Commerce ePathshala NOTES
(IGNOU)
Important Questions & Answers
IGNOU
: BCOM
BCOC
137 – CORPORATE ACOUNTING
Q – State the types of Share
Capital.
Ans.
SHARE CAPITAL
A company should
have capital in order to finance its activities. Share capital means the
capital raised by a company by the issue of shares. In case of a company the
term capital’ and share capital’ means the same thing. A company limited by
shares should state its amount of share capital in its memorandum of
association. An unlimited company and a company limited by guarantee may not
have any share capital.
Categories
of Share Capital
From accounting point of view, there are different
types of share capital. These are as follows:
1.
Authorized
or Registered or Nominal Capital: The Authorized or Nominal
or Registered capital is the amount of share capital which a company is
authorised to issue by its memorandum of association. This is the maximum amount
which a company is authorised to raise by the issue of shares. The amount of
authorised capital of a company depends upon its business requirements, it can
be increased or decreased by adopting the prescribed legal procedure.
2.
Issued
Capital: It is that part of nominal capital which is actually
offered to the public for subscription. Normally a company does not issue its
entire nominal capital at a time. In this case the issued capital-is less than
the nominal capital. The difference between issued capital and nominal capital
is called “unissued capital”. Issued capital can never be more than the nominal
capital. It can at the most be equal to the nominal capital.
3.
Subscribed
Capital: It is that portion of the issued capital which has
been actually subscribed by the public. Where the shares issued for
subscription are wholly subscribed, issued capital would be the same as the
subscribed capital.
4.
Called
up Capital: It is that part of nominal value of issued
capital which has been called up on the shares. For example, a share may be of
Rs. 10 each. But at the time of issue the company is collecting Rs. 5 per share
only. The remaining Rs 5 may be collected later on as and when needed. So called
up will be Rs. 5 per share.
5.
Paid-up
Capital: It refers to that amount of the called-up capital which
has actually been received from shareholders. It is quite possible that some
shareholders may not pay the full amount called up. The amount not paid in
respect of the allotment and calls made are known as calls in arrears. Thus the
paid-up capital is equal to the called up capital minus calls in arrears. In
care there are no calls in arrears, the paid-up capital will be same as called
up capital.
6.
Uncalled
Capital: This is the remaining part of the issued capital which
has not yet been called. The company may call this amount, any times, when it
needs further capital, according to the provisions of the Articles.
Q – What are the different
classes of preference shares? Explain.
Ans.
Preference Shares
Preference
shares are shares which satisfy the following two conditions:
i)
With reference to dividends, they carry a
preferential right over equity shares. The preferential rights of dividend as
ascertained at a fixed amount per share or an amount calculated at a fixed
rate.
ii)
With reference to capital, on the occasion
of winding up of a company or repayment of capital, they carry a preferential
right to be paid back. In other words, the amount paid upon preference shares
must be paid back before anything is paid to the equity shareholders.
The preference shares can be of various types. These
are discussed below.
i)
Cumulative
and Non-Cumulative Preference Shares: Preference shares are
issued with two distinctive features in respect of right to dividend based on
which they are classified as cumulative and non-cumulative preference shares.
In case of cumulative preference shares, if there are no sufficient profits in
a year for payment of dividends at the stipulated rate, the arrears of dividend
are to be carried forward and paid out of the profits of subsequent years. In
case of noncumulative preference shares, right of recovery of arrears of
dividend does not exist.
ii)
Redeemable
and Irredeemable Preference Shares: Preference shares are
also classified based on redemption, into redeemable preference shares and
irredeemable preference shares. In case of redeemable preference shares, at the
end of specified period, the company pays back the amount of capital to the
holders thereof. Sometime redemption may be made at premium. For example, a
preference share of Rs. 100 of PQR Co. Ltd. is redeemable at a premium of Rs. 5
after ten years. After the lapse of 10 years, on redemption the holder will get
Rs: 105 on each preference shares. In case of irredeemable preference shares,
the amount of capital is not paid back before the winding up. According to the
new Section 80-A of the Companies (Amendment) Act. 1988 all the existing
irredeemable preference shares shall be compulsorily redeemed the company
within five years from the commencement of this Amendment Act.
iii)
Participating
and Non-participating Preference Shares: Generally, preference
shares are non-participatory i.e., they are not entitled to have any share in
surplus. But, some companies issue participating preference shares. A
participating preference share is a share which carries the right of sharing
profits left after paying preference and equity dividends at a fixed rate.
Non-participating preference shares are those which are not entitled to share
in the ‘surplus profit’. They are entitled to a fixed rate of dividend.
iv)
Convertible
and Non-convertible Preference Shares: A convertible preference
share is one which can be converted into equity shares. When a share cannot be
converted into equity shares, then it is said to be a non-convertible
preference share. From the above discussion, it is clear that there are
different classes of preference shares based on different factors.
Q – What do you mean by Right
issue? Discuss the advantages of right issue
Ans. When
an existing company makes subsequent issue of shares to the existing
shareholders, it is called right issue. According to Section 81 of the
Companies Act, 2013 when at any time, after the formation of two years of the
company or the completion of one year of the first allotment of shares in the
company, whichever happens earlier, it is decided by the board of directors to
increase the subscribed capital of the company through the allotment of the
subsequent shares; then:
· Such subsequent
shares should be offered to persons who are at that time, the holders of the
shares of the company, and proportionately in the ratio of the shares held by
them.
· The offer of such
shares should be given through notice which should specify the number of shares
offered, limiting the time to a minimum of 15 days from the date of offer
within which, if the offer is not accepted, it will be deemed to be rejected.
· After the expiry
of the time of notice or information received from the shareholders, and before
the date of rejecting the offer of the company, the Board of Directors can
proceed to dispose of the shares in the manner which they feel beneficial for
the company.
Advantages
of Right Issue
(1) Ownership is Retained: With the issue of right
shares, the company can retain the control in the hands of the existing
shareholders. The right issue makes possible equitable distribution and it does
not disturb the established equilibrium as the allotment under right issue is
made proportionately among the shareholders.
(2) No Dilution in Value: The existing shareholders do
not suffer dilution in the value of their shares due to the fresh issue made by
the company because of the right issue.
(3) Avoid Expenses: The expenses which are required to
be incurred for the fresh issue of shares can be avoided through right issue.
(4) Enhancement in the Image: Image of the company
becomes better when right issues are made from time-to-time. This is because
existing shareholders remain satisfied.
(5) More Certainty of Funds: There is more certainty of
capital or the funds when the fresh issue of shares is offered to the existing
shareholders than to the general public.
(6) No Misuse of Opportunity: Directors cannot misuse
the opportunity of issuing the new shares at lower rates to their friends and
relatives, and in maintaining more control hands with the issue of right
shares.
Q – State the Conditions for
Buy-back of shares.
Ans.
CONDITIONS FOR BUY BACK OF SHARES
1. The Articles of Association of the company authorize
buy back of shares.
2. The special resolution is to be passed in the
General Meeting of the company.
3. The buy back of shares should not exceed 25% of the
paid-up capital and free reserves of the company.
4. After such buy back, the debt equity ratio should
not exceed 2:1.
5. From the 12 months of the date of passing the
resolution, the buy back should be completed.
6. All the buy back shares should be fully paid-up.
7. A declaration of the company should be filed with
the Registrar of the Companies and Securities Exchange Board of India in the
form of an affidavit.
8. The securities should be listed at the Stock
Exchange of India.
9. Within seven days of the last date of completion of
buy back, the company shall extinguish or physically destroy such shares.
10. Company shall not make further issue of shares
within a period of 24 months, except the issue of bonus shares after completing
the buy back of shares.
11. The buy back cannot be done through a subsidiary or
investment company.
Q – State the Conditions for redemption
of preference share.
Ans.
CONDITIONS FOR REDEMPTION OF PREFERENCE SHARES
Under Section 80 of the Companies Act, 2013, certain
conditions are laid down, which are to the followed by the company for making
the redemption of preference shares valid. Let us discuss these valid
conditions:
1.
Authorized
by Article of the Company
If authorized by the Article, the
company limited by shares can issue preference shares, which are at the option
of the company, can be redeemed after the expiry of the stipulated period.
2. Fully Paid-up Shares
The preference shares cannot be
redeemed unless these are fully paid-up. Therefore, the partly paid-up shares
cannot be redeemed and for redemption, these partly paid-up shares are to be
converted into fully paid-up for the purpose of redemption.
3. Out of Profits or Issue of New shares
Preference shares can be redeemed
either out of profits, which would be available for dividend or out of the
proceeds of the fresh issue of shares (equity shares or new preference shares)
made for the purpose of the redemption. Preference Shares cannot be redeemed
out of the proceeds of the issue of debentures or the proceeds from the sale of
the property.
4. Creation of Capital
Redemption Reserve When the redemption
of preference shares is made out of the profits, it is necessary to transfer
the equivalent amount from reserves to the Capital Redemption Reserve.
5. Use of Capital Redemption Reserve A/c
Capital Redemption Reserve A/c can be
used for issuing fully paid bonus shares to the shareholders. This account
cannot be reduced except in accordance with the sanction of the court relating
to the reduction of share capital.
6. Time Period of Redemption
If the redemption of shares is done
through issue of new shares then it should be done within one month of the
issue of new shares.
7. Premium on Redemption
Any premium on redemption of
preference shares should be provided either from securities premium or from the
revenue profits or capital profits actually realized.
Q – What is debenture ? State
It’s types.
Ans.
Issue
of debentures is a method of raising loan from the public. Thus, a debenture
may be defined as an instrument acknowledging a debt by a company to some person
or persons which may or may not be secured by a charge on its assets. According
to Mr. Topham “A debenture is a document given by a company as evidence of a
debt to the holder usually arising out of a loan and most commonly secured by a
charge”. Section 2(12) of the Companies Act, 2013 “Debenture includes debenture
stocks, bonds and any other securities of the company whether constituting a
charge on the company’s assets or not”.
TYPES
OF DEBENTURES
A company can issue various types of debentures which can
be classified on the basis of security, permanence, convertibility and records.
Let us now explain all of them one by one.
1. Redeemable and Irredeemable Debentures:
Redeemable Debentures are issued for a specified period after which the company
must repay the amount of debentures on a specified date or after notice or by
periodical drawings. Irredeemable Debentures, on the other hand are those
debentures for which no fixed date is specified for repayment and the holders
of which cannot demand payment as long as the company is functioning and does
not make default in interest payment. Normally companies issue redeemable
debentures.
2. Registered and Bearer Debentures:
Registered debentures are those which are registered in the name of the holder
by the company in the Register of Debentureholders. Such debentures are made
out in the name of holder which appears in the debenture certificate. Such
debentures are transferable in the same manner as shares by transfer deeds.
Interest on such debentures is payable to the person whose name is registered
with the company in the register of Debenture holders. Bearer debentures are
those which are transferable by mere delivery. Interest on such debenture is
payable on the basis of coupons attached with the debenture certificate.
3. Secured and Unsecured Debentures:
Secured debentures are those debentures which are secured either by the
mortgage of a particular asset of the company known as Fixed Charge or by the
mortgage of general assets of the company known as Floating Charge. Secured
debentures are also known as Mortgaged Debentures. Unsecured debentures, on the
other hand are those debentures which are not secured by any charge or mortgage
on any property of the company. Unsecured debentures are also known as ‘Naked
Debentures’. Only good companies of strong financial standing can issue such
naked debentures.
4. Convertible and Non-convertible
Debentures: Convertible debentures are those
debentures wherein the debenture holder is given an option to exchange a part
or whole of the debenture amount for equity shares in the company on the expiry
of a specified period. Some companies issue convertible debentures wherein a
part or whole of the debenture amount, after the specified period, is
compulsorily converted into equity shares of the company. Where only a part of
the debenture amount is convertible into equity shares such debentures are
known as ‘Partly Convertible Debentures’ but when the full amount of the
debenture is convertible into equity shares such debentures are known as ‘Fully
Convertible Debentures’. Non-convertible debentures, on the other hand, are
those debentures for which the debenture holder does not have any right for
conversion into equity shares.
Q – State the Special
Features of Company Profit & Loss A/c.
Ans.
Special Features of Company Profit and Loss Account The special features of the
Profit and Loss Account of a company are summarized below.
1 It is not necessary to prepare a Trading Account
showing gross profit. The Profit and Loss Account includes all items of income
and expenditure and shows the net profit.
2 After net profit is ascertained, the distribution or
appropriation of profit is show in the second part of the Profit and Loss
Account known as ‘Below the line’. In this part, the balance of profit brought
forward from, the previous year is added to the current year’s profit. Dividend
proposed to be paid to shareholders and transfer to general reserve is two main
items of appropriation. The final balance of profit is shown in the Balance
Sheet.
3 The Companies Act requires that figures of the
previous year must be shown r a separate column alongside the respective
figures of the current period.
4 Since various details relating to income and
expenditure must be shown as required by the Act, a summarised Profit and Loss
Account is prepared and details of items are shown separately in the form of
annexures.
5 The form of presentation may be ‘vertical’ or
‘horizontal,(Left-Right)’. It is not necessary to write ‘To’ and ‘By’ on the
two sides even when the account is prepared in ‘horizontal’ form.
Q – What do You Mean By Contingent Liabilities?
Explain.
Ans.
Contingent Liabilities : Liabilities which are uncertain and
may arise depending upon future events are known as ‘contingent liabilities’.
Thus, contingent liability is one which, though not a liability at the date of
Balance Sheet, may be so later upon the happening of a certain event. Such
liabilities are required to be shown as a foot-note, after all other
liabilities have been listed. These are not to be added to the other
liabilities. Items which may come under this sub-heading are:
i)
Claims against the company acknowledged as
debts: A typical situation in which such a claim may arise is where an amount
is expected to be paid to contractors on completion of a building according to
the contract signed.
ii)
Uncalled liability on shares partly paid:
Where investment has been made in shares of another company and the shares are
partly paid up, liability may arise on further call being made for payment of
the uncalled amount.
iii)
Arrears of fixed cumulative dividends:
Arrears of dividend on preference share capital are payable out of future profits,
hence it is shown as a contingent liability.
iv)
Estimated amount of contracts remaining to
be executed on capital account and not provided for: This type of liability may
relate to expenses to be incurred on incomplete contracts which are yet to be
fully executed.
v)
Any other amount for which the company is
contingently liable: This may include, for example, customers’ claim for
damages for delay in delivery which is pending, and yet to be settled.
Q – What are Preliminary
Expenses and how are they treated in the books of account?
Ans.
Preliminary Expenses
All expenses relating to the formation of company are
grouped under one heading known as Preliminary
Expenses. This includes expenses like cost of printing the Memorandum and
Articles of Association, fees paid to lawyers for drafting various documents,
stamp duty, and registration and filing fees payable at the time of
registration of the company. The total amount debited to Preliminary Expenses
Account is treated as a capital expenditure. It is generally written off within
a period of 3 to 5 years. The annual amount decided to be written off is
debited to the Profit and Loss Account. The balance of the Preliminary Expenses
Account is shown on the asset side of the Balance Sheet as a separate item
under the heading ‘Miscellaneous Expenditure and Losses’.
Suppose a company incurred preliminary expenses
amounting to Rs. 9,000 and decided to write off the amount in equal proportions
over three years. At the end of first year, Rs. 3,000 will be charged to the
Profit & Loss Account and Rs. 6,000 will be shown on the asset side of the
Balance Sheet. The debit balance of Rs. 6,000 in the Preliminary Expenses
Account will be carried forward to the next year. At the close of second year,
another Rs. 3,000 will be charged to Profit and Loss Account and the remaining
balance of Rs. 3,000 will be shown on the asset side of Balance Sheet. In the
third year again Rs. 3,000 will be charged to Profit & Loss Account. The
Preliminary Expenses A/c will thus be closed, and it will no longer appear in
the Balance Sheet.
Q – What is Cash Flow
Statement ? State the Need for Preparing cash Flow statements.
Ans.
The statement of cash flows, required by the Accounting Standard AS-3 and now
Ind-AS:7 is a major development in accounting measurement and disclosure
because of its relevance to financial statement users. Cash Flow Statement is
reasonably simple and easy to understand. It is also difficult to fudge or
manipulate the cash flow numbers and hence often used as a way to test the real
profitability of the firm.
NEED FOR CASH FLOW STATEMENT
The primary objective of the statement of cash flows is
to provide information about an entity’s cash receipts and cash payments during
a period. The net effect of cash flow is provided under different heads namely
cash flow from operating, investing and financing activities. It helps users to
find answers to the following important questions:
a) Where did the cash come from during the period?
b) What was the cash used for during the period?
c) What was the change in the cash balance during the
period?
The
AS-3 identifies two important uses of cash flow statement as follows:
a) A cash flow statement, when used in conjunction with
the other financial statements, provides information that enables users to
evaluate the changes in net assets of an 46 enterprise, its financial structure
(including its liquidity and solvency) and its ability to affect the amounts
and timing of cash flows in order to adapt to changing circumstances and
opportunities. Cash flow information is useful in assessing the ability of the
enterprise to generate cash and cash equivalents and enables users to develop
models to assess and compare the present value of the future cash flows of
different enterprises. it also enhances the comparability of the reporting of
operating performance by different enterprises because it eliminates the
effects of using different accounting treatments for the same transactions and
events.
b) Historical cash flow information is often used as an
indicator of the amount, timing and certainty of future cash flows. It is also
useful in checking the accuracy of past assessments of future cash flows and in
examining the relationship between profitability and net cash flow and the
impact of changing prices.
A Statement issued by Securities and Exchange Board of India
in 1995 when it made the cash flow statement mandatory also lists the above are
primary objective of requiring the listed companies to provide cash flow
statement to the investors.
Q – Distinction Between Cash
Flow Analysis & Fund Flow Analysis.
Ans.
DISTINCTION BETWEEN CASH FLOW ANALYSIS AND FUND FLOW ANALYSIS
Following are the major points of difference between
cash flow analysis and fund flow analysis:
1) Fund flow analysis deals with the change in working
capital position between two balance
sheet dates, whereas the cash flow analysis is concerned with the change in
cash position.
2) Cash flow analysis is more useful as a tool in
short-term financial planning, whereas fund flow analysis is more useful in
long-term financial planning.
3) An increase in current liability or decrease in
current asset (other than cash) results in an increase in cash whereas such
changes result in decrease in the net working capital. Similarly, a decrease in
any current liability or an increase in current asset (other than cash) results
in a decrease in cash, whereas such changes increase the net working capital.
4) Cash flow statement recognizes ‘cash basis of
accounting’ where as funds flow statement is based on accrual basis of
accounting.
5) Cash flow analysis explains only the causes of cash
variations, whereas funds flow analysis discloses the causes of overall working
capital variations.
Q - What is a Holding Company
? State the advantages & Disadvantages of Holding Company.
Ans.
Holding
Company As per 2(46) of the Companies Act, 2013 defines holding company as: A
company which has one or more subsidiary company having full control over them.
It is formed for the purpose of purchases and owning share in other company.
Holding company offers several benefits such as gaining more control, retaining
the management of the subsidiary firm and incurring lower tax liabilities.
ADVANTAGES
OF HOLDING COMPANIES
Holding company offers several advantages. Let us
discuss those advantages in detail. .
1. Better quality Decisions: The holding companies
allow the better quality decisions at all levels of the company. The holding
company concentrates on the corporate policies and strategies and the operating
levels in the implementation.
2. Better Utilization of Resources: Holding companies
facilitate the better utilization of the financial and the other resources of
the companies. The holding company pools the resources of group of enterprises.
3. Easy method of Acquiring Control: Through this
method organizations have to spend less in acquiring the control of the other
company.
4. Reduces Competition: Competition among the two
companies is totally eliminated as both of the companies are managed by the
same group.
5. Easy Rid from Subsidiary: If the company wants to get
rid of the subsidiary; it can easily do so by selling the shares of the
subsidiary in the open market.
6. Income tax benefits: Separate identities are
maintained by both the companies so that they can avail the tax benefits by
carrying forward their losses of the previous years.
7. Efficient Management: It becomes easier to manage
both the companies as both the companies maintain their separate identities.
This increases the efficiency of the management.
8. Enhances Corporate Planning: The holding company is
able to concentrate to corporate planning, acquisition, and update technology
and building of corporate culture on sound business principles.
9. Managerial and Commercial Culture: The management of
the holding company promotes the commercial and managerial culture instead of
bureaucratic culture.
LIMITATIONS OF HOLDING COMPANY
Holding company suffers from several disadvantages. Let
us discuss those disadvantages in detail.
1. Secret Reserves: To the detriment of the minority
interest, the unscrupulous directors can easily create secret reserves.
2. Difficulty in Ascertaining Financial Position: The
creditors in the subsidiary company and the shareholders in the holding company
may not be aware of the true financial position of the company.
3. Mismanagement: When in the holding company number of
constituents is more and there is not equivalent management efficiency, it
results in the mismanagement of the operations of the company.
4. Fraud in Inter-Company Transactions: There are more
chances of fraud due to the inter-company transactions. This is due to the
reason that inter-company transactions are settled at very high or very low
price according to the requirement of the holding company.
5. Forced Appointment of the Directors: The subsidiary company
is sometimes forced by the holding company to appoint some directors or the
officers in the company.
6. Difficulty in Valuation of Stock: It becomes
difficult to value the stock as the stock of the company consists of huge
quantity of inter-company goods.
7. Oppression of Minority Shareholders: There is always
the fear of oppression of minority shareholders as the financial and other
resources are totally managed in a way that suits the interest of the holding
company.
Q - State the Procedure of
Preparing Consolidated Financial Statements.
Ans.
PROCEDURE OF PREPARING CONSOLDIATED FINANCIAL STATEMENTS WITH ADJUSTMENT
As the main objective of Consolidated Financial
Statements is to show the information of holding company and subsidiary company
under a consolidated form as a single entity.
Following steps are involved in the formation of
consolidated financial statements. Let us discuss these steps in detail.
(a) The cost to the parent of its investment in each
subsidiary and the parent’s portion of equity of each subsidiary, at the date
on which investment in each subsidiary is made, should be eliminated;
(b) Any excess of the cost to the parent of its
investment in a subsidiary over the parent’s portion of equity of the
subsidiary, at the date on which investment in the subsidiary is made, should
be described as goodwill to be recognized as an asset in the consolidated
financial statements;
(c) When the cost to the parent of its investment in a
subsidiary is less than the parent’s portion of equity of the subsidiary, at
the date on which investment in the subsidiary is made, the difference should
be treated as a capital reserve in the consolidated financial statements;
(d) Minority interests in the net income of
consolidated subsidiaries for the reporting period should be identified and
adjusted against the income of the group in order to arrive at the net income
attributable to the owners of the parent; and
(e) Minority interest in the net assets of consolidated
subsidiaries should be identified and presented in the consolidated balance
sheet separately from liabilities and the equity of the parent’s shareholders.
Minority interests in the net assets consist of:
· The
amount of equity attributable to minorities at the date on which investment in
a subsidiary is made; and
· The
minorities’ share of movements in equity since the date the parentsubsidiary
relationship came in existence
Q – State the Factors
Affecting the Valuation of Goodwill.
Ans.
FACTORS AFFECTING THE VALUE OF GOODWILL
The value of goodwill depends upon various factors. Let
us identify those factors that influence the value of goodwill.
(1) Location of Business: If the firm is located in the
centralized place where there is more traffic, has high sales, so earns more goodwill.
Therefore, if the business is located at the prominent place, it will attract
more customers and will generate more goodwill.
(2) Management: If the business has good and efficient
management, it helps the business to earn more profit and goodwill. So, the
business with efficient and experienced management will generate more goodwill.
(3) Business longevity: The business with higher
longevity or the older business is known by more customers and therefore will
have more goodwill as with time business can earn more reputation and with the
number of customers also goes on increasing.
(4) Nature of Product: The business which deals in the
daily use products will have stable profits and demand so will have more
goodwill in comparison to those business which deals in the fancy products.
(5) Risk: if the risk involved in the business is more
than it will have less goodwill and on the other hand if the risk involved is
less, firm will have more goodwill.
(6) Competition: If in the near future there are chances
of increase in the competition of the firm, it will reduce the goodwill of the
business.
(7) Profit trend: If the profits of the firms are
reducing from the past years, i.e. the profits are showing the declining trend
then, the goodwill of the firm will also reduce and vice versa.
(8) License: If the firm has the import license,
definitely its goodwill will increase because it can take the advantage of
their license which the other firms without license cannot avail.
(9) Requirement of Capital: The capital requirement of
the business also affects its goodwill. If the two firms earn same rate of
return then, the business with lesser capital will enjoy more goodwill
Q – State the need for
valuation of Shares.
Ans.
NEED FOR THE VALUATION OF SHARES
In most cases,
shares are quoted on the stock exchange. For ordinary transactions in shares or
debentures or Government securities, the price prevailing on the stock exchange
may be taken as the proper value. The stock exchange price does not hold good for
very large lots. All the shares are not quoted on the stock exchange. Shares of
private companies in any case will not be quoted. Shares of such a company have
to change hands and therefore, the value of such shares will have to be
ascertained.
(1) For
amalgamation and reconstructions: Where companies amalgamate or are similarly
reconstructed, it may be necessary to arrive at the value of the shares held by
the members of the company being absorbed or taken over.
(2) At the time of dissolution: Where the shares are
held jointly by the partners and the dissolution of the firm takes place, it
becomes necessary to value the shares for proper distribution of the
partnership property among the partners.
(3) Transfer of shares: Where a portion of the shares is
to be given by a member of the proprietary company to another member as the
member cannot sell it in the open market, it becomes necessary to certify the
fair prices of the shares by the auditor or an accountant.
(4) At the time of taking loan: When the loan is taken
on the security of the shares it becomes necessary to value the share on the
basis of which loan is to be taken.
(5) At the time of conversion: When the preference
shares or debentures are to be converted into equity shares it becomes necessary
to value the equity shares for the purpose of calculation of the number of
equity shares to be issued in place of preference shares or debentures.
(6) Shares of private companies: Shares of private
companies are not quoted on the stock exchange. If shares of such companies are
to be sold, the value of such shares has to be ascertained.
(7) At the time of appraisal of shares: When the shares
of the company are not quoted on the stock exchange and shareholders require
the appraisal of their shares, at such times the valuation of shares is
required.
(8) For declaring the Net Assets Value: The valuation
of shares is made by such companies to find the correct value of his assets for
declaring the net asset value.
(9) For determination of gift and wealth tax: When the
shares are received as a gift, it is necessary to determine the value of shares
for the purpose of assessing the gift duty and also for determination of the
wealth tax by the taxation authorities.
Q – What is Amalgamation ?
State It’s Objectives.
Ans. Amalgamation:
When two or more companies same in all respects go into liquidation and the new
company is formed to take over their business is called amalgamation. For
example, if a new company C Ltd. is formed to take over A Ltd. and B Ltd. which
are existing companies, it is an example of amalgamation.
Absorption:
Under absorption, no new company is formed, whereas an existing company
purchases another existing company, it is called absorption.
OBJECTIVES
OF AMALGAMATION
Amalgamation means the merging of two or more than two
companies for eliminating competition among them or for growing in size to
achieve the economies of scale. Amalgamation is a broad term which includes
mergers (uniting of two existing companies) and acquisition (one company buying
out another company).There are many objectives of amalgamation. Some of the
objectives are as follow: Let us discuss them in detail.
(i)
To have a better control over the market
and also to increase the market share and area of operations.
(ii)
To eliminate the cut-throat competition and
rivalry among competing the amalgamating companies.
(iii)
To enjoy the economies of large scale
production.
(iv)
To utilize the services of professional
experts.
(v)
To increase the availability of funds for
the future investment plans.
(vi)
To achieve all other advantages of
combination.
Q – State the Dfference
between Amalgamation,
Absorption, and Reconstruction of companies
Ans. Distinguish between Amalgamation,
Absorption, and Reconstruction of companies
|
Sr.No |
Basis |
Amalgamation |
Absorption |
External Reconstruction |
|
1. |
Meaning |
Amalgamation is a fusion between two
or more companies to consolidate their business activities by establishing a
new company having a separate legal existence. |
Absorption is the process in
which the one leading company takes control over the weaker company. |
External reconstruction refers
to forming of a new company to take over the assets and liabilities of old
company. |
|
2 |
Objectives |
To
reduce the competition and to reap the benefit of Economies of scale |
To
reduce the competition and to reap the benefit of Economies of scale |
The
basic purpose is to reorganize the financial structure of the company. |
|
3. |
Companies
taken over |
Two
or more companies are taken over by the new company and one new company is
formed. |
One
or more companies are absorbed by the existing company. |
One
company is liquidated to form the new company |
|
4. |
Example |
A
ltd and B ltd amalgamate and for new company AB Ltd |
A
Ltd takes over B Ltd |
B
Ltd is formed to take over A Ltd |
Q – State the steps Involved
in Internal Reconstruction.
Ans.
STEPS INVOLVED IN INTERNAL RECONSTRUCTION
The usual steps involved in internal reconstruction are
discussed as follow: In brief the modus operandi of capital reduction involved
sacrifices on the part of the shareholders, debenture holders and creditors and
utilizing the amount foregone by them to write off losses and also scale down
assets to their real values. An account names as ‘capital reduction account’
also called ‘internal reconstruction account’ is opened for this purpose.
Amounts sacrificed by various interests are credited to this account and then
the balance in this account is utilized to write off the losses. The items that
are written off as part of capital reduction are as follow:
1. Goodwill: In the case of a company which lost
capital the appearance of goodwill in the balance sheet does not make any sense
so this item is usually written off.
2. Other items like discount on Issue of shares and
debentures, capital issue expenses, preliminary expenses are only deferred
expenses and it is not healthy to keep such items in the balance sheet. Such
items are also written off on reorganization.
3. Any debit balance in profit and loss account
represents accumulated losses and such losses will be written off as part of
capital reorganization.
4. Assets with inflated book values. Some of the assets
may be appearing at unreasonable book values either due to insufficient
depreciation or due to technological changes. Such assets must be brought down
to realistic values.
Q – Write short notes on the
following:
(a) Disposal of Non-Banking Assets
(b) Demerits of Slip System
(c) Conditions for a license to Banking Company
(d) Distinction between a Bank and a NBFC
Ans.
A. Disposal of non-banking assets
No banking company can directly or indirectly deal in
buying or selling or bartering of goods, except in connection with realization
of security given or held by it. A bank cannot acquire certain asset but can
lend against such assets. This means that sometimes, in case of failure on part
of borrower to repay the loans, the bank may have to take possession of such
assets. In that case, the assets will be shown in the balance sheet as
‘non-banking assets’. These assets must be disposed off in maximum seven years.
The banking company may, within the period of seven years deal or trade in such
property for the purpose of facilitating the disposal thereof. The duration of
seven years may be further extended by the RBI up to the maximum five years
where the RBI is satisfied that such extension would be in the interest of the
depositors of the banking company.
b.
Slip system of ledger posting In this system, posting is made
from slips prepared inside the organization itself or slips filled by the
customers. The slip system is a method of rapid posting in books maintained
under double entry principle. In this system, posting is done from slips and
not from journals or cash books. The subsidiary books are not maintained in the
system. Slips are loose leaves and they are given by the customers or by the
bank staff. In a banking company the main slips are – pay in slip, withdrawal
slip and cheques and all these slips 8 are filled by clients of the bank. In
fact, the slips are the vouchers dealt in a bank. It becomes necessary for a
bank to know the position of its individual customer’s account at any time to
see that the transaction is recorded as soon as they take place. It is not
actually possible if transactions are recorded in bound books. So, original
cheques and pay in slips are used as vouchers. The transactions which are not
covered by original slips are posted by mean of ‘dockets’ which are made out by
the bank staff. These are used for posting purposes. In banking system, there
is a need that accounts stand updated very quickly. In fact, after every
transaction they should be updated simultaneously. After introduction of CBS
accounting, the optimum speed in ledger posting is warranted and it is easily
done through the softwares.
c.
Conditions for a license to Banking Company
Licensing
of Banking Companies §
In India, no company can carry on banking business
unless it holds a license issued from RBI and such license may be issued
subject to certain conditions as the RBI may think fit to impose in the case.
Before granting a license to the company, the RBI may require to be satisfied
by an inspection of the books of the company. Further, the following conditions
are to be fulfilled strictly.
(a) The company is or will be in a position to pay its
present or future depositors in full as their claims accrue.
(b) The affairs of the company are not being conducted
in a manner detrimental to the interests of its present or future depositors.
(c) The general character of the proposed management of
the company will not be prejudicial to the public interest or the interest of
its depositors.
(d) The company has adequate capital structure and
earning prospects.
(e) The public interest will be served by the grant of
a license to the company to carry on banking business in India.
(f) The grant of license would be suitable for the
monetary stability and economic growth of the area of operation of the company.
The potential scope for expansion of banks already in existence in the area and
other relevant factors would be examined before issuance of the license.
(g) Any other additional condition whichever is
considered fit to be imposed by the RBI for carrying on banking business.
d.
DIFFERENCE BETWEEN NBFCs AND BANKS NBFCs are doing the functions
similar to banks but there are certain differences between NBFCs and banks.
i. A NBFC cannot
accept demand deposits. The demand deposit means – savings accounts or current
accounts.
ii. It is not a part of the payment and settlement
system which includes clearing house services and facilities like NEFT, RTGS,
IMPS.
iii. It cannot issue cheque books to its customers.
iv. The deposit insurance facility of DICGC is not
available for NBFC depositors as it is available to all bank depositors.
Q – State the reasons for
growing Non-Performing Assests.
Ans.
REASONS FOR GROWING NON-PERFORMING ASSET
The banking sector all over the world is facing the
serious problems of the rising NPAs. The problem of NPAs is more in public
sector banks when compared to private sector banks and foreign banks. The rate
of growth of NPAs is such a high that it has become the matter of concern for
the bankers. The bankers are investigating the reasons for such high growth
rate of NPAs. Following are some of the reasons for the high growth rate of
NPAs.
External
Factors:
1. Failure of the Activity: When the borrower has taken
the loan for any specific business activity and that very activity fails, the borrower
is unable to repay the loan. This creates NPA in the bank.
2. Willful Defaults: There are borrowers who are able
to pay back loans but are intentionally withdrawing it. Sometimes the borrower
takes the loan from the bank in a large amount but they are unable to repay the
same or sometimes they are unwilling to repay the amount. Sometimes willful
defaults, frauds and misappropriations of accounts by the borrowers also
results in NPA.
3. Natural Calamities: Natural calamities are the major
factor, which is creating alarming rise in NPAs of the PSBs. Even now and then
India is hit by major natural calamities thus making the borrowers unable to
pay back their loans. Due to irregularities of rain fall the farmers are not to
achieve the production level thus they are not repaying the loans.
4. Unhealthy Competition: Sometimes the businessmen
enter into cut throat competition. When they enter into price base competition,
they suffer a loss. Because of such loss they are not capable to repay the
amount of loan. This also results into NPAs in Banks.
5. Industrial Sickness: Improper project handling,
ineffective management, lack of adequate resources, lack of advance technology,
day to day changing Government policies give birth to industrial sickness. Hence
the banks that finance those industries ultimately end up with a low recovery
of their loans reducing their profitability and liquidity.
6. Lack of Demand: Entrepreneurs in India could not
foresee their product demand and starts production which ultimately piles up
their product thus making them unable to pay back the money they borrow to
operate these activities. The banks recover the amount by selling of their
assets, which covers a minimum label. Thus, the banks record the non-recovered
part as NPAs and have to make provision for it.
7. Ineffective Recovery Tribunal: The Govt. has set of
numbers of recovery tribunals, which works for recovery of loans and advances.
8. Recessionary Market Trend: In the situation of
recession, the firm is not able to generate enough revenue and it is unable to
repay the borrowed fund. Because of the effect of economic cycles, the profits
of the firm decreases. When the recession becomes very stiff, it results into
the bankruptcy of the firms, which results into NPAs for the banks.
9. Government Policy for Financing Priority Sector: The
government has selected some priority sector for the overall growth and
development of the Indian economy and to maintain the regional and sectoral
balance. According to the government policy, public sector banks have to give
loans to this priority sector at a low rate of interest and sometimes loans are
subsidized. This is the direct loss to the bank. In addition to it, these
priority sectors do not work efficiently and hence are not capable to repay the
loans. This creates NPAs in public sector banks.
Internal
Factors
1.
Defective Lending Process: Defective
lending process is one of the internal factors responsible for NPAs in banks.
Without ensuring that the enterprise or business for which a loan is sought is
a sound one and the borrower is capable of carrying it out successfully creates
NPAs in public sector banks.
2.
Mismanagement and Diversion of Funds:
Because of the mismanagement of the fund or because of diversion of the
investment, the fund is invested in low interest securities or the securities
that don’t pay any interest. Such kind of investment creates the NPA.
3.
Poor Credit Appraisal System: Poor credit
appraisal is another factor for the rise in NPAs. Due to poor credit appraisal
the bank gives advances to those who are not able to repay it back which also
results into NPAs for the banks.
4.
Improper Selection of Borrowers/Activities:
Banker mistake in the selection of borrower or the business activity also
causes NPAs in the bank. When the less creditworthy borrower is selected by the
bank, the amount given as a loan does not realize back and the NPA results.
5.
Non-compliance of Sanction Terms and
Conditions: The banks must follow the terms and conditions provided by the RBI
for sanctioning the loan. In some cases, the banks do not comply with this
terms and conditions and they sanction the loan. In such cases, there are chances
of NPAs.
6.
Unrealistic Repayment Schedule: The
schedule for the repayment of the loan should be prepared after considering the
amount of loan and the repayment capacity of the borrower. Sometimes the bank
makes the mistakes in preparing the repayment schedule for some borrowers. It
creates overburden on such borrowers and they are unable to repay the amount
according to the prescribed schedule.
7.
Lack of Inter-bank Co-ordination: When
there is lack of inter-bank co-ordination as well as lack of co-operation with
financial institutions, there is no exchange of information of the solvency of
the borrowers. Because of this the borrowers make default in more than one
bank. As a result one borrower becomes the cause of NPA in many banks.
8.
Absence of Regular Industrial Visits: The
irregularities in spot visit also increases the NPAs. Absence of regularly
visit of bank officials to the customer point decreases the collection of
interest and principle on the loan. As a result NPAs of banks increases.
9.
Lack of Proper Pre-appraisal and Follow-up:
As per the guidelines of RBI, the banks must appraise the project report before
sanctioning the loan to any borrower. But sometimes the banks do not perform
proper appraisal of the project reports. Without such pre-appraisal, the loan
is sanctioned. Proper follow-up is also not taken by the bank.
10. Inappropriate
Technology: Proper Management Information System (MIS) and financial accounting
system is not implemented in the banks, which leads to poor credit collection,
thus it leads to increase in NPAs. Thus, due to inappropriate technology and
management information system, market driven decisions on real time basis
cannot be taken.
11. Improper
SWOT Analysis: While providing unsecured advances the banks depend more on the
honesty, integrity, and financial soundness and credit worthiness of the
borrower. The improper strength, weakness, opportunity and threat analysis is
another reason for rise in NPAs.
Q – State NPA Recovery
Mechanism & SARFAESI ACT 2002.
Ans.
NON-PERFORMING ASSETS RECOVERY MECHANISM
Presently, it is the burning issue for the RBI as well
as the Government of India to control the NPAs. Reduction in NPAs is the most
important task for the banks. The government of India has taken certain steps
for reducing NPAs of the Indian banking sector. Indian commercial banks are
adopting the measures to reduce and control the NPAs in accordance with the
recommendations of RBI. These strategies are necessary to control NPAs. For
this, the government has established a recovery mechanism that involves the
steps of preventive management and curative management.
A.
Preventive Management: Preventive measures are to prevent
the asset from becoming a non-performing asset. In order to minimize the level
of NPAs, Banks has to concentrate on the following preventive management:
i)
Redesigning
Unpaid Loan Installments: The bank should make an effort to
redesign the loan repayment schedule for those borrowers who are unable to
repay the loans. By reducing the amount of installment and extend the time for
repayment of the loan, bank can recover the maximum loan from its borrowers.
This will convince the borrowers that they can repay the loan.
ii)
Know
Your Client (KYC): The bank should make it a point that the
reminders are sent on time and frequent visits should be taken in the case of
hardcore borrowers. The visit should not be only the formality but it should
bring some quality results. The continuous follow–up for collecting the
advances will definitely help the banks in collecting the older advances also.
iii)
Credit
Assessment and Risk Management Mechanism: Managing credit
risk is a much more forward-looking approach and is mainly concerned with
managing the quality of credit portfolio before default takes place. It is
believed that the credit assessment and risk management mechanism are ever
lasting solution to the problem of NPAs. The documentation of credit policy and
credit audit immediately after the sanction is necessary to upgrade the quality
of credit appraisal in banks.
iv)
Recovery
Camps: It is believed that in the recovery camp the banks can
recover maximum advances by offering some discount or certain other
relaxations. These camps can be organized in the cases of agricultural advances
and advances given to seasonal businesses. It is also suggested that these
camps should be organize during the peak season of the business or during the
harvest season in agriculture. It is advisable to take the help of outsiders such
as local Panchayats officials, regional bank managers and similar other person
and these camps should be properly planned to ensure maximum advantage.
v)
Watch-List:
The purpose of identification of potential NPAs is to ensure that appropriate
preventive/corrective steps could be initiated by the bank to protect against
the loan asset becoming non-performing. Most of the banks have a system to put
certain borrowable accounts under watch list or special mention category if
performing advances operating under adverse business or economic conditions are
exhibiting certain distress signals.
vi)
Willful
Defaulters: As per the revised guidelines of RBI, a
willful default occurs when a borrower defaults in meeting its obligations to
the lender when funds have been utilized for purposes other than those for
which finance was granted. The list of willful defaulters is required to be
submitted to Securities Exchange Board of India (SEBI) and RBI to prevent their
access to capital markets. The process of sharing of information of this nature
helps banks in their due diligence exercise and helps in avoiding financing
unscrupulous elements.
vii)
Early
Warning Signals (EWS): Banks should have adequate preventive
measures, fixing pre-sanctioning appraisal responsibility and having an
effective post-disbursement supervision. It is believed that the origin of the
flourishing NPAs lies in the quality of managing credit assessment, risk
management by the banks concerned. Therefore, banks should continuously monitor
loans to identify accounts that have potential to become non-performing.
viii)
Rehabilitation
Package: According to RBI guidelines, the banks should
introduce rehabilitation package for such sick units. For this banks should
firstly identify sick units in SSI as well as in medium and large scale
industry. It is suggested that while introducing such rehabilitation package,
the bank should keep in mind that the causes of sickness should be genuine and
the project should be viable in terms of debt-service coverage ratio.
ix)
Deposit
Insurance and Credit Guarantee Corporation of India (DICGC):
Banks can also take the services of DICGC regarding settlement of their claims.
For that bank should submit their proposals for outstanding loans with DICGC
for settlement of their claims and reduce their NPAs.
x)
Corporate
Debt Restructuring (CDR): The process of CDR enables the
companies to restructure their dues and reduce the incidence of fresh NPAs. It
has been introduced in the year 2001. The aim of CDR is to provide a timely and
transparent system for restructuring of the corporate debt with the banks and
financial institutions.
B.
Curative Management: The Central government and RBI have taken
various steps for controlling the issue NPAs. For the same they create legal
and regulatory environment to facilitate the recovery of existing NPAs of
banks. The curative measures are designed to maximize recoveries so that banks
funds locked up in NPAs are released for recycling. Following are the curative
measurement:
i)
Compromise Settlement Schemes: This scheme
covers all sectors sub-standard assets, doubtful or loss assets as on 31st
March 2000. All cases on which the banks have initiated action under the
SRFAESI Act and also cases pending before Courts/DRTs/BIFR, subject to consent
decree being obtained from the Courts/DRTs/BIFR are covered. However cases of
willful default, fraud and malfeasance are not covered.
ii)
Lok Adalats: RBI has issued guidelines to
commercial banks advising them to make use of Lok adalats. They are voluntary
agencies created by state governments to assist in matters of loan compromise.
Lok adalats work out an acceptable compromise and issue a recovery certificate
which shortens the period of obtaining a court decree.
iii)
Debt Recovery Tribunals (DRTs): The Debt
Recovery Tribunals have been established by the Government of India under an
Act of Parliament (Act 51 of 1993) for expeditious adjudication and recovery of
debts due to banks and financial institutions. The Debt Recovery Tribunal is
also the appellate authority for appeals filed against the proceedings
initiated by secured creditors under the Securitization and Reconstruction of
Financial Assets and Enforcement of Security Interest Act.
iv)
Securitization
and Reconstruction of Financial Assets and Enforcement of Security Interest
(SARFAESI) Act, 2002: The Government has passed the SARFAESI Act
on 21st June 2002 in order to vested more powers to the banks to proceed
against the “willful defaulter”, and affect recoveries without the intervention
of courts and tribunals. Securitization is considered an effective tool for
improvement of capital adequacy. The primary objective of the act is reduction
of NPA levels of banks or financial institutions and unlocking value from
distressed asset in the banking and financial system. It is also seen as a tool
for transferring the reinvestment risk, apart from credit risk helping the
banks to maintain proper match between assets and liabilities. Securitization
can also help in reducing the risk arising out of credit exposure norms and the
imbalances of credit exposure, which can help in the maintenance of healthy
assets. The SARFAESI Act, 2002 is seen as a booster, initially, for banks in
tackling the menace of NPAs without having to approach the courts. Therefore,
SARFAESI is the preferred route for finding solution to NPA.
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