Explain The Share Issuance Of Sharad Ltd., Which Includes The Issuance Of 10,000 Shares At ₹10 Each, Payable In Installments, Oversubscription With 14,000 Applications Received, And The Accounting Treatment For These Transactions.
When a company decides to raise capital from the public, it often issues shares through an Initial Public Offering (IPO). This process involves offering shares to the public at a predetermined price, allowing investors to become shareholders in the company. In this detailed analysis, we will delve into the case of Sharad Ltd., a company that issued equity shares to the public, and explore the intricacies of share allocation, oversubscription, and the accounting entries involved. Understanding these concepts is crucial for anyone interested in corporate finance, investment, and the stock market.
Understanding the Share Issuance by Sharad Ltd.
Sharad Ltd. embarked on a journey to raise capital by issuing 10,000 equity shares to the public. Each share had a face value of ₹10, indicating the nominal value of the share. The company structured the payment schedule in installments to make it easier for investors to participate. The payment structure was as follows:
- ₹1 on application
- ₹3 on allotment
- ₹2 on the first call
- ₹4 on the second and final call
This phased payment approach allows investors to pay for the shares over time, reducing the initial financial burden. It also enables the company to raise capital in stages, aligning the inflow of funds with the company's needs and project timelines. Equity shares represent ownership in a company, and shareholders are entitled to a portion of the company's profits and have voting rights in key decisions. The face value of a share is an accounting concept and may not reflect the market price of the share, which is determined by supply and demand in the stock market.
Oversubscription: A Sign of Investor Confidence
In the case of Sharad Ltd., the company offered 10,000 shares to the public, but the response was overwhelming. Applications poured in for 14,000 shares, indicating that investors were highly interested in the company. This situation is known as oversubscription, where the demand for shares exceeds the number of shares available. Oversubscription is often seen as a positive sign, reflecting investor confidence in the company's prospects and growth potential. It suggests that the market believes the company is undervalued and that the shares are likely to appreciate in value over time.
However, oversubscription also presents a challenge for the company: how to allocate the limited number of shares among a larger pool of applicants. There are several methods for addressing oversubscription, including:
- Pro-rata Allotment: This method involves allocating shares to each applicant in proportion to the number of shares they applied for. For example, if an investor applied for 100 shares and the oversubscription rate is 1.4 (14,000 applications for 10,000 shares), they might be allotted approximately 71 shares (100 / 1.4). Excess application money is then adjusted against future calls or refunded to the applicants.
- Rejection of Excess Applications: The company may choose to reject some applications entirely, typically those for smaller numbers of shares. This approach simplifies the allocation process but may disappoint some investors.
- Combination of Pro-rata and Rejection: A company may combine these methods, allotting shares on a pro-rata basis to some applicants and rejecting others. This allows for a balanced approach, accommodating a larger number of investors while still managing the allocation process efficiently.
In the case of Sharad Ltd., the company received excess applications, which means it had to decide on an allocation method. The method chosen can impact investor sentiment and the company's relationship with its shareholders.
Accounting Entries for Share Issuance
Accounting for share issuance involves recording the financial transactions related to the issue of shares. These entries reflect the inflow of cash, the increase in share capital, and the allocation of funds for various calls. Here's a step-by-step breakdown of the accounting entries for Sharad Ltd.'s share issuance:
1. Application Money Received
When applications are received, the company debits the Bank account (increasing the cash balance) and credits the Share Application account (a temporary liability account). This entry reflects the initial inflow of funds from applicants. The journal entry would be:
| Account | Debit (₹) | Credit (₹) |
|---|---|---|
| Bank Account | 14,000 | |
| To Share Application Account | 14,000 | |
| (Application money received) |
Explanation: The bank account is debited because the company's cash balance increases when application money is received. The share application account is credited to recognize the company's liability to allot shares or refund the money.
2. Allotment of Shares and Transfer to Share Capital
Once the company decides on the allocation method, it transfers the application money to the Share Capital account. In the case of Sharad Ltd., 10,000 shares were allotted. The journal entry would be:
| Account | Debit (₹) | Credit (₹) |
|---|---|---|
| Share Application Account | 10,000 | |
| To Share Capital Account | 10,000 | |
| (Application money transferred to share capital) |
Explanation: The share application account is debited to reduce the liability, and the share capital account is credited to increase the company's equity. Share capital represents the total value of shares issued by the company.
3. Adjustment or Refund of Excess Application Money
Since Sharad Ltd. received applications for 14,000 shares but could only allot 10,000, the excess application money (₹4,000) needs to be adjusted or refunded. If the company uses a pro-rata allotment method, the excess money can be adjusted against allotment money due. If some applications are rejected, the money is refunded. Assuming the company adjusts the excess application money towards allotment, the journal entry would be:
| Account | Debit (₹) | Credit (₹) |
|---|---|---|
| Share Application Account | 4,000 | |
| To Share Allotment Account | 4,000 | |
| (Excess application money adjusted towards allotment) |
Explanation: The share application account is debited to reduce the liability further, and the share allotment account is credited to recognize the advance payment received for allotment.
4. Allotment Money Due
When allotment money becomes due, the company debits the Share Allotment account and credits the Share Capital account. This entry recognizes the amount receivable from shareholders on allotment. The journal entry would be:
| Account | Debit (₹) | Credit (₹) |
|---|---|---|
| Share Allotment Account | 30,000 | |
| To Share Capital Account | 30,000 | |
| (Allotment money due) |
Explanation: The share allotment account is debited to create a receivable, and the share capital account is credited to increase the equity further.
5. Allotment Money Received
When the allotment money is received, the company debits the Bank account and credits the Share Allotment account. This entry reflects the cash inflow and the settlement of the receivable. Considering the excess application money adjusted, the actual cash received would be ₹30,000 - ₹4,000 = ₹26,000. The journal entry would be:
| Account | Debit (₹) | Credit (₹) |
|---|---|---|
| Bank Account | 26,000 | |
| To Share Allotment Account | 26,000 | |
| (Allotment money received) |
Explanation: The bank account is debited to increase the cash balance, and the share allotment account is credited to reduce the receivable.
6. First Call Money Due
When the first call money becomes due, the company debits the Share First Call account and credits the Share Capital account. The journal entry would be:
| Account | Debit (₹) | Credit (₹) |
|---|---|---|
| Share First Call Account | 20,000 | |
| To Share Capital Account | 20,000 | |
| (First call money due) |
Explanation: The share first call account is debited to create a receivable, and the share capital account is credited to increase equity.
7. First Call Money Received
When the first call money is received, the company debits the Bank account and credits the Share First Call account. The journal entry would be:
| Account | Debit (₹) | Credit (₹) |
|---|---|---|
| Bank Account | 20,000 | |
| To Share First Call Account | 20,000 | |
| (First call money received) |
Explanation: The bank account is debited to increase the cash balance, and the share first call account is credited to reduce the receivable.
8. Second and Final Call Money Due
When the second and final call money becomes due, the company debits the Share Second Call account and credits the Share Capital account. The journal entry would be:
| Account | Debit (₹) | Credit (₹) |
|---|---|---|
| Share Second Call Account | 40,000 | |
| To Share Capital Account | 40,000 | |
| (Second and final call money due) |
Explanation: The share second call account is debited to create a receivable, and the share capital account is credited to increase equity.
9. Second and Final Call Money Received
When the second and final call money is received, the company debits the Bank account and credits the Share Second Call account. The journal entry would be:
| Account | Debit (₹) | Credit (₹) |
|---|---|---|
| Bank Account | 40,000 | |
| To Share Second Call Account | 40,000 | |
| (Second and final call money received) |
Explanation: The bank account is debited to increase the cash balance, and the share second call account is credited to reduce the receivable.
Conclusion: Sharad Ltd.'s Successful Share Issuance
Sharad Ltd.'s issuance of 10,000 equity shares, with an oversubscription of 14,000 applications, highlights the importance of understanding share issuance processes, oversubscription management, and accounting entries. The company's successful navigation of this process, including the collection of all amounts due on time, demonstrates its financial management capabilities and investor confidence. This case study provides valuable insights into the dynamics of initial public offerings and the financial mechanisms that underpin them. For businesses looking to raise capital and investors seeking opportunities in the stock market, understanding these concepts is essential for making informed decisions and achieving financial success.
By following the step-by-step accounting entries and understanding the principles behind share allocation, companies can effectively manage their capital-raising activities and build strong relationships with their shareholders. The case of Sharad Ltd. serves as a practical example of how these principles are applied in the real world of corporate finance.