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Multiple choice commercial studies sources of business finance - 2 equity shares share and stock equity and preference shares

Which of the following type of security can be issued at discount as per Companies Act, 2013?
(1) Equity Shares
(2) Sweat Equity Shares
(3) Preference Shares
(4) Debentures
(5) Bonds
Select the correct answer from the option given below :-

  1. (1) & (3) only

  2. (1) & (3) & (4) only

  3. (2), (4) & (5) only

  4. (3), (4) & (5) only
Reveal answer Fill a bubble to check yourself
C Correct answer
Explanation
1. Equity shares
Meaning:
Equity shares are the main source of finance of a firm. It is issued to the general public. Equity share¬holders do not enjoy any preferential rights with regard to repayment of capital and dividend. They are entitled to residual income of the company, but they enjoy the right to control the affairs of the business and all the shareholders collectively are the owners of the company.
Features of Equity Shares.

The main features of equity shares are:
1. They are permanent in nature.

2. Equity shareholders are the actual owners of the company and they bear the highest risk.

3. Equity shares are transferable, i.e. ownership of equity shares can be transferred with or without consideration to other person.

4. Dividend payable to equity shareholders is an appropriation of profit.

5. Equity shareholders do not get fixed rate of dividend.

6. Equity shareholders have the right to control the affairs of the company.

7. The liability of equity shareholders is limited to the extent of their investment.

Advantages of Equity Shares:

Equity shares are amongst the most important sources of capital and have certain advantages which are mentioned below:

i. Advantages from the Shareholders’ Point of View
(a) Equity shares are very liquid and can be easily sold in the capital market.
(b) In case of high profit, they get dividend at higher rate.
(c) Equity shareholders have the right to control the management of the company.
(d) The equity shareholders get benefit in two ways, yearly dividend and appreciation in the value of their investment.

ii. Advantages from the Company’s Point of View:
(a) They are a permanent source of capital and as such; do not involve any repayment liability.
(b) They do not have any obligation regarding payment of dividend.
(c) Larger equity capital base increases the creditworthiness of the company among the creditors and investors.

Disadvantages of Equity Shares:
Despite their many advantages, equity shares suffer from certain limitations. These are:
i. Disadvantages from the Shareholders’ Point of View:
(a) Equity shareholders get dividend only if there remains any profit after paying debenture interest, tax and preference dividend. Thus, getting dividend on equity shares is uncertain every year.
(b) Equity shareholders are scattered and unorganized, and hence they are unable to exercise any effective control over the affairs of the company.
(c) Equity shareholders bear the highest degree of risk of the company.
(d) Market price of equity shares fluctuate very widely which, in most occasions, erode the value of investment.
(e) Issue of fresh shares reduces the earnings of existing shareholders.

ii. Disadvantage from the Company’s Point of View:
(a) Cost of equity is the highest among all the sources of finance.
(b) Payment of dividend on equity shares is not tax deductible expenditure.
(c) As compared to other sources of finance, issue of equity shares involves higher floatation expenses of brokerage, underwriting commission, etc.

2. Debentures
A debenture is one of the most typical forms of long term loans that a company can take.

It is normally a loan that should be repaid on a specific date, but some debentures are irredeemable securities (sometimes referred to as perpetual debentures).

The majority of debentures come with a fixed interest rate. This interest must be paid before dividends are paid to shareholders.

Debenture holders
Debenture holders (investors) are not allowed to vote in the company's general shareholders meetings, but they may have separate meetings or votes, for instance regarding changes to the rights associated with the debentures.

The interest that is paid to debenture holders is calculated as a charge against profit in the company's financial statements.

Types of debentures
Debentures come in two types:

Convertible debentures: Convertible bonds or bonds that can be converted into equity shares of the issuing company after a predetermined period of time. To investors, convertible bonds are more attractive because the bonds can be converted, and to companies they have the advantage that they normally have lower interest rates than non-convertible corporate bonds.

Non-convertible debentures: Standard debentures that can't be converted into equity shares of the liable company. Since they can't be converted, they usually have higher interest rates than convertible debentures.

Benefits
Debentures are mainly beneficial to companies by having a lower interest rate than other types of loans, e.g. overdrafts. Further, they normally only need to be repaid by a very remote date.
The main benefits of debentures to investors is that they can usually be sold in stock exchanges quite easily and they come with less risk than e.g. equities.



3. Bonds
In finance, a bond is an instrument of indebtedness of the bond issuer to the holders. The most common types of bonds include municipal bonds and corporate bonds.
The bond is a debt security, under which the issuer owes the holders a debt and (depending on the terms of the bond) is obliged to pay them interest (the coupon) or to repay the principal at a later date, termed the maturity date. Interest is usually payable at fixed intervals (semiannual, annual, sometimes monthly). Very often the bond is negotiable, that is, the ownership of the instrument can be transferred in the secondary market. This means that once the transfer agents at the bank medallion stamp the bond, it is highly liquid on the secondary market. 
Thus a bond is a form of loan or IOU: the holder of the bond is the lender (creditor), the issuer of the bond is the borrower (debtor), and the coupon is the interest. Bonds provide the borrower with external funds to finance long-term investment, or, in the case of government bonds, to finance current expenditure.  
Multiple choice commercial studies sources of business finance - 2 equity shares share and stock equity and preference shares

When shares are not payable in a lump sum, first instalment is called ___________.

  1. Application Money

  2. Allotment Money

  3. First Call Money

  4. Final Call Money
Reveal answer Fill a bubble to check yourself
A Correct answer
Explanation
Share Application Money: A company receives certain amount from shareholders' on application (known as share application money). Share Application Money Pending Allotment means amount received on application on which allotment is not yet made (pending allotment). Share Application Money Pending Allotment to the extent not refundable is included in Shareholders' Fund (as it is the amount received by the company against which allotment will be made).
Multiple choice commercial studies sources of business finance - 2 equity shares share and stock equity and preference shares

Shares forfeited account is to be shown in the balance sheet by way of ____________ to the paid up share capital on the liabilities side until the concerned shares are re-issued.

  1. Addition

  2. Deduction

  3. Both (A) & (B)

  4. Neither (A) nor (B)
Reveal answer Fill a bubble to check yourself
A Correct answer
Explanation
Share forfeited account:-
If a shareholder fails to pay allotment money or a call or a part thereof by the last date fixed for payment, the Board of Directors, if Articles of Association of the company empower it to do so, proceed to forfeit the shares on which allotment money or call has become in arrear.The Articles of Association lay down the procedure. A notice has to be served on the defaulter requiring him to pay the unpaid amount together with interest accrued by a certain date.

The notice also must state that in the event of non-payment on or before the date so named, the shares in respect of which the notice has been served will be liable to be forfeited. When shares are forfeited, the shareholder’s name is removed from the register of members and the amount already paid by him on shares is forfeited to the capital. It is a capital gain and is credited to Forfeited Shares Account. A forfeited share may be reissued even at a loss. But the loss on reissue cannot exceed the gain on forfeiture of the share reissued.
Multiple choice commercial studies sources of business finance - 2 equity shares share and stock equity and preference shares

Which of the following security can be forfeited for non-payment of allotment or call money?
(I) Equity Shares
(II) Equity Shares, Preference Shares
(III) Preference Shares, Equity Shares & Debentures
(IV) Debentures
Select the correct answer from the options given below :-

  1. (I) only

  2. (III) only

  3. (I) & (IV) only

  4. (II) only
Reveal answer Fill a bubble to check yourself
D Correct answer
Explanation
Meaning:
Equity shares are the main source of finance of a firm. It is issued to the general public. Equity share¬holders do not enjoy any preferential rights with regard to repayment of capital and dividend. They are entitled to residual income of the company, but they enjoy the right to control the affairs of the business and all the shareholders collectively are the owners of the company.
Features of Equity Shares
The main features of equity shares are:
1. They are permanent in nature.
2. Equity shareholders are the actual owners of the company and they bear the highest risk.
3. Equity shares are transferable, i.e. ownership of equity shares can be transferred with or without consideration to other person.
4. Dividend payable to equity shareholders is an appropriation of profit.
5. Equity shareholders do not get fixed rate of dividend.
6. Equity shareholders have the right to control the affairs of the company.
7. The liability of equity shareholders is limited to the extent of their investment.
Advantages of Equity Shares
Equity shares are amongst the most important sources of capital and have certain advantages which are mentioned below:
i. Advantages from the Shareholders’ Point of View
(a) Equity shares are very liquid and can be easily sold in the capital market.
(b) In case of high profit, they get dividend at higher rate.
(c) Equity shareholders have the right to control the management of the company.
(d) The equity shareholders get benefit in two ways, yearly dividend and appreciation in the value of their investment.
ii. Advantages from the Company’s Point of View:
(a) They are a permanent source of capital and as such; do not involve any repayment liability.
(b) They do not have any obligation regarding payment of dividend.
(c) Larger equity capital base increases the creditworthiness of the company among the creditors and investors.
Disadvantages of Equity Shares:
Despite their many advantages, equity shares suffer from certain limitations. These are:
i. Disadvantages from the Shareholders’ Point of View:
(a) Equity shareholders get dividend only if there remains any profit after paying debenture interest, tax and preference dividend. Thus, getting dividend on equity shares is uncertain every year.
(b) Equity shareholders are scattered and unorganized, and hence they are unable to exercise any effective control over the affairs of the company.
(c) Equity shareholders bear the highest degree of risk of the company.
(d) Market price of equity shares fluctuate very widely which, in most occasions, erode the value of investment.
(e) Issue of fresh shares reduces the earnings of existing shareholders.
ii. Disadvantage from the Company’s Point of View:
(a) Cost of equity is the highest among all the sources of finance.
(b) Payment of dividend on equity shares is not tax deductible expenditure.
(c) As compared to other sources of finance, issue of equity shares involves higher floatation expenses of brokerage, underwriting commission, etc.

Preference shares are those shares which carry certain special or priority rights. Firstly, dividend at a fixed rate is payable on these shares before any dividend is paid on equity shares.
Secondly, at the time of winding up of the company, capital is repaid to preference shareholders prior to the return of equity capital. Preference shares do not carry voting rights. However, holders of preference shares may claim voting rights if the dividends are not paid for two years or more on cumulative preference shares and three years or more on non-cumulative preference shares.
Preference shares have the characteristics of both equity shares and debentures. Like equity shares, dividend on preference shares is payable only when there are profits and at the discretion of the Board of Directors.
Preference shares are similar to debentures in the sense that the rate of dividend is fixed and preference shareholders do not generally enjoy voting rights. Therefore, preference shares are a hybrid form of financing.
Advantages:
1. Appeal to Cautious Investors:
Preference shares can be easily sold to investors who prefer reasonable safety of their capital and want a regular and fixed return on investment.
2. No Obligation for Dividends:
A company is not bound to pay dividend on preference shares if its profits in a particular year are insufficient. It can postpone the dividend in case of cumulative preference shares also. No fixed burden is created on its finances.
3. No Interference:
Generally, preference shares do not carry voting rights. Therefore, a company can raise capital without dilution of control. Equity shareholders retain exclusive control over the company.
4. Trading on Equity:
The rate of dividend on preference shares is fixed. Therefore, with the rise in its earnings, the company can provide the benefits of trading on equity to the equity shareholders.
5. No Charge on Assets:
Preference shares do not create any mortgage or charge on the assets of the company. The company can keep its fixed assets free for raising loans in future.
6. Flexibility:
A company can issue redeemable preference shares for a fixed period. The capital can be repaid when it is no longer required in business. There is no danger of over-capitalisation and the capital structure remains elastic.
7. Variety:
Different types of preference shares can be issued depending on the needs of investors. Participating preference shares or convertible preference shares may be issued to attract bold and enterprising investors.
Preference shares can be made more popular by giving special rights and privileges such as voting rights, right of conversion into equity shares, right of shares in profits and redemption at a premium.
Disadvantages:
1. Fixed Obligation:
Dividend on preference shares has to be paid at a fixed rate and before any dividend is paid on equity shares. The burden is greater in case of cumulative preference shares on which accumulated arrears of dividend have to be paid.
2. Limited Appeal:
Bold investors do not like preference shares. Cautious and conservative investors prefer debentures and government securities. In order to attract sufficient investors, a company may have to offer a higher rate of dividend on preference shares.
3. Low Return:
When the earnings of the company are high, fixed dividend on preference shares becomes unattractive. Preference shareholders generally do not have the right to participate in the prosperity of the company.
4. No Voting Rights:
Preference shares generally do not carry voting rights. As a result, preference shareholders are helpless and have no say in the management and control of the company.
5. Fear of Redemption:
The holders of redeemable preference shares might have contributed finance when the company was badly in need of funds. But the company may refund their money whenever the money market is favourable. Despite the fact that they stood by the company in its hour of need, they are shown the door unceremoniously.
Multiple choice commercial studies sources of business finance - 2 equity shares share and stock equity and preference shares

If a company receives excess application money and the application money equal to shares issued transferred to Share Capital A/c and application money received on excess shares-some money is adjusted and against allotment and remaining was refunded, then which of the following entry is correct?

  1. Share Application A/c Dr.

    Bank A/c Dr.

    To Share Allotment A/c

    To Share Capital A/c

  2. Share Application A/c Dr.

    To share Allotment A/c Dr.

    To Share Capital A/c

    To Bank A/c

  3. Share Allotment A/c Dr.

    Share CapitalA/c Dr.

    To Bank A/c

    To Share Application A/c

  4. None of the above
Reveal answer Fill a bubble to check yourself
B Correct answer
Explanation
  • Sometimes a company may receive applications for a large number of shares than offered to public by it for subscription and this situation is termed as over-subscription.
  • Therefore, such surplus (applications received > offered to public) is to be adjusted.
  • Generally, it is stated in the given question that surplus money received on applications will be adjusted either on:

a)      Share allotment only or

b)      Share allotment and on subsequent calls

 But if question does not specify treatment then it is to be adjusted against allotment and surplus money is refunded by cash or cheque.

  • For example:-

Question- A Company invited for 30000 equity shares of ₹ 10 each, payable ₹ 2 on application,₹ 3 on allotment and balance on call. Total applications money received at ₹ 2 per share was ₹ 72000. Application money should be adjusted against allotment and excess money is to be refunded by bank.

Solution- Total application money received is ₹ 72000

                   Number of applications received = Total application money received ÷ Rate of application money

                                                                           = ₹ 72000 ÷ ₹2  = 36000 shares

                   Number of shares to be issued    = 30000 shares

Number of application is more than shares to be issued hence, it is over- subscription. As given in question, company decides to allot 30000 shares in full and refund the excess money received on application by bank for 6000 shares at ₹ 2 per share.

Multiple choice commercial studies sources of business finance - 2 equity shares share and stock equity and preference shares

The forfeited shares may be re-issued:-
(I) At par only
(II) At  par or premium only
(III) At par or at discount only
(IV) At or par at premium or at discount 
The correct answer is :

  1. (II)

  2. (III)

  3. (I)

  4. (IV)
Reveal answer Fill a bubble to check yourself
D Correct answer
Explanation
Reissue of Forfeited Shares:-
Reissue of forfeited shares is not the allotment of shares, but it is only a re-sale. A company can reissue forfeited shares in accordance with the provisions contained in the articles. The forfeited shares can be reissued at a discount, but the maximum discount should not exceed the amount available in the share forfeiture account.
• If the shares re issued at discount
When shares are reissued at a loss, then such a loss should be debited to the share forfeiture account. If the loss on reissue is less than the amount forfeited, then the excess should be transferred to the capital reserve account.
• If the shares re issued at premium
If the shares are reissued at a price more than face value, then the excess should be credited to the securities premium account.
When only a portion of shares is reissued, only the profit made on the reissue of such shares must be transferred to the capital reserve account.
• If the shares are re issued at par
When the shares re issued at the same value as the face value then they are issued at  par.
Multiple choice commercial studies sources of business finance - 2 equity shares share and stock equity and preference shares

Balance of share forfeiture account remaining after reissue is transferred to ________________.

  1. Capital Reserve A/c

  2. Securities Premium A/c

  3. Revenue Reserve A/c

  4. Profit & Loss A/c
Reveal answer Fill a bubble to check yourself
A Correct answer
Explanation
 Meaning Of Capital Reserve:

A reserve which is created out of the capital profit is known as capital reserve. It is not created out of the profit earned in normal course of the business. Capital reserve is created out of the profit earned from some specific transactions of capital nature. Capital reserve is not available for the distribution to the shareholders. The examples of capital profit from which capital reserve is created are as follows:

* Profit on sale of fixed assets
* Profit on sale of investment
* Profit on revaluation of assets and liabilities
* Premium on issue of shares and debentures
* Profit on re-issue of forfeited shares
* Discount on redemption of debentures
* Profit on purchase of an existing business

Objectives And Advantages Of Capital Reserve
The following are the objectives and advantages of capital reserves
* Capital reserve helps in making the organization financially strong.
* Capital reserve helps in writing off the capital losses arising from the sale of fixed assets, shares and debentures.
* Capital reserve helps in the issue of fully paid bonus shares to the existing shareholders.

Disadvantages Of Capital Reserve
The following are the disadvantages of capital reserve
* Capital reserve is not available for the distribution to shareholders.
* Capital reserve does not give any indication of operating efficiency of the business.
* Capital reserve does not help in making the management responsible to sale old assets at satisfactory price.
Multiple choice commercial studies sources of business finance - 2 equity shares share and stock equity and preference shares

In case of oversubscription of shares each applicant receives the shares in some proportion, it is known as ____________.

  1. Bonus allotment

  2. Right allotment

  3. Per applicant allotment

  4. Pro rata allotment
Reveal answer Fill a bubble to check yourself
D Correct answer
Explanation
Pro rata allotment:-
If the promoters of a company are reputed for their successful promotional successes, the applications are received for more than shares offered under prospectus (over-subscription). They may allot full shares to some of applicants refuse allotment to others, accord partial allotment to someone. This way of allotting shares shows favour to someone and disfavour to others.

Justice in every walk of life needs that the company should also adopt it in making allotment. Instead of showing favour to certain applicants by allotting them full applied shares and disfavour to others by rejecting their applications, the company should treat all the applications of shares at par and allot them shares on pro-rata basis or proportionately. It means that all the applicants have been allotted or refused allotment on proportionate basis. For example: A company issued 60,000 shares, receives applications for 2, 40,000 shares and makes pro-rata allotment.

This will mean that applicants have been allotted 25% of the shares applied. In other words, applicants for 100 shares must have been allotted 25 shares; for 500 shares must have been allotted 125 shares and for 1,000 shares, 250 shares would have been allotted.
Multiple choice commercial studies sources of business finance - 2 equity shares share and stock equity and preference shares

_______may be said to be the compulsory termination of membership by way of penalty for non-payment of allotment and/or any call money.

  1. Surrender of shares

  2. Forfeiture of shares

  3. Transfer of shares

  4. Transmission of shares
Reveal answer Fill a bubble to check yourself
B Correct answer
Explanation
 Forfeiture of shares:-

Forfeiture of shares means cancellation of shares as such whatever amount has already been received on shares being forfeited is seized. The shareholder, who applies for the shares of the company makes an offer on the one hand, and on the other hand company by accepting or allotting shares accords acceptance. In this way, offer and acceptance with the lawful consideration makes a valid contract between the shareholder and the company. The contract makes it binding upon the shareholder to pay the installment of amount due on allotment and calls, whenever due.
Notice before Forfeiture:
If a member having been called upon to pay any call on his shares fails to pay the calls, the directors may either by adoption of Table A or by an express provision on the articles proceed to forfeit the shares held by such a defaulting member. Before the shares can be forfeited the company may serve a notice on the defaulting member requiring payment of the call.
The notice must give not less than fourteen days’ time from the date of service of notice for the payment of the amount due. The notice must also state that in the event the non-payment of the amount due within the period mentioned in the notice the shares in respect of which call was made will be liable to forfeiture.
Non-compliance of Notice:
If the shareholder fails to comply with the requirement of this notice, the directors may pass a resolution effecting the forfeiture of the shares.
Effect of Forfeiture:
When the shares have been forfeited, the defaulting shareholder ceases to be member of the company and he loses all rights or interests in his shares. But notwithstanding the forfeiture he remains liable to pay to the company all moneys which at the date of forfeiture were payable by him to the company in respect of the shares.
Multiple choice commercial studies sources of business finance - 2 equity shares share and stock equity and preference shares

Which of the following statement is false?

  1. Equity shares have a right to vote on every resolution of the company

  2. Preference shares cannot vote on all the resolutions of the company

  3. All the equity shareholders have equal voting rights

  4. All of the above
Reveal answer Fill a bubble to check yourself
C Correct answer
Explanation

As per companies act, 2013, every member of company limited by shares and holding any equity share capital shall have a right to vote in respect of such capital on every resolution placed before the company and his voting rights on a poll shall be proportionate to his share of the equity share capital of a company. Therefore, the statement that all equity shareholders have equal voting rights is FALSE.