SHARE CAPITAL
The share capital of a company limited by shares formed is of two types, i.e., Equity Share Capital and Preference Share Capital.
The audit of share capital is necessary on incorporation and afterward as well as whenever the Directors decide to increase the subscribed share capital. To verify capital newly issued, the auditor should have the following points in view:
(1) The “guidelines for disclosure and investor protection” issued by the Securities and Exchange Board of India (SEBI) must be complied with. These guidelines will apply to all issues to be made after the promulgation of Ordinance No. 9 of 1992 by which the Capital Issues (Control) Act, 1947 has been repealed. (BCom 3rd Year Company Audit Notes Study Material)
(2) It should be seen that a prospectus or a statement in lieu of a prospectus has been filed with the Registrar. This is necessary in the case of the first allotment of shares. It is to be noted that:
(a) a prospectus will include in it all the details as required under the Act;
(b) a prospectus should be duly signed and dated by the directors of the company as required by the Act; and
(c) no prospectus will be issued more than ninety days after the date on which a copy thereof is delivered for registration.
(3) No allotment shall be made of any share capital of a company offered to the pub for a subscription unless the amount stated in the prospectus as the minimum amount has been subscribed. The provisions of section 39 have to be complied with in this connection.
Restrictions on Allotment of Shares
(1) No allotment shall be made of any share capital of a company unless any sum payable on application for the amount so stated has been paid to and received by the company whether in cash or by a cheque or other instrument which has been paid.
Minimum Subscription. The minimum amount which in the opinion of the Directors or of the signatories of the Memorandum, must be raised by the issue of shares is the Minimum Subscription. It is 90% of the capital being issued.
The Prospectus issued by the company should contain information about the minimum subscription
(2) The auditor should check whether the company has received the sum payable on the application in respect of the shares to be allotted.
(3) The amount payable on application on each share must not be less than five percent of the nominal value of the share.
All sums so received from the applicants for shares must be deposited in a Scheduled Bank until the certificate to commence business is obtained or they are returned. (BCom 3rd Year Company Audit Notes Study Material)
In the event of any contravention of the provisions of these rules, every Promoter, Director, or another person who is knowingly responsible for such contravention shall be punishable with imprisonment up to one year or with a fine which may extend from Rs.50,000 to Rs.3 lakh.
Refund of Application Money. If the stated minimum amount has not been subscribed and the sum payable on the application is not received within the period specified therein, then the application money shall be repaid within a period of fifteen days from the closure of the issue and if any such money is not so repaid within such period, the directors of the company who are officers in default shall jointly and severally be liable to repay that money with interest at the rate of fifteen percent per annum.
The application money to be refunded shall be credited only to the bank account from which the subscription was remitted.
(4) Under Section 39(4), a company is required to file with the Registrar within thirty days a return of allotment stating the number and nominal amount of the shares comprised in the allotment, the names, addresses, and occupations of the allottees, and the amount, if any, paid or due and payable on each share. Such particulars are to be given for:
(a) Shares issued for cash,
(b) Shares issued for consideration other than cash,
(c) Bonus Shares allotted.
In the case of bonus shares, a return stating the number and nominal amount of such shares comprised in the allotment, full particulars of the allottees, and a copy of the resolution authorizing the issue of such shares is to be filed.
(5) Every company should within two months after the allotment of any of the shares have ready for delivery the certificates of all shares, debentures, etc.
(6) Entries should be passed into the Register of Members immediately after the allotment.
If the default is made in complying with these rules, every officer of the company who is in default shall be punishable with a fine which may range from Rs.10,000 to Rs.1 lakh. (BCom 3rd Year Company Audit Notes Study Material)
Audit of Share Capital
The auditor should examine the following books and documents for the purpose of auditing share capital newly issued:
(i) Memorandum of association,
(ii) Articles of association,
(iii) Prospectus,
(iv) Directors’ minute book,
(v) Application for shares,
(vi) Application and allotment book,
(vii) Copies of letters of allotment,
(viii) Copies of letters of regret,
(ix) Letters of calls,
(x) Calls book,
(xi) Share register,
(xii) Cash book,
(xiii) Passbook.
For the purpose of the audit, the share capital of a company may be put under two heads:
- Shares issued for cash.
- Shares issued for consideration other than cash.
Shares Issued for Cash
The entire procedure may be divided into three stages:
(These are now in electronic form)
- Receipts of applications along with the application money, i.e., application stage.
- Allotment of shares, issuing letters of allotment, and receipt of the allotment money, i.e., allotment stage.
- Calls made and money due thereon received, i.e., call stage.
1. Application Stage
The auditor should proceed in the following manner:
(i) He should check original applications. Entries in the Application and Allotment Book should be vouched with these applications.
(ii) Then he should compare the entries in the Application and Allotment Book with those in the Cash Book.
(iii) He should ensure that the application money was deposited into a scheduled bank until the certificate to commence business is obtained or the money is returned in accordance with the provisions of section 39.
(iv) Entries of the amount passed in the Cash Book, returned to the unsuccessful applicants should be vouched with copies of letters of regret and compared with those in the Application and Allotment Book.
(v) The totals of the Application and Allotment Book should be checked and it should be seen that the Journal Entry debiting the Share Application Account and crediting Share Capital Account has been passed.
- Allotment Stage
(i) The auditor should examine the Directors’ Minute Book to verify approvals for allotment.
(ii) He should compare the entries in the Application and Allotment Book with the copies of letters of regret.
(iii) For receipt of money on the allotment, he should check the Cash Book and compare it with the Application and Allotment Book.
(iv) Postings of the receipts on application and allotment into the Share Register should be checked.
(v) It should be confirmed that the totals are correct and allotment has been duly recorded in the Journal.
- Call Stage
(i) The auditor should examine the Directors’ Minute Book for making calls.
(ii) Entries in the Calls Book should be checked with the help of copies of letters of calls.
(iii) Postings from the Calls Book and the Cash Book into the Share Register should be checked.
(iv) He should compare the Application and Allotment Book with the schedule of calls in arrears and confirm that the amount is correct.
(v) Calls in advance should be verified.
(vi) The totals of the Calls Book should be checked and the entries passed in this connection should be vouched.
Other General Duties
(i) The auditor should confirm that the nominal value of the shares allotted does not exceed the authorized and issued capital and that conditions mentioned in the Prospectus have been duly complied with.
(ii) The total of the balances of the Shareholders’ Account should be tallied with the balances of the Share Capital Account.
(iii) If the issue is underwritten, the contract with the underwriters should be examined and it should be confirmed whether the terms laid down in the contract have been complied with. (BCom 3rd Year Company Audit Notes Study Material)
(iv) Payment of the commission, brokerage, etc. should be vouched with reference to the relevant documentary evidence.
The above-cited procedure can be well applied to the checking of accounts of a company in the first year of existence. In subsequent years, however, an auditor can apply test checking unless there is the further issue of shares in these years.
- Shares Issued for Consideration other than Cash
Shares for consideration other than cash are issued to those persons or institutions from which either property has been acquired or which have rendered some services to the company. Such cases may be as follows:
- Issue of shares to vendors,
- Issue of shares to underwriters of shares, and
- Issue of shares to promoters.
- Issue of Shares to Vendors
The auditor should proceed in the following manner:
(i) Contract. He should examine the contract entered into by the company with the vendors so as to know the exact amount of the purchase consideration. This is the basic document to be consulted by the auditor.
(ii) Prospectus. He should examine the prospectus to enquire about the mode of payment of the purchase consideration.
(iii) Directors’ Minute Book. The Directors’ Minute Book should be referred to confirm the allotment of shares to the vendor.
(iv) Vendor’s Authority in the name of Nominees. If shares have been allotted to the Nominees of the vendor, he should examine the authority of the vendor given to them in their favour.
- Issue of Shares to Underwriters of Shares
(i) Contract. If the shares are issued to the underwriters as remuneration for underwriting shares or debentures, the contract with the underwriters should be inspected. This is necessary to have knowledge of the terms and conditions given in the contract.
(ii) Directors’ Minute Book. Next, he should examine the resolution of the Directors with reference to the minutes of the Board of Directors. It is to be seen whether the allotment of shares to the underwriters is in order.
(iii) Articles of Association. He may also confirm from the Articles of Association the amount of the underwriting commission and the procedure to be followed for its payment. (BCom 3rd Year Company Audit Notes Study Material)
(iv) Prospectus. The Prospectus of the company has to be seen to verify whether the. right for the payment of commission has been mentioned in it or not.
- Issue of Shares to Promoters
(i) Contract. For this, again, the auditor should examine the contract with the promoters.
(ii) Directors’ Minute Book. The minutes of the board of directors should be inspected to verify the allotment of shares.
Besides taking the steps given above in individual cases, the auditor should also note that:
(i) The copies of contracts have been filed with the Registrar of Joint Stock Companies within thirty days of the date of allotment along with a return stating the number and nominal amount of shares so allotted, the extent to which they are to be treated as paid up, and the consideration for which they have been allotted. (BCom 3rd Year Company Audit Notes Study Material)
(ii) He should vouch for the entries passed into the journal to ensure that the issue of shares for consideration other than cash has been properly recorded.
(iii) It has also to be seen that such shares have been separately shown on the liabilities side of the Balance Sheet.
PURCHASE OF ITS OWN SHARES BY A COMPANY
No company limited by shares, and no company limited by guarantee and having a share capital, shall have the power to buy its own shares unless the consequent reduction of capital is effected and sanctioned.
Power of Company to Purchase its own Securities
(1) Notwithstanding anything contained in this Act, but subject to the provisions of section 68, a company may purchase its own shares or other specified securities (hereinafter referred to as “buy-back”) out of:
(i) its free reserves; or
(ii) the securities premium account; or
(iii) the proceeds of any shares or other specified securities;
Provided that no buy-back of any kind of shares or other specified securities shall be made out of the proceeds of an earlier issue of the same kind of shares or the same kind of other specified securities.
(2) No company shall purchase its own shares or other specified securities unless:
(a) the buy-back is authorized by its articles :
(b) a special resolution has been passed in a general meeting of the company authorizing the buy-back;
Provided that nothing in this clause will apply to a case where:
(i) the buy-back is ten percent or less of the total paid-up equity capital and free reserves of the company, and
(ii) such buy-back has been authorized by the Board by means of a resolution passed at the meeting.
(c) the buy-back is or less than twenty-five percent of the total paid-up capital and free reserves of the company:
Provided that the buy-back of equity shares in any financial year shall not exceed twenty-five percent of its total paid-up equity capital in that financial year;
(d) the ratio of the aggregate of secured and unsecured debt owed by the company is not more than twice the capital and its free reserves after such buy-back;
Provided that the Central Government may prescribe a higher ratio of the debt than that specified under this clause for a class or classes of companies.
(e) all the shares or other specified securities for buy-back are fully paid up;
(f) the buy-back of the shares or other specified securities listed on any recognized stock exchange is in accordance with the regulations made by the Securities and Exchange Board of India on this behalf;
The gap of one year. Provided that no offer of buy-back shall be made within a period of one year reckoned from the date of the closure of the preceding offer of buy-back if any. (BCom 3rd Year Company Audit Notes Study Material)
(3) The notice of the meeting at which a special resolution is proposed to be passed shall be accompanied by an explanatory statement stating:
(a) full and complete disclosure of all material facts;
(b) the necessity for the buy-back;
(c) the class of security intended to be purchased under the buy-back;
(d) the amount to be invested under the buy-back; and
(e) the time limit for completion of buy-back.
(4) Every buy-back shall be completed within twelve months from the date of passing the special resolution.
(5) The buy-back may be from:
(a) the existing security holders on a proportionate basis; or
(b) the open market; or
(c) by purchasing the securities issued to employees of the company pursuant to a scheme of stock options or sweat equity.
(6) Declaration of solvency. Where a company has passed a special resolution to buy back its own shares or other securities, it shall, before making such buy-back, file with the Registrar and the Securities and Exchange Board of India a declaration of solvency in the form as may be prescribed and verified by an affidavit to the effect that the Board has made a full inquiry into the affairs of the company as a result of which they have formed an opinion that it is capable of meeting its liabilities and will not be rendered insolvent within a period of one year of the date of the declaration adopted by the Board, and signed by at least two directors of the company, one of whom shall be the managing director if any;
Provided that no declaration of solvency shall be filed with the Securities and Exchange Board of India by a company whose shares are not listed on any recognized stock exchange.
(7) Destroying securities. Where a company buys back its own securities, it shall extinguish and physically destroy the securities so bought back within seven days of the last date of completion of the buy-back.
(8) No further issues in six months. Where a company completes a buy-back of its shares or other specified securities under this section, it shall not make a further issue of the same kind of shares or other specified securities within a period of six months except by way of bonus issue or in the discharge of subsisting obligations such as the conversion of warrants, stock option schemes, sweat equity or conversion of preference shares or debentures into equity shares.
(9) Register of securities bought. Where a company buys back its shares or specified securities under this section, it shall maintain a register of the shares or securities bought, the consideration paid for the securities bought-back, the date of cancellation securities, the date of extinguishing and physically destroying of securities and such other particulars as may be prescribed.
(10) Filing return. A company shall, after the completion of the buy-back under the section, file with the Registrar and the Securities and Exchange Board of India, a return containing such particulars relating to the buy-back within thirty days of such completion as may be prescribed;
Provided that no return shall be filed with the Securities and Exchange Board of India by a company whose shares are not listed on any recognized stock exchange. (BCom 3rd Year Company Audit Notes Study Material)
(11) Punishment. If a company makes a default in complying with the provisions of this section or any rules made by SEBI in this regard, the company can be fined between 1 lakh to 3 lakh. Any officer of the company who is in default shall be punishable with imprisonment for a term which may extend to three years, or with a fine which may range between 1 lakh to 3 lakh or both.
Explanation:
(a) “specified securities includes employees’ stock options or other securities as may be notified by the Central Government from time to time.
(b) “free reserves” under this rule includes securities premium account.
Transfer of certain sums to Capital Redemption Reserve Account
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 account and details of such transfer shall be disclosed in the balance sheet.
Prohibition for Buy-back in certain circumstances
No company shall directly or indirectly purchase its own shares or other specified securities:
(a) through any subsidiary company including its own subsidiary companies; or
(b) through any investment company or group of investment companies; or
(c) if a default, by the company, in repayment of deposit or interest payable thereon, the redemption of debentures, preference shares, or payment of dividend to any shareholder, or repayment of any term loan or interest payable thereon to any financial institution or bank, is subsisting.
Issue of Shares at a Premium
Section 52 of the Companies Act prescribes that:
(1) When a company issues securities at a premium, whether for cash or otherwise, a sum equal to the aggregate amount or value of the premiums on those securities collected shall be transferred to an account to be called The Securities Premium Account and the provisions of this Act relating to the reduction of the Capital of a Company shall except as provided in this section, apply as if the securities premium account were paid-up securities capital of the Company. (BCom 3rd Year Company Audit Notes Study Material)
(2) The Securities Premium Account may be applied by the company:
(a) Towards issue of unissued shares of the company to be issued to members of the company as fully paid bonus shares;
(b) In writing off the preliminary expenses of the company:
(c) In writing off the expenses of or the commission paid or discount allowed on any issue of securities or debentures of the company: or
(d) In providing for the premium payable on the redemption of any redeemable preference securities or debentures of the company.
(e) For the purchase of its own shares or other securities.
Auditor’s Duty
(i) The auditor should examine the Prospectus, the Articles, and the Minutes of the Directors to see whether the issue of shares at a premium is duly authorized or not. He should confirm the rate of premium.
(ii) The receipt of the premium should be vouched with the entries in the Cash Book and the supporting documents.
(iii) He should see that the amount of the share premium is used for specified purposes only.
(iv) The auditor should not have any objection so far as the utilization of the amount of premium is concerned. However, he should see that the sum available has been utilized in the manner as laid down by the Articles.
Prohibition of issue of shares at discount. Except for the allotment of shares as sweat equity shares can not be issued at discount. Any share issue by a company at discounted price shall be void. (BCom 3rd Year Company Audit Notes Study Material)
Issue of Sweat Equity Shares
(1) A company may issue sweat equity shares of a class of shares already issued if the following conditions are fulfilled, namely:
(a) the issue of sweat equity shares is authorized by a special resolution passed by the company in the general meeting;
(b) the resolution specifies the number of shares, current market price, a consideration if any, and the class or classes of directors or employees to whom such equity shares are to be issued;
(c) not less than one year has, at the date of the issue elapsed since the date on which the company was entitled to commence business;
(d) the sweat equity shares of a company whose equity shares are listed on a recognized stock exchange are issued in accordance with the regulations made by the Securities and Exchange Board of India on this behalf;
Provided that in the case of a company whose equity shares are not listed on any recognized stock exchange, the sweat equity shares are issued in accordance with the guidelines as may be prescribed.
(2) All the right limitations, restrictions, and provisions relating to equity shares shall be applicable to such sweat equity shares.
Calls in Arrears
The calls in arrears are the sums of call money due from shareholders. Such calls due from others are required to be shown separately in the Balance Sheet. Often, there is a provision in the Articles of Association of a company to charge interest on calls in arrears.
Auditors’ Duty
(i) The auditor should obtain a schedule of all calls in arrears, the amount of calls due should be verified by reference to the Share Register.
(ii) He should ensure that calls in arrears are properly shown on the Balance Sheet. it is deducted from the amount of the called-up capital and shown on the liabilities side. (BCom 3rd Year Company Audit Notes Study Material)
Calls in Advance
A company, if permitted by the Articles of Association, may accept from members either the whole or a part of the amount remaining unpaid on any shares held by him, as called in advance. The amount so received should not be treated as part of the capital for purposes of any voting rights.
A company may, if so authorized by the Articles, pay dividends in proportion to the amount paid up on each share where a large amount is paid up on some shares than others. However, it is prescribed in Clause 83(2) of Table F of Schedule I that no amount paid or credited as paid on a share in advance of calls shall be treated for the purpose of paying dividends.
The shareholders who have paid the calls in advance will be entitled to receive interest at the rate specified in the Articles. In Table F of Schedule I of the Companies Act, it is provided that the Board of Directors can pay on the advance money such interest not exceeding 12 percent per annum as may be agreed upon between the Board and the members paying the sum in advance. Such an interest can be paid out of capital if profits are not available for such a payment. (BCom 3rd Year Company Audit Notes Study Material)
Auditor’s Duty
- The auditor should see that calls in advance have not been treated as part of the capital. Calls in advance should be shown separately in the Balance Sheet.
- He should vouch for the calls in advance with counterfoils of the Receipt Book and entries in the Cash Book.
- He should see that interest on calls in advance if its payment is permitted by the Articles has been paid. He should study the Articles.
- He should compare the Share Register and the Cash Book.
Issue and Redemption of Preference Shares
(1) No irredeemable preference shares. No company limited by shares shall, after the commencement of the Companies Act, 2013, issue any preference shares which are irredeemable. (BCom 3rd Year Company Audit Notes Study Material)
(2) A Company limited by shares may, if so authorized by its articles, issue preference shares which are liable to be redeemed within a period not exceeding 20 years from the date of their issue subject to such conditions as may be prescribed.
Provided that a company may issue preference shares for a period exceeding 20 years for infrastructure projects, subject to the redemption of such percentage of shares as may be prescribed on an annual basis at the option of such preferential shareholders :
Provided further that:
No such shares shall be redeemed except out of the profits of the company which would otherwise be available for dividend or out of the proceeds of a fresh issue of shares made for the purposes of such redemption.
No such shares shall be redeemed unless they are fully paid;
Transfer to Redemption Reserve Account. Where such shares are proposed to be redeemed out of the profit of a company, there shall, out of such profits, be transferred. a sum equal to the nominal amount of the shares to be redeemed, to a reserve to be called the capital ‘Redemption Reserve Account’, and the provisions of this Act relating to the reduction of the share capital of a company shall, except as provided in this section, apply as if the Capital Redemption Reserve Account was paid-up share capital of the company: and
(i) in case of such class of companies, as may be prescribed and whose financial statement complies with the accounting standards the premium, if any payable of redemption shall be provided for out of the profits of the company, before the shares at redeemed:
Provided also that premium, if any, payable on redemption of any preference shares issued on or before the commencement of this Act by any such company shall be provided for out of the profits of the company or out of the company’s securities premium account before such shares are redeemed.
(ii) in a case not falling under the rule stated above, the premium, if any, payable on redemption shall be provided for out of the profits of the company or out of the company’s Securities premium account before such shares are redeemed.
Auditor’s Duty
(i) For Issue:
(1) The auditor should, first of all, examine the Articles of Association of the company to ensure that such an issue is authorized by the Articles.
(2) The issue should be vouched and the auditor should check the necessary records made in the books of accounts in this connection.
(3) Unless the shares are redeemed, the terms of redemption, if any, must be stated in the Balance Sheet along with the earliest date of redemption or conversion. (BCom 3rd Year Company Audit Notes Study Material)
(ii) For Redemption:
(1) The auditor should see that the rules given above have been complied with.
(2) If the shares are redeemed out of a fresh issue, he should examine the Articles and the Minutes of Directors.
(3) He should vouch for the entries passed to give effect to redemption and ensure that they are correct.