CMA Intermediate · Corporate Accounting and Auditing

Issue, Forfeiture, Rights, Bonus, Sweat Equity, ESOP and Buy-back of Shares

This chapter covers how a company issues shares and records calls, premium and forfeiture, then raises or returns capital through right shares, bonus shares, sweat equity, ESOP and buy-back. Solve it by fixing the legal rule first, then passing journal entries in date order and checking that the balance sheet balances.

What this chapter covers

This chapter follows the life of a company's share capital. First the company issues shares, collects money in instalments and may issue at a premium. If a shareholder does not pay a call, the shares can be forfeited and later re-issued. After that come the ways a company changes its capital or rewards people: right shares, bonus shares, sweat equity, employee stock options and finally buy-back, where the company takes its own shares back.

Every topic has two parts: a rule and an entry. The rule decides whether the transaction is allowed and from which source. The entry shows the effect on share capital, securities premium, reserves and cash. Examiners test both, so a numerical answer with the wrong source of funds loses marks even if the arithmetic is right.

This chapter connects to the rest of Paper 10 in many places. The share capital and reserves you build here flow into company financial statements in Schedule III format. Buy-back and bonus issues change reserves, which affects later chapters on final accounts, valuation of shares and amalgamation or reconstruction. Good control of this chapter makes those chapters easier.

This chapter is mostly rule-driven, so it rewards a student who learns the conditions once and applies them cleanly. It suits both parts of the exam. Section A can ask short MCQs on who may authorise a buy-back, what the limits are, or where the securities premium may be used. The descriptive questions can ask for a full set of journal entries with workings, such as forfeiture and re-issue or a buy-back with the transfer to a reserve. The entries are predictable, so careful practice turns this into dependable marks.

Issue, Forfeiture, Rights, Bonus, Sweat Equity, ESOP and Buy-back of Shares: topics in the order to study them

1Issue of Shares: Premium, Discount and CallsIt builds the base: application, allotment, calls, premium and the rule that a company cannot issue shares at a discount except as the Act allows.
2Forfeiture and Re-issue of SharesIt extends calls to non-payment, so you must be fluent in call entries before you reverse them.
3Right SharesIt is a fresh issue to existing shareholders, so it reuses the issue entries with the added idea of an offer to current members.
4Bonus SharesIt shows how the securities premium account and reserves can be applied to pay up bonus shares. This helps you read the reserve effects in later topics such as buy-back.
5Sweat Equity SharesThese shares are issued to directors or employees, for example for know-how or value additions. The special resolution must state the consideration, if any. It is one of the cases where the Act's ban on discount issue gives way. The other is a discount issue to creditors when their debt is converted under a statutory resolution plan or debt restructuring scheme following RBI guidelines (s.53(2A)).
6Employee Stock Option Plan (ESOP)It adds time: grant, vesting and exercise, so study it after plain issues are clear.
7Buy-back of SharesIt is the reverse of an issue and the heaviest on conditions, limits and reserve entries, so it comes last when all the earlier ideas are ready.

How to prepare Issue, Forfeiture, Rights, Bonus, Sweat Equity, ESOP and Buy-back of Shares

Prepare this chapter in two layers: first the rules, then the entries. Do not mix them in your first pass.

Read the rule for each topic and write it as a short checklist of conditions in your own words. For buy-back, list the authority, the limits, the source of funds and the time limits.
Learn the standard journal entries for issue, calls, premium and forfeiture, and practise them until you can write them without a book.
Solve forfeiture and re-issue questions with a small table: amount received, amount forfeited, discount allowed on re-issue and the balance transferred to capital reserve.
For bonus, sweat equity, ESOP and buy-back, first decide the permitted source or treatment, then pass the entries, then show the effect on the balance sheet.
Do a timed set of 15 MCQs on the legal conditions, covering limits, resolutions and time periods, and note each one you miss.
Write two full descriptive answers with working notes, then compare each line against the rules checklist to find missed steps.

Common mistakes in Issue, Forfeiture, Rights, Bonus, Sweat Equity, ESOP and Buy-back of Shares

Writing the wrong figure in the forfeiture entry, for example debiting share capital with the amount received instead of the amount called up.
Fix: Debit share capital with the called-up amount, credit the unpaid calls and credit the forfeited shares account with the amount received.
Transferring the whole forfeited shares balance to capital reserve after re-issue.
Fix: Use the discount allowed on re-issue against the forfeited balance of those shares first, then transfer only what remains to capital reserve.
Using the securities premium or reserves for a purpose the Act does not allow.
Fix: Keep the list of permitted uses in the Act's section on securities premium in front of you and tick one before you pass any entry.
Applying the buy-back limits to the wrong base or skipping a test.
Fix: Run all the tests in a fixed order in every buy-back problem. For equity shares, take 25% of paid-up equity capital for the year. For other securities, take 25% of paid-up capital plus free reserves. Show each calculation as a working note.
Treating bonus issue, buy-back and ESOP as one-line entries without the effect on reserves.
Fix: After each entry, state the closing figures of share capital, securities premium and reserves, and check the total is consistent.

Last-day revision: Issue, Forfeiture, Rights, Bonus, Sweat Equity, ESOP and Buy-back of Shares

A company cannot issue shares at a discount. The exceptions are sweat equity shares (s.54) and an issue to creditors when their debt is converted under a statutory resolution plan or debt restructuring scheme under RBI guidelines (s.53(2A)). Any other share issued at a discount is void.
Premium received on issue goes to the securities premium account.
Securities premium may be used for bonus shares, preliminary expenses, share or debenture issue expenses, premium on redemption, and buy-back.
On forfeiture, share capital is debited with the called-up amount and the amount already paid by the shareholder stays with the company.
On re-issue of forfeited shares, the discount allowed is debited to the forfeited shares account. Only the balance relating to the re-issued shares is then transferred to capital reserve.
Sweat equity shares must be of a class already issued and need a special resolution that states the number of shares, current market price, consideration (if any) and class of directors or employees receiving them.
Sweat equity shares rank pari passu with other equity shares.
A buy-back may be made from free reserves, the securities premium account or proceeds of a fresh issue, but not from the proceeds of an earlier issue of the same kind of shares.
Buy-back needs authority in the articles and a special resolution; a board resolution is enough if the buy-back is 10% or less of paid-up equity capital and free reserves.
Buy-back limit is 25% or less of the aggregate of paid-up capital and free reserves. For a buy-back of equity shares in a financial year, the 25% is measured on the total paid-up equity capital in that year. Debt after buy-back must not exceed twice the paid-up capital and free reserves.
Buy-back must be completed within one year, shares must be fully paid, and the bought-back shares must be destroyed within seven days of completion.
After a buy-back, no new shares of the same kind may be issued for six months, except bonus issues and discharge of existing obligations.

Issue, Forfeiture, Rights, Bonus, Sweat Equity, ESOP and Buy-back of Shares practice questions

Issue, Forfeiture, Rights, Bonus, Sweat Equity, ESOP and Buy-back of Shares in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Issue, Forfeiture, Rights, Bonus, Sweat Equity, ESOP and Buy-back of Shares: frequently asked questions

Can a company issue shares at a discount?

As a general rule, no. Except as provided in section 54 (sweat equity shares), a company shall not issue shares at a discount (s.53(1)), and a share issued at a discount is void (s.53(2)). Section 53(2A) permits an issue at a discount to creditors when their debt is converted into shares under a statutory resolution plan or debt restructuring scheme under RBI guidelines. A company that breaks the rule faces a penalty and must refund the money received with interest at 12% per annum (s.53(3)).

From which sources can a company buy back its shares?

A company may use its free reserves, the securities premium account or the proceeds of a fresh issue of shares or other specified securities. It cannot use the proceeds of an earlier issue of the same kind of shares. The Act also states that free reserves include the securities premium account for this purpose.

Who must approve a buy-back?

The articles must authorise it and a special resolution must be passed at a general meeting. If the buy-back is ten per cent or less of the total paid-up equity capital and free reserves, a board resolution passed at a meeting is enough.

How should I study this chapter for the MCQ section?

Make a one-page sheet of limits, time periods and authorities, such as 25%, 10%, 2:1, one year, seven days and six months. Revise it daily and practise short questions. Since there is no negative marking, attempt every MCQ.