ADVANCED ACCOUNTING BCOM (All streams)

VENUGOPAL JYOTHI
AVINASH COLLEGE OF COMMERCE,
HIMAYAT NAGAR
 UNIT-I
Partnership:
A partnership is a kind of business where a formal agreement between two or more people is
made who agree to be the co-owners, distribute responsibilities for running an organization and share
the income or losses that the business generates.
In India, all the aspects and functions of the partnership are administered under ‘The Indian
Partnership Act 1932’. This specific law explains that partnership is an association between two or
more individuals or parties who have accepted to share the profits generated from the business under
the supervision of all the members or behalf of other members.

Features:

 Agreement between Partners:

 It is an association of two or more individuals, and a partnership arises from an
agreement or a contract. The agreement (accord) becomes the basis of the association
between the partners. Such an agreement is in the written form.
 Two or More Persons:
 In order to manifest a partnership, there should be at least two persons possessing a
common goal. To put it in other words, the minimal number of partners in an
enterprise can be two. However, there is a constraint on their maximum number of
people.
 Sharing of Profit:
 Another significant component of the partnership is, the agreement between partners
has to share gains and losses of a trading concern.
 Business Motive:
 It is important for a firm to carry some kind of business and should have a profit
gaining motive.
 Mutual Business:
 The partners are the owners as well as the agent of their firm. Any act performed by
one partner can affect other partners and the firm. It can be concluded that this point
acts as a test of partnership for all the partners.
 Unlimited Liability:
 Every partner in a partnership has unlimited liability.

Types of Partners

 Active Partner
 Active partners invest in the partnership and participate in its day-to-day activities to
maximize their returns. They typically hold some of the most important positions and
can serve in various roles, including those of a manager, advisor, organizer and
controller of the company's operations.
 The active partner may withdraw compensation from the business, subject to the
partnership deed's terms and conditions. Additionally, they are completely liable for
any debts.
 Inactive or Sleeping Partner
 An inactive partner is not involved in the day-to-day operations of the partnership
firm. But other partners might consult with them when making important decisions
for the company.
 Similar to other partners, a sleeping partner contributes a fair portion of capital to the
business and shares its gains and losses.
 Outsiders may not be aware of this partner's relationship, but they invest in the
company and are responsible for paying off any debts on the company's behalf. They
have limited financial obligations and liability to the business.
 Nominal Partner
 A nominal partner has no substantial stake in a partnership firm. They do not
participate in the operation of the company and merely lend their name to it. They
make no capital investments in the company and hence do not share in its profits.
 Partner by estoppel or holding out
 A partner who indicates through their words, deeds or conduct that they are a partner
in the firm is a partner by estoppel. Even if they are not actually a partner in the
company, they may have presented themselves in a way that legally binds them to
become a partner by estoppel.
 5. Partner in profits only
 A partner who enters the partnership firm as a 'partner in profits only' participates in
profits but is not responsible for any losses. Even when engaging with third parties,
they are only accountable for their profit-making activities and do not share any other
liabilities.
 They do not participate in firm management and are not accountable for the
company's business decisions. These types of partners often join a company for its
money and goodwill.
 6. Minor as a partner
 A minor, or someone under the age of 18, cannot be a formal partner in any
partnership firm as per the Contract Act. But, if other business partners agree, they
may still be eligible for a partnership.
 A minor may participate in a company's profits, but they are only liable for their
capital contribution if the company suffers a loss. After reaching maturity or turning
18, a minor partner has six months to determine whether they want to stay on as a
partner or leave the firm. They declare this by a public notice in both situations.
 7. Secret partner
 A secret partner is a partner whose affiliation with the company is unknown to the
broader public. The secret partner occupies the space between the active and sleeping
partners.
 They invest capital, enjoy profits, share losses, take part in business management and
are subject to unlimited liability. But they keep their membership a secret from
outsiders and other parties.
 A silent partner is similar to a secret partner but does not have the right to take part in
business management.

 8. Sub-partner
  A third party who shares a stake in a company with an existing partner is a sub-
partner.
 This occurs when a partner consents to divide the company's profits with another
party.
 A sub-partner is not an entity of the firm and has no obligations to the firm as a result.

Partnership Deed

The smooth and successful running of a partnership firm requires a clear understanding
among its partners regarding the various policies governing their partnership. The partnership deed
serves this purpose. The partnership deed contains various terms such as profit/loss sharing, salary,
interest on capital, drawings, admission of a new partner, etc. in order to bring clarity to the partners.

The partnership deed helps to resolve any disagreement or conflict which arises between the
partners regarding the partnership norms. The purpose of a partnership deed is to give a clear
understanding of the roles of all partners, ensuring the smooth running of the operations of the
partnership firm.

Contents of a Partnership Deed

 Name of the firm

The partners of the firm should decide the firm’s name which adheres to the provisions of the
Partnership Act. The firm name is the name under which the business is conducted.
 Details of the partners
The deed should include details of all the partners, such as their names, addresses, contact
number, designation, and other particulars.
 Business of the firm
The deed should mention the business that the firm undertakes. It may be dealing with
producing goods or rendering services.
 Duration of firm
The deed should mention the duration of the partnership firm, i.e. if the firm is constituted for
a limited period, for a specific project or for an unlimited period.
 Place of business
The deed should contain the principal place of business where it carries on the partnership
business. It should also mention the names of any other places where it conducts business.
 Capital contribution
Each partner will contribute an amount of capital to the firm. The entire capital of the firm
and the share contributed by each partner are to be mentioned in the deed.
 Sharing of profit/loss
The ratio of sharing profits and losses of the firm amongst partners should be noted in the
deed. It can be shared equally amongst all partners, or according to the capital contribution
ratio or any other agreed ratio.

 Salary and commission

 The details of the salary and commission payable to partners should be mentioned in the
deed. The salary and commission can be paid to the partners based on their role, capabilities
or any other capacity.
 Partner’s drawings
The drawings from the firm allowed to each partner and interest to be paid to the firm on such
drawings, if any should be mentioned in the deed.
 Partner’s loan
The deed should mention whether the business can borrow loans, the interest rate of loans,
properties to be pledged, etc. It can also mention if a partner of the firm can borrow loans
from the business or not.
 Duties and obligations of partners
The rights, duties and obligations of all the partners of the firm should be mentioned in the
deed to avoid future disputes.
 Admission, death and retirement of partners
The deed should mention the date of admission of the partner, the regulations governing the
admission of a new partner, resignation, or changes after the death of a partner of the firm.
 Accounts and audit
The deed should contain details about the audit procedure of the firm. It should mention the
details of how the partnership accounts are to be prepared and maintained.

Goodwill treatment in admission of Partner

The incoming partner brings in some amount as his share of Goodwill or Premium to compensate the
existing partners for the loss of their share in the future profits of the firm. Thus, at the time of
admission of a partner, there are following two ways to treat goodwill.

When the incoming partner brings his share of goodwill in cash, the existing partners share it in the
sacrificing ratio. However, when the amount of goodwill is paid privately by the new partner to
old partners privately in cash, no entry is passed in the books of the firm.

(A) Goodwill does not appear in the books:

I The new partner brings goodwill in cash.

 Cash A/c ………………………...…. Dr

To Goodwill A/c
(Being share of goodwill of new partner brought in cash)

 Goodwill A/c ………………………. Dr

To Old Partners Capital A/c
(Being goodwill distributed among the old partners in their sacrificing
ratio)
 II Goodwill withdrawn by the old partners

 Cash A/c ……………………………. Dr

To Goodwill A/c
(Being share of goodwill of new partner brought in cash)

 Goodwill A/c ………………………. Dr

To Old Partners Capital A/c
(Being goodwill distributed among the old partners in their sacrificing
ratio)

 Old Partners Capital A/c ……………. Dr

To Cash A/c
(Being goodwill withdrawn by the old partners)

III Goodwill is retained or raised

 Goodwill A/c …………………….…. Dr

To Old Partners Capital A/c
(Being goodwill distributed among the old partners in their sacrificing
ratio)

IV Goodwill is written off

 Cash A/c ………………………….... Dr

To Goodwill A/c
(Being share of goodwill of new partner brought in cash)

 Goodwill A/c ………………………. Dr

To Old Partners Capital A/c
(Being goodwill distributed among the old partners in their sacrificing
ratio)

 All Partners Capital A/c ……………. Dr

To Goodwill A/c
(Being goodwill is debited to all partners with New Profit Ratio)
B When Goodwill already exists in the books:

 Old Partners Capital A/c ……………. Dr

To Goodwill A/c
(Being goodwill written off with old Ratio)

 Cash A/c ………………………….... Dr

To Goodwill A/c
(Being share of goodwill of new partner brought in cash)

 Goodwill A/c ………………………. Dr

 To Old Partners Capital A/c
(Being goodwill distributed among the old partners in their sacrificing
ratio)
UNIT II
Dissolution of Partnership firm
Dissolution of partnership firm is a process in which relationship between partners of firm is
dissolved or terminated. If a relationship between all the partners of firm is dissolved then it is
known as dissolution of firm. In case of dissolution of partnership of firm, the firm ceases to exist.

Modes of Dissolution of a Partnership Firm

A). Voluntary Dissolution:
This refers to the situations where all the partners of a firm mutually agree to terminate its
operations. These are:
 By Agreement (Section 40):
 Section 40 of the Indian Partnership Act grants the authority to the partners to dissolve
their firm, provided they all provide their consent to such dissolution. An extant
contract can also be used for the purpose of officiating the dissolution.
 Compulsory Dissolution (Section 41):
 Section 41 of the Indian Partnership Act, 1932 deals with the concept of compulsory
dissolution. It states that the dissolution of a firm becomes compulsory if the
occurrence of a certain event renders its operations unlawful.
 In cases where a firm owns multiple business units, and one of them becomes illegal,
then it can continue to carry its operations out of the other ones.
 On the happening of certain contingencies (Section 42):
This section states certain contingencies which lead to the immediate dissolution of a firm.
These are:
 When the tenure for which a firm was constituted comes to an end, the firm also
dissolves.
 The death of a partner can lead to the dissolution of the firm if the partners so decide.
 Insolvency of partners.
 Upon completion of undertakings.
 By notice of partnership at will (Section 43):
 Where a partnership has been constituted as per the will of the partners, any partner
can serve a written notice to all the other partners informing them about his will to
dissolve the firm. The firm is dissolved on the date specified in the notice. If no date
is specified, the date of the firm’s dissolution is the date of notification.
B). Dissolution by Court Order:
A court may dissolve a partnership firm on any of the following grounds:
 Insanity/Unsound Mind
 Permanent Incapacity
 Misconduct
 Persistent Breach of the Agreement
 Continuous/Perpetual Losses
 Just and Equitable Grounds: A court may also order the dissolution of the firm on the
basis of just and equitable grounds. Some of these are:
 Management standoff
 Partners not communicating with one another
  Loss of the very foundation of the business
 Gambling at the stock exchange
Revaluation Account Vs Realization Account

A revaluation account is used to adjust the value of assets and liabilities on the balance
sheet to their current market value. A realization account, on the other hand, is used to record the
sale of an asset and the resulting gain or loss from the sale.

BASIS FOR
REVALUATION ACCOUNT REALISATION ACCOUNT
COMPARISON
Meaning Revaluation account is an account Realization account is an account
prepared to ascertain the variation in prepared to ascertain the net profit or
the values of the assets and liabilities loss on the sale of assets or discharge
of the firm. of liabilities.

Comprise of Only those assets and liabilities which All the assets and liabilities.
are revalued.
Preparation At the time of reconstitution. At the time of dissolution.
How many times It can be prepared at various events It can be prepared only once, i.e.,
it can be during the life of the firm. when the firm is dissolved.
prepared?
Accounting Based on the difference in the book Based on the book value of assets and
entries value and the revalued amount of liabilities.
assets and liabilities.

Remaining Transferred to the capital account of Transferred to the capital account of

balance old partners. all partners.

Purpose Revaluation Account is used to record A realization account records the sale of
changes in the value of assets due to assets or converts investments into cash.
market changes.
Triggering Event The triggering event for Revaluation The triggering event for the Realization
Account is a change in market value. Account is the sale of assets.

Frequency Revaluation Account is recorded The realization Account is recorded

periodically, usually annually or semi- once when the assets are sold.
annually.
Impact on The Revaluation Account affects only The Realization Account affects the
Financial the balance sheet. profit and loss account and the balance
Statements sheet.

Insolvency of Partner

If a partner having a debit balance in his Capital Account is unable to bring in the necessary cash to
make up the deficiency, he is said to be an insolvent partner. In other words, it is a position of
financial distress when the business or the individual is unable to repay its debts.
Garner Vs Murray Rule

Garner, Murray and Wilkins were equal partners with unequal capitals. The assets of the firm
on dissolution, after satisfying all the liabilities to creditors and advance from partners was
insufficient to repay the capitals in full. There was a deficiency of Rs. 635 and the capital account of
Wilkins was showing a debit balance of Rs.263. Nothing could be recovered from Wilkins owing to
insolvency.
DECISION OF THE CASE
The solvent partners are only liable to make good their share of deficiency, and that the
remaining assets should be divided among them in the proportion of their capitals.

EFFECT OF THIS CASE

The solvent partner should contribute to the deficiency of capital in cash of their share only.
The net effect is that the deficiency of capital of the insolvent partner gets distributed among
the solvent partners in the ratio of their last agreed capitals.

CRITICISM OF GARNER VS MURRAY RULE

 It does not apply when the firm is having only two partners.
 It considers only the book capitals of the partners, ignoring the private assets of the solvent
partners. If a partner contributed more capital than that of the other partners, he will have to
bear more burden than the other partners who had contributed less capital.
 If a partner having zero capital balance or debit balance, will not have to bear the deficiency
of the insolvent partner.
 Introduction of cash by the solvent partners to make good their share of loss on realization is
unnecessary, when the balance of capital accounts of the solvent partners is sufficient to bear
the deficiency of insolvent partner.

APPLICABILITY OF GARNER VS MURRAY RULE IN INDIA

 Section 48 of Indian Partnership Act 1932 is similar to the Section 44 of the Partnership Act
in Great Britain and further there has been no case law in India to deal with such situations.
So, in India this is applicable with respect to following considerations:
 Garner vs Murray is applicable only when there is no agreement between the partners for
sharing the deficiency in capital account of insolvent partner.
 Realization loss should be divided in the profit-sharing ratio in the usual manner.
 The solvent partners should bring in cash to make good the loss on realization.
 Final debit balance of insolvent partner should be distributed amongst the solvent partners in
proportion in their last agreed capital.
 A solvent partner having debit balance in capital account will not share any loss due to
insolvency of a partner.

CONCLUSION
 To conclude, it can be said that it is not unjust and inequitable law to ask a partner with larger
capital to bear the larger portion of the loss. Psychologically, the partners with the lesser
capital will not react unfavorably.
Sale to A Company
Sale of a partnership firm to a limited company refers to the transfer of ownership of a partnership
firm to a limited company. In this process, the partners of the partnership firm sell their ownership
rights to the limited company.

In this case, the business of the firm is sold to a company and the consideration is paid by the
company in the form of shares and debentures. The value of such shares and debentures shall be
credited to the realization a/c along with other assets and liabilities.

UNIT III
Share
A share is referred to as a unit of ownership which represents an equal proportion of a company's
capital. A share entitles the shareholders to an equal claim on profit and losses of the company. There
are majorly two kinds of shares i.e.,
1. Equity shares and
2. Preference shares.
Equity shares:
A company issues equity shares to raise capital at the cost of diluting its ownership. Investors
can purchase units of equity shares to get part ownership of the firm. By purchasing the equity
shares, investors will be contributing towards the total capital of the company and becoming its
shareholder.
Equity shareholders are the owners of the company to the tune of the shares held by them.
Through equity investing, investors benefit from capital appreciation and dividends. In addition to
the monetary benefits, equity holders also enjoy voting rights in critical matters of the company.

Features:

 Permanent Shares: Equity shares are permanent in nature. The shares are permanent assets
of a company. And are returned only when the company winds up.
 Significant Returns: Equity shares have the potential to generate significant returns to the
shareholders. However, these are risky investment options.
 Dividends: Equity shareholders share the profits of a company. In other words, a company
may distribute dividends to its shareholders from its annual profits. However, a company is
under no obligation to distribute dividends. In case a company doesn’t make good profits and
doesn’t have surplus cash flow, it can choose not to give dividends to its shareholders.
 Voting Rights: Most equity shareholders have voting rights. This allows them to select the
people who will govern the company. Choosing effective managers assists the company to
enhance its annual turnover. As a result, investors can receive higher average dividend income.
 Additional Profits: Equity shareholders are eligible for additional profits a company makes.
It, in turn, increases the wealth of the investor.
 Liquidity: Equity shares are highly liquid investments. The shares are trade on the stock
exchanges. As a result, you can buy and sell the share anytime during trading hours.
Therefore, one doesn’t have to worry about liquidating their shares.
 Limited Liability: Losses a company makes doesn’t affect the ordinary shareholders. In
other words, the shareholders are not liable for the company’s debt obligations.

Preference Shares:
 Preference shares, also known as preferred stock, is an exclusive share option which enables
shareholders to receive dividends announced by the company before the equity shareholders.
 Preference shares provide the shareholders with the special right to claim dividends during
the company lifetime, and also with the option to claim repayment of capital, in case of the
wind up of the company.

Features:
 1. Preferential dividend option for shareholders.
2. Preference shareholders do not have the right to vote.
3. Shareholders have a right to claim the assets in case of a wind up of the company.
4. Fixed dividend payout for shareholders, irrespective of profit earned.
5. Acts as a source of hybrid financing.

Difference between Equity and Preference Shares:

Basis of Equity Shares Preference Shares

Difference
Definition Equity shares represent the ownership Preference shareholders have a
of a company. preferential right or claim over the
company’s profits and assets.
Return Capital appreciation Regular dividend income
Dividend Equity shareholders receive dividends Preference shareholders have the priority
Pay-out only after the preference shareholders to receive dividends.
receive their dividends.
Dividend Rate Varies based on the earnings. The rate is fixed.
Bonus Shares Equity shareholders are eligible to Preference shareholders do not receive
receive bonus shares against their any bonus shares against their holdings.
existing holdings.

Capital Equity shareholders are paid last. Preference shareholders are paid before
Repayment the equity shareholder when the company
is winding up.
Voting Rights Equity shareholders enjoy voting Preference shareholders do not enjoy
rights. voting rights.
Participation in Equity shareholders have voting Preference shareholders do not
Management rights, and as a result, they participate participate in management operations.
Decisions in the management decisions.

Redemption Equity shares cannot be redeemed. Preference shares can be redeemed.

Convertibility Equity shares cannot be converted. Preference shares can be converted to
equity shares.

Share Capital
Share capital is referred to as the capital that is raised by the company by issuing shares to
investors. Share capital comprise of capital that is generated from funds generated by issuing of
shares for cash or non-cash considerations.
Types of Share Capital:
 Share capital can be classified as authorized, issued, subscribed, called up and paid-up share
capital. From an accounting point of view the share capital of the enterprise can be categorized as
follows:
 Authorized Capital: Authorized capital is the amount of the share capital in which a
company is allowed to issue its Memorandum of Association. The company is not supposed
to raise more than the amount of capital as mentioned in the Memorandum of Association. It
is also known as Registered or Nominal capital.
 Issued Capital: It is that portion of the authorized capital which is usually circulated to the
public for subscription comprising the shares assigned to the merchants and the endorsers to
the enterprise’s memorandum. The authorized capital which is not proffered for public
consent is called as ‘unissued capital’.
 Subscribed Capital: The subscribed capital is referred to as that part of issued capital that is
subscribed by the company investors. It is the actual amount of capital that the investors have
taken.
 Called up Capital: The amount of share capital that the shareholders owe and are yet to be
paid is known as called up capital. It is that part of the share capital that the company calls for
payment.
 Paid-up capital:
It is essentially a part of called-up capital. It signifies the amount of money paid by
shareholders in response to the call made by a company. Usually, the paid-up capital of a
company can be ascertained by subtracting the outstanding calls from called up capital.
 Right Issue:
A rights issue is an invitation to existing shareholders to purchase additional new shares in
the company. This type of issue gives existing shareholders securities called rights. The
company is giving shareholders a chance to increase their exposure to the stock at a discount
price.
 Calls In Arrears:
The portion of called up capital which is not paid by the shareholder within a specified
time is known as calls-in-arrears. Thus, any default arising due to the failure to send the call money
is known as calls in arrears. A separate account is opened for calls in arrears.
Companies can charge interest on all such calls in arrears for the period that the amount
remains unpaid. The rate used is 5% p.a. The total of calls in arrears is shown in the balance
sheet as a deduction from the called-up capital.
 Calls In Advance:
The money received by a company in excess of what has been called up is known as calls in
advance. A company, if authorized by its articles, may accept calls in advance from
shareholders. If such an amount, which has not been called, is received, the amount should be
credited to a separate account known as the calls in advance account.
A company may pay interest on such amount received in advance at the rate of 12% p.a. No
dividend is payable on this amount.
 Forfeiture of Shares:
It refers to company shares that have been surrendered or given up by a shareholder due to
non-payment of the required amount. When a shareholder fails to make the necessary
payments for the subscribed shares, the company has the right to forfeit or cancel them.

 Re-Issue of Shares:
 After the shares are forfeited, the company can re-issue the shares, in this case it is known as
re-issue of forfeited shares or reissue of shares. For reissue of shares, the company can
conduct an auction and dispose of the shares.

Debentures:
A debenture is a type of debt instrument that is not backed by any collateral and usually has a
term greater than 10 years. Debentures are backed only by the creditworthiness and reputation of the
issuer. Both corporations and governments frequently issue debentures to raise capital or funds.

Types of Debentures:
Debentures are a debt to a firm, but they are preferred because there is no equity dilution. It is
just a form of loan which is used for a company’s long-term profit and growth.
There are various types of debentures in the market:
 Convertible Debentures:
One of the various types of debentures is convertible debentures. The most significant feature
of differentiation of a convertible debenture is that it can be converted into shares or stocks at
a certain point in time or when the firm notifies of the same. Although these debentures have
a lower interest rate when compared to stock, they are extremely useful.
 Partially Convertible Debentures:
The debentures which can be converted into shares but to a certain limit or a certain
percentage are known as partially convertible debentures. It is hybrid as after its partial
conversion, some portion remains debenture while some become part of the company’s share.
 Non- Convertible Debentures:
These are normal or basic kinds of debentures which can never be converted into stocks after
they have been issued and till the time they exist.
 Registered Debentures:
The kind of debentures which are transferred providing a pepper proof of records and
documents needed for it. These are one of the safest kinds of debentures as there is less
chance of fraud compared to bearer debentures discussed below.
 Bearer Debentures:
The type of debentures that are unregistered and can be delivered after purchase without any
compulsory need for evidence or record are known as bearer debentures. There is no tertiary
involvement in the transaction for a bearer debenture and it a comparatively more prone to
tax evasion and fraud.
 Secured Debenture:
These are the kind of debentures that are like an alternative to a loan where the collateral is
needed to make money and when the firm starts paying off the debts at the time of its closure
due to any reason, then the secured debenture holders are paid first.
 Unsecured Debentures:
The type of debentures which don’t need any kind of collateral are unsecured debentures and
are preferred less at the time of payment compared to secured debentures.
 Redeemable Debentures:
The debentures which are purchases for a pre-specified period and are paid by the end of this
time are known as redeemable debentures.

 Irredeemable Debentures:
 Also known as perpetual debentures, irredeemable debentures don’t have a fixed time for the
redemption of the invested amount.

Share Vs Debenture

Basis Shares Debentures

A share is a unit (a part) of the capital A debenture is a debt instrument

Meaning of the company. issued to raise a borrowed fund.

Nature A share forms an Equity capital. A debenture forms a debt capital.

A holder of a share is known as a A holder of a debenture is known as a

Holder shareholder. debenture holder.

A debenture yields a fixed rate

A shareholder earns a dividend in
Return of interest (coupon rate) at a
return for their investment. specified date.

An interest on debenture is paid

Dividend and A dividend is paid only when there is irrespective of whether the company
Interest Payment a profit. is making a profit or incurring a loss.

A debenture holder has no right to

A shareholder enjoys the right to vote
Voting Rights participate or cast a vote at the
at the company’s meeting. company’s meeting.

A company, at its option, can buy back A debenture shall be redeemed at a

Redemption its own shares. fixed maturity date.

A share cannot be converted into A debenture can be converted into

Conversion debenture. shares as per the term of the issue.

At the time of winding up, payment

At the time of winding up, payment to
Priority of to the debenture holder is made
shareholders is made after the
Repayment before the payment to the
repayment to a debenture holder. shareholders.

Section 53 of the Companies Act

restricts the issue of shares at A debenture can be issued at discount
Issue at Discount discount, except for the sweat equity without any restrictions.
shares.

Debentures are the debt for the

High degree of risk is borne by the
Degree of Risk companies; hence debenture holders
equity shareholders. bear little risk.
Underwriting

The term underwriting is used for the process through which an institution or an individual
takes on a financial risk for a fee or at a predetermined cost. This risk is generally taken in the case of
loans, insurance or investments.
In the securities market, underwriting involves determining the risk and price of a particular
security. It is a process seen most commonly during initial public offerings, wherein investment
banks first buy or underwrite the securities of the issuing entity and then sell them in the market.

The underwriters may be individuals, partnership firms, joint stock companies, banks and financial
institutions. Ex: ICICI, SFC’s, LIC etc.,

Types of Underwriting:

1 On the basis of number of shares or debentures underwritten:

According to this basis underwriting contracts are classified in to two types they are-
a) Complete underwriting: It is one under which the whole of the issue of shares or
debentures of a company is underwritten by one or more underwriters.
b) Partial Underwriting: It is one under which a part of the issue of shares or debentures of
a company is underwritten by one or more underwriters.

2. On the basis of liability of underwriters:

According to this basis underwriting contracts are classified into two types they are-
a) Pure / Open Underwriting: it is an arrangement under which and underwriters or
underwriters agree to take up the shares or debentures of a company only when the shares or
debentures underwritten by him or them is not fully subscribed by the public.
b) Firm Underwriting: It is an arrangement where underwriters agree to buy a definite
number of shares and debentures irrespective of the number of shares or debentures
subscribed by the public. In case of firm underwriting, the underwriters get priority over
general public if shares / debentures are oversubscribed.

Importance of Underwriting:

 Assurance of Adequate Finance:

 Supplying Valuable Information to Companies:
 Distribution of Securities:
 Increase in Goodwill of the Issuing Company:
 Service to Prospective Investors:
 Service to the Society:
Bonus Shares
Bonus shares cannot be issued as a result of a split or consolidation of shares. Bonus shares must be
issued in a fair and equitable manner to all shareholders. Companies must disclose their bonus issue plans to
SEBI and the stock exchanges. Bonus shares cannot be issued to promoters or controlling shareholders.

SEBI Guidelines:

SEBI guidelines on bonus issue of a company are as follows:

 No bonus shares shall dilute other issues:

Issue of bonus shares shall not be made pending conversion of fully convertible debentures or partly
convertible debentures unless sufficient number of shares is reserved for allotment to the holders of
the said FCDs or PCDs after conversion.
 Bonus issue from free reserves:
Bonus shares can be issued only out of free reserves built out of genuine revenue profits or share
premium collected in cash.
 Revaluation reserve not eligible:
Reserve created by revaluation of assets cannot be capitalized for issue of bonus shares.
 Issue in lieu of dividend:
Bonus issue shall not be made in lieu of dividend.
 Partly paid shares not eligible:
Partly paid shares, if any, will not be eligible for bonus shares. Such partly paid shares, if any, must be
made fully paid before a bonus issue is contemplated.
 No default of payment of interest, etc.:
The issuing company shall not have defaulted in the payment of interest or principal in respect of
fixed deposits and interest payment on dentures or repayment of principal on redemption of
debentures. The company must be certain that it has not defaulted in respect of payment of statutory
dues of the employees, such as contribution of provident fund, gratuity, bonus, etc.
 Time within which bonus issue shall be made:
A company which announces a bonus issue after the approval of its Board of Directors must
implement the proposal within a period of six months from the date of such approval.
 Bonus proposal cannot be withdrawn:
A company which has announced its proposal to issue bonus shares, cannot have the option to change
its decision.
 Provision in the articles:
There must be a suitable provision in the Articles of Association of the company for capitalization of
reserves. If not, the company must pass a special resolution and incorporate a suitable provision in the
Articles of Association, before initiating action for a bonus issue.
 Increase in authorized capital:
Where necessary, before action on a bonus issue is taken, the company shall increase its authorized
capital so as to permit the proposed bonus issue.
 Prohibition of issue of bonus shares by revaluation of assets:
The Department of Company Affairs has vided Circular No. 9/94 dated 6-9-1994, informed all
companies (listed as well as unlisted) that no company shall venture to issue bonus shares out of
reserves created by revaluation of fixed assets.

________ * ________
 UNIT IV

Profit Prior to Incorporation

A company comes into existence after its incorporation. Incorporation is the first step in
establishing a company. The founders of a company need to keep certain preliminary documents
ready before going for its registration. After applying for registration, the Registrar of Companies
(ROC) issues the company registration certificate.
The company comes into existence after the issue of the company registration certificate. A
company can commence its business and earn profits after its incorporation. Sometimes, a company
earns profits when the founders do business in the company name before its incorporation, i.e.,
before receiving the registration certificate. Such profits are profits prior to the incorporation of a
company.
The period before incorporation is the pre-incorporation period of the company, and the
period after its incorporation is the post-incorporation period of the company.
A private company can commence business after its incorporation, but a public company can
commence business after receipt of the certificate of commencement of business. Thus, any profits
made by a private company before incorporation and a public company before commencement of
business, respectively, are the pre-incorporation period profits.
The pre-incorporation profits made by the company are capital profits and not legally
available for distribution as dividends, as a company cannot earn profits before it comes into
existence. The profits earned by the company after incorporation are revenue profits and will be
available for distribution as dividends.

Advantages of pre-incorporation profit

One of the key advantages of pre-incorporation profit is that it can help a new business get off
the ground. For example, if a business generates pre-incorporation profit through sales or
investments, this can be used to fund initial expenses such as rent, equipment, or salaries. This can
help the business avoid taking on debt or giving up equity to investors.
However, there are also potential drawbacks to pre-incorporation profit. For example, if the
business is not incorporated properly, there may be legal issues surrounding the transfer of pre-
incorporation profit to the new company. Additionally, pre-incorporation profit may be subject to
taxation, depending on the specific circumstances.
To avoid these issues, it is important to work with a knowledgeable attorney or accountant
when incorporating a new business. They can help ensure that the incorporation process is done
correctly and that any pre-incorporation profit is transferred in a way that is legally and financially
sound.
Private companies may commence business immediately after incorporation; however, public
companies must wait until they receive the certificate of commencement of business in order to
begin a business. Profits generated by a Private limited company before incorporation or profits
generated by a public company before the commencement of operations are defined as pre-
incorporation profits.

Profit or loss is calculated before incorporation according to these steps:

 Compile a trading account for the entire period
 To calculate the gross profit for the entire period, we must first create a trading account. Since
we can divide the gross profit of a year based on time after calculating the gross profit of a
year, we will not create separate trading accounts before and after incorporation.
 Determination of the time ratio and the sale ratio
It is critical to note that the sales and time ratios are two very relevant ratios that can be used
to allocate gross profit and other items of the profit and loss account before and after
incorporation. The time ratio would be 4 months: 8 months or 1:2 if the company was
incorporated after 4 months from the first of January 2010. In the case of a sale
of ₹100,000 prior to incorporation and ₹3,00,000 after incorporation, the sale ratio is 1:3.

 Prepare a net profit statement separately for pre- and post-incorporation periods
 A separate allocation of gross profits should be made based on the sales ratio for the pre-and
post-incorporation period
 A timely allocation of fixed expenses, such as rent, copying, office supplies, mailings, phone
calls, amortization, etc., must be done across both periods
 You’ll need to allocate variable expenses between the two periods, like marketing,
transportation, insurance, fees, bad debts, etc.
 Pre-incorporation expenses include interest on the purchase price, partner salary, and vendor
financing
 Post-incorporation expenses, like board fees, the salary of the managing director, interest on
debentures, issue discount, issuance discount, etc., must be taken out
 The duration ratio allows auditing fees to be allocated before and after incorporation.
 List of expenses that have been allocated according to sales/turnover-
 The gross profit
 The selling expenses
 The advertisement
 Carriage in an outward direction
 Rent for the godown
 Discounts are permitted
 Salaries of salespeople
 Commissions to salespeople
 Promotional expenses for sales
 Expenses related to distributions (variable portions)
 Provision of free samples
 Expenses incurred for After-Sale Service
 Expenses for delivery vans.
 Expense Allocation According to Time:
 Office and administrative expenses
 Salaries paid to office staff
 Rates, taxes, and rent
 Fixed asset depreciation
 Stationery and printing
 Fees for audits
 Miscellaneous Expenses
 General Travel Expenses
 Interest on debentures
  General Expenses
 Expenses that are fixed in nature, etc.;
Company Final Accounts
Final accounts are those accounts that are prepared by a joint stock company at the end of a
fiscal year. The purpose of creating final accounts is to provide a clear picture of the financial
position of the organization to its management, owners, or any other users of such accounting
information.
Final account preparation involves preparing a set of accounts and statements at the end of an
accounting year. The final account consists of the following accounts:
1. Trading and Profit and Loss Account
2. Balance Sheet
3. Profit and Loss Appropriation account
Objectives:
Final accounts are prepared with the following objectives:
1. To determine profit or loss incurred by a company in a given financial period
2. To determine the financial position of the company
3. To act as a source of information to convey the users of accounting information (owners,
creditors, investors and other stakeholders) about the solvency of the company.

P&L Account:
It is a financial statement of an organization that helps in determining the loss incurred or
profit earned by the business during the financial or accounting year. In simple terms, Profit and Loss
Account is a summary of an organization’s expenses and revenues and ultimately calculates the net
figure of the business in terms of profit or loss.
If the revenues of an organization are more than its expenses, it is known as Net Profit. However,
if the revenues of an organization are less than its expenses, it is known as Net Loss. The Profit and
Loss Account collects information from Trial Balance and other given transactions.

 General instructions for preparation of Profit and Loss Account:

 Revenue from Operations:

 The revenue earned from business operations comes under Revenue from
Operations. For example, Net Sales, Sale of Scrap, Trading Commission Received,
and Revenue from Services.
 Other Income:
 The revenue that is not earned from business operations comes under Other Income. It
is classified under three categories; viz., Rent Received, Interest and Dividend
Received, and Net Gain/Loss on the Sale of Investments.
 Cost of Materials Consumed:
 Cost of Materials Consumed = Opening Stock of Materials + Net Purchases – Closing
Stock of Materials
 Purchases of Stock-in-Trade:
 The Purchases of Stock-in-Trade consist of Net Purchases.
 Changes in Inventories of Finished Goods, Work-in-Progress, and Stock-in-Trade:
 Changes in Inventories of Finished Goods, Work-in-Progress, and Stock-in-Trade =
Opening Stock – Closing Stock
 Employee Benefit Expenses:
  It consists of Wages, Salaries, Staff Welfare Expenses like Canteen Expenses, and
Contributions of Provident Fund, and other staff welfare funds.

 Depreciation and Amortization Expenses:

 It consists of depreciation and amortization expenses of the company.
 Finance Costs:
 Finance Cost is the amount of interest paid by the company on its borrowings.
 Other Expenses:
 Other expenses consist of expenses other than the ones that are mentioned above. For
example, Telephone Expenses, Selling and Distribution Expenses, Rent and Taxes,
Loss on Sale of Fixed Assets/Investments, Advertisement Expenses, Bad Debts,
Provision for Bad and Doubtful Debts, and Cash Discount Allowed.

Format of P&L Account:

Balance Sheet:

A balance sheet is a financial statement that contains details of a company’s assets or

liabilities at a specific point in time. It is one of the three core financial statements (income
statement and cash flow statement being the other two) used for evaluating the performance of a
business.

A balance sheet serves as reference documents for investors and other stakeholders to get an
idea of the financial health of an organization. It enables them to compare current assets and
liabilities to determine the business’s liquidity, or calculate the rate at which the company generates
returns. Comparing two or more balance sheets from different points in time can also show how a
business has grown.

 General instructions for preparation of Balance Sheet:

The provisions are relating to financial statements under the new companies act 2013, Section
129 provides for preparation of financial statements:

 Sec 2(40) to include balance sheet, profit and loss account/income and expenditure
account, cash flow statement, statement of changes in equity and any explanatory note
annexed to the above.
 New section 129 corresponds to existing section 210. It provides that the financial
statements shall give a true and fair view of the state of affairs of the company and
shall comply with the accounting standards notified under new section 133.
 It is also provided that the financial statements shall be prepared in the form provided
in new schedule III of Companies Act, 2013.
 It may be noted that in the new schedule III the provisions for preparation of balance
sheet and statement of profit and loss have been given which are on the same lines as
in the existing schedule VI.
 Further, in the new Schedule III detailed instructions have been given for preparation
of consolidated financial statements as consolidation of accounts of subsidiary
companies is now made mandatory in section 129.
 It may be noted that for the first time a provision has been made in the new section
129(3) that if a company has one or more subsidiaries it will have to prepare a
consolidated financial statement of the company and of all the subsidiaries in the form
provided in the new schedule III of Companies Act, 2013.
 The company has also to attack along with its financial statement, a separate
statement containing the salient features of the financials of the subsidiary companies
in such form as may prescribed by the rules.
 It is also provided that if the company has interest in any associate company or a joint
venture the accounts of that company as well as joint venture shall be consolidated.
 For this purpose, associate company has been definedinnewsection2(6) company has
significant influence i.e., it has. 20% of the total share capital of the company or has
control on the business decision under an agreement.
Format of Balance Sheet:

FORMAT OF BALANCE SHEET

BALANCE SHEET of …………. Company Limited as on 31st
March……….
 Particulars Note Amount (Rs.)
No.
I.EQUITY AND LIABILITIES
1 Shareholders’ Funds:
(a) Share Capital
(b) Reserves and surplus
(c) Money received against share warrants (Not to be evaluated)
2 Share Application Money pending allotment: (Not to be evaluated)
3 Non - Current Liabilities:
(a) Long-term borrowings
(b) Deferred Tax Liabilities (Net) (Not to be Evaluated)
(c) Other Long-Term Liabilities (Not to be Evaluated)
(d) Long-term provisions
4 Current Liabilities:
(a) Short-term borrowings
(b) Trade payables
(c) Other current liabilities
(d) Short-term provisions
TOTAL [1 +2+3+4]
II.ASSETS
1 Non-Current Assets:
(a)Fixed Assets
(i) Tangible Assets
(ii) Intangible Assets
(b)Non-Current Investments
(c) Long Term Loans &Advances
(d) Other Non-Current Assets
2 Current Assets:
(a) Current investments
(b) Inventories
(c) Trade receivables
(d) Cash and cash equivalents
(e) Short-term loans and advances
(f) Other current assets
TOTAL [1 + 2]

Key Difference Between a Balance Sheet and a Profit and Loss Account

Profit & Loss Account (Income

Aspect Balance Sheet
Statement)
Purpose Provides a snapshot of the company's Summarizes revenues, expenses, and
 profits or losses over a specific
financial position at a specific point in
period (e.g., a month, quarter, or
time.
year).
Represents the financial position at a Covers a specific period (e.g., a
Timeframe
specific point in time. month, quarter, or year).

Consists of revenues, expenses, and

Components Consists of assets, liabilities, and equity.
net profit or net loss.

Focuses on the company's financial Focuses on the company's

Focus position and resources at a given operational performance and
moment. financial results over a period.

Used for assessing the company's Used for evaluating the company's
Usage financial health, liquidity, and capital profitability, operational efficiency,
structure. and revenue sources.

Calculation of Does not directly calculate profits or Calculates net profit by deducting
Profits/Losses losses. total expenses from total revenues.

Presented in a 'T' format, showing assets Presented in a linear format, starting

Presentation on one side and liabilities & equity on the with revenues, followed by expenses,
other. and ending with net profit or net loss.

Prepared at the end of each

Frequency of Prepared at the end of an accounting
accounting period to summarize the
Preparation period (e.g., quarterly or annually).
period's financial activity.

Long-Term vs
Provides insights into the company's Provides insights into the company's
Short-Term
long-term financial health. short-term financial performance.
Perspective

Assets: cash, accounts receivable,

Revenues: sales, fees earned, etc.
Examples of Items equipment, etc. Liabilities: loans,
Expenses: cost of goods sold,
Included accounts payable, etc. Equity: owner's
salaries, rent, etc.
equity, retained earnings, etc.

___ o ___
UNIT-V
Goodwill
Goodwill is an intangible asset that represents the market value of a business firm. In simple
words, Goodwill is a monetary value of a reputation of a business firm in the market, earned by the
owner through his/ her hard work and best quality service.
 Goodwill of the firm enables the firm to earn supernormal profit in the long run and increases
its competitiveness in the market. Goodwill of any business unit is an outcome of the satisfaction of
its customers, good employee relationships, a strong consumer base, a big brand name, and so on.
Goodwill is an asset that does not depreciate, but its value fluctuates depending on the
earnings of the firm, i.e., the value of the goodwill declines with a decline in the earnings.

Factors Affecting the Value of Goodwill:

Any factor that affects the profit-making capacity of a firm, affects the goodwill of the business.
Some of the factors affecting goodwill have been discussed below:
 Location of the Firm:
If the business unit is located in the prime market area, then the firm enjoys the attention of
more customers, which means more profit. When the profit of the firm is rising, the value of
goodwill also rises.
Similarly, if the firm is located in a backward area, or is a part of an undeveloped market
area, less customers will visit the place due to which the firm’s earnings will be less, thereby
decreasing the value of goodwill of the firm.
 Life Span of the Firm:
A firm that has been serving society for a number of years has more satisfied customers, a
strong brand name, improved customer services, etc. Therefore, an older business unit will
have a strong customer base and a high reputation in the market compared to newly
established units. So, the older the business, the more is the value of the goodwill.
 Efficient Management:
The development of any business unit depends upon the efficiency of the management. A
business operated under the supervision of efficient managers will earn more profit, and is
likely, to enjoy a high value of goodwill in the market.
 Risk Factor:
A business with a high-risk factor fails to win the trust of the stakeholders, like investors,
bankers, lenders, customers, etc. When the risk involved is high, a business firm fails to attain
its capital requirements, which in turn hampers the execution of a managerial plan and the
profit-making ability of the firm. All this adversely affects the value of goodwill. So, it can be
concluded that the higher the risk, the lower the value of goodwill.
 Nature of the Goods:
If a firm deals in the necessary items or daily use products, it is likely to have a more stable
profit and regular customers, which increases the value of the goodwill.
Similarly, firms selling trendy goods have unstable sales and profits, as it fails to attract more
customers and will have less value of goodwill comparatively.
 Nature of the Firm:
The nature of the business firm highly affects the goodwill of the business unit. If the firm
enjoys monopoly rights in a market, there is an assured profit earning, as there is no
competition in the market.
 Trend of Profit:
A profit trend of a firm depends on a number of business factors, like a boom period, efficient
management, product trends, service quality, etc.
 If the profit of a firm is rising continuously, the value of the goodwill will also rise
simultaneously, and if the profit of a firm tends to fall, the value of goodwill will also start
falling.
 Capital Requirement:
A business unit with less capital requirement and a high rate of profit-making shall enjoy
more goodwill than a firm with more capital requirements and a low rate of profit-making.
This is because when a small or medium scale business with less financial investment makes
a large profit, it attracts more investors and has a strong financial position, which builds ups a
good reputation of the firm in the market, thereby increasing the value of the goodwill.
 Product Quality:
The market reputation of any firm depends upon its customer base and a satisfied customer
base is a result of the quality products. If the firm offers best quality products and services,
then it will rule the major part of the market, thereby earning high profit and a strong
reputation in the market. So, the better the quality of the goods, the more is the goodwill.
 Technological Advancement:
Technological Advancement requires huge capital investment. Such capital investment by a
firm indicates a strong financial position, which builds up the reputation of the firm in the
eyes of the stakeholders.
Moreover, a business that uses advanced technology for production has a high-profit margin,
as the cost of production decreases. Such increased repetition and high profit boost the value
and goodwill of the firm.

Need for Valuation of Goodwill:

The valuation of goodwill is done under the following circumstances:

 A Change in Profit-Sharing Ratio:

Sometimes it becomes necessary to change the existing profit-sharing ratio among the
partners because of a change in the capital contribution or change in active participation. As a
result of such changes, some partners (sacrificing partners) have to surrender some of their
shares in favor of other partners (gaining partners).
Therefore, to maintain equity among the partners, goodwill is required to be valued to
calculate the amount of compensation, gaining partners shall pay to the sacrificing partners.

 Admission of a New Partner:

Admission of a new partner leads to the reconstitution of a partnership firm. This causes a
change in the existing profit-sharing ratio among the partners. When a new partner enters the
firm, generally the existing partners have to surrender some of their shares in favor of the
new partner.
Besides this, the new partner also enjoys a ready-made reputation in the market. Under such a
case, it becomes necessary to value the goodwill to find the amount that the new partner shall
bring as compensation for enjoying the shares of the sacrificing partners, and such
compensation is paid based on a proportionate amount of goodwill.

 Retirement of an Old Partner:

 When a partner retires from a firm, his/her share of the goodwill shall be enjoyed by the
continuing partners. Now here, the retiring partner shall be the one sacrificing the shares in
favor of the continuing partners, who are also the gaining partners.
As a result of this, the continuing partners shall pay the compensation to the retiring partner
in the proportion of the value of the goodwill of the firm. Hence, the valuation of goodwill
becomes necessary in case of the retirement of an old partner.
 Death of a Partner:
The sudden death of the partner causes a reconstitution of the partnership firm as in the case
of the retirement of a partner. The continuing partners (gaining partners) shall take over the
shares of the deceased partner (sacrificing partner) and shall pay the compensation for such
takeover based on a proportionate amount of goodwill to the nominee of the deceased partner.
The valuation of goodwill is needed under such conditions to calculate the amount to be paid
to the deceased partner by the continuing partners.
 Sale or Amalgamation of the Firm:
The valuation of goodwill is done when a business firm is been sold, to accurately calculate
the purchase consideration of the firm, i.e., the actual amount which has to be paid or
received while selling the firm.
 Amalgamation:
Amalgamation is a condition under which two or more firms are combined to form a new
entity. Under this, the assets and liabilities of the transferor firm are taken over by the
transferee firm, so valuation of goodwill becomes necessary to accurately calculate the
amount of consideration to be paid by the transferee company.

Methods for Valuation of Goodwill

There are several methods which can be implemented for valuation of goodwill which is as follows:
1. Average Profit Method
Goodwill’s value in this method is considered by multiplying the Average Future profit by a
certain number of year’s purchase.
Goodwill = Future maintainable profit after tax x No. of years purchase
Steps Involved under Average Profits Method:
 Calculate past profits before tax.
 Calculate the future profit before tax after making past adjustments.
 Calculate the average past adjusted profits.
 Multiply the future profits to be maintained by the number of years’ purchase.
2. Super Profit Method:
This super profit method is the additional estimated future maintainable profits over the
normal profits.
Steps Involved in Calculating Goodwill under Super Profit Method:
 Calculate capital employed (always should the aggregate of Shareholders’ equity and
long-term debt or fixed assets and net current assets).
 Calculate the Usual Profits by multiplying employed capital with normal return rate.
 Calculate average maintainable profit.
 Calculate Super Profit as follows:
Super Profit = Maintainable Average profits – Normal Profits.
 Calculate goodwill by multiplying super profit by the number of year’s purchase.
3. Capitalization Method:
 Goodwill under this method can be calculated by capitalizing average normal profit or
capitalizing super profits. Following are those: -
(I) Capitalization of Average Profit Method:
Under this particular system, goodwill can be discovered by deducting actual Capital
Employed (i.e., valuation date of Net Assets) from the capitalized value of the average
profits. It should be on the basis of the normal rate of Return (also known as the value of the
firm or capitalized value of business)
Goodwill = Capitalized Value – Net Assets of Business

Following are the stages involved in calculating goodwill as per capitalization of Average
Profits Method:
 Calculate Average future maintainable profits.
 Calculate the Capitalized value of business on the basis of the Average Profits.

 Calculate the value of Net Assets on the valuation date

 Net Assets means All Assets (other than fictitious assets, goodwill and non-trade
investments) at their current values – Outsider’s Liabilities
 Calculate Goodwill (Goodwill equals to Capitalized Value – Net assets of the
business.)
(II) Capitalization of Super Profit Method:
The goodwill assertion in this method is done by capitalizing the super profits on the basis of
the normal rate of return. Capital needed for earning the super profit can be calculated by this
method.
The value of goodwill is computed as follows:

Valuation of Share
 The ‘valuation of shares’ suggests determining the fair value of a stock. It involves assessing
the financial worth of a company's equity or ownership stake.
 Primarily. ‘Stock valuation’ helps you to find out whether a stock is currently overvalued,
undervalued, or fairly priced in the market.

Need:
The valuation of stocks helps investors make informed decisions by identifying opportunities
and managing risk. Thus, the primary purpose of valuation is to provide a reliable and objective
assessment of a stock’s future price potential.

The several purposes of valuation can be listed as:

 Investment Decision-Making:
By decoding the true value of a stock, valuation helps investors determine whether it is a
good buy or not.
 Mergers and Acquisitions:
 Companies engage in valuation when considering mergers, acquisitions, or strategic
partnerships. Accurate valuation helps in determining the fair price of the company and helps
in negotiating favorable terms.
 Financial Reporting:
Valuation is a crucial part of financial reporting, i.e., assessment of balance sheet and income
statement.
 Regulatory Compliance:
Valuation is often required to comply with regulatory requirements, such as financial
reporting standards and tax regulations.
 Investor Relations:
Companies sometimes use valuation metrics to communicate their worth to potential
investors or stakeholders, so as to attract investment decisions and capital.
 Risk Management:
Valuation helps businesses and investors manage risk by providing a clearer understanding of
the value of assets and investments. It enables risk mitigation strategies.
 Litigation and Dispute Resolution:
Valuation serves a crucial part in legal proceedings involving determination of assets
distribution.

Factors to Consider in Share Valuation:

Share valuation is a necessary process that helps investors determine the worth of a company’s
shares in the stock market. Assessing various factors influences the value of a share. It allows
investors to make informed decisions. When valuing shares, it is crucial to take into account the
following key factors:
 Financial Performance: Analyzing a company’s financial statements reveals its financial
health and growth potential. It provides insights into revenue growth, net profit, and cash
flow.
 Industry Analysis: Understanding the industry dynamics in which the company operates is
essential. Market size, competition, and trends can impact the company’s prospects and share
value.
 Management Team: Evaluating the competence and track record of the company’s
management team is crucial. Strong leadership and a clear strategic vision can contribute to a
company’s success. It, in turn, positively affects share valuation.
 Competitive Advantage: Assessing the company’s unique strengths determines its ability to
outperform competitors. It includes proprietary technology, strong brand recognition, and
exclusive distribution networks.
 Market Sentiment: Investor perception and market sentiment can significantly influence
share prices. Considering news events, economic conditions, and investor sentiment helps
gauge their potential impact. Investors should assess these factors to make informed
decisions.
 Dividends and Cash Flow: The company’s dividend history and projected future cash flows
can impact share value. Investors often value companies with consistent dividend payments
and strong cash generation. These factors contribute to their perceived value in the market.
 Share valuation is a complex process that requires a comprehensive analysis of
various factors. Investors must consider financial performance and industry dynamics. They
should also assess the extent of preference share capital, number of equity shares, and the
total number of shares in issue.

Additionally, investors should take into account the paid-up equity share capital. A
combination of valuation methods is essential to arrive at a complete picture.

Methods for valuation of Shares:

Valuation of shares is a critical process of determining the real worth of a company’s shares.
Here are commonly used methods for valuing shares:

1 Net Asset Method:

 The net asset method values shares based on the company’s net assets. Net assets include
tangible and intangible assets. Tangible assets consist of properties, inventory, equipment,
receivables and so on.

 Intangible assets include patents, trademarks, brand value, and intellectual property. One
subtracts liabilities from the company’s net assets to determine the net asset value (NAV) per
share.

 This approach is precious for companies with substantial assets, such as real estate or
manufacturing firms. This asset-based approach provides a snapshot of a company’s intrinsic
value based on the company’s assets. It is based on its underlying assets and offers investors
insights into its tangible worth beyond its market value.

 However, this following step should carefully be followed while calculating Net Assets or the
Funds Available for Equity Shareholders:

(a) Ascertain the total market value of fixed assets and current assets;
(b) Compute the value of goodwill (as per the required method);
(c) Ascertain the total market value of non-trading assets (like investment) which are
to
be added;
(d) All fictitious assets (viz, Preliminary Expenses, Discount on issue of
Shares/Debentures, Debit-Balance of P&L A/c etc.) must be excluded;
(e) Deduct the total amount of Current Liabilities, Amount of Debentures with arrear
interest,” if any, Preference Share Capital with arrear dividend, if any.
(f) The balance left is called the Net Assets or Funds Available for Equity
Shareholders.
 The following chart will make the above principle clear:

Alternatively:
Net Assets = Share Capital + Reserves and Surplus Revaluation – Loss on Revaluation

Applicability of the Method:

 The permanent investors determine the value of shares under this method at the time
of purchasing the shares;
 The method is particularly applicable when the shares are valued at the time of
Amalgamation, Absorption and Liquidation of companies; and
 This method is also applicable when shares are acquired for control motives.

2 Yield-Basis Method:

 Yield is the effective rate of return on investments which is invested by the investors. It is

always expressed in terms of percentage. Since the valuation of shares is made on the basis of

Yield, it is called Yield-Basis Method.

 For example, an investor purchases one share of Rs. 100 (face value and paid-up value) at

Rs. 150 from a Stock Exchange on which he receives a return (dividend) @ 20%.
Under Yield-Basis method, valuation of shares is made on Profit Basis:

Under this method, at first, profit should be ascertained on the basis of past average profit;

thereafter, capitalized value of profit is to be determined on the basis of normal rate of return, and,

the same (capitalized value of profit) is divided by the number of shares in order to find out the value

of each share.

The following procedure may be adopted:

3 Fair Value Method:

There are some accountants who do not prefer to use Intrinsic Value or Yield Value for
ascertaining the correct value of shares. They, however, prescribe the Fair Value Method which is the
mean of Intrinsic Value Method end Yield Value Method. The same provides a better indication
about the value of shares than the earlier two methods.

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