Corporate Accounting Unit: 2 Incentive Equity, Buyback, and Valuation of Shares & Goodwill Notes [Gauhati University BCom 2nd Sem. FYUGP]

In this blog post, we have provided Gauhati University BCom 2nd Semester NEP FYUGP Corporate Accounting Unit 2: Incentive Equity, Buyback, and Valuation of Shares & Goodwill Notes with most important questions and previous year questions (PYQs). Each question is answered perfectly to help you boost your preparation to the next level.

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Gauhati University BCom 2nd Semester

Corporate Accounting 

Unit 2: Incentive Equity, Buyback, and Valuation of Shares & Goodwill

Syllabus: Concept and meaning of Internal Reconstruction, Different forms of Internal Reconstruction; Provisions as per Companies Act and Accounting treatment for Alteration of Share Capital and Reduction of Share Capital; Preparation of Balance Sheet after Internal Reconstruction.

1. Fill in the Blanks

1. The buyback of shares does not exceed _______ percent of the total paid-up capital and free reserves of the company. (2024)
   Answer: 25

2. Right shares are first offered to the _______ of the company. (2016)
   Answer: existing shareholders

3. Under the asset-backing method, the value of one equity share = _______ divided by the number of equity shares. (2023)
   Answer: Net Assets

4. Reserve arising out of revaluation of assets is _______ available for issue for bonus shares. (2024)
   Answer: not

5. Capital Redemption Reserve can be utilized for issuing _______ bonus shares. (2023)
   Answer: fully paid-up

6. The debt-equity ratio after the buyback of shares should not exceed _______. (2023)
   Answer: 2:1

7. The Accounting Standard _______ deals with accounting for amalgamation. (2023)
   Answer: AS 14

8. Post-acquisition profits are treated as _______ profits. (2023)
   Answer: revenue

9. Reduction of share capital requires sanction by _______. (2023)
   Answer: the Tribunal (NCLT)

10. Securities Premium Account can be utilised only for issuing _______.
    Answer: fully paid-up bonus shares

11. Bonus issue can be made out of securities premium collected in _______. [G.U. B. Com. 2010]
    Answer: cash

12. In the case of partly owned subsidiaries, the question of minority shareholders _______. (2023)
    Answer: will arise

13. Matters relating to rights issue are incorporated in Section _______ of the Companies Act, 2013.
    Answer: 62

14. Rights shares are offered only to existing _______ shareholders.
    Answer: equity

15. The right to subscribe rights share is _______.
    Answer: transferable

16. The Provision for buyback is given in section _______ of Companies Act, 2013.
    Answer: 77A

17. The Debt-Equity ratio after the buyback must be _______.
    Answer: 2:1

18. Goodwill is an example of _______ asset.
    Answer: intangible

19. Goodwill is the capacity to earn _______ profit.
    Answer: super

20. Goodwill of a firm represents the excess of _______ of assets over their book value.
    Answer: fair value

21. For valuation of goodwill, only _______ profit is taken into consideration.
    Answer: average

22. A Share is a _______ in the share capital of a company.
    Answer: unit

23. Generally, valuation of shares means valuation of _______ shares.
    Answer: equity

24. Intrinsic value of a share is based on the value of _______.
    Answer: net assets

25. Yield Method of valuation of shares is based on _______.
    Answer: expected dividends or earnings
    
    

2. True or False

1. Premium on the issue of shares can be used for the distribution of profits. (2016)
   False
   Explanation: As per Section 52 of the Companies Act, 2013, securities premium cannot be used for dividend distribution or profit distribution. It can only be used for specific purposes like issuing fully paid-up bonus shares, writing off preliminary expenses, etc.

2. Buyback of shares does not affect the authorized share capital of a company. (2023)
   True
   Explanation: Buyback reduces the issued and paid-up share capital, but the authorized share capital remains unchanged unless altered by a resolution.

3. Goodwill is a non-current asset. (2023)
   True
   Explanation: Goodwill is an intangible asset that is expected to provide long-term economic benefits, classifying it as a non-current asset.
   
   

4. In a rights issue, an existing Equity Shareholder gets a pre-emptive right to subscribe for the new shares offered by the company.
   True
   Explanation: A rights issue is a method by which a company offers new shares to its existing shareholders in proportion to their holdings, giving them a pre-emptive right.

5. Accounting entries for the issue of rights shares and other shares are different.
   False
   Explanation: The accounting entries for the issue of rights shares and other shares (such as a public issue) are generally the same, except that the rights issue is made to existing shareholders at a preferential price.

6. A private limited company cannot issue rights shares.
   False
   Explanation: As per the Companies Act, 2013, private companies can issue rights shares just like public companies, though the offer is made only to existing shareholders.

7. The right to subscribe to rights shares is not optional.
   False
   Explanation: Shareholders can choose to subscribe, renounce, or ignore the rights issue. Hence, it is optional.

8. The right to apply for Right Shares is optional. (2023)
   True
   Explanation: Existing shareholders are given the choice to apply for the rights issue, renounce their rights, or do nothing.

9. At the time of valuation of Goodwill, only operating profit is considered. (2023)
   False
   Explanation: While operating profit is important, goodwill valuation also considers factors like super profit and normal profit, depending on the method used.

10. A subsidiary company cannot buy shares of the holding company after it becomes its subsidiary. (2023)
    True
    Explanation: As per the Companies Act, a subsidiary company is prohibited from holding shares in its holding company, except in certain permitted cases (like in a fiduciary capacity).

11. Reduction in share capital must be sanctioned by the National Company Law Tribunal. (2023)
    True
    Explanation: Section 66 of the Companies Act, 2013 requires NCLT approval for capital reduction.
    
    

12. Companies Act 2013 prohibits the issue of bonus shares.
    False
    Explanation: Section 63 of the Companies Act, 2013 allows companies to issue fully paid-up bonus shares from free reserves, securities premium, or capital redemption reserves.

13. The issue of bonus shares must be recommended by the Board of Directors and approved by the shareholders in the general meeting.
    True
    Explanation: As per company law, the board recommends the issue, but shareholders must approve it in a general meeting.

14. As per Section 52 of the Companies Act, the balance of the Securities Premium Reserve Account cannot be used for the issue of fully paid bonus shares. (G.U. B. Com. 2011)
    False
    Explanation: Section 52 allows the use of securities premium for issuing fully paid bonus shares.

15. Buyback of shares means the purchase of own equity and preference shares by a company.
    False
    Explanation: As per Section 68 of the Companies Act, 2013, companies can only buy back their own equity shares, not preference shares.

16. Buyback of shares must be authorized by the Articles of Association.
    True
    Explanation: A company can buy back its shares only if its Articles of Association permit it, as per Section 68 of the Companies Act.

17. Securities Premium Account cannot be used for buyback of shares.
    False
    Explanation: Section 68(1) of the Companies Act allows companies to use securities premium for share buybacks.

18. Goodwill consists of the advantages a business has in connection with its permanent customers only with whom it has contact.
    False
    Explanation: Goodwill arises from multiple factors, including brand value, reputation, and customer loyalty, not just from permanent customers.

19. Goodwill is an asset that can be disposed of only in the event of the business being sold as a going concern.
    True
    Explanation: Goodwill is typically transferred when the business is sold, as it represents intangible benefits tied to the business itself.

20. The average profit method takes into account the abnormal profit or loss incurred during the course of business.
    False
    Explanation: The average profit method excludes abnormal profits or losses to ensure a fair valuation of goodwill.

21. Super profit is the excess of normal profit over the actual profit earned by a business.
    False
    Explanation: Super profit is the excess of actual profit over normal profit, not the other way around.
    
    

22. Under the asset-backing method, all assets shown in the balance sheet are considered for the valuation of shares.
    False
    Explanation: Only net assets (total assets minus liabilities) are considered for valuation, not all assets.

23. For the valuation of shares under the intrinsic value method, fixed assets are taken at realizable value and investments are taken at current market prices.
    True
    Explanation: Intrinsic value considers the realizable value of fixed assets and the current market value of investments.

24. No consideration is given for unrecorded assets, but unrecorded liabilities are taken into consideration while valuing shares under the intrinsic value method.
    False
    Explanation: Both unrecorded assets and liabilities should be considered for fair valuation.

25. Under the yield method of valuing shares, yield may be 'Earning yield' or 'Dividend yield'.
    True
    Explanation: The yield method considers both earning yield (based on profits) and dividend yield (based on dividend payments).

3. Multiple-Choice Questions (MCQs)

1. Which of the following is a reason for issuing right shares? (2023)
   a) To reduce the shareholding of existing shareholders
   b) To raise additional funds from existing shareholders
   c) To increase the authorized share capital
   d) None of the above
   Answer: b) To raise additional funds from existing shareholders 

2. What is the primary advantage of bonus shares? (2023)
   a) Increase in share capital without additional investment from shareholders
   b) Decrease in earnings per share
   c) Reduction of market price per share
   d) Both (a) and (c)
   Answer: d) Both (a) and (c) 

3. Buyback of shares can be financed through: (2023)
   a) General Reserve
   b) Securities Premium
   c) Fresh Issue of Shares
   d) All of the above
   Answer: d) All of the above 

4. Which of the following methods is used for the valuation of shares? (2023)
   a) Intrinsic Value Method
   b) Yield Method
   c) Fair Value Method
   d) All of the above
   Answer: d) All of the above 

4. Short Answer Questions (2-5Marks Each)

1. What is meant by Valuation of Shares? (2018, 2023)

Answer: Valuation of shares refers to the process of determining the fair value of a company’s shares based on various financial and market factors. It is essential in cases like mergers, acquisitions, taxation, investment decisions, and legal disputes. The valuation is conducted using methods such as the Intrinsic Value Method, Yield Method, and Fair Value Method to assess the worth of a share based on assets, earnings, and market conditions.

2. Explain the meaning of rights share.

Answer: Rights shares are additional shares issued by a company to its existing shareholders in proportion to their current holdings, at a price lower than the market value. This is done to raise additional capital while giving preference to existing shareholders before offering shares to the public. Rights shares help companies expand their operations without increasing debt.

3. What is meant by value of right in relation to rights share?

Answer:  The value of right represents the monetary benefit that an existing shareholder gets by subscribing to a rights issue at a discounted price instead of purchasing shares at the prevailing market price. It is calculated as:

Value of Right = Market Price per Share - Rights Issue Price per Share /Total Number of Shares (Old + New) per Rights Issue

This value ensures fair treatment of shareholders by compensating them if they choose not to exercise their rights.

4. State the procedure of issue of rights share.

Answer: The procedure for issuing rights shares includes the following steps:

1. Board Approval: The Board of Directors passes a resolution approving the rights issue.

2. Shareholder Approval (if required): In some cases, approval from shareholders in a general meeting may be necessary.

3. Offer Letter: The company issues a letter of offer to existing shareholders, specifying the price, ratio, and duration of the offer.

4. Subscription Period: Shareholders are given a specific time to subscribe to the rights shares or renounce them.

5. Allotment of Shares: Shares are allotted to those who have subscribed, and any remaining shares may be disposed of as per the company’s discretion.

6. Filing with ROC: The company files the required documents with the Registrar of Companies (ROC) to complete the process.

5. Describe the procedure of valuing rights share.

Answer:  The valuation of rights shares follows this process:

1. Determine the Market Price of Existing Shares – Identify the current market price of the company’s shares.

2. Determine the Issue Price of Rights Shares – The company offers new shares at a discounted price.

3. Calculate the Theoretical Ex-rights Price (TERP):

TERP = Market Price x Old Shares) + Rights Issue Price x New Shares/Total Number of Shares (Old + New)

4. Calculate the Value of Right:

Value of Right  = Market Price - TERP

This helps in determining the fair price of rights and allows shareholders to decide whether to subscribe or sell their rights.

6. Write a short note on Buyback of Shares. (2016, 2020, 2023)

Answer:  Buyback of shares refers to the process where a company repurchases its own shares from existing shareholders, reducing the number of outstanding shares in the market. It can be done through open market purchases, tender offers, or direct negotiations.

Objectives of Buyback:

• To improve earnings per share (EPS) by reducing the number of outstanding shares.

• To enhance shareholder value by returning surplus cash.

• To prevent hostile takeovers by reducing available shares.

• To adjust capital structure by decreasing equity capital.

Sources of Buyback:

• Free reserves

• Securities Premium Account

• Proceeds from fresh issue of shares

As per Section 68 of the Companies Act, 2013, a company must meet conditions such as maintaining a 2:1 debt-equity ratio post-buyback and completing the process within 12 months from board approval.

7. State the legal provisions under the Companies Act, 2013, regarding the buyback of shares. (2023)

Answer: The Companies Act, 2013, under Section 68, lays down the legal provisions for the buyback of shares by a company. The key provisions include:

1. Authorization in Articles of Association (AOA) – The company must have the power to buy back shares mentioned in its Articles of Association.

2. Board and Shareholder Approval –

• If the buyback is 10% or less of total paid-up equity capital and free reserves, it can be approved by the Board of Directors.

• If it exceeds 10% but is within 25%, shareholders must approve it via a special resolution.

3. Sources of Buyback – Buyback can be done using:

• Free reserves

• Securities premium account

• Proceeds from the issue of other shares or securities (but not from a fresh issue of the same kind of shares).

4. Limits on Buyback – The buyback should not exceed 25% of the total paid-up equity capital and free reserves in a financial year. Also, the post-buyback debt-to-equity ratio should not exceed 2:1.

5. Fully Paid-up Shares Only – The company can only buy back fully paid-up shares or securities.

6. Time Gap Between Buybacks – A company cannot issue further buybacks for one year from the date of the last buyback.

7. Declaration of Solvency – A declaration confirming the company’s solvency must be filed with the Registrar of Companies (ROC) and SEBI (for listed companies).

8. Extinguishment of Shares – The shares bought back must be extinguished or physically destroyed within seven days from the buyback completion date.

9. No Further Issue of Shares – The company cannot issue the same type of shares within six months of the buyback, except for bonus issues or stock option schemes.

These provisions ensure that buybacks are done legally and do not harm creditors or minority shareholders.

8. Explain the need for valuation of shares in a company. (2018, 2021, 2023)

Answer: Valuation of shares is essential for various financial and legal purposes in a company. The key reasons for share valuation include:

1. Merger and Acquisition (M&A) – When a company is merging with or acquiring another firm, share valuation helps determine the fair exchange ratio.

2. Investment Decisions – Investors need to assess whether a company’s shares are overvalued, undervalued, or fairly priced before making investment decisions.

3. Buyback of Shares – During buyback, the company must ensure it purchases its shares at a fair price, benefiting both the company and shareholders.

4. Taxation Purposes – The Income Tax Act requires fair share valuation in case of capital gains tax, gift tax, or estate duty.

5. Issue of Shares (IPO, Rights Issue, Private Placements) – Companies issuing new shares need a valuation to set the right price for IPOs, rights issues, or preferential allotments.

6. Litigation and Dispute Resolution – In case of shareholder disputes, divorce settlements, or corporate restructuring, share valuation helps in fair division of assets.

7. Loan Collateral – Banks and financial institutions may require share valuation when shares are pledged as collateral for loans.

8. ESOP (Employee Stock Ownership Plan) – Share valuation is needed when companies issue shares to employees as part of compensation.

Valuation ensures transparency, protects stakeholders, and helps in making informed financial decisions.

9. What are the different types of Goodwill? (2023)

Answer: Goodwill represents a company's intangible asset that arises due to its reputation, customer relationships, and market position. The main types of goodwill are:

1. Purchased Goodwill – Arises when a company purchases another business for a price higher than its net assets. It is recorded in the books of accounts and can be amortized.

2. Inherent (Non-Purchased) Goodwill – Developed internally over time due to brand loyalty, customer relationships, and reputation. It is not recorded in financial statements as it has no specific cost.

3. Institutional Goodwill – Exists due to the location, name, or long-standing operations of a business, such as prestigious universities or hospitals.

4. Professional Goodwill – Found in firms where goodwill depends on expertise, skill, or personal reputation (e.g., law firms, medical practices).

5. Trade Goodwill – Arises due to customer satisfaction, trade relationships, and brand recognition.

6. Hidden Goodwill – The difference between the agreed purchase price of a firm and its net assets, which is indirectly inferred in partnership firm valuations.

Goodwill helps businesses gain competitive advantages and influences valuation during acquisitions or restructuring.

10. What are the sources of funds for buyback of shares? (2016, 2023)

Answer: As per Section 68(1) of the Companies Act, 2013, companies can buy back shares using the following sources:

1. Free Reserves – The accumulated profits of the company, excluding revaluation reserves, can be used for buyback.

2. Securities Premium Account – The premium received on the issue of shares can be utilized for buyback.

3. Proceeds of Fresh Issue of Securities (Other Than Same Kind of Shares)–

• If a company raises funds by issuing debentures or preference shares, these proceeds can be used for buyback.

• However, funds from a fresh issue of equity shares cannot be used to repurchase existing equity shares.

Restrictions on Sources of Buyback

• The company cannot use borrowed funds (debt financing) for buyback.

• It cannot use capital reserves unless explicitly allowed.

• These provisions ensure companies use legitimate funds, protecting creditors and financial stability.

11. Explain the accounting treatment of bonus shares. (2020, 2022, 2023)

Answer: Bonus shares are free shares issued to existing shareholders from the company’s reserves. The accounting treatment involves the following steps:

1. Transferring Amount from Reserves to Share Capital –

• The required amount is transferred from free reserves, securities premium account, or capital redemption reserve to the share capital account.

2. Journal Entries for Issuing Bonus Shares:

When Reserves Are Capitalized:
General Reserve A/c   Dr.  

Securities Premium A/c Dr.  

        To Bonus Share Capital A/c  

(Transfer of reserves for issuing bonus shares)

When Bonus Shares Are Issued:
Bonus Share Capital A/c Dr.  

        To Equity Share Capital A/c  

(Bonus shares issued to existing shareholders)

3. Impact on Financial Statements –

• The company’s total share capital increases, but net worth remains unchanged.

• No cash outflow occurs.

4. Conditions for Issuing Bonus Shares –

• Must be authorized by the Articles of Association (AOA).

• Should be approved in a general meeting.

• Bonus shares cannot be issued in place of dividend payments.

Issuing bonus shares helps companies reward shareholders without affecting cash reserves and improves market perception.

12. State the meaning of bonus share. [G.U. B. Com. 2011 (Old)]

Answer: Bonus shares are free shares issued by a company to its existing shareholders in proportion to their current shareholding. They are issued from the company's free reserves, securities premium account, or capital redemption reserve and do not involve any cash outflow.

For example, if a company declares a 1:2 bonus issue, it means a shareholder holding 2 shares will receive 1 additional share for free.

Key Features of Bonus Shares:

1. Issued as a reward to shareholders.

2. Increase the total number of shares but do not change the shareholder's proportionate ownership.

3. Do not affect the company’s cash reserves.

4. Improve market perception and investor confidence.

13. What do you mean by or Explain 'Capitalisation of Profits'?

Answer: Capitalisation of profits refers to the process of converting a company's free reserves or retained earnings into share capital by issuing bonus shares to shareholders instead of paying cash dividends.

This means that profits, instead of being distributed as dividends, are reinvested into the company’s equity, increasing the company's paid-up share capital.

Example:
If a company has ₹10 crore in retained earnings and decides to issue ₹5 crore as bonus shares, this amount is capitalised, meaning it is transferred from reserves to share capital.

Importance of Capitalisation of Profits:

1. Strengthens the financial base of the company.

2. Maintains liquidity as no cash outflow occurs.

3. Helps in improving investor confidence.

4. Increases share capital without requiring additional funds from shareholders.

14. What is Escrow Account?

Answer: An Escrow Account is a temporary holding account managed by a third party (such as a bank or financial institution) to hold money or assets until certain conditions of a transaction are met.

It is commonly used in:

1. Mergers & Acquisitions – The buyer deposits funds in an escrow account, which is released to the seller only after all conditions are fulfilled.

2. Initial Public Offerings (IPOs) – Funds collected from investors are held in escrow until the company allots shares.

3. Online Transactions – E-commerce platforms use escrow accounts to hold buyer payments until the seller delivers the product/service.

4. Real Estate Deals – Buyers deposit funds in escrow accounts, which are released to the seller after legal verification of property documents.

Benefits of an Escrow Account:

• Ensures security and transparency in financial transactions.

• Protects both parties in a deal from fraud or breach of contract.

• Reduces risks associated with large transactions.

15. How is the value of a right share calculated?

Answer: A right share is a new share offered to existing shareholders at a discounted price before being offered to the public. The value of a right share is calculated as follows:

Formula for Value of a Right Share (Theoretical Ex-rights Price – Issue Price of Right Share):

Value of Right  = Market Price of Existing Share + Issue Price of Right Share x No. of Right Shares) / Total Shares (Existing + Right Shares) - Issue Price of Right Share

Example:

• Market Price of Existing Share = ₹100

• Issue Price of Right Share = ₹80

• Rights Ratio = 1:4 (1 right share for every 4 existing shares)

Theoretical Ex-rights Price = (100 x 4) + (80 x 1) / 4+1 = 400 + 80 / 5 = 96

Value of Right Share  = 96 - 80 = ₹16

Thus, the value of each right share in this case is ₹16.

Importance of Right Share Calculation:

• Helps shareholders decide whether to subscribe or sell rights.

• Ensures fair pricing in the secondary market.

• Provides companies with an efficient way to raise additional capital.

16. What is commercial goodwill?

Answer: Commercial goodwill is the type of goodwill that arises due to a business's competitive advantages, brand value, customer loyalty, and market reputation. It directly affects the company’s ability to generate higher profits.

Characteristics of Commercial Goodwill:

1. Intangible Asset – It has no physical existence but adds value to a business.

2. Created Over Time – Built through brand recognition, quality service, and customer relationships.

3. Increases Business Valuation – Helps a company command a higher selling price in mergers or acquisitions.

4. Not Recorded in Books – Unless purchased, it remains an unrecorded asset.

5. Affects Profitability – Businesses with strong goodwill can charge premium prices and retain customers.

For example, companies like Apple, Google, or Tata enjoy high commercial goodwill due to their strong brand reputation and customer trust.

17. Discuss five characteristics of goodwill.

Answer: Goodwill is an intangible asset that represents a company's brand value, customer trust, and competitive advantage. Its key characteristics are:

1. Intangible Nature – Goodwill has no physical form but adds significant value to a business. It exists in the reputation, brand loyalty, and customer relationships of a company.

2. Arises Over Time – Goodwill is developed through years of consistent service, product quality, and customer satisfaction. It is not an overnight achievement.

3. Valuable in Mergers & Acquisitions – When a company is sold, goodwill is an important factor in determining its selling price. Firms with strong goodwill command higher valuations in the market.

4. Not Separately Transferable – Unlike tangible assets (land, machinery), goodwill cannot be sold separately from the business. It is attached to the company’s identity.

5. Affects Business Profitability – Companies with high goodwill can charge premium prices and maintain a loyal customer base. It helps in securing long-term growth and financial stability.

For example, brands like Coca-Cola, Google, and Mercedes-Benz have high goodwill, giving them a competitive advantage in the market.

5. Long Answer Questions (5-10 Marks Each)

1. What is the Buyback of Shares? Explain the accounting entries with an example. (2017, 2019, 2023)

Answer:  Buyback of shares refers to the process by which a company repurchases its own shares from existing shareholders. This is done to reduce the number of outstanding shares in the market, increase earnings per share (EPS), and return surplus cash to shareholders. The buyback of shares is regulated under Section 68 of the Companies Act, 2013 in India.

Objectives of Buyback of Shares

1. To improve the earnings per share (EPS) by reducing the number of outstanding shares.

2. To return excess cash to shareholders when the company has surplus funds.

3. To increase the market value of shares by reducing supply.

4. To prevent hostile takeovers by reducing the number of freely available shares.

5. To provide an exit option to shareholders in case of undervaluation of shares.

Accounting Entries for Buyback of Shares

When a company buys back its shares, the following accounting entries are recorded:

1. For transferring the amount to the Buyback Account:

Equity Share Capital A/c    Dr.   

(Nominal value of shares)

Securities Premium A/c      Dr.  

(If buyback price is more than face value)

General Reserve A/c         Dr.   (If required)

      To Buyback of Shares A/c          

           (Buyback Price)

2. For payment to shareholders:

Buyback of Shares A/c    Dr.  

 (Buyback price)

    To Bank A/c                     

  (Payment to shareholders)

3. For transfer to Capital Redemption Reserve (CRR) (if buyback is from free reserves):

General Reserve A/c     Dr.   

(Nominal value of shares bought back)

       To Capital Redemption Reserve A/c

4. For cancellation of bought-back shares:

Equity Share Capital A/c     Dr.   

(Face value of shares)

To Shares Bought Back A/c

Example ABC Ltd. decides to buy back 10,000 shares at ₹50 per share. The face value per share is ₹10. The buyback is financed using general reserves.

Accounting Entries:

For Buyback Liability:
Equity Share Capital A/c    Dr.  ₹1,00,000  (10,000 × ₹10)

General Reserve A/c         Dr.  ₹4,00,000  (10,000 × ₹40)

To Buyback of Shares A/c           ₹5,00,000  (10,000 × ₹50)

For Payment to Shareholders:

Buyback of Shares A/c   Dr.  ₹5,00,000

       To Bank A/c                   ₹5,00,000

For Transfer to Capital Redemption Reserve (CRR):

General Reserve A/c     Dr.  ₹1,00,000

  To Capital Redemption Reserve A/c ₹1,00,000

Thus, buyback helps in reducing equity capital while improving financial ratios.

2. What is Rights Share? Discuss Mention any five advantages and disadvantages of rights share. (VVI) (2017, 2022)

Answer:A rights share issue is a method by which a company raises additional capital by offering shares to existing shareholders at a discounted price in proportion to their existing holdings. This is governed under Section 62 of the Companies Act, 2013.

Features of Rights Issue

1. Offered only to existing shareholders.

2. Issued at a price lower than the market price.

3. Shareholders have the option to accept or reject the offer.

4. Helps companies raise capital without involving outsiders.

Advantages of Rights Issue

1. Retention of Ownership: Since shares are offered to existing shareholders, ownership control remains unchanged.

2. Cost-Effective: No underwriting or public issue expenses.

3. Faster Fundraising: It requires fewer legal formalities and is quicker than a public issue.

4. Increase in Shareholder Value: Existing shareholders get shares at a discount, increasing their investment value.

5. Flexibility for Shareholders: Shareholders can either subscribe, sell, or ignore the rights.

Disadvantages of Rights Issue

1. Limited to Existing Shareholders: No new investors are introduced.

2. Reduction in Share Price: The issue of new shares at a lower price can reduce market value.

3. Not Suitable for All Companies: Loss-making companies may not attract investor interest.

4. Dilution of EPS: More shares in circulation may reduce earnings per share.

5. Dependence on Shareholder Response: If shareholders do not subscribe, the issue may fail.

3. What is the difference between Right Shares and Bonus Shares in table? (2016, 2021, 2023)

Answer:

Basis of Difference	Right Shares	Bonus Shares
Meaning	Shares issued to existing shareholders at a discount.	Free shares issued to shareholders as a bonus.
Consideration	Shareholders must pay for these shares.	Issued free of cost.
Purpose	To raise additional capital.	To capitalize reserves and reward shareholders.
Impact on Share Capital	Increases paid-up capital.	Increases share capital but not cash inflow.
Effect on Market Price	May decrease due to an increased number of shares.	May initially boost price but later adjusts.

4. Discuss the various methods of Valuation of Shares with examples. (2018, 2020, 2023)

Answer: Valuation of shares refers to the process of determining the intrinsic value of a company's shares for investment, merger, acquisition, or financial reporting purposes.

Methods of Valuation

1. Net Asset Value (NAV) Method (Intrinsic Value Method):
   Based on the net assets of the company.

1. Formula:
   NAV per Share = (Total Assets – External Liabilities) / Number of Equity Shares 

• 
  

2. Example: If a company has assets worth ₹10,00,000 and liabilities of ₹2,00,000 with 20,000 shares, then:
   NAV per Share = (10,00,000 – 2,00,000) / 20,000 = ₹40 per share 

2. Earnings Capitalization Method:
   Based on future earnings and expected rate of return.

3. Formula:
   Value per Share = (Earnings per Share × 100) / Capitalization Rate 

4. Example: If EPS is ₹8 and capitalization rate is 10%, then:
   Value per Share = (8 × 100) / 10 = ₹80 

3. Market Price Method: Based on the average market price of shares over a period. Used for listed companies.

4. Yield Method: Based on dividend or earnings yield.

5. Formula:
   Value per Share = (Expected Dividend / Normal Rate of Return) × 100 

5. Fair Value Method: A combination of NAV, Earnings, and Market Price methods.

Formula:
Fair Value per Share = (NAV + Earnings-based Value) / 2 

Each method is used depending on the purpose of valuation and company conditions.

5. Prepare Journal Entries for Buyback of Shares with proper explanations. (2016, 2019, 2023)

Answer: Buyback of shares means a company repurchasing its own shares from shareholders. It is governed by Section 68 of the Companies Act, 2013. The company can buy back shares using free reserves, securities premium, or share capital.

Accounting Entries for Buyback of Shares

1. For Transferring the Buyback Amount to a Separate Account (Optional Entry)

If the company transfers the buyback amount to a special account before making the payment:

Buyback of Equity Shares A/c    Dr.   ₹XXX  

To Bank A/c                                 ₹XXX 

(This entry is optional but preferred in some cases for better tracking of payments.)

2. For Buyback of Shares

Equity Share Capital A/c     Dr.   (Face value of shares bought back)  

Securities Premium A/c       Dr.   (If applicable)  

General Reserve A/c          Dr.   (If required)  

To Shareholders A/c                (Total buyback amount) 

(Here, the amount is credited to shareholders who are selling their shares back to the company.)

3. Payment Made to Shareholders

Shareholders A/c     Dr.   ₹XXX  

To Bank A/c                 ₹XXX 

(Here, the company pays cash to shareholders for the buyback.)

4. Transfer of Nominal Value to Capital Redemption Reserve (CRR)

If the buyback is from free reserves, an equivalent amount must be transferred to CRR:

General Reserve A/c    Dr.   ₹XXX  

To Capital Redemption Reserve A/c   ₹XXX 

(This step ensures that the capital structure remains intact.)

Example

XYZ Ltd. buys back 5,000 shares at ₹50 per share (face value ₹10). The buyback is done using free reserves.

Journal Entries

For Buyback Liability:
Equity Share Capital A/c   Dr.  ₹50,000  (5,000 × ₹10)  

General Reserve A/c        Dr.  ₹2,00,000  (5,000 × ₹40)  

To Shareholders A/c          ₹2,50,000  (5,000 × ₹50) 

Payment to Shareholders:
Shareholders A/c     Dr.  ₹2,50,000  

To Bank A/c                  ₹2,50,000 

Transfer to CRR:
General Reserve A/c    Dr.  ₹50,000  

To Capital Redemption Reserve A/c ₹50,000 

6. Explain the legal provisions regarding the issue of Bonus Shares under the Companies Act, 2013. (2021, 2023)

Answer: Bonus shares are additional shares issued by a company to its existing shareholders free of cost by capitalizing its reserves and surplus. It is governed by Section 63 of the Companies Act, 2013.

Bonus shares are free additional shares issued to existing shareholders in proportion to their current holdings. These shares are issued by capitalizing free reserves, securities premium, or retained earnings instead of distributing cash dividends.

The issue of bonus shares is regulated by Section 63 of the Companies Act, 2013, along with SEBI (for listed companies).

Legal Provisions for Bonus Shares (Section 63 of the Companies Act, 2013)

1. Sources for Issuing Bonus Shares:
   A company can issue bonus shares from:

• Free Reserves

• Securities Premium Account

• Capital Redemption Reserve (CRR)
  However, a company cannot issue bonus shares from:

• Revaluation reserves

• Unrealized profits

2. Conditions for Issuing Bonus Shares:

• The company’s Articles of Association (AOA) must allow the issue of bonus shares. If not, it must be amended first.

• The decision must be approved by the Board of Directors and shareholders in a general meeting.

• The company must have sufficient reserves to issue the bonus shares.

• The company must not have defaulted on payment of interest, deposits, or statutory dues.

• A company cannot withdraw a bonus issue once announced.

3. Procedure for Issuing Bonus Shares:

• Board of Directors proposes the bonus issue.

• Approval is obtained in a general meeting.

• The company files a resolution with the Registrar of Companies (ROC).

• The shares are credited to the shareholders’ accounts.

4. SEBI Guidelines (For Listed Companies):

• The bonus issue must be fully paid-up shares.

• A company must announce a record date to determine eligible shareholders.

• SEBI must be informed before issuing bonus shares.

Conclusion

Bonus shares do not affect the company's cash position but increase the number of shares in circulation, benefiting long-term investors.

7. What is Goodwill? Explain the different methods of Goodwill valuation with examples. (2018, 2022, 2023)

Answer: Goodwill is an intangible asset that represents the excess of the purchase price of a company over the fair value of its net identifiable assets. It reflects factors such as reputation, brand strength, customer loyalty, and overall market position. Goodwill is typically recognized when a business is acquired and indicates the future economic benefits arising from assets that are not separately identifiable.

Below are the primary methods used for the valuation of goodwill along with examples for each:

1. Average Profit Method

Concept:
This method calculates goodwill based on the average profits generated by the business over a certain number of years. The idea is that the value of the business (and its goodwill) is related to its ability to generate earnings.

Formula: Goodwill=Average Profit×Number of Years’ Purchase

Example:
Suppose a company has recorded an average annual profit of ₹50,000 over the past 3 years, and it is decided that goodwill should be valued at a premium of 3 years’ purchase:

Goodwill=₹50,000×3=₹1,50,000

2. Super Profit Method

Concept:
This method considers the “super profit” — the excess profit earned over the normal profit (expected return on investment). It is based on the premise that a business earns more than what is typically expected due to its superior performance, which is attributed to goodwill.

Steps:

1. Calculate the normal profit (often based on a predetermined rate of return on the capital employed).

2. Determine the super profit by subtracting the normal profit from the actual average profit.

3. Multiply the super profit by the number of years’ purchase to obtain the value of goodwill.

Formula:

Goodwill=(Actual Profit−Normal Profit)×Number of Years’ Purchase 

Example:
Assume the average actual profit is ₹60,000 per annum. If the normal profit (based on the capital invested) is estimated to be ₹40,000 per annum, then:

Super Profit=₹60,000−₹40,000=₹20,000

If the business is valued at 3 years’ purchase:

Goodwill=₹20,000×3=₹60,000

3. Capitalization Method

Concept:
The capitalization method values goodwill by capitalizing the super profit (or the overall profit) at a normal rate of return. This method is useful when the business is expected to continue earning a steady profit.

Formula:

Goodwill=Super Profit×100/Normal Rate of Return (%)

Alternatively, if using overall profit:

Value of Business=Average Profit×100/Normal Rate of Return (%) 

Then, goodwill is determined by subtracting the net tangible assets from the capitalized value.

Example (Using Super Profit):
If the super profit is ₹20,000 and the normal rate of return is 10%:

Goodwill=₹20,000×100/10=₹2,00,000

Example (Using Overall Profit):
Assume the average profit is ₹60,000 per annum and the normal rate of return is 12%. Then:

Capitalized Value of Business=₹60,000×100/ 12=₹5,00,000 

If the net tangible assets (assets minus liabilities) are valued at ₹4,00,000, the goodwill would be:

Goodwill=₹5,00,000−₹4,00,000=₹1,00,000 

4. Residual Method (Capitalized Earnings Method)

Concept:
In the residual method, goodwill is calculated as the difference between the total value of the business (obtained by capitalizing the overall earnings) and the net value of its identifiable assets. This method reflects the portion of the business value that cannot be attributed to tangible or identifiable intangible assets.

Steps:

1. Capitalize the average earnings of the business at an appropriate rate to determine the total business value.

2. Subtract the net identifiable assets (tangible and identifiable intangible assets) from this total value.

3. The remainder is considered as goodwill.

Example:
If the capitalized value of the business is ₹10,00,000 and the net identifiable assets are valued at ₹8,00,000, then:

Goodwill=₹10,00,000−₹8,00,000=₹2,00,000 ,

Conclusion

Each method has its own advantages and is applicable under different circumstances:

• The Average Profit Method is straightforward and useful when profits are stable.

• The Super Profit Method highlights the extra earning capacity that is directly attributable to the business’s unique strengths.

• The Capitalization Method is effective when the business exhibits consistent earning power.

• The Residual Method comprehensively reflects the excess value over the net identifiable assets.

8. Write a detailed note on Accounting for Buyback of Shares under the Companies Act, 2013. (2016, 2023)

Answer: Buyback of shares means a company repurchasing its own shares from shareholders. It is governed by Sections 68 to 70 of the Companies Act, 2013 and SEBI (Buyback of Securities) Regulations, 2018.

Sources of Buyback

A company can buy back shares from:

• Free Reserves

• Securities Premium Account

• Fresh Issue (Not Allowed)

Accounting Treatment of Buyback of Shares

For Buyback of Shares
Equity Share Capital A/c  Dr.  ₹XXX  

Securities Premium A/c    Dr.  ₹XXX  

To Shareholders A/c            ₹XXX 

(This reduces the share capital and creates a liability towards shareholders.)

For Payment to Shareholders
Shareholders A/c  Dr.  ₹XXX  

To Bank A/c            ₹XXX 

Transfer to Capital Redemption Reserve (CRR)
General Reserve A/c  Dr.  ₹XXX  

To Capital Redemption Reserve A/c ₹XXX 

Conclusion

Buyback of shares helps companies increase EPS, stabilize share prices, and return excess cash to shareholders.

9. State the relevant provisions of the Companies Act regarding right issue in the case of a public company. How is the value of the rights computed?

Answer: shares to its existing shareholders in proportion to their current shareholding. The objective is to protect the ownership percentage of shareholders and provide them with a discounted price before offering shares to the general public.

The Companies Act, 2013, under Section 62, governs the right issue for public and private companies. Additionally, SEBI (ICDR) Regulations, 2018 apply to listed companies.

Provisions of Right Issue Under the Companies Act, 2013

1. Offer to Existing Shareholders (Section 62(1)(a))

A public company must first offer new shares to its existing equity shareholders in proportion to their existing shareholding. This ensures that current shareholders get the first right to subscribe before new investors.

Example: If a shareholder owns 10% of the company's shares and the company issues a right issue of 1:5 (one new share for every five existing shares), the shareholder will be entitled to buy additional shares in the same proportion.

2. Mode of Offering the Right Issue (Section 62(1)(a)(i))

The company must send a letter of offer to its shareholders, specifying:

• The number of shares offered.

• The issue price of shares and payment terms.

• The time limit for accepting the offer (minimum 15 days, maximum 30 days).

If a shareholder does not accept the offer within this period, the company can dispose of the shares in any manner that is not disadvantageous to the company or shareholders.

3. Renunciation of Rights (Section 62(1)(a)(ii))

Shareholders have the right to:

• Accept the offer and subscribe to the shares.

• Partially accept and renounce the remaining shares.

• Fully renounce the entitlement to another investor (this is called trading of rights).

Example: If a shareholder is entitled to 10 right shares but only wants to buy 5 shares, they can sell the remaining 5 rights to another investor.

4. Pricing of Right Shares

The Companies Act does not fix the price of right shares, but they are usually issued below the current market price to attract investors.

Example: If the current market price of a share is ₹120, the company may issue right shares at ₹100 per share.

5. Disposal of Unsubscribed Shares (Section 62(1)(a)(iii))

If some shareholders do not subscribe or renounce their rights, the company can:

• Offer the remaining shares to other existing shareholders.

• Offer the shares to new investors or the general public.

• Cancel the issue if there is insufficient demand.

A public company cannot force a shareholder to subscribe to a right issue.

6. Regulatory Compliance & Filing with ROC

• After allotment of right shares, the company must file Form PAS-3 with the Registrar of Companies (ROC) within 30 days.

• Details of shareholders, issue price, and shares allotted must be submitted.

7. SEBI Guidelines for Listed Public Companies

For listed public companies, SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018 apply:

6. The company must file a Letter of Offer (LOO) with SEBI before issuing the right shares.

7. A record date must be announced to determine eligible shareholders.

8. The right shares must be fully paid-up before trading on the stock exchange.

Computation of Right Value

A right issue usually offers shares below the current market price, which creates a financial advantage for shareholders. The value of the right is calculated to determine the benefit shareholders receive.

Formula to Calculate Value of a Right Share:

Value of Right=Market Price per Share−Right Issue Price / 1+Number of Rights Offered per Existing Share 

Example:

• Market price of a share = ₹120

• Right issue price = ₹100

• Right issue ratio = 1:4 (one new share for every four existing shares)

Value of Right=120−100 / 1+4=20 / 5=₹4 

This means that shareholders gain ₹4 per share through the right issue.

10. What do you mean by bonus shares? What are the Objectives and Advantages and Disadvantages of Bonus Share? (vvi) 

Answer: Bonus Shares: Bonus shares are additional shares that a company issues to its existing shareholders without any additional cost. These shares are distributed in proportion to the shareholders' current holdings and are issued from the company’s accumulated profits or reserves. Bonus shares increase the total number of shares without affecting the company's market capitalization.

Objectives of Issuing Bonus Shares

1. Utilization of Reserves – Helps companies convert retained earnings into share capital, improving financial structure.

2. Increase in Marketability – A larger number of shares in circulation makes trading easier and more attractive to investors.

3. Boost Shareholder Confidence – Rewards shareholders and signals the company’s strong financial health.

4. Maintain Liquidity – Instead of paying cash dividends, the company retains cash for business expansion.

5. Meet Regulatory Requirements – Some regulations require companies to maintain a specific debt-to-equity ratio, which bonus shares help balance.

Advantages of Bonus Shares

1. Enhances Shareholder Wealth – Shareholders get more shares without investing additional funds.

2. Improves Liquidity – Increased number of shares makes them more tradable in the market.

3. Positive Market Perception – Indicates company growth and stability, attracting more investors.

4. No Cash Outflow – Unlike dividends, the company does not have to use cash, preserving financial strength.

5. Lowers Share Price per Share – Makes shares more affordable, attracting small investors.

Disadvantages of Bonus Shares

1. No Immediate Monetary Benefit – Shareholders do not receive cash but only additional shares.

2. Dilution of Earnings per Share (EPS) – More shares reduce the EPS, which may affect investor perception.

3. Reduced Dividend per Share – If the company maintains the same total dividend payout, each share gets a lower dividend.

4. No New Capital Inflow – The company does not raise additional funds as shares are issued for free.

5. Possible Overvaluation – If the company keeps issuing bonus shares frequently, it may create an artificial increase in stock price.

11. Explain the meaning of bonus shares and accounting entries for the same. [G.U. B. Com. 2008]

Answer: Meaning of Bonus Shares: Bonus shares are additional shares that a company issues to its existing shareholders free of cost. These shares are issued in proportion to their existing holdings and are distributed from the company’s accumulated profits or reserves. The issuance of bonus shares does not involve any cash flow; instead, it converts a part of the company’s reserves into share capital.

Accounting Entries for Bonus Shares

When a company issues bonus shares, it must adjust its reserves and share capital accordingly. The accounting treatment depends on the source from which the bonus shares are issued.

(a) When Bonus Shares are Issued from Free Reserves

Transferring the Amount to Bonus Share Capital Account:
Dr. Free Reserves / General Reserve / Retained Earnings  

To Bonus to Shareholders Account 

Issuance of Bonus Shares:
Dr. Bonus to Shareholders Account  

To Equity Share Capital Account 

(b) When Bonus Shares are Issued from the Securities Premium Account

Transferring the Amount to Bonus Share Capital Account:
Dr. Securities Premium Account  

To Bonus to Shareholders Account 

Issuance of Bonus Shares:
Dr. Bonus to Shareholders Account  

To Equity Share Capital Account 

12.  Discuss the sources from which bonus shares can be issued by a company. Briefly state the main guidelines issued by SEBI for the issue of bonus shares. (Delhi, 1998)

Answer: Sources from Which Bonus Shares Can Be Issued

A company can issue bonus shares from the following sources:

1. Free Reserves – Accumulated profits that are available for distribution as dividends.

2. Securities Premium Account – The premium collected from the issue of shares can be used, provided it is not earmarked for any specific purpose.

3. Capital Redemption Reserve – This reserve is created when redeemable preference shares are repaid, and it can be used for issuing bonus shares.

4. Profit & Loss Account (Retained Earnings) – Undistributed earnings from previous years can also be utilized.

Note: A company cannot issue bonus shares from revaluation reserves.

SEBI Guidelines for the Issue of Bonus Shares

The Securities and Exchange Board of India (SEBI) has set specific guidelines for issuing bonus shares to protect investor interests:

1. Authorisation in Articles of Association – The company's Articles of Association must permit the issue of bonus shares.

2. Approval from Shareholders – A resolution must be passed in the general meeting of shareholders.

3. No Default in Statutory Payments – The company should not have defaulted in the payment of interest or principal on loans, deposits, or statutory dues.

4. Fully Paid-up Shares Only – Bonus shares can only be issued on fully paid-up shares. If there are partly paid-up shares, they must be converted into fully paid-up before issuing bonus shares.

5. Time Limit for Bonus Issue – Once announced, the company must issue bonus shares within a stipulated time (generally six months).

6. No Bonus Issue Instead of Dividend – Companies cannot declare a bonus issue in lieu of dividends.

7. Compliance with Listing Agreement – If the company is listed on a stock exchange, it must comply with the regulations of SEBI and the exchange.

These guidelines ensure transparency and fairness in the process of issuing bonus shares.

13. Discuss the procedure of issue of bonus share. State the entries to be made in the books in this regard. [G.U. B. Com. 2009]

Answer: Procedure for the Issue of Bonus Shares

The issuance of bonus shares involves several steps to ensure compliance with legal and regulatory requirements. The process is as follows:

1. Check Articles of Association (AOA) – The company's Articles of Association must permit the issue of bonus shares. If not, it must be amended.

2. Board Meeting & Resolution – The Board of Directors must approve the proposal for issuing bonus shares.

3. Shareholders’ Approval – A general meeting must be held to pass an ordinary resolution or special resolution (if required).

4. Approval from Regulatory Authorities – If the company is listed, it must obtain approval from SEBI and the stock exchange.

5. Determine the Record Date – The company must announce a record date to determine eligible shareholders.

6. Make Necessary Adjustments in Financial Statements – Ensure that sufficient reserves are available for issuing bonus shares.

7. Issue of Bonus Shares & Allotment – The shares are credited to eligible shareholders' accounts, and relevant stock exchange regulations are followed.

8. Intimate Shareholders & Stock Exchange – After issuing the bonus shares, the company informs shareholders and updates stock exchanges accordingly.

Accounting Entries for Bonus Shares

Transferring the Amount from Reserves to Bonus Share Account:
Dr. Free Reserves / Securities Premium / Capital Redemption Reserve  

Cr. To Bonus to Shareholders Account 

Issuing the Bonus Shares:
Bonus to Shareholders Account  Dr.

To Equity Share Capital Account 

These entries ensure that the reserves are reduced while the share capital increases without affecting the cash position.

14. State the relevant provisions of the Companies Act regarding right issue in the case of a public company. How is the value of the right computed?

Answer: Provisions of the Companies Act on Right Issue

The right issue is governed by Section 62(1)(a) of the Companies Act, 2013, which provides the following provisions:

1. Offer to Existing Shareholders – A public company must first offer new shares to existing shareholders in proportion to their current holdings.

2. Notice to Shareholders – A notice specifying the number of shares offered and the time limit (minimum 15 days and maximum 30 days) for accepting the offer must be sent.

3. Renunciation Option – Shareholders can transfer (renounce) their right to another person.

4. Board Approval – The Board of Directors must approve the right issue and pass a resolution.

5. Pricing of Shares – The price can be decided by the company, and it is usually lower than the market price to encourage shareholder participation.

6. Unsubscribed Shares – If shareholders do not subscribe within the given time, the company can dispose of the shares in a manner it deems fit.

Computation of the Value of Right

The value of the right is determined using the formula:

Value of Right=Ex-right price−Issue price of right share / Total number of shares after right issueWhere:

• Ex-right price = (Total Market Value of Old Shares + Total Value of New Shares) / Total Number of Shares after Issue

• Market Price per Share = Current market price before the right issue

• Issue Price of Right Shares = Price at which the new shares are offered

• Number of Old Shares = Existing shares held by the shareholder

• Number of New Shares = Shares offered under the right issue

Example:

• Market price per share before right issue = ₹100

• Right issue price = ₹70

• Right ratio = 1:4 (one right share for every four shares)

15. Discuss Mention any six advantages of buy back of shares.

Asnwer:  Buyback of shares refers to a process where a company repurchases its own shares from existing shareholders, reducing the total number of outstanding shares in the market.

Advantages of Buyback of Shares

1. Increase in Earnings Per Share (EPS) – Since the number of shares outstanding decreases, EPS increases, making the company's stock more attractive to investors.

2. Improved Shareholder Value – Buyback enhances shareholder returns by increasing the market price of shares.

3. Utilization of Surplus Funds – Companies with excess cash can use buyback instead of distributing dividends, offering long-term benefits.

4. Prevention of Hostile Takeovers – By reducing the number of publicly available shares, companies can limit the chances of a hostile takeover.

5. Tax Benefits – Unlike dividends, which are taxable in the hands of shareholders, buyback may have lower tax implications for investors.

6. Enhancement of Market Perception – A buyback signals to investors that the company believes its shares are undervalued, boosting confidence.

16. What is goodwill? What are its distinguishing features or Characteristics? Distinguish between 'Purchased' and 'Not Purchased Goodwill'. (GU.. B. Com. 2004)

Answer:  Meaning of Goodwill: Goodwill is an intangible asset that represents the reputation, brand value, customer loyalty, and other non-physical advantages a business enjoys. It arises due to factors like quality service, skilled employees, and strong market position. Goodwill is reflected in the premium paid when acquiring a business.

Distinguishing Features or Characteristics of Goodwill

1. Intangible Asset – Goodwill has no physical existence but contributes to the company’s earning potential.

2. Value Fluctuates – Its value depends on business reputation, market trends, and profitability.

3. Not Separately Identifiable – Unlike other assets, goodwill cannot be separated or sold independently.

4. Generated Over Time – It is developed through consistent business performance, customer trust, and brand recognition.

5. Influences Future Profits – A strong goodwill helps attract customers and enhances profitability.

6. Subject to Amortization or Impairment – In accounting, goodwill is tested for impairment periodically instead of being depreciated.

.Distinction between Purchased and Not Purchased Goodwill

Basis	Purchased Goodwill	Not Purchased Goodwill
Meaning	Arises when one business acquires another for a price higher than the fair value of net assets.	Internally generated goodwill due to the company’s own efforts, reputation, and market position.
Recognition	Recorded in books of accounts as it is acquired at a cost.	Not recorded in accounts as it is self-generated.
Valuation	Measured based on the excess amount paid over net assets.	Cannot be accurately valued as it lacks a purchase cost.
Accounting Treatment	Shown as an intangible asset in the balance sheet and subject to impairment testing.	Not recorded in financial statements but influences business performance.
Transferability	Can be transferred when the business is sold.	Cannot be transferred separately.
Amortization	Subject to impairment testing; amortization may apply based on accounting policies.	No amortization since it is not recorded in accounts.

17. What are the needs/circumstances for the valuation of goodwill?

Answer: The valuation of goodwill is necessary in various business scenarios where a company’s intangible value needs to be assessed. The key circumstances requiring goodwill valuation are:

1. When Selling or Purchasing a Business – To determine a fair price during the acquisition or sale of a business.

2. Amalgamation, Absorption, or Merger – In corporate restructuring, goodwill valuation helps in deciding the exchange ratio for shares.

3. Admission of a New Partner – In a partnership firm, when a new partner is admitted, goodwill valuation determines their contribution.

4. Retirement or Death of a Partner – The goodwill share of the retiring or deceased partner is calculated to compensate them or their legal heirs.

5. Change in Profit-Sharing Ratio – When partners decide to change their profit-sharing ratio, goodwill is valued to compensate affected partners.

6. For Taxation Purposes – Goodwill valuation may be required for income tax or capital gains tax assessments.

7. At the Time of Liquidation – When a company is winding up, goodwill is valued to ensure fair distribution of assets.

8. For Raising Loans or Investments – Lenders and investors may assess goodwill to determine a company’s creditworthiness.

18. Write the steps for issuing Bonus Shares?

Answer: Issuing bonus shares involves a systematic process to ensure compliance with legal and regulatory requirements. The steps are:

1. Check Articles of Association (AOA) – Ensure that the company’s AOA permits the issuance of bonus shares. If not, amend the AOA.

2. Board Approval – The Board of Directors must approve the proposal for the issue of bonus shares in a board meeting.

3. Shareholders’ Approval – A resolution must be passed in the general meeting of shareholders for issuing bonus shares.

4. Approval from SEBI (if applicable) – If the company is listed, it must comply with SEBI regulations and obtain approval.

5. Determine the Record Date – Fix the record date to identify eligible shareholders who will receive the bonus shares.

6. Capitalization of Reserves – Transfer the required amount from free reserves, securities premium, or capital redemption reserve to share capital.

7. Issuance and Allotment of Bonus Shares – Bonus shares are credited to eligible shareholders' accounts in their demat holdings.

8. Inform Stock Exchange & Shareholders – If the company is listed, it must notify the stock exchange and update shareholders about the allotment.

19. What are the conditions for issuing Bonus Share?

Answer: To issue bonus shares, a company must meet certain conditions as per the Companies Act and SEBI guidelines:

1. Authorization in Articles of Association (AOA) – The AOA must allow the issuance of bonus shares. If not, the company must amend it.

2. Availability of Free Reserves – Bonus shares can only be issued from free reserves, securities premium, or capital redemption reserves, not from revaluation reserves.

3. Fully Paid-up Shares Only – Bonus shares can be issued only to fully paid-up equity shares. If any shares are partly paid, they must first be converted into fully paid-up shares.

4. No Default in Statutory Payments – The company must not have defaulted on the payment of interest or principal on loans, deposits, or statutory dues like provident fund, gratuity, or dividend.

5. No Bonus Issue in Lieu of Dividend – Bonus shares cannot be issued as a substitute for dividends.

6. Compliance with SEBI Regulations (for Listed Companies) – If the company is listed, it must follow SEBI’s bonus issue guidelines and inform the stock exchange.

7. Time Limit for Issuance – Once the bonus issue is announced, the company must complete the issuance within the prescribed period (generally six months).

These conditions ensure that the bonus issue is conducted transparently and fairly, maintaining investor confidence.

20. Explain the provisions of Sec 62 of Companies Act, regarding Right issue 2013.

Answer: Section 62 of the Companies Act, 2013, deals with the further issue of share capital, including the rights issue. The key provisions regarding the rights issue are as follows:

1. Offer to Existing Shareholders – When a company plans to increase its subscribed capital by issuing new shares, it must first offer them to existing shareholders in proportion to their current shareholding.

2. Notice Period – The company must send a notice to eligible shareholders specifying the number of shares offered, the price, and the timeline for subscription. The notice should provide at least 15 days and at most 30 days for shareholders to accept the offer.

3. Renunciation of Rights – Shareholders can choose to accept or decline the offer. They also have the option to transfer (renounce) their right to another person.

4. Disposition of Unsubscribed Shares – If shareholders do not subscribe within the given period, the company can issue the remaining shares to new investors at a price and terms determined by the board.

5. Issue of Shares to Employees (ESOP) – Under Section 62(1)(b), companies can issue shares to employees under an Employee Stock Option Plan (ESOP) with the approval of a special resolution.

6. Preferential Allotment – If the company wishes to issue shares to specific investors (other than existing shareholders), it must do so through a special resolution in compliance with SEBI regulations.

21. What are the factors which effect valuation of shares?

Answer: The valuation of shares depends on several factors, including:

1. Earnings of the Company – Higher profitability increases the value of shares. Investors prefer companies with consistent earnings growth.

2. Dividend Policy – Companies that pay regular and high dividends tend to have higher share values as they provide direct returns to shareholders.

3. Net Assets of the Company – The book value of assets, liabilities, and net worth influence share valuation. Companies with strong assets and low debt generally have higher valuations.

4. Market Conditions – Share prices fluctuate based on market demand, investor sentiment, and economic trends. A bullish market increases share value, while a bearish market decreases it.

5. Industry Growth and Competition – A company operating in a rapidly growing industry may have a higher share value than one in a stagnant or declining industry.

6. Interest Rates and Inflation – High interest rates make fixed-income investments more attractive, reducing share demand. Inflation affects business costs and profitability, impacting share prices.

7. Government Policies and Regulations – Tax policies, legal changes, and government support for certain industries can affect share values positively or negatively.

8. Management and Corporate Governance – Companies with efficient management and good governance practices tend to have higher valuations due to investor confidence.

9. Liquidity of Shares – Shares that are actively traded on stock exchanges tend to have higher valuations than illiquid shares of private or small companies.

10. Mergers and Acquisitions – If a company is involved in a merger or acquisition, its share value may increase based on anticipated future growth.

22. What are the methods of valuation of equity shares?

Answer: There are several methods used to determine the value of equity shares:

1. Net Asset Value (NAV) Method – Also known as the book value method, this approach calculates the value of shares based on the company’s net assets after deducting liabilities. 

Formula:
NAV per share=Total Assets - Total Liabilities/Number of Equity Shares 

Yield Method – This method values shares based on expected future earnings or dividends, considering the company’s dividend-paying capacity. 

Formula:
Value per Share=Expected Dividend per Share×100/Normal Rate of Return 

Earnings Capitalization Method – It calculates share value by capitalizing the expected future earnings of the company at a normal rate of return. Formula:
Value per Share=Expected Earnings per Share×100 / Capitalization Rate  

Discounted Cash Flow (DCF) Method – This method estimates the present value of future cash flows generated by the company. It is useful for valuing growth-oriented companies.

Market Price Method – If the shares are publicly traded, their market value on the stock exchange is used for valuation. This is based on the supply and demand of shares in the stock market.

Fair Value Method – This approach combines the Net Asset Value and Yield methods to arrive at a fair value of shares:
Fair Value=Net Asset Value+Yield Value/2

Each method has its advantages and is used based on the purpose of valuation, such as mergers, acquisitions, taxation, or investment decisions.

23. Explain annual average profit method. [imp]

Answer: The Annual Average Profit Method is one of the simplest methods used to calculate the value of goodwill in a business. This method considers the average of past profits to estimate goodwill. The key steps involved are:

Steps to Calculate Goodwill Using the Annual Average Profit Method:

1. Determine Past Profits – Collect the profits of the business for a certain number of years (usually 3 to 5 years).

2. Adjust for Abnormal Items – Add back any extraordinary losses and deduct any extraordinary gains to get the adjusted profits.

3. Calculate the Average Profit – Add the adjusted profits of the selected years and divide by the number of years to get the average annual profit.
   Average Profit=Sum of Adjusted Profits/Number of Years 

4. Multiply by the Agreed Number of Years – Goodwill is calculated by multiplying the average profit by a certain number of years' purchase (as agreed upon by the parties).
   Goodwill=Average Profit×Number of Years’ Purchase 

Example:

If a company's past five years' adjusted profits are ₹50,000, ₹55,000, ₹60,000, ₹58,000, and ₹57,000, then:

• Average Profit = (50,000 + 55,000 + 60,000 + 58,000 + 57,000) ÷ 5
  = ₹56,000

If the agreed years’ purchase is 3, then:
Goodwill=56,000×3=₹1,68,000 

This method is straightforward but does not consider future profit potential or risk factors.

24. What is super profit? What are the steps to be followed for valuation of super profit? [imp]

Answer: Super Profit refers to the excess profit a business earns over the normal expected profit in its industry. It represents the additional earning capacity of a business due to factors such as strong brand value, efficient management, or a loyal customer base.

Super Profit=Actual Average / Profit−Normal Profit 

• Actual Average Profit – The average of past profits of the business.

• Normal Profit – The profit that a business is expected to earn based on its capital employed and the normal rate of return in the industry.

Normal Profit=Capital Employed×Normal Rate of Return / 100

Steps for Valuation of Super Profit:

1. Calculate the Actual Average Profit – Find the average of past profits after adjusting for abnormal items.

2. Determine the Normal Profit – Multiply the capital employed by the normal rate of return (industry standard).

3. Calculate Super Profit – Subtract normal profit from actual average profit.

4. Calculate Goodwill Using Super Profit Method – Multiply the super profit by the agreed number of years’ purchase:
   Goodwill=Super Profit×Number of Years’ Purchase

Example:

• Actual Average Profit = ₹80,000

• Capital Employed = ₹5,00,000

• Normal Rate of Return = 10%

• Normal Profit = ₹5,00,000 × (10/100) = ₹50,000

• Super Profit = ₹80,000 - ₹50,000 = ₹30,000

• If years’ purchase is 3, then:
  Goodwill=₹30,000×3=₹90,000

25. Explain the capitalization method of valuation of goodwill.

Answer: The Capitalization Method is a widely used method to calculate goodwill based on the company’s expected profits and the normal rate of return in the industry. It assumes that a business’s worth is determined by capitalizing its profits.

There Are Two Approaches to This Method:

1. Capitalization of Average Profit Method

2. Capitalization of Super Profit Method

1. Capitalization of Average Profit Method

Under this method, goodwill is calculated as the difference between the total capitalized value of the business and its actual capital employed.

Steps:

1. Calculate the Average Profit – Compute the average of past adjusted profits.

2. Determine Capitalized Value – Using the normal rate of return, estimate the total capital required to earn this profit:
   Capitalized Value=Average Profit×100Normal Rate of Return 

3. Calculate Goodwill – Subtract actual capital employed from the capitalized value:
   Goodwill=Capitalized Value−Actual Capital Employed 

Example:

• Average Profit = ₹1,00,000

• Normal Rate of Return = 10%

• Capital Employed = ₹8,00,000
  Capitalized Value=1,00,000×10010=₹10,00,000  Goodwill=10,00,000−8,00,000=₹2,00,000

2. Capitalization of Super Profit Method

This approach calculates goodwill by capitalizing the super profit rather than the total profit.

Steps:

1. Calculate Super Profit – Subtract normal profit from actual average profit.

2. Calculate Goodwill – Capitalize the super profit using the normal rate of return:
   Goodwill=Super Profit×100/Normal Rate of Return 

Example:

• Super Profit = ₹30,000

• Normal Rate of Return = 10%
  Goodwill=30,000×10010=₹3,00,000

Comparison of the Two Approaches:

Method	Formula	Use Case
Capitalization of Average Profit	Goodwill = Capitalized Value - Capital Employed	Used when the total business value is important.
Capitalization of Super Profit	Goodwill = Super Profit × (100 / Normal Rate of Return)	Used when the focus is on extra profit over the industry norm.

26. Why “Goodwill” is considered an “Intangible Assets” but not a “Fictitious Asset”?

Answer: 1. Goodwill as an Intangible Asset:

Goodwill is considered an intangible asset because:

• It represents the reputation, brand value, customer loyalty, and strong business relationships of a company.

• It does not have a physical form but provides long-term financial benefits.

• It appears on the assets side of the balance sheet when purchased or acquired through mergers.

• It helps in generating higher earnings and profits compared to competitors.

2. Why Goodwill is Not a Fictitious Asset?

A fictitious asset is an expense or loss that does not have any real asset value but is carried forward in the books of accounts. Examples include preliminary expenses, deferred revenue expenses, and discounts on the issue of shares.

Goodwill is not a fictitious asset because:

• It has real value and enhances the earning capacity of the business.

• Unlike fictitious assets, goodwill is not an expense or loss; rather, it reflects the extra price paid for a business’s reputation.

• It can be sold, purchased, or transferred when a business is acquired, unlike fictitious assets that are gradually written off.

Conclusion:

Goodwill is classified as an intangible asset because it generates financial benefits despite lacking a physical form. However, it is not a fictitious asset because it has intrinsic value and is not just a deferred expense.

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