Accounting for Share Capital

The full picture

Every big company you see — Infosys, Reliance, the new startups listing on NSE — started by convincing people to invest money in exchange for ownership. That ownership is divided into equal units called shares. A company that sells shares is raising share capital. Unlike a loan, share capital is never repaid — the shareholder becomes a part-owner of the business. Share capital is recorded on the equity side of the balance sheet because it belongs to the owners, not the creditors.

A company does not collect all the money at once. It raises capital in stages, each stage called a call. First comes the application money, collected when investors apply. After the company decides how many shares to allot to each investor, allotment money is called. Later, one or more final calls may be made. This staged system protects investors and helps the company manage its cash needs. At each stage, an intermediary account — Share Application, Share Allotment, Share First Call — is raised first and then cleared when cash is received.

A share has a face value (also called nominal value or par value). For example, a share with ₹10 face value may be issued at ₹10 (at par), above ₹10 (at a premium), or rarely below ₹10 (at a discount, subject to strict rules). When shares are issued at a premium, the extra amount is credited to the Securities Premium Reserve (or Securities Premium Account) — a special equity reserve that can only be used for specific purposes like issuing bonus shares, writing off share issue expenses, or providing redemption premium on preference shares or debentures. It cannot be used to pay cash dividends.

Two important accounts to understand clearly: Calls in Arrears is the amount a shareholder owes the company because they did not pay a called amount on time. It is an asset — the company will collect this money. Calls in Advance is the opposite: a shareholder pays before the company has made the call. The company now owes the application of this money, so it is a liability until the call is formally made. Never confuse the two — they sit on opposite sides of the balance sheet.

If a shareholder fails to pay calls even after proper notice, the company can forfeit (cancel) those shares. On forfeiture, the Share Capital previously credited and any Securities Premium previously credited on those shares are reversed, and the called-up amount actually paid by the defaulter stays in a Forfeited Shares Account as a credit balance. The company can then re-issue these forfeited shares, typically at a discount. On re-issue, the loss on re-issue (the discount given) is debited first against the Forfeited Shares Account balance. Any remaining credit in the Forfeited Shares Account after the re-issue is transferred to Capital Reserve — a permanent gain to the company. Capital Reserve records only gains, never losses.

When you prepare balance sheet extracts for this chapter, remember the layout: Share Capital (called-up) and Securities Premium Reserve go under Equity; Calls in Arrears go on the asset side; Calls in Advance go on the liability side. The called-up capital equals the nominal value of shares issued multiplied by the amount called per share so far — the uncalled portion does not appear on the balance sheet as a figure, though it may appear as a note.

An Indian example

Imagine Arjun, a Class 12 student in Thrissur, whose uncle Rajan starts a small textile company called Kerala Threads Pvt. Ltd. The company needs ₹1,20,000 to buy looms and raw materials. Rajan decides to issue 1,000 shares of ₹100 each at ₹120 per share — a premium of ₹20. He announces that investors must pay ₹40 on application, ₹60 at allotment (including the ₹20 premium), and the remaining ₹20 on a final call later. Arjun's neighbour Mrs. Menon applies for 50 shares and pays ₹2,000 (50 × ₹40) as application money. When allotment is made, she pays her ₹3,000 (50 × ₹60) but her colleague Mr. Varghese, who was allotted 30 shares, fails to pay the allotment money. That ₹1,800 (30 × ₹60) is shown as Calls in Arrears — an asset the company expects to collect. The ₹20 premium per share (₹20,000 total) goes into Securities Premium Reserve, locked away from dividend use. This single transaction — one small textile company, real Kerala names, real ₹ amounts — captures the entire engine of share capital accounting you will encounter in your board exam.

Common misconceptions to watch for

• Many students think Calls in Arrears and Calls in Advance are the same type of account. They are exact opposites. Calls in Arrears is money the shareholder owes the company because a called amount was not paid on time — so it is an asset. Calls in Advance is money the shareholder has already given the company before it was asked for — so it is a liability the company must account for when the call is eventually made.
• A common exam error is thinking Securities Premium can be used to pay cash dividends. It cannot. Under Section 52 of the Companies Act 2013, Securities Premium is a restricted reserve — it may only be used to issue bonus shares, write off share issue expenses or preliminary expenses, or provide the premium on redemption of redeemable preference shares or debentures. Paying dividends in cash is not on that list.
• Students often write that the loss on re-issue of forfeited shares is charged to Capital Reserve. This is wrong — Capital Reserve records only gains, never losses. When forfeited shares are re-issued at a discount, the loss (discount given) is first absorbed by the Forfeited Shares Account, which already has a credit balance from the forfeiture. Only the net credit remaining in the Forfeited Shares Account after absorbing the re-issue loss is transferred to Capital Reserve as a permanent gain.