Corporate Finance and Accounting Principles Explained
Internal Reconstruction: Meaning and Importance
Meaning: Internal reconstruction involves reorganizing a company’s financial structure without liquidation. This process includes reducing share capital, writing off accumulated losses, and rearranging assets and liabilities to improve financial health.
Importance: It enables financially distressed companies to recover. Benefits include:
- Removal of accumulated losses.
- Improvement of the balance sheet.
- Increased real value of shares.
- Restored confidence among shareholders and creditors.
- Smooth continuation of business operations.
Methods of Internal Reconstruction
- Reduction of share capital.
- Cancellation of unissued share capital.
- Reduction of liability on shares.
- Writing off losses and overvalued assets.
Buyback of Shares
Meaning: A buyback occurs when a company purchases its own shares from existing shareholders to reduce market circulation and improve its financial position.
Maximum Limits and Regulations
Under the Companies Act, 2013:
- Buybacks must not exceed 25% of total paid-up share capital and free reserves.
- For equity shares, the annual buyback limit is 25% of total paid-up equity capital.
- The post-buyback debt-equity ratio must not exceed 2:1.
Reserves and Surplus
Meaning: These represent accumulated profits retained in the business rather than distributed as dividends, strengthening the company’s financial position.
Disclosure: Per Schedule III of the Companies Act, 2013, these are shown under “Shareholders’ Funds” in the balance sheet.
Items Included: Capital Reserve, Capital Redemption Reserve, Securities Premium Reserve, Debenture Redemption Reserve, General Reserve, and Surplus (Profit and Loss Account balance).
Debenture Pricing: Cum-Interest vs. Ex-Interest
Cum-Interest Price
This price includes interest accrued from the last payment date to the purchase date. The buyer pays the security price plus interest to the seller.
Ex-Interest Price
This price excludes accrued interest. The buyer pays the security price, while interest is paid separately to the seller for the period they held the security.
Corporate Social Responsibility (CSR)
Meaning: CSR refers to a company’s commitment to social and environmental welfare. Under the Companies Act, 2013, eligible companies must spend at least 2% of their average net profits from the last three years on CSR.
Examples: Education, healthcare, environmental protection, rural development, and poverty eradication.
Reserves vs. Surplus
- Reserve: Profits set aside for future use or unforeseen losses.
- Surplus: The remaining balance in the Profit and Loss Account after dividends and transfers.
Share Capital Overview
Share capital is the money raised by issuing shares, representing ownership. It is categorized as follows:
- Authorised: Maximum capital a company is permitted to issue.
- Issued: Portion of authorised capital offered to the public.
- Subscribed: Portion of issued capital taken by the public.
- Paid-up: Amount actually paid by shareholders.
Borrowings: Long-Term vs. Short-Term
- Long-Term: Repayable after one year; used for fixed assets and expansion (e.g., debentures, bank loans).
- Short-Term: Repayable within one year; used for working capital (e.g., bank overdrafts).
Reconstruction Types
Internal Reconstruction
Reorganization of an existing company’s financial structure to resolve financial difficulties, write off losses, and restore stakeholder confidence.
External Reconstruction
The liquidation of an existing company and the formation of a new entity to take over its assets and liabilities, typically used in severe financial distress.
Share Capital Adjustments
- Subdivision: Dividing shares of a larger face value into smaller units to increase marketability.
- Consolidation: Combining smaller face value shares into larger units to simplify the capital structure.
Investment Accounting
This involves recording transactions related to the purchase, sale, and income (interest/dividends) of investments like shares and bonds. It ensures accurate valuation and profit/loss calculation.
Whistle Blowing
Meaning: The act of reporting illegal or unethical activities within an organization. It promotes transparency, accountability, and good corporate governance as encouraged by the Companies Act, 2013.