Share and Debentures

What do you mean by share and debentures of a company? Explain its types? Distinguish between shares and debentures?

A company form of organisation is the third stage in the evolution of forms of organisation. Its capital is contributed by a large number of persons called shareholders who are the real owners of the company. But neither it is possible for all of them to participate in the management of the company nor considered desirable. Therefore, they elect a Board of Directors as their representative to manage the affairs of the company. In fact, all the affairs of the company are governed by the provisions of the Companies Act, 1956. A company means a company incorporated or registered under the Companies Act, 1956 or under any other earlier Companies Acts. According to Chief Justice Marshal, “a company is a person, artificial, invisible, intangible and existing only in the eyes of law. Being a mere creation of law, it possesses only those properties which the charter of its creation confers upon it, either expressly or as incidental to its very existence”. A company usually raises its capital in the form of shares (called share capital) and debentures (debt capital.) This chapter deals with the accounting for share capital of companies.

Share Capital of a Company A company, being an artificial person, cannot generate its own capital which has necessarily to be collected from several persons. These persons are known as shareholders and the amount contributed by them is called share capital. Since the number of shareholders is  very large, a separate capital account cannot be opened for each one of them. Hence, innumerable streams of capital contribution merge their identities in a common capital account called as ‘Share Capital Account’.

Categories of Share Capital From accounting point of view the share capital of the company can be classified as follows:

• Authorised Capital: Authorised capital is the amount of share capital which a company is authorised to issue by its Memorandum of Association. The company cannot raise more than the amount of capital as specified in the Memorandum of Association. It is also called Nominal or Registered capital. The authorised capital can be increased or decreased as per the procedure laid down in the Companies Act. It should be noted that the company need not issue the entire authorised capital for public subscription at a time. Depending upon its requirement, it may issue share capital but in any case, it should not be more than the amount of authorised capital.

• Issued Capital: It is that part of the authorised capital which is actually issued to the public for subscription including the shares allotted to vendors and the signatories to the company’s memorandum. The authorised capital which is not offered for public subscription is known as ‘unissued capital’. Unissued capital may be offered for public subscription at a later date.

 • Subscribed Capital: It is that part of the issued capital which has been actually subscribed by the public. When the shares offered for public subscription are subscribed fully by the public the issued capital and subscribed capital would be the same. It may be noted that ultimately, the subscribed capital and issued capital are the same because if the number of share, subscribed is less than what is offered, the company allot only the number of shares for which subscription has been received. In case it is higher than what is offered, the allotment will be equal to the offer. In other words, the fact of over subscription is not reflected in the books.

• Called up Capital: It is that part of the subscribed capital which has been called up on the shares. The company may decide to call the entire amount or part of the face value of the shares. For example, if the face value (also called nominal value) of a share allotted is Rs. 10 and the company has called up only Rs. 7 per share, in that scenario, the called up capital is Rs. 7 per share. The remaining Rs. 3 may be collected from its shareholders as and when needed.

 • Paid up Capital: It is that portion of the called up capital which has been actually received from the shareholders. When the shareholders have paid all the call amount, the called up capital is the same to the paid up capital. If any of the shareholders has not paid amount on calls, such an amount may be called as ‘calls in arrears’. Therefore, paid up capital is equal to the called-up capital minus call in arrears. • Uncalled Capital: That portion of the subscribed capital which has not yet been called up. As stated earlier, the company may collect this amount any time when it needs further funds.

• Reserve Capital: A company may reserve a portion of its uncalled capital to be called only in the event of winding up of the company. Such uncalled amount is called ‘Reserve Capital’ of the company. It is available only for the creditors on winding up of the company.

Shares, refer to the units into which the total share capital of a company is divided. Thus, a share is a fractional part of the share capital and forms the basis of ownership interest in a company. The persons who contribute money through shares are called shareholders. The amount of authorised capital, together with the number of shares in which it is divided, is stated in the Memorandum of Association but the classes of shares in which the company’s capital is to be divided, along with their respective rights and obligations, are prescribed by the Articles of Association of the company. As per Section 86 of The Companies Act, a company can issue two types of shares

(1) preference shares, and

 (2) equity shares (also called ordinary shares).

Preference Shares

According to Section 85 of The Companies Act, 1956, a preference share is one, which fulfils the following conditions : (a) That it carries a preferential right to dividend to be paid either as a fixed amount payable to preference shareholders or an amount calculated by a fixed rate of the nominal value of each share before any dividend is paid to the equity shareholders. (b) That with respect to capital it carries or will carry, on the winding up of the company, the preferential right to the repayment of capital before anything is paid to equity shareholders. However, notwithstanding the above two conditions, a holder of the preference share may have a right to participate fully or to a limited extent in the surpluses of the company as specified in the Memorandum or Articles of the company. Thus, the preference shares can be participating and non-participating. Similarly, these shares can be cumulative or non-cumulative, and redeemable or irredeemable.

Types of Preference Shares:

·         Cumulative and Non-cumulative Shares: Let us say that a company was not doing well for 4 years but suddenly in the 5th year it started performing well. Then, the persons having cumulative shares will get the interest of past 5 years but the persons having non-cumulative shares will get only the interest of the 5th year.

·         Redeemable and Non-redeemable: Redeemable shares could be matured during the lifetime of the company or before the company closes down , they have a maturity period but the non-redeemable shares mature only after closing down of the company.

·         Convertible and Non-convertible: Shares that could be converted into other kinds of shares and security say equity shares or debentures is known as convertible shares and if they are not convertible on their maturity they are known as non-convertible shares.

·         Participating and Non-participating: In case of winding up of the company, the debenture holders were paid up first, then the preference shareholders and then the equity shareholders were paid up, after this if any surplus amount is left, it is distributed equally to equity shareholders and participating shareholders if investors have participating preference.

Equity Shares According to Section 85 of The Companies Act, 1956, an equity share is a share which is not a preference share. In other words, shares which do not enjoy any preferential right in the payment of dividend or repayment of capital, are termed as equity/ordinary shares. The equity shareholders are entitled to share the distributable profits of the company after satisfying the dividend rights of the preference share holders. The dividend on equity shares is not fixed and it may vary from year to year depending upon the amount of profits available for distribution. The equity share capital may be (i) with voting rights; or (ii) with differential rights as to voting, dividend or otherwise in accordance with such rules and subject to such conditions as may be prescribed.

Types of Equity Shares:

a.    Blue Chip Shares: The big companies which have the potential to dictate the terms come under this umbrella. These companies are never fixed as performance of these companies may fall apart sometimes.

b.    Income Shares: The companies coming in this area, are generally stable and do not vary much in their performance.

c.    Growth Shares: These companies have secured their positions in specific industry; their shares have less dividend payout ratio and thus, more growth potential.

d.    Cyclical Shares: The share of the companies coming into this umbrella varies with the economy. A definite business cycle keeps on operating and the performance keeps on operating with the stages of the cycle.

e.   Defensive Shares: The shares of the company do not vary with the economy.
f.    Speculative Shares: The shares of a company which has usually more speculation than others and they cannot be categorized into one category only and may overlap with blue chip shares.

Another classification is given by investor Peter Lynch:

·         Slow growers: These are the companies having growth rate equal to the industrial growth rate or higher than GDP.

·         Fast Growers: Newly started companies having good growth rate.

·         Stalwarts: The big companies having and whose dividend payout is high.

·         Cyclicals: The shares of these companies  are not going through the business cycle or varying to the business cycle.

·         Turn-around: The shares of those big companies whose performance were very bad in the past but a sudden turn around takes place and they started performing very good.
f.    Asset Plays: these shares generally do not have recognition instead of having a large asset base.

A Debenture is a unit of loan amount. When a company intends to raise the loan amount from the public it issues debentures. A person holding debenture or debentures is called a debenture holder. A debenture is a

document issued under the seal of the company. It is an acknowledgment of the loan received by the company equal to the nominal value of the debenture. It bears the date of redemption and rate and mode of payment of interest. A debenture holder is the creditor of the company. As per section 2(12) of Companies Act 1956, “Debenture includes debenture stock, bond and any other securities of the company whether constituting a charge on the company’s assets or not”. Types of debentures Debenture can be classified as under :

 1. From security point of view

(i) Secured or Mortgage debentures : These are the debentures that are secured by a charge on the assets of the company. These are also called mortgage debentures. The holders of secured debentures have the right to recover their principal amount with the unpaid amount of interest on such debentures out of the assets mortgaged by the company. In India, debentures must be secured. Secured debentures can be of two types :

(a) First mortgage debentures : The holders of such debentures have a first claim on the assets charged.

 (b) Second mortgage debentures : The holders of such debentures have a second claim on the assets charged.

 (ii) Unsecured debentures : Debentures which do not carry any security with regard to the principal amount or unpaid interest are called unsecured debentures. These are called simple debentures.

 2. On the basis of redemption

 (i) Redeemable debentures : These are the debentures which are issued for a fixed period. The principal amount of such debentures is paid off to the debenture holders on the expiry of such period. These can be redeemed by annual drawings or by purchasing from the open market.

(ii) Non-redeemable debentures : These are the debentures which are not redeemed in the life time of the company. Such debentures are paid back only when the company goes into liquidation.

3. On the basis of Records

(i) Registered debentures : These are the debentures that are registered with the company. The amount of such debentures is payable only to those debenture holders whose name appears in the register of the company.

(ii) Bearer debentures : These are the debentures which are not recorded in a register of the company. Such debentures are transferrable merely by delivery. Holder of these debentures is entitled to get the interest.

4. On the basis of convertibility

(i) Convertible debentures : These are the debentures that can be converted into shares of the company on the expiry of predecided period. The term and conditions of conversion are generally announced at the time of issue of debentures.

 (ii) Non-convertible debentures : The debenture holders of such debentures cannot convert their debentures into shares of the company.

5. On the basis of priority

(i) First debentures : These debentures are redeemed before other debentures.

(ii) Second debentures : These debentures are redeemed after the redemption of first debentures.

Difference Between Shares and Debentures

Investment in shares and debentures has now taken a dominant position in the society. People of every age, gender, religion, etc. whether they are youngsters or elders, men or women, Hindu or Muslim invest in various investments with the aim of earning more and more money. Novice investors might not understand about these terms, So here we have an article not only for beginners and existing investors but for all the people to understand the differences between shares and debentures in tabular form.

Comparison Chart

Key Differences Between Shares and Debentures

The following are the major differences between Shares and Debentures:

1.      The holder of shares is known as a shareholder while the holder of debentures is known as debenture holder.

2.      Share is the capital of the company, but Debenture is the debt of the company.

3.      The shares represent ownership of the shareholders in the company. On the other hand, debentures represent indebtedness of the company.

4.      The income earned on shares is the dividend, but the income earned on debentures is interest.

5.      The payment of dividend can be made only out of current profits of the business and not otherwise. Unlike the interest on debentures which has to be paid by the company to debenture holders, no matter company has earned profit or not.

6.      Dividend is not a business expense and so is not allowed as deduction. On the contrary, interest on debentures is a expense and so allowed as a deduction.

7.      In the event of winding up, debentures get priority of repayment over shares.

8.      Shares cannot be converted as opposed to debentures are convertible.

9.      There is no security charge created for payment of shares. Conversely, security charge is created for the payment of debentures.

10.  A trust deed is not executed in case of shares whereas trust deed is executed when the debentures are issued to the public.

11.  Unlike debenture holders, shareholders have voting rights.

12.  Shares are issued at a discount subject to some legal compliance. Debentures can be issued at a discount without any legal compliance.

As everything has two aspects, shares and debentures also have its merits and demerits. While shares are give voting rights to the shareholders, debentures get priority in payment, at the time of winding up of the company.