Share Forfeiture, Re-issue and its Accounting treatment

Share forfeiture, Re-issue and its Accounting treatment:

Today we are going to learn another important concept of company accounting Share Forfeiture. So far we have learned—“The process of issue of share and their accounting treatment” we have also learned that if any share holder fails to pay allotment money we write it as “calls in Arrear” and this “calls in arrear” gets adjusted when that shareholder pays his outstanding amount at the time of 1^st call or final call but what if any share holders completely failed to pay his or her allotment or call money? Here comes our today’s  term “Share Forfeiture” which says that in that case their shares would be forfeited-that is, cancelled. Thus, Share Forfeiture is said to happen when company imposed penalty on the shareholder for the non- payment of their allotment or call money and because of this, those shareholders cease to become the member of that company.

But what do you think; company can overnight forfeit their shares without saying anything to them? Answer is definitely No! The company must send prior intimation notice to the defaulting shareholders and informed him that if they failed to pay their due amount with interest within some specific time limit their share will be forfeited. And I think you know that there must be a clause of share forfeiture in the company’s article of association otherwise they first have to alter it and then go for the SF.

Now what exactly happens in the process of share forfeiture is that the company takes the money given by the defaulting shareholders and terminates their membership. INTERESTING!  Means, if suppose you as a shareholders has paid ‘application money’ ‘allotment money’ ‘1^st call money’ but failed to pay final call money, your total money of application, allotment and first call will be taken by the company , you won’t receive any money from that and moreover, you will be ceased to become the shareholder of that company . Complete loss man, your complete loss! But why the Company Ac is so harsh about the defaulting shareholders? Answer is because if millions of share holders will do the same, it would be hard for the companies to decide who their original shareholder is and the normal activity of the companies would be next to impossible, thus the company act is so harsh for this type of defaulting shareholders. Ok forget about the shareholder; let’s think from the company’s point of view— as we are learning Company Accounting , let’s think about whether company is getting profited by it or not? Answer is Yes probably, because they reissue or resell those forfeited shares and transfer this forfeited money (gain) to Capital Reserves but when forfeited share are re-issued at discount –that is, less than the face value then the company adjust the discounted (loss) amount with that forfeited amount and then balance will be transferred to Capital Reserve.

Curious readers can think that what if the forfeited shares are re-issued at premium? Answer is, nothing you just relax, premium amount will be credited as usually to security premium account -as simple as that!

Now very interesting part is about to come please reader I beg you to order some tea or coffee till then we need to recall what we have learned so far-

ü  Meaning of share Forfeiture.

ü  Consequence of share Forfeiture.

ü  Accounting treatment when forfeited shares are reissued at discount and premium.

You’re ready? Let’s move further:       

With the help of Double Entry concept, it would be interesting to imagine the Balance sheet affect of the whole scenario..

1)      When share holder ‘X’ gives application money say Rs 5000—In the Asset side of Balance sheet, Bank balance increases with Rs 5000 and in the liability side share capital increases with the similar amount Rs 5000.

2)      When that shareholder gives allotment money say Rs 6000 (including premium Rs1000).—In the Asset side of Balance sheet, Bank balance increases with Rs 6000 and in the liability side share capital increases with Rs 5000 and Security premium account increases with Rs 1000.

3)      Now the shareholder ‘X’ hasn’t paid first and final call money say Rs 7000—In the asset side of balance sheet, calls in arrear created with Rs 7000 and in the liability side share capital increase with Rs 7000. Here till now it has not been cleared whether ‘X’ will paid his part of liability or not. He can pay within time limit or maybe not.  

4)      Now after the specific time limit, after giving notice, company has decided to forfeit his share—means time for cancellation has come---firstly, total Share Capital a/c  which has so far been credited with Rs 17000 should be debited with same amount to cancel it. Secondly, calls in arrear of Rs 7000 in asset side should be credited to cancel the entry. Till now financial position is, liability is decreased for Rs 17000 and asset is decreased for Rs7000. Now third and final is create share forfeiture account for Rs 10000 in liability side under capital reserve. To make it very clear I’m showing you journal entry for step 4—

                                       Share capital a/c     debit 17000

                                                  To share forfeiture a/c      10000

                                                   To calls in arrear a/c           7000

 It is to be noted that Security premium of 1000 given by ‘X’ should not be touched and remain as it is in Balance sheet.

 Now suppose ‘X’ had failed to pay allotment money also then calls in arrear would be Rs13000, share forfeiture would be Rs5000, share capital would be Rs 17000 and very important point security premium account would be debited with Rs1000. Journal entry on that case would be:

                                        Share capital a/c            debit 17000

                                        Security premium a/c    debit 1000

                                                    To share forfeiture a/c                          5000

                                                    To calls in arrear a/c                               13000

Suppose share were issued at discount for say Rs 2000 and shareholder ‘X’ failed to pay  the same first and final call Rs 7000. Allotment money paid was Rs 3000, and application money paid was Rs 5000

 Here when share were issued entry were:

   Bank a/c                                        debit   8000

  Calls in arrear a/c                          debit   7000

   Discount on issue of share a/c   debit   2000

                         To   share capital a/c                                    17000

Now after forfeiture, entry for cancellation would be:

               Share capital a/c                debit   17000

                     To share forfeiture a/c                               8000

                      To calls in arrear a/c                                    7000

                      To discount on issue of share a/c              2000

                        

It is very interesting to know that when shares are issued at a discount, it will be credited to cancel entry but if shares are issued at a premium and shareholder failed to pay premium money; it will not be touched to cancel entry at the time of forfeiture.

Well done! You have paid enough attention just my final point is coming, you are about to have the mastery in this concept. I need to say one more thing listen carefully!

When the part of forfeited shares is re-issued, the proportionate amount will be transferred to Capital reserve after adjusting discount if any. Suppose 100 shares are forfeited for say Rs 5000 and of this, 80 shares are re-issued at a discount of say Rs 200. Here calculation would be: 5000/100*80= Rs4000 (minus) 200= 3800 will go directly in the capital reserve and the remaining 1000 will go for share forfeiture Account.

This is how I explained about share forfeiture; Re-issue and their accounting treatment if you have any question regarding this concept feel free to ask in the comment box below.