Liabilities and Shareholders Equity

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LIABILITIES

AND

SHAREHOLDERS EQUITY


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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, sharesor loan from bank creates an obligation to pay a fix monetary amount in future are theexample of contractual obligations.

Different liability items are primarily classified as current liabilities and non-currentliabilities.

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.


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Provision s are the liabilities about to payment of an expense or to cover a loss thatmight take place in future the timing and mount of such expense/loss is notcertain. Eg: Provision for doubtful debts, provision for repairs and renewals etc arecreated by debiting to profit and loss account.

Rest of the liability items included in the balance sheet is identified as non-currentliabilities.

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, long-term 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 orshareholders net worth .


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The current and non-current liabilities are disclosed in the balance sheet andmonetary obligation about these is almost certain; whereas there are certain liabilitiesthe 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 uponthe outcome of some future event, therefore, these are called contingent liabilities

Contingent liabilities are not presented in the balance sheet but disclosed outsidethe balance sheet as foot note to balance sheet.

Eg. Deepak Fertilizers and Pesticides Limited paid corporate tax of Rs. 30 crore for theyear 2009-10. the assessing authority challenged the tax calculation of the companyand estimated the same for 43 crore, stating , thereby the short tax payment of 13crore by the company. The company challenged the decision of assessing authority inthe direct tax tribunal, if case is settled against the company then it will result into thepayment 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 thebalance sheet.


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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 andreceivables.

In pledge, the borrower gives physical possession of the asset to the lender, such aspawing jewellery with a bank as security for a loan.

In a hypothecation , the borrower is allowed to use the asset, such as running a vechilethat has been given as security.

Convertible debenturesThe debenture holder has the option of exchanging there debentures for shares of theissuing company.

Zero-coupon bonds (deep discount bonds)These debentures do not carry any periodic interest payment or coupon. Zero couponbonds issued at discount and redeemed at par value.


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CHANDRA RUBBER COMPANY CASE

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

1 . The company has decided top accept the claim of Rs. 2,50,000 to avoid adversepublicity. Thus, a voluntary liability has been created. It is possible that the liabilitymay 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. 2,50,000given by the advocates is immaterial. Besides, if the company pursues the legalcourse, it will have to incur legal expense including advocates fees and incidentalexpense such as travel to Mumbai. There is no information in the question toestimate the total liability, if the consumer court were to uphold the claim. In thecircumstances, the company should provide an estimated liability of Rs,. 2,50,000

in its financial statements for the year.


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3.The claim of Walt Disney Company for Rs. 10 million for infringement of its intellectualproperty 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 iskeen to avoid publicity, it is likely to agree for settlement at Rs. 200,000, probableamount estimated by the companys legal advisors. This amount must be provided inits financial statements . Nevertheless, the full facts of the case must be reported in thenotes to the financial statements notwithstanding any effect on the companys exportsto 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 companyeither put up the pollution control equipment or shuts down the plant. The financialproblems make it difficult for the company to put up the equipment. The only solutionseems to be to close the plant.


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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
http://www.icai.org.in/codeofethics.phphttp://www.icai.org.in/codeofethics.php


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SHAREHOLDERS EQUITY


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A company is an artificial legal person and is created by law. The followingare the important features of corporate organization.

A. Separate legal entityB. Limited liability of shareholdersC. Free transferability of ownership rightsD. Perpetual existenceE. Common seal

F. Professional managementG. Government regulations


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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 excludingpart or present employees of the company who are also members of thecompany (c) prohibits any invitation to the public to subscribe for any shares ordebentures 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 THELINK MENTIONED BELOW

http://www.mca.gov.in/MCA21/RegisterNewComp.html
http://www.mca.gov.in/MCA21/RegisterNewComp.htmlhttp://www.mca.gov.in/MCA21/RegisterNewComp.html


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Share capital

Shareholders equity of a company consists of two parts: a. Share capitalb. Reserves and surplus

Company may be authorized to issue only equity shares or both equity shares andpreference share capital.

As the real owners of the company, equity shareholders appoint the companysdirectors and declare the dividends

Share capital of the company divided into following categories

Authorized capitalIssued capitalSubscribed capitalCalled up capitalPaid up capital


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AUTHORISED CAPITAL10,00,000 equity shares of Rs. 10 each

1,00,00,000

2,00,000 preference sharesof Rs. 50 each 1,00,00,000 2,00,00,000

ISSUED CAPITAL

8,00,000 equity shares of Rs.

10 each80,00,000

1,00,000 preference sharesof Rs. 50 each

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

SUBSCRIBED CAPITAL

6,00,000 equity shares of Rs.10 each

60,00,000

1,00,000 preference sharesof Rs. 50 each

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


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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 legalminimum 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 thecompanys 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 rightof preemption is known as a right issue.


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Preference Share Capital

Preference shareholders enjoy preference over equity shareholders in two aspectsA. Payment of periodic dividendsB. Distribution of assets on liquidation of the company

Preference shares usually carry a fixed rate of dividend which is payable when thecompany has earned adequate profits and when the dividend declared in thecompany annual general meeting.

Classification of preference shares:

Cumulative and non-cumulative preference sharesCumulative 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


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Participating and non-participating preference shares

Participating preference shares carry the right to share in the profits of the after theequity shareholders are paid a certain rate of dividend.

The holders of non-participating preference shares can only receive the fixeddividend 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 inshare certificate.

Non redeemable preference shares cannot be repaid except at the time of liquidation.

In India companies cannot issue non-redeemable preference shares or preferenceshares redeemable after eight years from the date of issuance.


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Convertible and non-convertible preference shares:

Convertible preference shares can be converted into equity at a predeterminedratio.

Non-convertible preference shares always remain preference shares.

RESERVES:

Refer page no: 490

.


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BUY-BACK OF SHARES

Companies are allowed to reacquire their own shares. Prior to 1999, the companieswere not allowed to buy back their own securities. But after the promulgation of Companies (Amendments) Act 1999, the companies are allowed to buy back theirown securities. Reasons for buy-back may be:

Company has surplus cash but does not have any plans for capital expenditureor acquisition of another business enterprises

The managers believe that the companys stock is undervalued and want tosignal 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.


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Bonus Shares:

Bonus shares means issuing equity shares free of cost to existing equity shareholders inthe proportion of their existing shareholding.Issue of bonus shares does not result into inflow of funds for the company but it resultsinto 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 dueamount.

Bonus shares are issued by the companies to give positive signal about the financialhealth and profitability of the company.

Sweat Equity:

When equity shares are issued to either employees or directors of the company at adiscount 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) Act1999.


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Earning Per Share (EPS)

Earning per share (EPS) is an important measure of corporate performance forshareholders and potential investors.

When a company has only equity share capital (Simple Capital Structure), its basicearning per share equals the profit after tax divided by the number of equityshares.

When company capital structure includes potentially dilutive securities, such asconvertible debentures and options the company must present , in addition, adiluted earnings per share computed under the assumption that potentiallydilutive securities were converted into equity shares.


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TARAPORE COMPANY LIMITED

1.COMPUTATION OF BOOK VALUE PER SHARE

SHAREHOLDERS EQUITY 82,00,000

LESS: PREFERENCE CAPITAL 5,00,000

77,00,000

LESS: ESTIMATED LIABILITYFOR DIVIDEND(35,00,000X10/100)

3,50,000

EQUITY SHAREHOLDERSFUNDS

73,50,000

BOOK VALUE PER EQUITYSHARE

Rs. 24.50

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


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2. The market price of a share is influenced by a number of factors including thecompanys future earnings prospectus, ease of salability of share (liquidity),government polity, business and investment environment, and general economic andpolitical conditions.

Book value is a historical figure and may at best be one of the several factors thatinfluence 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 itsauthorised capital. Tarapore company has an authorised capital of 500,000 and anissued capital of 300,000 equity shares. So it can issue an additional 200,000 equityshares. Of course, the company can increase its authorised capital (equity orpreference or both) with the approval of its shareholders.


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

RESERVES AND SURPLUS AS PER BALANCESHEET

47,00,000

LESS: ESTIMATED DIVIDEND LIABILITY 3,50,000

LESS: REVALUATION RESERVE (NOT AVAILABLEFOR BONUS ISSUE)

7,00,000

BALANCE REQUIRED IN RETAINED EARNINGS 6,50,000 17,00,000

AMOUNT AVAILABLE FOR BONUS ISSUE 30,00,000

MAXIMUM BONUS RATIO 1 FOR 1


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CHOLAMANDALAM CHEMICALS LIMITED

1. Dividends to be distributed

Current net profit 1,40,000

Additional net profit from expansion (10,00,000 X 25 %) 2,50,000

Total net profit after expansion 3,90,000

ALTERNATIVE AISSUE 10,000, 10 % CUMULATIVE, NON-PARTICIPATING PREFERENCE SHARES OF RS.

100 AT PAR

Preference share holders 1,00,000

Equity share holders 2,90,000

total 3,90,000


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

Equity share holders 390,000

ANALYSIS

Alternative Dividend toESH

No. of . ES Dividend pershare

A 290,000 60,000 Rs. 4.83B 2,12,727 60,000 Rs. 3.54

C 3,90,000 100,000 Rs. 3.90

Current 1,40,000 60,000 Rs. 2.33

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


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2.

The extent to which the company can honor its commitment to pay dividends on10,000, 10% cumulative, non-participating preference shares would depend on thestability of the future earnings of the company.

If the business is subject to cyclical fluctuations, dividend payments cannot be made inbad years.

Note that since the preference shares are cumulative, arrears of preference dividendsmust be paid before equity shareholders can receive any dividend.

Although the company has no legal obligation to pay preference dividends on thebasis of profits, in practice failure to honor dividends commitments will make itdifficult for the company to raise capital later.


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Liabilities and Shareholders Equity