Share capital and debentures are two essential components of a company’s capital structure. Share capital represents the ownership interest of shareholders in the company, while debentures represent a company’s borrowing from its creditors.
Accounting for Share Capital
Share capital represents the money invested by shareholders in the company. It is a long-term source of finance that a company raises by issuing shares to the public. Shareholders are the owners of the company and have a right to vote on important company decisions, such as the appointment of directors, the adoption of the annual report, and the distribution of dividends. The accounting treatment of share capital involves the following steps:
Issuing Shares:
The first step in accounting for share capital is to issue shares to the public. A company can issue shares in two ways: through an initial public offering (IPO) or by issuing additional shares to existing shareholders. In both cases, the company must ensure that it complies with all legal and regulatory requirements.
Recording the Receipt of Share Capital:
When a company issues shares, it receives money from shareholders in exchange for ownership in the company. This money is recorded as share capital in the company’s balance sheet. Share capital is classified as equity in the balance sheet, which means that it represents the residual interest in the assets of the company after deducting its liabilities.
Accounting for Share Premium:
When a company issues shares at a price higher than their face value, the excess amount received is called share premium. Share premium is also recorded as equity in the balance sheet. However, it is shown separately from share capital. Share premium represents the additional amount received by the company for issuing shares and is not available for distribution as dividends.
Accounting for Bonus Shares:
A company may issue bonus shares to its existing shareholders as a reward for their loyalty. Bonus shares are issued free of charge and do not require shareholders to pay any additional money. The accounting treatment of bonus shares involves the following steps:
- Debiting the share capital account with the nominal value of the bonus shares issued.
- Crediting the share premium account with the amount of the nominal value of the bonus shares issued.
- No change in the total equity of the company occurs, as there is no inflow of new funds.
Accounting for Rights Issues:
A rights issue is a method of raising additional share capital from existing shareholders. In a rights issue, shareholders are given the right to buy new shares in proportion to their existing shareholding. The accounting treatment of rights issues involves the following steps:
- Debiting the share capital account with the nominal value of the shares issued.
- Crediting the share premium account with the amount of the nominal value of the shares issued.
- Recording any excess amount received as share premium.
- Recording the increase in the number of shares issued.
Accounting for Debentures:
Debentures are a long-term source of finance that a company raises by borrowing money from its creditors. Debentures are similar to bonds, but they are not secured by any specific asset. Instead, they are backed by the general creditworthiness of the company. The accounting treatment of debentures involves the following steps:
Issuing Debentures:
The first step in accounting for debentures is to issue them to creditors. A company can issue debentures in two ways: through a public issue or by issuing them privately to institutional investors. In both cases, the company must ensure that it complies with all legal and regulatory requirements.
Recording the Receipt of Debentures:
When a company issues debentures, it receives money from creditors in exchange for the promise to pay back the principal amount with interest. This money is recorded as a liability in the company’s balance sheet. The liability is classified as long-term borrowing in the balance sheet, which means that it is not due for payment within one year.
Accounting for Debenture Redemption Reserve:
When a company issues debentures, it is required to create a debenture redemption reserve (DRR) equal to at least 50% of the amount of debentures issued. The purpose of the DRR is to ensure that the company has sufficient funds to repay the principal amount of the debentures at maturity. The accounting treatment of DRR involves the following steps:
- Debiting the DRR account with an amount equal to at least 50% of the nominal value of the debentures issued.
- Crediting the DRR account with an amount equal to the amount transferred from the profit and loss account.
Accounting for Interest on Debentures:
A company is required to pay interest on the debentures it has issued. The interest is a charge against the profits of the company and is recorded in the profit and loss account. The accounting treatment of interest on debentures involves the following steps:
- Debiting the interest expense account with the amount of interest paid.
- Crediting the debenture interest account with the same amount.
- Recording any unpaid interest as a liability in the balance sheet.
Redemption of Debentures:
When a company redeems its debentures, it pays back the principal amount to the creditors. The accounting treatment of debenture redemption involves the following steps:
- Debiting the debenture redemption account with the nominal value of the debentures redeemed.
- Crediting the debenture account with the same amount.
- Debiting the DRR account with an amount equal to the amount transferred from the profit and loss account.
- Crediting the debenture redemption account with the amount transferred from the DRR account.
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Recording any gain or loss on the redemption of debentures in the profit and loss account.