules.
- There are four widely recognized accounting rules. Conservatism, consistency, full disclosure, and importance.
- Accounting policies are the procedures that a company uses to prepare financial statements. Unlike accounting principles, which are rules, accounting policies are the basis for following those rules.
- Accounting policies may be used to legally manipulate revenue.
- The choice of a company in its accounting policy indicates whether management is willing or conservative in reporting its revenue.
- Accounting policies should still adhere to generally accepted accounting principles (GAAP).
AS - 1
The information presented in the financial statements of an organisation is of its financial position. The profit or loss can be affected to a large degree by the accounting policies followed. The accounting policies followed vary from organisation to organisation. It is important to disclose significant accounting policies followed to make the financial statements understandable. The disclosure is required by law in certain cases.
Fundamental Accounting Assumptions
Certain assumptions are used in the preparation of financial statements. They are usually not specifically stated because they are assumed to be followed. Disclosure is necessary only if they are not followed.
The following have been generally accepted as fundamental accounting assumptions:
Going Concern
An entity is considered to be in business unless there is evidence of opposition. Because companies are relatively permanent, financial accounting is designed with the assumption that the business will survive indefinitely in the future.
Consistency
It is assumed that accounting policies are consistently followed from one period to another. No frequent changes are expected.
Accrual
Revenues and costs are recorded when they are earned or incurred (and not as money is received or paid) in the periods to which they relate.
Considerations in the Selection of Accounting Policies
The major considerations governing the selection and application of accounting policies are:
Prudence
In view of the uncertainty of future events, profits are not anticipated but recognised only when earned, though not necessarily in cash. However, provision is made for all known liabilities and losses even though the amount cannot be determined with certainty and represents only an estimate.
Substance over Form
The accounting treatment and presentation of transactions and events in financial statements should be governed by their substance and not merely by the legal form.
Materiality
Financial statements should disclose all “material” items, i.e. items, the knowledge of which might influence the decisions of the user of the financial statements.
Accounting standard 9 – revenue recognition
Revenue refers to measurement of the amount charged to the clients for the sale of goods and services. in the case of the agency relationship, the revenue are measured by the amount charged for commission and not on the gross inflow of the cash, receivables or other consideration.
As per the AS 9 Revenue Recognition issued by ICAI “Revenue is the gross inflow of cash, receivables or other consideration arising in the course of the ordinary activities of an enterprise from the sale of goods, rendering of services & from various other sources like interest, royalties & dividends”.
Applicability of AS 9 Revenue Recognition
This accounting standard was issued by ICAI in the year 1985. In the initial years, it was for only Level I enterprises and but from April 01, 1993 it was made mandatory for all other enterprises.
As per ICAI, “Enterprise means a company as defined in section 3 of the Companies Act, 1956”.
Level I enterprises are those enterprises whose turnover for the immediately preceding accounting year exceeds 50 crores. The turnover here does not include other income and is applicable for holding as well as subsidiary companies.
Sale of goods
Sale of good is one of the key elements to recognise the revenue which involves for a consideration the seller has transferred the property in the goods to the buyer. The property in the goods means the transfer of the significant risks and rewards in ownership of the goods.
In case when the sale is assured under government guarantee or a forward contract or where the market exists and there is a negligible risk of failure to sell, the goods involved are often valued at the net realizable value (NRV).
Rendering of services
Service Revenue are recognised depends as the service is performed. This is further divided into two ways:
- Proportionate Completion Method: under his method revenue are recognised with the degree of completion of each service proportionately in the statement of profit & loss.
- Completed Service Contract Method: under this method revenue are recognised only when the rendering of services under a contract is completed or substantially completed in the statement of profit & loss.
Interest, royalties & dividends
- Interest: Revenue is recognized on the time proportion basis after taking into account the amount outstanding and the rate applicable.
For Example: If the interest on FD is due on 30th June and 31st Dec. On 31st March when the books will be closed, though the interest for the period of Jan-March will be received in June, still we have to recognize the revenue in March itself.
- Royalties: The charge for the use of patents, know-how, trademarks, and copyrights refers to royalties. On the basis of accrual basis and in accordance with the relevant agreement revenue has to be recognized.
For Example: If the royalty is payable based on the number of copies of the book, then it has to be recognized on that basis only.
Dividends: Revenue has to be recognized when the owner’s right to receive payment is established. This happens when the company declare the dividends on the shares to their shareholders
Issue of shares
Definition
A “share” has been defined by the Indian Companies Act, as “A share is the share in the Capital of the Company”.
Types of shares
A Company can issue two types of shares – Equity and Preference.
- Equity Shares: Equity shares means that part of the share capital which is not a Preference share capital. It means all such shares which are not Preference shares. Equity shares are also called as Ordinary Shares.
- Preference Shares: Preference shares are those shares which fulfill both the following two conditions:
(i) They carry preferential share right in respect of dividend at a fixed rate,
(ii) They also carry preferential right in regard to payment of capital on winding up of the company.
Preference shares can be further classified as follows:
1) Cumulative and Non – Cumulative : If in any year the profits are insufficient to pay the preference dividend then in case of cumulative preference shares this dividend can be paid in the subsequent year before any other dividend is paid. In other words the right to receive the dividend goes on accumulating till it is paid. In case of Non – cumulative preference shares the dividend can be paid only in that year. If there are insufficient profits then such preference shareholders do not get any dividend for that year.
2) Participating & Non-Participating Preference Shares: Participating preference shares are entitled to participate in the surplus profits remaining after the payment of (a) Fixed dividend to Preference shareholders and (b) Dividend to the equity shareholders. They are also entitled to participate in the surplus funds remaining at the time of winding of the company after payment of (a) Preference share capital & (b) Equity Share Capital. Non – participating preference share are not entitled to participate in the surplus profits or surplus funds left over at the time of winding off.
Procedure for issue of shares
- Issue of Prospectus: Whenever shares are to be issued to the public the company must issue a prospectus. Prospectus means an open invitation to the public to take up the shares of the company thus a private company need not issue prospectus. Even a Public Company issuing it’s shares privately need not issue a prospectus. However, it is required to file a “Statement in lieu of Prospectus” with the register of companies. The Prospectus contains relevant information like names of Directors, terms of issue, etc. It also states the opening date of subscription list, amount payable on application, on allotment & the earliest closing date of the subscription list.
- Application of Shares: A person intending to subscribe to the share capital of a company has to submit an application for shares in the prescribed form, to the company along with the application money before the last date of the subscription mentioned in the prospectus.
Over Subscription: If the no. of shares applied for is more than the no. of shares offered to the public then that is called as over Subscription.
Under Subscription: If the no. of shares applied for is less then the no. of shares offered to the public then it is called as Under Subscription.
3. Allotment of Shares: After the last date of the receipt of applications is over, the Directors, Proceed with the allotment work. However, a company cannot allot the shares unless the minimum subscription amount mentioned in the prospectus is collected within a stipulated period. The Directors pass resolution in the board meeting for allotment of shares indicating clearly the class & no. of shares allotted with the distinctive numbers. Then Letters of Allotment are sent to the concerned applicants. Letters of Regret are sent to those who are not allotted any shares & application money is refunded to them.
Partial Allotment: In partial allotment the company rejects some application totally, refunds their application money & allots the shares to the remaining applicants.
Pro-rata Allotment: When a company makes a pro-rata allotment, it allots shares to all applicants but allots lesser shares then applied for E.g. If a person has applied for three hundred shares he may get two hundred shares.
4. Calls on Shares: The remaining amount of shares may be collected in installments as laid down in the prospectus. Such installments are called calls on Shares. They may be termed as “Allotment amount, First Call, Second Call, etc.”
5. Calls–in–Arrears: some shareholders may not pay the money due from them. The outstanding amounts are transferred to an account called up as “Calls-in-Arrears” account. The Balance of calls-in-arrears account is deducted from the Called-up capital in the Balance Sheet.
6. Calls–in–Arrears: some shareholders may not pay the money due from them. The outstanding amounts are transferred to an account called up as “Calls-in-Arrears” account. The Balance of calls-in-arrears account is deducted from the Called-up capital in the Balance Sheet.
Terms of issue of shares
A limited company may issue the shares on following different terms.
(a) Issue of Shares for Consideration other than cash or for cash or on capitalization of reserves.
(b) Issue of Shares at par i.e. at face value or at nominal value.
(c) Issue of Shares at a Premium i.e. at more than face value.
(d) Issue of Shares at a Discount i.e. at less than the face value.(omitted in Companies Act,2013)
Accounting entries
For receipt of application money
Bank A/c………………………………Dr.
To Share Application A/c
On Allotment
1) Transfer of Application money to Share Capital
Share Application A/c..………….. Dr.
To Share Capital A/c
2) Amount due to on Allotment
Share Allotment A/c………………Dr.
To Share Capital A/c
To Securities Premium Account (if any)
Refund of excess Application money on rejected application
Share Application A/c……………..Dr.
To Bank A/c
Adjustment of excess application money towards allotment money due.
Share Application A/c…………….Dr.
To Share Allotment A/c
Receipt of Allotment money.
Bank A/c…………………………….Dr.
To Share Allotment A/c
For making First Call
Share First Call A/c……………………..Dr.
To Share Capital A/c
For receipt of First Call Money
Bank A/c…………………………………Dr.
To Share First Call A/c
For calls in arrears
Calls in Arrears A/c……………………..Dr.
To Share First Call A/c
For receipt if calls in advance
Bank A/c…………………………………Dr.
To Calls in Advance A/c
Issue of shares to vendors for consideration other than cash
A Company may take over a running business i.e. assets & liabilities of another business. The Sellers of the business are known as Vendors. The company may offer shares to the Vendors in settlement of the purchase price of the business. The buying company does not receive any cash for shares offered to them.
The following entries are passed in case of such takeover of the business:
(a) For recording takeover of the business
Sundry Assets A/c Dr
To Sundry liabilities A/c
To Vendor A/c
(b) For issue of shares to Vendor
Vendor A/c Dr.
To Share Capital A/c
To Securities Premium A/c (if any)
Issue of right shares
Under Companies Act, A company can issue additional shares at any time by passing an ordinary resolution at its General Meeting. However, under Sec. 81 of that, such additional shares must be first offered to the existing equity shareholders in the proportion of the shares already held by them. Such additional shares are called “Rights Shares”. Following legal provisions are pertinent in this regard.
a) The issue should be within the limits of the authorized capital, if not so, then the authorized capital must be increased first suitably.
b) The issue is to be made after two years from the formation of the company or after one year from the first allotment of shares.
c) The shares should be offered to the equity shareholders in proportion to the capital paid-up on their shares.
d) The offer should be made by a written notice specifying the no. of shares offered & the time limit for acceptance which should be at least 15 days from the date of offer.
e) Unless prohibited by the Articles, the offer should include & specify the power of the shareholder to renounce (sale) the right shares to others.
f) The shares not taken up by the shareholders can be sold by the Board of Directors in a manner most beneficial to the company.
g) Such right offer need not be made to the existing shareholders, if
i) A special resolution to that effect is passed by the shareholder in the General Meeting or
ii) An ordinary resolution to that effect is passed and approved from the Central Govt. is obtained for issue of shares to persons other than the existing shareholders.
Key takeaways –
- Revenue refers to measurement of the amount charged to the clients for the sale of goods and services.
- A company can issue additional shares at any time by passing an ordinary resolution at its General Meeting
The provisions regulating buy back of shares are contained in Section 77A, 77AA and 77B of the Companies Act,1956. These were inserted by the Companies (Amendment) Act,1999. The Securities and Exchange Board of India (SEBI) framed the SEBI(Buy Back of Securities) Regulations,1999 and the Department of Company Affairs framed the Private Limited Company and Unlisted Public company (Buy Back of Securities) rules,1999 pursuant to Section 77A(2)(f) and (g) respectively.
Objectives of buybacks
- To increase promoters holding
- Increase earnings per share
- Rationalize the capital structure by writing off capital not represented by available assets.
- Support share value
- To thwart takeover bid
- To pay surplus cash not required by business
Reasons of buybacks
A Company can purchase its own shares from
- free reserves; Where a company purchases its own shares out of free reserves, then a sum equal to the nominal value of the share so purchased shall be transferred to the capital redemption reserve and details of such transfer shall be disclosed in the balance-sheet or
- securities premium account; or
- proceeds of any shares or other specified securities. A Company cannot buyback its shares or other specified securities out of the proceeds of an earlier issue of the same kind of shares or specified securities.
Procedure for buybacks
- Where a company proposes to buy back its shares, it shall, after passing of the special/Board resolution make a public announcement at least one English National Daily, one Hindi National daily and Regional Language Daily at the place where the registered office of the company is situated.
- The public announcement shall specify a date, which shall be "specified date" for the purpose of determining the names of shareholders to whom the letter of offer has to be sent.
- A public notice shall be given containing disclosures as specified in Schedule I of the SEBI regulations.
- A draft letter of offer shall be filed with SEBI through a merchant Banker. The letter of offer shall then be dispatched to the members of the company.
- A copy of the Board resolution authorizing the buyback shall be filed with the SEBI and stock exchanges.
- The date of opening of the offer shall not be earlier than seven days or later than 30 days after the specified date
- The buy back offer shall remain open for a period of not less than 15 days and not more than 30 days.
- A company opting for buy back through the public offer or tender offer shall open an escrow Account
Key takeaways –
- A buyback occurs when the issuing company pays shareholders the market value per share and re-absorbs that portion of its ownership that was previously distributed among public and private investors
Preference shares cannot be redeemed unless they are fully paid up. In other words partly paid-up shares cannot be redeemed. Preference shares can be redeemed in two ways- one is profits which would be available for dividend. The other one is out of the proceeds of a fresh issue of shares made with the object of redemption.
When Preference shares are redeemed out of profits available for distribution as dividend, a sum equal to the nominal amount of the shares so redeemed must be transferred out of profits to a reserve account to be called ‘Capital Redemption Reserve Account’. Such reserve can be used for issuing fully paid bonus shares to the shareholders.
Conditions for redemption of preference shares
Before going for redemption, the company must follow the following conditions
- There must be a provision in the Articles of Association regarding the redemption of preference shares.
- The redeemable preference shares must be fully paid up. If there is any partly paid share, it should be converted in to fully paid shares before redemption
- The redeemable preference shareholders should be paid out of undistributed profit/ distributable profit or out of fresh issue of shares for the purpose of redemption.
- If the shares are redeemed at a premium, it should be should be provided out of securities premium or profit and loss account or general reserve account.
- The proceeds from fresh issue of debentures cannot be utilized for redemption.
- The amount of capital reserve cannot be used for redemption of preference shares.
- If the shares are redeemed out of undistributed profit , the nominal value of share capital, so redeemed should be transferred to Capital Redemption Reserve Account. This is also known as capitalization profit.
The redeemable preference shares can be redeemed by a) the proceeds of a fresh issue of equity shares/ preference shares, b) the capitalization of undistributed profit i.e. creating capital redemption reserve account, or c) a combination of both (a) and (b).
Accounting entries required for redemption of preference shares.
When new shares are issued at par:
Bank A/c …………………Dr.
To Share Capital A/c.
When new shares are issued at premium:
Bank A/c ……………………..Dr.
To Share Capital A/c
To Share Premium A/c
When new shares are issued at a discount:
Bank A/c ………………Dr.
Discount on Issue of Share Capital………..Dr.
To Share Capital A/c.
Conversion of partly paid shares into fully paid shares:
a) Share Call A/c ………..Dr.
To Share Capital A/c
b) Bank A/c ……………..Dr.
To Share Call A/c.
When preference shares are redeemed at par:
Redeemable Preference Share Capital A/c ………………Dr.
To Preference shareholders A/c.
When preference shares are redeemed at a premium:
Redeemable Preference Share Capital A/c ………………Dr
Premium of Redemption Preference Share Capital A/c….Dr.
To Preference shareholders A/c.
Adjustment of premium on redemption:
Profit and Loss A/c………………..Dr.
Share Premium A/c ……………….Dr.
To Premium of Redemption Preference Share Capital A/c
Transferring the amount to Capital Redemption Reserve Account:
General Reserve A/c …………….Dr.
Profit and Loss A/c …………….Dr.
To Capital Redemption Reserve A/c
Expenses on issue of shares:
Expenses on Issue of shares A/c…………….Dr.
To Bank A/c.
When payment is made to preference shareholders:
Preference Shareholders A/c ……………Dr.
To Bank A/c.
When the fully paid bonus shares are issued:
Capital Redemption Reserve A/c …………….Dr.
General Reserve A/c …………………………..Dr.
Share Premium A/c ……………………………Dr.
Profit & Loss A/c …………………………….. Dr.
To Bonus to Shareholders A/c
Capitalization of profit:
Bonus to Shareholders A/c ………………Dr.
To Equity share capital A/c
Key takeaways –
- Preference shares can be redeemed in two ways- one is profits which would be available for dividend. The other one is out of the proceeds of a fresh issue of shares made with the object of redemption.
Sources
- Corporate accounting by BS Raman
- Corporate accounting by Dr. S.M. Shukla, Dr. K.L. Gupta
- Corporate accounting by V RAJASEKARAN and R LALITA