Share Oversubscription And Premium Calculations A Detailed Guide With Example
Hey guys! Ever wondered what happens when a company issues shares and the public goes wild, applying for way more than are available? Or how premiums on shares affect the accounting? Let's dive into a scenario where a company, E2, issues shares and things get a bit oversubscribed, plus there's some premium action going on. This article breaks down the nitty-gritty of share oversubscription, premium calculations, and how to handle those tricky situations where shareholders don't pay their dues. We'll walk through a detailed example to make sure you've got a solid grasp of the concepts. So, buckle up and let’s get started!
The Scenario: E2's Share Issue
Let's set the stage. E2, a company looking to raise capital, decides to issue 1,00,000 shares with a face value of ₹10 each. This means that theoretically, E2 aims to raise ₹10,00,000 (1,00,000 shares * ₹10). However, the public's appetite is strong, and applications flood in for 1,50,000 shares. This is a classic case of oversubscription, where demand exceeds supply. To add a twist, E2 isn't just issuing shares at face value; they're charging a premium. This premium is payable in installments along with the share application, allotment, and call monies. Now, let's break down how this premium affects the share price and the company's financials.
What is a Share Premium? A share premium is the amount an investor pays above the face value of a share. For instance, if a share with a face value of ₹10 is issued at ₹14, the premium is ₹4. Companies charge premiums when their shares are in high demand, reflecting the market's confidence in the company's future prospects and financial health. This additional amount collected is not part of the share capital but is recorded separately in the company's books under the 'Securities Premium Reserve' account. This reserve can only be used for specific purposes outlined in the Companies Act, such as issuing bonus shares or writing off preliminary expenses.
Why Oversubscription Matters Oversubscription indicates a strong investor interest in the company. While it's a good sign, it also presents a challenge: how to allocate shares when demand exceeds supply? Companies typically use one of three methods: pro-rata allotment (allocating shares proportionally to applications), selective allotment (choosing certain applicants), or a combination of both. The method chosen can significantly impact shareholder satisfaction and the company's reputation. Pro-rata allotment is often favored as it ensures fairness, giving all applicants a partial allocation of the shares they applied for. Understanding the nuances of oversubscription and the methods to manage it is crucial for financial analysts and company secretaries alike.
Premium Payable and Share Allocation
In our E2 scenario, the premium is payable as follows: ₹4 on application, ₹4 on allotment, and ₹2 on each of the two calls (first and second call), totaling a premium of ₹12 per share (4 + 4 + 2 + 2). This premium bumps up the effective price per share significantly, showing just how much investors value E2's prospects. The breakdown of how the premium is collected is critical because it directly impacts the journal entries and the timing of revenue recognition. Each installment of premium money must be accounted for separately, ensuring compliance with accounting standards and regulations. This structured approach to collecting the premium allows E2 to stagger its revenue inflow and manage its cash flow more effectively.
The Director's Application Adding another layer to the situation, a director of E2 applies for 1,00,000 shares and is allotted the same. This is a common practice, signaling the director's confidence in the company. However, these shares also come with the premium payable as described above. The director's commitment can be a significant morale booster for other investors, as it demonstrates an insider's belief in the company's future. It's also a strategic move for the company, aligning the interests of the director with those of the shareholders. Such large-scale applications from directors often require careful scrutiny and adherence to corporate governance norms to ensure transparency and fairness.
Handling Oversubscription: Pro-rata Allotment Given the oversubscription, E2 likely opts for a pro-rata allotment for the remaining shares. This means that those who applied for shares will receive a proportion of what they requested. This method is considered fair and helps in maintaining good investor relations. Pro-rata allotment involves calculating the ratio of shares available to shares applied for and then applying this ratio to each application. This ensures that all applicants receive a fair share of the available stock, albeit less than what they initially requested. For E2, this means meticulously calculating the allotment for each category of applicants, ensuring that the total number of shares allotted does not exceed the 1,00,000 shares issued.
Default Scenarios: A and B
Now, let's introduce two shareholders who face different challenges in paying their dues: A and B. These scenarios highlight the complexities of managing share capital when shareholders default on their payments. Understanding how to handle these situations is crucial for maintaining the financial health and integrity of the company. It also sheds light on the procedures for forfeiture of shares and the subsequent re-issuance, which are essential concepts in corporate finance.
Shareholder A: Failure to Pay Both Calls Shareholder A holds 1,000 shares and fails to pay both calls. This means A has paid the application and allotment money, including the premium, but hasn't fulfilled their obligation for the call money. The calls are crucial for the company as they represent the final installments required to fully capitalize the shares. A's default creates a shortfall in the company's expected revenue and necessitates accounting adjustments. The company must follow a specific procedure, including issuing reminders and notices, before it can take more drastic action, such as forfeiting the shares. Shareholder A's situation is a common scenario in share management, and companies must have a robust system in place to handle such defaults effectively.
Shareholder B: The Pro-rata Allotment and Default Shareholder B applied for 20,000 shares but was allotted shares on a pro-rata basis. They have defaulted on allotment money (including premium) and the first call. To understand B's situation, we need to calculate how many shares B was actually allotted and how much money they should have paid. This involves understanding the pro-rata allotment ratio and applying it to B's application. Shareholder B's default is more complex because it involves not just non-payment but also the implications of the pro-rata allotment. The company needs to carefully calculate the amount due, considering any excess money received on application that may have been adjusted towards allotment. This complexity underscores the need for accurate record-keeping and meticulous accounting practices in share management.
The Calculation: Unraveling B's Default
To figure out how much B owes, we first need to determine the allotment ratio. The public applied for 1,50,000 shares, but only 1,00,000 were issued (excluding the director's shares). This gives us an allotment ratio of 1,00,000 / 1,50,000, or 2/3. Applying this ratio, B, who applied for 20,000 shares, would have been allotted (2/3) * 20,000 = approximately 13,333 shares. Since shares are typically allotted in whole numbers, let's assume B received 13,333 shares. Now, we calculate the amount B should have paid on allotment and the first call, considering the premium. This is where the numbers get interesting, and accuracy is paramount.
Allotment Money Due: For 13,333 shares, the allotment money due (including premium) is 13,333 shares * ₹4 (allotment premium) = ₹53,332. However, B may have paid some amount on application for the extra shares they didn't receive, which would be adjusted against the allotment money due. This adjustment complicates the calculation but is essential for determining the exact default amount.
First Call Money Due: Similarly, the first call money due is 13,333 shares * ₹2 (first call premium) = ₹26,666. B's default on both allotment and the first call creates a significant financial impact, and E2 must follow its procedures for dealing with such defaults, which may include sending demand notices, charging interest on arrears, and ultimately, the forfeiture of shares. The procedures for dealing with these defaults are critical for the financial integrity of the company and are governed by the Companies Act and the company's Articles of Association.
Accounting for Defaults and Forfeiture
When shareholders default, the company has a few options, including forfeiture of shares. Forfeiture means the company cancels the shares, and the shareholder loses the money already paid. This is a serious step, usually taken after several reminders and notices. Forfeited shares can then be reissued to new investors, adding complexity to the accounting. The accounting for forfeited shares involves several journal entries to adjust the share capital account, the securities premium reserve, and a new account called the 'Forfeited Shares Account.' This account reflects the amount received on the forfeited shares and can be used to offset any loss on the re-issuance of these shares.
Journal Entries: A Glimpse Let's briefly touch on the journal entries. When shares are forfeited, the share capital account is debited (reducing the capital), and the forfeited shares account is credited (representing the amount the company has received). If there was a premium involved, the securities premium reserve is also debited to the extent of the premium not received. When these forfeited shares are reissued, the bank account is debited (for the amount received), the forfeited shares account is debited (to the extent of any discount allowed on reissue), and the share capital account is credited (increasing the capital). Understanding these journal entries is crucial for accurate financial reporting and compliance with accounting standards.
Re-issuance of Forfeited Shares Once forfeited, these shares can be re-issued at a discount, but not exceeding the amount initially received on them. This allows the company to recover some of the lost capital. The re-issuance of forfeited shares is a strategic decision, and the company must consider the prevailing market conditions and the company's financial needs. The discount allowed on re-issuance is limited to the amount previously received on the forfeited shares, ensuring that the original investors' loss does not become a gain for the new investors. This principle maintains fairness and transparency in the company's dealings.
Final Thoughts
Dealing with share issues, oversubscription, premiums, and defaults can be complex. Understanding each component, from the initial share issue to handling defaults and forfeiture, is essential for anyone involved in corporate finance and accounting. In E2's case, meticulous calculations and adherence to accounting standards are crucial. By understanding these concepts, you can navigate the world of share capital with confidence. So, there you have it, guys! A comprehensive guide to understanding share oversubscription and premium calculations. Keep these concepts in mind, and you'll be well-equipped to handle similar scenarios in the future!