LIABILITIES AND SHAREHOLDERS EQUITY

Liabilities are the sources through which assets of a business enterprise are financed.
Liabilities come into existence by the enforcement of law or when a contract requires the settlement of definite obligation to pay in future.

Example for enforcement of law: payment of tax, legal compensation, penalties etc. originate from the law.
Example for contractual obligation: Raising the fund by the issue of debentures, shares or loan from bank creates an obligation to pay a fix monetary amount in future are the example of contractual obligations. Different liability items are primarily classified as current liabilities and non-current liabilities. Current liabilities are such liabilities that are paid off within one year from the date of balance sheet. (creditors, bills payable, outstanding expenses unearned income, tax, dividend payable etc.

Provisions are the liabilities about to payment of an expense or to cover a loss that might take place in future the timing and mount of such expense/loss is not certain. Eg: Provision for doubtful debts, provision for repairs and renewals etc are created by debiting to profit and loss account.
Rest of the liability items included in the balance sheet is identified as non-current liabilities. These are the liabilities that need to be settled beyond a period of 12 months from the date of the balance sheet.

These are also called as long term liabilities. Secured and unsecured loan, longterm mortgage loan are external liabilities
Whereas owners funds equity share capital, preference share capital, reserves and surplus called internal long term liabilities. Internal long term long term liabilities are also called owners funds or shareholders net worth.

The current and non-current liabilities are disclosed in the balance sheet and monetary obligation about these is almost certain; whereas there are certain liabilities the obligation to pay these is subject to outcome of a future event, such as decision of a competent court or government order. As the obligation to pay is contingent upon the outcome of some future event, therefore, these are called contingent liabilities
Contingent liabilities are not presented in the balance sheet but disclosed outside the balance sheet as foot note to balance sheet. Eg. Deepak Fertilizers and Pesticides Limited paid corporate tax of Rs. 30 crore for the year 2009-10. the assessing authority challenged the tax calculation of the company and estimated the same for 43 crore, stating , thereby the short tax payment of 13 crore by the company. The company challenged the decision of assessing authority in the direct tax tribunal, if case is settled against the company then it will result into the payment of tax liability of Rs. 13 crore apart from the earlier paid tax of 30 crore. This payment of Rs. 13 crore as additional tax is contingent subject to the decision of tribunal hence to be recognized as a contingent liability and reported outside the balance sheet.

Long term liabilities

Principal types of long-term liabilities Debentures: A debenture also called as BOND. A company may sell the debentures directly to the public. Types of debentures: Secured and Unsecured debentures Debentures which are backed by specific assets to ensure their repayment are secured debentures.

Unsecured debentures are backed only by the general creditworthiness of the issuer, not by a legal interest in any specific assets.

A mortgage is a legal arrangement for securing a borrowing with immovable assets, such as land, building. Pledge and hypothecation are means of securing movable assets such as inventory and receivables.

In pledge, the borrower gives physical possession of the asset to the lender, such as pawing jewellery with a bank as security for a loan.
In a hypothecation, the borrower is allowed to use the asset, such as running a vechile that has been given as security. Convertible debentures The debenture holder has the option of exchanging there debentures for shares of the issuing company. Zero-coupon bonds (deep discount bonds) These debentures do not carry any periodic interest payment or coupon. Zero coupon bonds issued at discount and redeemed at par value.

CHANDRA RUBBER COMPANY CASE

The chief financial officer should report all the items in the companys financial statements for the year ended march 31st, 2006 as mentioned below:

1 . The company has decided top accept the claim of Rs. 2,50,000 to avoid adverse publicity. Thus, a voluntary liability has been created. It is possible that the liability may become lower if the company decides to contest the claim in a court. Since the company has decided to pursue the latter course, the estimate of Rs. 2,50,000 given by the advocates is immaterial. Besides, if the company pursues the legal course, it will have to incur legal expense including advocates fees and incidental expense such as travel to Mumbai. There is no information in the question to estimate the total liability, if the consumer court were to uphold the claim. In the circumstances, the company should provide an estimated liability of Rs,. 2,50,000 in its financial statements for the year.

2.
The assessment order of the Assistant Commissioner of Income tax has imposed an additional tax liability of Rs. 1,08000 as a result of disallowance of the companys claim. The company has appealed to the commissioner and the position will become clear when the Commissioner decides the companys appeal. Several possibilities arise in this context. For example, the commissioner may accept the companys claim in which event there is no liability to pay Rs. 1,08000. Or the Commissioner may allow half the claim in which event income tax of Rs. 72,000 would be payable and penalty may be waived in full or in part. Or the Commissioner may reject the companys claim totally in which case both income tax and penalty would be payable. At this stage, nothing is clear except that the companys accountants are reasonably certain that the Commissioner would allow Rs. 36,000 of the claim and completely waive the penalty. It would be advisable for the company to go by the professional opinion and provide an estimated liability of Rs. 36,000. it would be necessary to disclose the remaining amount of Rs. 72,000 as a contingent liability.

3. The claim of Walt Disney Company for Rs. 10 million for infringement of its intellectual property rights which is likely to be settled at an amount ranging from Rs. 100,000 to Rs. 500,000 should be provided in the companys financial statements. Since the company is keen to avoid publicity, it is likely to agree for settlement at Rs. 200,000, probable amount estimated by the companys legal advisors. This amount must be provided in its financial statements. Nevertheless, the full facts of the case must be reported in the notes to the financial statements notwithstanding any effect on the companys exports to the united states.
4. The company must include the claim as a contingent liability 5. The demand for closure of the companys main plant in Howrah is yet to decided by the West Bengal State Pollution Control Board. At present not possible to predict the outcome. The possible solution may be company either put up the pollution control equipment or shuts down the plant. The financial problems make it difficult for the company to put up the equipment. The only solution seems to be to close the plant.

II.
The duty of the CFO of the company is to prepare for approval of the companys board of directors financial statements that would give a true and fair view of the companys profit and financial position. This is the duty imposed on him as well as the board and failure to discharge this duty can result in legal consequences (fine or imprisonment or both). The likely effect of a certain disclosure on the companys stock prices is not a valid consideration in deciding on the disclosure. Three accounting principles are relevant in the case: Full Disclosure, Going Concern and Conservatism. Full disclosure principle requires that financial statements provide information that is of sufficient importance to influence the judgment and decisions of an informed user.

According to conservatism principle, when in doubt, the company must choose the solution that will be least likely to overstate assets and income.

As for ethical considerations,

the chartered accounts act 1949 does not much guidance in the case of chartered accountants in employment. CHECK THE FOLLOWING LINK FOR MORE INFORMATION ON ETHICS http://www.icai.org.in/codeofethics.php

SHAREHOLDERS EQUITY

A company is an artificial legal person and is created by law. The following are the important features of corporate organization. A. B. C. D. E. F. G. Separate legal entity Limited liability of shareholders Free transferability of ownership rights Perpetual existence Common seal Professional management Government regulations

Kinds of Companies:
From the point of view of public investment companies may be two kinds: a. Private companies: A private company means a company which its articles of articles restricts the right to transfer its shares if any (b) limits the number of its members to fifty excluding part or present employees of the company who are also members of the company (c) prohibits any invitation to the public to subscribe for any shares or debentures of the company.

b. Public companies: Public companies are those companies which are not private companies. All the three restrictions of a private company are not imposed on such companies.
HOW TO REGISTER A NEW COMPANY AND FOR FURTHER INFORMATION CLICK THE LINK MENTIONED BELOW http://www.mca.gov.in/MCA21/RegisterNewComp.html

Share capital Shareholders equity of a company consists of two parts: a. Share capital b. Reserves and surplus Company may be authorized to issue only equity shares or both equity shares and preference share capital. As the real owners of the company, equity shareholders appoint the companys directors and declare the dividends Share capital of the company divided into following categories Authorized capital Issued capital Subscribed capital Called up capital Paid up capital

Eg.
A company has 2,00,00,000 as its authorised capital divided into 10,00,000 equity shares of Rs 10 each and 2,00,000 preference shares of Rs. 50 each. The company issued 8,00,000 equity shares and 1,00,000 preference shares. The public subscribed for 6,00,000 equity shares and 1,00,000 preference shares. Rs. 8 per share has been called on equity shares and Rs. 40 has been called on preference shares. All shareholders paid the amount with the exception of 50,000 equity shares Rs. 5 per share. Calculate the amount of various types of share capital. ANALYSIS IS IN NEXT SLIDE

AUTHORISED CAPITAL
10,00,000 equity shares of Rs. 10 each 2,00,000 preference shares of Rs. 50 each

1,00,00,000 1,00,00,000 2,00,00,000

ISSUED CAPITAL
8,00,000 equity shares of Rs. 10 each 1,00,000 preference shares of Rs. 50 each

80,00,000 50,00,000 1,30, 00,000

SUBSCRIBED CAPITAL
6,00,000 equity shares of Rs. 10 each 1,00,000 preference shares of Rs. 50 each

60,00,000 50,00,000 1,10,00,000

CALLED UP CAPITAL
6,00,000 equity shares of Rs. 10 each, Rs. 8 called up 1,00,000 preference shares of Rs. 50 each and Rs. 40 called up

48,00,000 40,00,000 88,00,000

PAID UP CAPITAL
6,00,000 equity shares of Rs. 10 each, Rs. 8 called up LESS: Calls in arrear on 50,000 equity shares @ Rs. 5 each 1,00,000 preference shares of Rs. 50 each, Rs. 40 called up and paid up

48,00,000 2,50,000 45,50,000 40,00,000

Par value:
It represents the minimum amount that a shareholder must pay on each share. The par value or face value of a companys stock constitutes the companys legal minimum capital. Each shareholder can be compelled to pay the par value of the shares held by him. Rights issue of share capital: When a company intends to make additional issue of share capital, the law gives the companys existing shareholders the preemptive right to subscribe to the new shares. This right enables them to maintain their proportion of the companys share capital. The offer of shares to the existing shareholders of a company in pursuance of the right of preemption is known as a right issue.

Preference Share Capital Preference shareholders enjoy preference over equity shareholders in two aspects A. Payment of periodic dividends B. Distribution of assets on liquidation of the company Preference shares usually carry a fixed rate of dividend which is payable when the company has earned adequate profits and when the dividend declared in the company annual general meeting.

Classification of preference shares:

Cumulative and non-cumulative preference shares Cumulative preference shareholders receive the dividends for one or more years in which no dividend was paid. Arrears of past dividends are not payable in non-cumulative preference shares

Participating and non-participating preference shares Participating preference shares carry the right to share in the profits of the after the equity shareholders are paid a certain rate of dividend.

The holders of non-participating preference shares can only receive the fixed dividend and cannot share in the surplus left after paying equity dividend.
Redeemable and non-redeemable preference shares

Redeemable preference shares are repayable after the period of holding stated in share certificate.
Non redeemable preference shares cannot be repaid except at the time of liquidation. In India companies cannot issue non-redeemable preference shares or preference shares redeemable after eight years from the date of issuance.

Convertible and non-convertible preference shares: Convertible preference shares can be converted into equity at a predetermined ratio. Non-convertible preference shares always remain preference shares. RESERVES: Refer page no: 490 .

Distinction between Debenture and Share:

a. Debenture holder is a creditor of the company and cannot take part in the management of the company while a shareholder is the owner of the company, has a voting right and also takes part in the management of the company. b. Debenture holders will bet interest on debentures and will be paid in all circumstances, whether there is profit or loss will not affect the payment of interest on debentures. Shareholders will get a portion of profit called dividend which is depend on the profits of the company. It can be declared by the directors out of the profits only. c. Shares cannot be converted into debentures where as debentures can be converted into shares d. Debenture holders will be priority in getting the money back as compared to shareholder in case of liquidation of a company

BUY-BACK OF SHARES Companies are allowed to reacquire their own shares. Prior to 1999, the companies were not allowed to buy back their own securities. But after the promulgation of Companies (Amendments) Act 1999, the companies are allowed to buy back their own securities. Reasons for buy-back may be: Company has surplus cash but does not have any plans for capital expenditure or acquisition of another business enterprises

The managers believe that the companys stock is undervalued and want to signal their belief that the stock is worth more
Difficult to serve the large capital base by paying high dividends

The companies act lays down the conditions to buy-back the shares. Refer page no 493.

Bonus Shares: Bonus shares means issuing equity shares free of cost to existing equity shareholders in the proportion of their existing shareholding. Issue of bonus shares does not result into inflow of funds for the company but it results into a decrease in free reserves and an increase in the paid-up capital of the company. Issue of bonus shares might be in the form of a. Issue of new fully paid equity shares at par or at premium b. Making existing partly paid up equity shares as fully paid up without receiving due amount. Bonus shares are issued by the companies to give positive signal about the financial health and profitability of the company. Sweat Equity: When equity shares are issued to either employees or directors of the company at a discount or without charging any consideration, it is called issue of sweat equity. Issue of such sweat equity is subject to the provisions of companies (Amendment) Act 1999.

Earning Per Share (EPS) Earning per share (EPS) is an important measure of corporate performance for shareholders and potential investors.

When a company has only equity share capital (Simple Capital Structure), its basic earning per share equals the profit after tax divided by the number of equity shares.
When company capital structure includes potentially dilutive securities, such as convertible debentures and options the company must present , in addition, a diluted earnings per share computed under the assumption that potentially dilutive securities were converted into equity shares.

TARAPORE COMPANY LIMITED

1.COMPUTATION OF BOOK VALUE PER SHARE SHAREHOLDERS EQUITY LESS: PREFERENCE CAPITAL LESS: ESTIMATED LIABILITY FOR DIVIDEND (35,00,000X10/100) EQUITY SHAREHOLDERS FUNDS BOOK VALUE PER EQUITY SHARE 82,00,000 5,00,000 77,00,000 3,50,000

73,50,000 Rs. 24.50

73,50,000/3,00,000 SHARES

2. The market price of a share is influenced by a number of factors including the companys future earnings prospectus, ease of salability of share (liquidity), government polity, business and investment environment, and general economic and political conditions. Book value is a historical figure and may at best be one of the several factors that influence share price. Therefore rather unusual for book value to equal market value. 3. The maximum amount of equity capital that the company can raise equals its authorised capital. Tarapore company has an authorised capital of 500,000 and an issued capital of 300,000 equity shares. So it can issue an additional 200,000 equity shares. Of course, the company can increase its authorised capital (equity or preference or both) with the approval of its shareholders.

4. Maximum amount of bonus issue can be computed as follows:

RESERVES AND SURPLUS AS PER BALANCE SHEET LESS: ESTIMATED DIVIDEND LIABILITY LESS: REVALUATION RESERVE (NOT AVAILABLE FOR BONUS ISSUE) BALANCE REQUIRED IN RETAINED EARNINGS AMOUNT AVAILABLE FOR BONUS ISSUE MAXIMUM BONUS RATIO 1 FOR 1 3,50,000 7,00,000 6,50,000 17,00,000 30,00,000 47,00,000

CHOLAMANDALAM CHEMICALS LIMITED

1. Dividends to be distributed Current net profit Additional net profit from expansion (10,00,000 X 25 %) Total net profit after expansion 1,40,000 2,50,000 3,90,000

ALTERNATIVE A ISSUE 10,000, 10 % CUMULATIVE, NON-PARTICIPATING PREFERENCE SHARES OF RS. 100 AT PAR Preference share holders Equity share holders total 1,00,000 2,90,000 3,90,000

ALTERNATIVE B: ISSUE OF 5,000, 10% CUMULATIVE, PARTICIPATING PREFERENCE SHARES OF Rs. 100 at Rs. 200 Preference share holders Equity share holders Preference share holders Equity share holders TOTAL dividend for preference share holders (50,000+1,27,273) TOTAL dividend for equity share holders (60,000+1,52,727) Total 50,000 60,000 1,27,273 1,52,727 1,77,273 2,12,727 3,90,000

Total amount available for distribution of dividend Rs. 390,000 dividend paid 1,10,000 (50+60) = 280,000.

Total capital : equity 6,00,000 and participating preference 5,00,000 = 11,00,000 Therefore participative shareholders share = 2,80,000 X 5,00,000/11,00,000 = 1,27,273. AND for equity share holders (390,000- 1,10,000-1,27,273) = 1,52,727

ALTERNATIVE C: ISSUE 40,000 EQUITY SHARES OF Rs. 10 each at Rs. 25

Equity share holders ANALYSIS Alternative A B C Current Dividend to ESH 290,000 2,12,727 3,90,000 1,40,000 No. of . ES 60,000 60,000 100,000 60,000 Dividend per share Rs. 4.83 Rs. 3.54 Rs. 3.90 Rs. 2.33 390,000

From the standpoint of existing equity shareholders, alternative A is the best; issuance of 10,000, 10% cumulative, non-participating preference shares of Rs. 100 at par. This alternative produces the highest earnings per share.

2.
The extent to which the company can honor its commitment to pay dividends on 10,000, 10% cumulative, non-participating preference shares would depend on the stability of the future earnings of the company. If the business is subject to cyclical fluctuations, dividend payments cannot be made in bad years. Note that since the preference shares are cumulative, arrears of preference dividends must be paid before equity shareholders can receive any dividend. Although the company has no legal obligation to pay preference dividends on the basis of profits, in practice failure to honor dividends commitments will make it difficult for the company to raise capital later.

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