BCom Company Audit in Auditing Notes Study Material

Table of Contents

FORFEITURE OF SHARES

If some of the shareholders of a company do not pay the amount due on calls and if the Articles of Association so authorize, the company can forfeit the amount received by it under the regulations laid down by the Articles or the Regulations 28 to 34 of Table F. Usually, the Articles of Association of a company lay down the procedure to be followed and the rights and liabilities of the members whose shares have been forfeited.

Procedure for forfeiture of shares. The Articles lay down the procedure under which a company is required to give defaulting shareholders a notice asking them to pay the amount due on a certain call and in the event of non-payment, the shares will be forfeited. If they do not pay the demanded call the amount received from them is forfeited and transferred to the Forfeited Shares Account. If shares to be forfeited have been issued at a premium, the amount of premium in respect thereof is not transferred to the Forfeited Shares Account.

The Forfeited Shares Account should be separately shown in the Balance Sheet until the shares have been reissued. If the forfeited shares are reissued, the total amount (the amount received before the forfeiture and on the reissue) received should not be less than the nominal value of the shares otherwise it will amount to a reduction of capital. The final balance (i.e., the amount more than the nominal value of the shares received) lying in the credit of the Forfeited Shares Account should be transferred to the Capital Reserve Account as it is a Capital Profit.

In Madhwa Ram Chandra Kamath vs. Canara Banking Corporation (1941), it was held that the Articles of a company only authorized it to expel a member. That was held to be not sufficient ground to enable the company to deprive the expelled member of his shares.

Forfeited shares become the property of the company. To this extent, forfeiture involves a reduction of the company’s capital. The shares can, however, be sold or disposed of on such terms the Board thinks fit, but that is not the same thing as an allotment. This was observed in re: Calcutta Stock Exchange Association (1957). Upon reissue, the capital becomes intact.

In Kaushiram vs. Kishore Chandra (1915) it was held, “The right to forfeit shares must be pursued with the greatest exactness; it must be exercised by the proper parties, that is, by Directors properly appointed, and by the requisite number of them and in the proper manner and for the proper cause. The right must be exercised bona fide for the purposes for which it is conferred.

The power of expulsion is a trust, the execution of which will be narrowly scanned by the Courts. In Vishwanath Prasad Jallan vs. Holyland Cinetone L (1939) it was held that where certain subscribers had undertaken to purchase a certain number of shares but there was no term in the Articles of Association by which they to pay the amount on a particular date, nor was any date fixed by the Board of Directors their shares were not liable to forfeiture. (BCom 3rd Year Company Audit Notes Study Material)

Similarly, in Panna Lals vs. Jagjit D. & A Industries (1952) it was held that where a call for payment is made on the transferee of shares before his name is registered as a member, the call would be invalid and consequently, the forfeiture of shares for non-payment of the call money would also be invalid. (BCom 3rd Year Company Audit Notes Study Material)

Auditor’s Duty

(i) Forfeiture:

(1) The auditor should study the Articles of the company to ascertain that the Board of Directors has been authorized to forfeit the shares. If the Articles of Association do not have any such provisions, Regulations 28 to 34 of Table F of Schedule I of the Companies Act, 2013 would be applicable.

(2) He should verify the number of calls or installments outstanding in respect of shares forfeited.

(3) He should refer to the Minutes of the Board of Directors to ensure that the procedure prescribed by the Articles has been followed.

(4) Then, he should check the entries passed in the books of accounts and confirm that the premium, if any, received on the issue of shares, has not been transferred to the Forfeited Shares Account.

(5) After forfeiture, a shareholder ceases to be a member of the company in respect of the shares forfeited. The auditor should see that the necessary entries have been made in the Register of Members as required.

(ii) Reissue of forfeited shares:

(1) He should ascertain that the Board of Directors has the necessary authority under the Articles to reissue the forfeited shares.

(2) He should study the resolution of the Board of Directors under which the forfeited shares have been reallotted.

(3) He should vouch for the entries made on reallotment in the Cash Book.

(4) He should inspect the copy of the return on allotment filed with the Registrar of Joint Stock Companies.

(5) He should see that the balance remaining in the Forfeited Shares Account has been transferred to the Capital Reserve Account.

Bonus Shares

Usually, the following reasons are given for the issue of Bonus Shares:

(1) When the company has sufficient reserves that it does not need in the future, it issues bonus shares.

(2) When there is a big gap between the paid-up capital and the capital actually employed in the business on account of huge reserves, it is thought proper to issue bonus shares and, thus, to fill up the gap.

(3) Payment of dividends at a high rate is possible if there are excessive divisible profits within the company. This attracts competitors in the business. Thus, bonus shares are issued to reduce the rate of dividends and to regularize it from year to year.

(4) A high rate of dividend paid to the shareholders is usually resented by the employees and customers. Hence, Bonus Shares are issued and the rate of dividends is kept down. (BCom 3rd Year Company Audit Notes Study Material)

It is thus seen that the issue of bonus shares is a good method of capitalizing large profits or reserves.

The following points have to be noted when auditing the issue of bonus shares:

(1) The issue of bonus shares increases the volume of the share capital of a company. It should be seen that the profits are enough to enable the company to pay the same rate of dividend.

(2) There should be a sufficient number of unissued shares (from authorized capital) for allotment as bonus shares. Only then, bonus shares can be issued.

(3) If there is no unissued share capital, a resolution altering the Memorandum and Articles of Association should be passed so as to enable the company to increase the authorized capital of the company.

(4) For making payment of dividends otherwise than in cash, Articles will have to be altered to enable the company to do so.

Bonus shares are issued to all the existing shareholders in their shareholding proportion.

Rules for Issue of Bonus Shares

(1) A company may issue fully paid-up bonus shares to its members, in any manner whatsoever, out of:

(i) its free reserves;

(ii) the securities premium account; or

(iii) the capital redemption reserve account;

Provided that no issue of bonus shares shall be made by capitalizing reserves created by the revaluation of assets.

(2) No company shall capitalize its profits or reserves for the purpose of issuing fully paid-up bonus shares unless:

(a) Issue of bonus shares it is authorized by its articles;

(b) It has been done on the recommendation of the Board and authorized in the general meeting of the company;

(c) The company has not defaulted in payment of interest or principal in respect of fixed deposits or debt securities issued by it;

(d) The company has not defaulted in respect of the payment of statutory dues of the employees, such as contribution to provident fund, gratuity, and bonus;

(e) The partly paid-up shares, if any outstanding on the date of allotment, have been made fully paid-up;

(1) The company complies with such conditions as may be prescribed.

(3) The bonus shares shall not be issued in lieu of dividends.

RIGHTS ISSUE

When a company offers new shares issued by it to its existing shareholders, it is known as a rights issue. If at any time, after the expiry of two years from its formation or after the expiry of one year from the allotment of shares by it for the first time after its formation, whichever is earlier, the company proposes to issue further shares then such Shares have to be offered to the existing shareholders, in proportion to the shares held by them. (BCom 3rd Year Company Audit Notes Study Material)

The existing shareholders have to exercise this right within fifteen days (or within more time if allowed). They can renounce this right in favour of some other persons also. The company can also decide not to issue shares on a rights basis by passing a special resolution. It can also do this by passing an ordinary resolution and obtaining the permission of The Central Government.

Auditor’s Duties about Bonus and Rights Issue

Ensure that provisions of the company law are followed about the issue of bonus and rights shares, and Articles permit it.
Necessary resolutions are passed at Board and general meetings, he should check the minutes about it.
The consideration money has been duly received.
The return of allotment about it has been filed with the Registrar.
The allotment has been made on prorata basis.
Ensure that the Guidelines issued by SEBI about it have been followed.
The Balance Sheet shows the changed position.

PREFERENCE SHARES

Preference shares are those shares that carry preferential rights in respect of dividends and also the preferential right with regard to the repayment of capital in case of winding up of the company. The rate of dividend on such shares is fixed at the rate of 14% or 12%, dividend at a prescribed rate has to be paid to preference shareholders before any dividend can be paid on equity shares. If a company has not made any profit in a particular year no dividend will be paid on preference shares also.

Features of preference shares

The main features of preference shares are:

Preference in the distribution of income. No dividend can be distributed on equity shares unless a dividend at a determined rate has been paid on preference shares, of course, the company must have earned profits and the Board of Directors should have decided to recommend payment of dividend. If the dividend is not declared in a particular year the preference shareholders lose the right to get a dividend in that year. Only in the case of cumulative preference shares, the amount of unpaid dividend can be carried over to coming years and paid then, of course, the Board of Directors should recommend a dividend in these coming years.
Repayment of capital. Preference shareholders get preference in repayment of capital in the case of winding up of the company, their claim will have to be settled before any money is returned to equity shareholders. In case of liquidation of the company, only the face value of preference shares is returned to them; they are not entitled to any surplus. If the preference shares are irredeemable their money is never returned during the lifetime of the company. Money of redeemable preference shareholders can only be repaid after the prescribed period say five years or ten years. (BCom 3rd Year Company Audit Notes Study Material)
No participation in management. Ordinarily, preference shareholders have no right to attend company meetings or to vote therein. They have no right to elect directors or appoint auditors. However, under section 87 of the Companies Act, preference shareholders can vote on resolutions that directly affect their rights. Holders of preference shares can vote on any kind of resolution if their dividend has remained in arrears for an aggregate period of not less than two years on the date of the meeting.

Types of Preference Shares

Preference shares can be of the following types:

Cumulative preference shares. The unpaid dividend on these shares in any year or years keeps on accumulating and is paid when there are profits in the future. For example, if in the years 2003 and 2004 there were no distributable profits to be paid to cumulative debentures and there were profits in 2005, such preference shareholders would get their arrears of 2003 and 2004 in 2005.

Non-cumulative preference shares. The unpaid dividend on such shares in any year gets finished there, it does not accumulate as arrears. Such shareholders are paid dividends if there are profits in any particular year for that year only.

Redeemable preference shares. If the money of preference shareholders can be paid back within a stated number of years say 5 years or 7 years, they are called redeemable preference shares. These shares can be issued if the Articles of the company permit it. They can be redeemed only if they are fully paid up and only out of the profits which would be available for dividends or out of the proceeds of new issues of shares made with the object of redemption. (BCom 3rd Year Company Audit Notes Study Material)

As per the Companies Act, 2013 Section 55(a) issue of any preference share which is irredeemable or is redeemable after the expiry of a period of twenty years from the date of issue has been prohibited.

Participating preference shares. Participating preference shares are those shares that get additional dividends over and above their fixed rate of dividend if there are surplus profits after payment of dividends to equity shareholders at some maximum rate. For example, if there is a provision that preference shareholders will get dividends at the rate of 12 percent and they will get more dividends if there is a surplus after payment of a 30 percent dividend to equity shareholders, such shares will be called participating preference shares.

Non-participating preference shares. If preference shares are entitled to dividends at a fixed rate (e.g. 12%) and nothing more, whatsoever, maybe the profits, such preference shares are called non-participating preference shares.

Convertible preference shares. If the preference shareholders are given the option of converting their preference shares into equity shares after a stipulated period, these are called convertible preference shares. The Articles of Association of the company must authorize the issue of such shares. A company can also issue partly convertible preference shares. In such a case only some part of the total preference shareholdings is convertible into equity shares. (BCom 3rd Year Company Audit Notes Study Material)

Non-convertible preference shares. If the preference shares can never be converted into equity, such preference shares are called non-convertible preference shares. (BCom 3rd Year Company Audit Notes Study Material)

SHARE TRANSFER AUDIT

It is not part of an auditor’s duty to check the share transactions in detail but he is usually asked to undertake the audit of share transfer for which he is paid an extra remuneration.

Its objects are:

(i) to prevent clerical errors, and

(ii) to prevent the improper issue of Duplicate Share Certificates or certified transfers (whether fraudulently or otherwise).

Transfer and Transmission of Securities

Delivering instrument of transfer. A company shall not register a transfer of securities of the company unless a proper instrument of transfer, in such form, as may be prescribed, duly stamped, dated, and executed by or on behalf of the transfer and the transferee and Specifying the name, address, and occupation, if any, of the transferee has been delivered to the company by the transferor or the transferee within a period of sixty days from the date of execution, along with the certificate relating to the securities, or if no such certificate is in existence, along with the letter of allotment of securities;

Lost instrument of transfer. Where the instrument of transfer has been lost or the instrument of transfer has not been delivered within the prescribed period, the company any register the transfer on such terms as to indemnity as the Board may think fit.

By operation of law. A company can register, on receipt of an intimation of transmission of any right to securities by operation of law from any person to whom such right has been transmitted.

In case of partly paid shares: Where an application is made by the transferor alone and relates to partly paid shares, the transfer shall not be registered, unless the company gives the notice of the application, in such manner as may be prescribed, to the transferee and the transferee gives no objection to the transfer within two weeks from the receipt of notice.

Time period for delivery of certificates. Every company shall, unless prohibited by any provision of law or any order of Court, Tribunal or other authoristy, delivery the certificates of all securities allotted, transferred or transmitted as per following schedule.(BCom Company Audit in Auditing Notes Study Material)

(a) within a period of two months from the date of incorporation, in the case of subscribers to the memorandum;

(b) within a period of two months from the date of allotment, in the case of any allotment of any of its shares;

(c) within a period of one month from the date of receipt by the company of the instrument of transfer or the intimation of transmission in the case of a transfer or transmission of securities;

(d) within a period of six months from the date of allotment in the case of any allotment of debenture.

In case of depository. Where the securities are dealt with in a depository, the company shall intimate the details of allotment of securities to depository immediately on allotment of such securities.

In case of death of transferor. The transfer of any security or other interest of a deceased person in a company made by his legal representative shall, even if the legal representative is not a holder thereof, be valid as if he had been the holder at the time of the execution of the instrument of transfer.

Punishment for default. Where any default is made in complying with the provisions of the Act in this regard, the company shall be punishable with fine which shall not be less than twenty-five thousand rupees but which may extend to five lakh rupees and every officer of the company who is in default shall be punishable with fine which shall not be less than ten thousand rupees but which may extend to one lakh rupees.

Without prejudice to any liability under the Depositories Act, 1996, where any person of depository or depository participant, with an intention to defraud a person, has transferred shares, it shall be liable for fine and imprisonment.

NOMINATION OF SHARES

(1) Every holder of shares in, or holder of debentures of a company may, at any time. nominate, in the prescribed manner, a person to whom his securities of the company shall vest in the event of his death.

(2) Where the securities of a company are held by more than one person jointly, the joint holders may together nominate, in the prescribed manner, a person to whom all the rights in the securities in the company shall vest in the event of death of all the joint holders.

(3) Where a nomination made in the prescribed manner confers on any person the right on the securities of the company, the nominee shall, on the death of the security-holder of the company will be entitled to all the rights in the security of company.

(4) Where the nominee is a minor, it shall be lawful for the holder of the securities to make the nomination to appoint in the prescribed manner any person to become entitled to securities of the company, in the event of his death, during the minority.

Auditor’s Duty About Transfer of Shares

Besides confirming that the provisions regarding transfer of securities have been duly complied with and the laid down procedure has been followed, the auditor should take the following steps which are considered necessary for the audit of share transfer:

(1) He should examine the Articles of Association as to the procedure to be followed in case of transfer of shares.

(2) It should be seen that due notices have been given to all the transferees if the application for registration has been made by the transferor in the case of partly paid shares. (BCom 3rd Year Company Audit Notes Study Material)

(3) He should check the transfer forms.

(4) Next, he should examine and verify the signatures of the transferors from their specimen signatures on the original application forms or previous transfer deeds.

(5) It should be seen that none of the transferees is disqualified for holding shares in the company.

(6) He should vouch the entries in the Share Transfer Journal on the basis of transfer forms.

(7) He should inspect the Minutes Book of the Board of Directors to ascertain that the transfer is duly approved by the Board.

(8) He should check the transfer and postings made from the Share Transfer Journal into the Share Register and the Register of Members.

(9) He should cancel the old Share Certificates by a distinctive mark and especially verify the particulars entered on the counterfoils of certificates issued to the transferees. (BCom 3rd Year Company Audit Notes Study Material)

(10) He should confirm that a duplicate certificate issued in place of the one lost or destroyed has been issued with the consent of the Board of Directors. The fact has to be entered in the duplicate certificate that it is so issued.

(11) It should be seen that share certificates have been issued on printed forms and unused stock of share certificates is being kept under safe custody.

(12) If shares have been issued in the absence of Share Certificates, he should examine the Letters of Indemnity.

(13) If shares mortgaged with some other institutions have been transferred, it is to be ensured that due notices were given to the mortgagees.

(14) In the case of transmissions registered on the death or insolvency of shareholders, the auditor should see:

(i) that the provisions of the Articles have been duly followed.

(ii) that for transmissions on death to any executor, the following documents have to be examined:

(a) Succession Certificate granted by the Court.

(b) Certificate issued by the Controller of Estate Duty to ensure that Estate Duty has been paid.

(d) Order of the Court of Insolvency.

(e) The resolution of the Board of Directors in their Minutes Book approving the transmission.

(15) He should see that the transfer fee is duly received and credited to the Profit & Loss Account. He should also compare it with the number of transfers lodged.

(16) He should confirm that if the registration of the transfers has been refused, due notices are given to the transferor and the transferee within a period of thirty days. (BCom 3rd Year Company Audit Notes Study Material)

(17) Lastly, he should confirm that in case of shares held by Directors, Managing Agents, Secretaries and Treasurers, the relevant entries in respect thereof have been duly passed. (BCom 3rd Year Company Audit Notes Study Material)

Blank Transfer

Under a blank transfer, the transferor handsover to the transferee the Share Certificate with a transfer form completely blank except for the signature of the transferor. Its advantage is that the transferee shall be at liberty to sell the shares again to a subsequent buyer without disclosing his own identity and without paying for the transfer stamp.

Evils Associated with a Blank Transfer

Concealment of the identity of the real owner.
Evasion of Tax.
Window-dressing of the Balance Sheet.
Creation of fictitious transactions in the books to manipulate accounts.

Every instrument of transfer of shares must be in the prescribed form and before it is signed by the transferor and before any entry is made in it, be presented to the prescribed authority who shall stamp or otherwise endorse thereon the date on which it! is so presented. It should then be executed by the transferor and the transferee and completed in all other respects and should be presented to the company for registration. (BCom 3rd Year Company Audit Notes Study Material)

An instrument of transfer not in conformity with the above provisions shall not be accepted by the company.

The basic principles have recently been restated by the Gujarat High Court in Pranlal Jayanand Thakur vs. Vasudev Ramchandra Shelat (1973) as given below:

An instrument of transfer which carries no entry except the signature of the transferor is a valid instrument.
A person to whom such an instrument is delivered along with share scrip gets an implied authority to complete the instrument.
The transferee acquires good title to the shares if he has received the documents in good faith and for consideration.

The facts of the case were that the transferee had received the shares under a Gift Deed from a lady who signed blank transfer forms which, however, could not be registered before her death.

The other heirs having claimed the shares the Court held that the transferee had not acquired a goods title to shares as he had received them without consideration. (BCom 3rd Year Company Audit Notes Study Material)

Thus, the transferee gets good title if the transfer is registered during the lifetime of the transferor. But if the transferor dies before registration, other heirs can question the validity of the gift.

The Supreme Court has overruled the decision in Vasudev Ramchandra Shelat vs. Pranlal Jayanand Thakur (1974) and has held that on these facts a complete equitable and legal ownership is transferred to the transferee and he is entitled to have the transfer registered in the company’s registers.

ISSUE OF SHARE CERTIFICATES

A share certificate certifies that a person is the bonafide holder of specified number of shares in a company. The certificate can be in physical or demo form. Every company must complete and have the share certificates ready for delivery within two months of the allotment of shares. In the case of transfer, the share certificate must be issued within two months of registration of the transfer. Same rules apply for issue of debenture and debenture stock certificates. The particulars of share certificates issued must be entered in the register of members.

Where a share is held in depository form, the record of the depository is prima facie evidence of interest of the beneficial owner.