Accounting Treatment for alteration of Share Capital and Reduction of the Share Capital

Alteration of share capital and reduction of share capital are two important events in a company’s life cycle that require specific accounting treatment. Here’s a brief explanation of the accounting treatment for both:

Alteration of Share Capital:

Alteration of share capital refers to any change in the share capital of the company. This can include the issue of new shares, the conversion of debentures or preference shares into equity shares, or the consolidation or subdivision of shares. The accounting treatment for alteration of share capital depends on the nature of the alteration.

• Issue of new shares: When a company issues new shares, it needs to record the transaction in its books. The amount received from the issue of new shares is credited to the share capital account, and the number of shares issued is added to the existing number of shares outstanding. If the shares are issued at a premium, the premium amount is credited to a separate account called “securities premium account”.
• Conversion of debentures or preference shares: When debentures or preference shares are converted into equity shares, the accounting treatment depends on the terms of the conversion. If the conversion ratio is fixed, the amount of debentures or preference shares converted is debited to the debenture or preference share account and credited to the share capital account. If the conversion ratio is variable, the accounting treatment is more complex and requires the use of fair value accounting.
• Consolidation or subdivision of shares: When a company consolidates its shares, it reduces the number of shares outstanding and increases their par value. The accounting treatment for this involves reducing the share capital account and increasing the share premium account. When a company subdivides its shares, it increases the number of shares outstanding and reduces their par value. The accounting treatment for this involves increasing the share capital account and reducing the share premium account.

Reduction of Share Capital:

Reduction of share capital refers to the reduction of the company’s share capital by cancelling or extinguishing any part of the share capital that is not required by the company. This can be done either by reducing the nominal value of the shares or by cancelling shares that are not paid up. The accounting treatment for reduction of share capital involves the following steps:

• Determine the amount of share capital to be cancelled or extinguished
• Adjust the share capital account to reflect the reduction.
• Transfer the amount of reduction to a reserve account called “capital redemption reserve” or “share buyback reserve”.
• If the reduction results in a change in the company’s net assets, this should be reflected in the profit and loss account.

It is important for companies to comply with the legal requirements for alteration and reduction of share capital, including obtaining necessary approvals from shareholders and the regulatory authorities. Failure to comply with these requirements can result in legal and financial consequences for the company.

Example:

Assuming the company, ABC Pvt Ltd. has the following details:

• Authorized Share Capital: 10,00,000 Equity Shares of Rs. 10 each
• Issued and Paid-up Capital: 6,00,000 Equity Shares of Rs. 10 each
• Face Value of Share: Rs. 10 each
• Market Price of Share: Rs. 20 each
• Par Value of Share: Rs. 5 each

The company decided to reduce its share capital by 20% due to the current financial situation.

Before Reduction of Share Capital:

After Reduction of Share Capital:

For Alteration of Share Capital:

Assuming a company has an authorized share capital of 1,00,000 equity shares of Rs. 10 each, out of which 50,000 shares have been issued and subscribed, and paid up fully. The company now wants to alter its share capital by increasing it by Rs. 5,00,000.

Before alteration:

Authorized share capital: Rs. 10,00,000 (1,00,000 shares of Rs. 10 each)

Issued and subscribed share capital: Rs. 5,00,000 (50,000 shares of Rs. 10 each)

Paid-up share capital: Rs. 5,00,000 (50,000 shares of Rs. 10 each)

After alteration:

Authorized share capital: Rs. 15,00,000 (1,50,000 shares of Rs. 10 each)

Issued and subscribed share capital: Rs. 10,00,000 (1,00,000 shares of Rs. 10 each)

Paid-up share capital: Rs. 10,00,000 (1,00,000 shares of Rs. 10 each)

The alteration in share capital will lead to an increase in the company’s assets and net worth. The company must follow the legal procedure for altering its share capital, which includes obtaining the approval of the shareholders and the court. The company will also need to file the necessary documents with the Registrar of Companies.