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CORPORATE ACCOUNTING
SHORT QUESTIONS
1. What steps should be followed before forfeiting shares on non-payment of call money?
Ans: The companies Act does not contain any specific provisions regarding forfeiting of shares but it provides
that company including to forfeit shares must have the power authorized by the Articles of Association. If a
Share holder has not paid any call on the day fixed for payment it is brought to his notice by a registered notice
of 14 days allowed to pay the Call. Even after the shareholder does not pay, the Board of Directors may, by
passing a resolution declares the share forfeit i.e. cancelled.
2. Write short note on right issue of shares.
Ans: When a company, which has already issued shares, wants to make a further issue of shares, it is under a
legal obligation to first offer the fresh issue to the existing shareholders unless; the Company has resolved
otherwise by a special resolution. The right of the existing shareholder to buy shares from the company in this
manner is transferable. If the market price of the shares is higher than the amount at which the company has
offered new shares, the right to buy shares from the company will carry a price. Such fresh issue of shares is
known as right issue.
3. Can a company issue irredeemable preference share? State the legal provisions in these regards.
Ans:The amount of irredeemable preference shares can only be returned when the company is wound up. After
the commencement of the Companies Act 1996 ; no Company limited by shares shall issue any preference
share, which is irredeemable or is redeemable after the expiry of a period of 20 years from the date of issue.
4. What are the methods of providing for redemption of debentures?
Ans:Debentures can be redeeming at par or at premium or at discount. Redemption can be done through
through the following method:

i. Lump sum method- a) out of profit

b)out of capital
c)Through sinking fund
d)Through insurance policy
ii. Annual drawing
iii. Conversion method –a)conversion into equity shares
b)conversion into preference shares
c)conversion into debenture
iv.Purchase of own debenture-a)for immediate cancellation
b)for holding as investment
i. Write short notes on:-
a. Minimum Subscription
For a new Company, issuing shares for the first time, minimum subscription means the amount which in the
opinion of Board of directors, is the minimum to be raised by the issue of shares. If the company fails to
raise minimum subscription within 120 days from the date of first issue of prospectus, it is required to
refund whatever amount it has received from the applicants within the next 10 days i.e. within 130 days
from the date of the issue of the prospectus.
b. Pro-rata allotment
Pro-rata means proportionately. Allotment on pro-rata basis means that allotment on every application is
made in the ratio which the total no. of shares to be allotted on this basis ,bears to the total number of
shares applied for in all such applications. If 20,000 shares are allotted on pro-rata basis on applications of
25,000 shares, it means that four shares are allowed for every five shares applied for.

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c. Own Debentures:
Own debentures are those debentures, which are owned by the company on its own name. The company
issued these debentures to the public to collect borrowed capital. When the company is over capitalized,
they may redeem the short term debentures and in doing so they purchase back their own debentures from
the open market and keep such debentures till their maturity. Such debentures are called own debentures.
d. Write a note on “redemption of debenture by sinking fund”.
Ans:Knowing the date on which debentures have to redeem, it would be wise to make arrangement, so that
the required amount is available on the due date otherwise the payment of the sum may seriously upset the
working of the business. The ideal method is to set aside every year a certain amount of money that
together with the interest can be obtained amounts to the required figure on the required date, by
investing the sums in some safe securities. The annual installment should be debited to the P/L
Appropriation A/c so that the amount is available for dividends to shareholders are reduced. Thus, a part of
the profit will be applied towards collecting funds for redeeming debentures. This operation will have no
adverse effect on the working of the business.
e. Authorized share capital
This is the nominal or face value of the shares, which the company is authorized to issue by its
Memorandum of Association. This is the maximum capital which a company can issue without altering i.e.
capital clause of the Memorandum of Association for an increase in its Authorized Capital.
5. What are the characteristics of a debenture? Distinguish it from share.
Ans:When a company borrows money from investing people , it issues certificates that is stamped with the
official seal of the company. This certificate are called debentures.Debentures are a creditorship security.
The main features of debenture are:
i. It is a document which evidences a loan made to the company.
ii. It is a fixed interest bearing security where interest falls due on specific dates .
iii. Interest is paid at a predetermined rate regardless of the level of profit.
iv. The original sum is repaid at a specified future date or it is converted into shares or other debenture.
v. It may or may create a charge on the asset into shares or other debenture.
vi. It can generally be brought or sold through the stock exchange above or below its face value.
vii. It is a movable property.
Distinction between debentures and shares.

 Creditorship Security V. Ownership Security.

Debenture is a creditorship security, whereas a share is an ownership security. It means that a
debenture holder is a creditor of the Company, while a shareholder is a part owner of a company.
 Certainty of return: A debenture holder is certain return on his investment. The company has to pay
interest on debentures at the fixed rate agreed upon at the time of issue even if it suffers heavy
losses. A shareholder cannot get dividends if the company does not even earn profits. As a matter of
fact, even when a company earns a profit, its Director may decide to plough back the profits and not
declare a dividend. Thus, there is no certainty of return on investments in shares.
 Order of repayment on winding up: - In case of winding up of a company, the amount of
debentures will be repaid before any amount is paid to shareholders in lieu of their share capital.
 Restrictions on issue at a discount:- There are no restrictions on issue of a debenture at a discount,
but there are legal condition which have to be fulfilled to issue shares at discount.

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 Convertibility: Debentures, which can be converted into shares at the opinion of debenture holders,
can be issued. But shares convertible into debentures cannot be issued.
 Voting right: Debentureholders have no voting rights and consequently do not pose any threat to
the existing control of the company. Whereas shareholders having voting right control the total
affairs of the company.
 Types :Debenture can be of various types such as secured/unsecured; redeemable/non-
redeemable;convertible /nonconvertible etc. whereas there are only two types of shares –eqity and
preference shares.
6. Write notes on different kinds of Debentures?
Ans: ON THE BASIS OF LONGIVITY-When debentures are redeemable within a specified period of time, those
debentures are called Redeemable debentures, if debentures are not redeemed during the existence of the
company those are called Irredeemable debentures. ON THE BASIS OF SECURITY-Debentures which are secured
by charge in company assets are called secured debenture. If such debentures are not secured then those are
called unsecured debentures.
ON THE BASIS OF THE NEGOTIABILITY -Debentures can be classified as Bearer debentures or registered
debentures. The holders of a bearer debenture certificate are entitled to claim the amount due on debentures.
But in case of registered debentures, individual whose name is is registered can only claim the amount due on
debentures.
ON THE BASIS OF CONVERTIBILITY-Sometimes companies issue debentures which can be converted into shares
after a certain period, those are called convertible debentures. If such convertibility option is not provided, then
debentures are called non-convertible debentures.
ON THE BASIS OF PAYMENT MADE AT THE TIME OF REPAYMENT-Sometimes debentures are issued at large
discount, but those carry zero rate of interest and those are redeemed at par after a certain period of time. Such
debentures are called Zero interest debentures or deep discount debenture. If similar types of debenture are
redeemed at a large premium those are called Deep Gain Debenture.
ON THE BASIS OF PRIORITY OF PAYMENT-Debenture which are considered first for payment are called First
Debenture. Whereas those considered for payment thereafter are called Second Debenture.
7. How Unclaimed dividends are treated in books of account of a company.
Ans: According to section 205A of the companies Act, 1956 amended by the companies act ,2000, where a
dividend has been declared by a company but has not been paid or claimed within 30 days from the date of of
the declaration to any shareholder entitled to the payment of the dividend , the company shall within 7 days
from the date of expiry of the said period of 30 days transfer the total amount of dividend which remains unpaid
or unclaimed within the said period of 30 days to a special account to be opened by the the company in that
behalf in any scheduled bank to be called “ Unpaid dividend account of….. Company limited”. If default is made
in transferring the unpaid or unclaimed dividend to the said account , the company shall pay interest from the
date of default @ 12% per annum. Such interest will be paid to the members of the company in proportion to
the amounts remaining unpaid to them. Section 205A(5) provides that money transferred to the unpaid
dividend account of a company which remains unpaid or unclaimed for a period of seven years from the date of
transfers must be transferred by the company to Investor Education and Protection Fund.
8. Distinguish between interim and final dividend.
Ans:Interim dividend refers to dividend declared before close of current year books by the Board of Directors on
the basis of expectation of profit during the current year.
Final dividend refers to dividend proposed by the Board of Directors and approved by the shareholders of the
company at the Annual general meeting.
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9. What is dividend equalization reserve?
Ans:Dividend equalization fund means a find accumulated out of profits otherwise available for dividends with
the purpose of making the rate of dividend uniform from year to year. Dividend equalization fund is utilized to
pay out dividend when profit is small and it is accumulated when profit is higher. It protects the share of the
company being waged out by speculators in the capital market.
10. Discuss different method of alteration of share Capital and reduction of share capital.
Ans:According to Sec, 94, 95 and 97 of the Companies Act 1957, a limited company, if so authorized by its
articles, may alter its share capital since it does not require the approval of the court, and the alteration can be
carried out only by altering the condition of memorandum in any one of the following method.
 Increase its share capital by making fresh issue: If a company wants to increase its capital beyond the
amount of its authorized capital, it must increase its authorized capital by the amount of new shares.
Entries for the purpose will be the same as in the case of original issue of shares.
 Consolidate and divide all and any of its share capital into shares of layer denomination:-
Share capital (say Rs. 10) A/c- (Dr)
To share capital (say Rs. 100) A/c
By this Consolidation only the number of shares will change and share Capital will remain unchanged.
 Sub-divide all or any of its share capital into shares of smaller denomination.
Entry will be:
Share capital (say Rs. 10000 A/c-9Dr)
To share capital (Say Rs. 10) A/c
In this case only the number of share is increased whereas the amount of share capital will not change.
 Convert all or any of fully paid up shares into stock or reconvert stock into fully paid-up shares of any
denomination. The entry will be
Equity share capital A/c (Dr.)
To equity stock A/c
Or vice versa, in the opposite case.
 Cancel unissued share capital [not taken or agreed to be taken by any person] and thereby diminish the
amount of share capital. NO journal entry is required for this purpose. Only the details of authorized
capital are to be incorporated in the next balance sheet. It should be remembered that if reduction
results in a decrease of paid up capital, it requires the approval of court.

Reduction of share capital:

Reduction of capital can take any one of the following three forms:-

a. Reducing [or extinguishing] liability in respect of unpaid /uncalled amount.

b. Canceling any paid-up share capital that is lost or unrepresented by available assets together with or without
extinguishing or redacting liability on shares.
c. Paying off paid –up Capital, which is in excess of the needs of the company together with or without
extinguishing or reducing liability or shares.
11. What are the steps involved in formation of a scheme of reconstruction?
Ans:Steps involved in preparing a scheme of capital reduction:-
a. Calculate total amount to be written off in respect of accumulated losses, fictitious assets, over valuation of
assets, under provisions of liabilities.

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b. The total amount so calculated as above has to be distributed among various stakeholders, equitable, being
considerate enough about anyone going for liquidation have to bear the maximum losses, but their claim
cannot be reduced to nil. If not assets is less than preference shared capital, preference shareholders are
also required to bear loss, through their loss can b e compensated by an increase of rate of dividend.
c. Preference shareholders should be convinced to forgo their claim of arrear dividend.
d. If net assets are not sufficient to cover debentures and other external liabilities, the unsecured creditors may
bear loss, and then the turn of such creditors come who have foliating charges on the assets. All of them
should be compensated while they sacrifice some of their shares.
e. Secured Creditors should not sacrifice anything.
f. While preparing the scheme adequate provision should be made for future working Capital.
g. As far as possible internal reconstruction should be adopted.

12. Write a short note on “own Debenture”.

Ans: “Own debenture refers to the debentures purchased by the debenture issuing company from the open
market as investment with the intention of redeeming such debentures either on a date before redemption or
on redemption date. It is one of the methods of redemption of debentures, which a company carry out from the
sinking fund or out of profit appropriated. The company may hold debentures so purchased as investment till
the date of maturity or the debentures can be redeemed immediately.
13. Write short note on redemption of debentures by sinking fund.
Ans:Debentures are required to be redeemed at a certain period of time say after 3 or five years. In order to
avoid the fund crunch a company can systematically withdraw an equal amount of fund out of profit each during
the tenure of the debenture and can invest the in marketable securities outside the business. Annual interest
income is also re-invested so as to reduce the burden of annual appropriation from profit. The annual
installment required to be withdrawn from profit is calculated out of future value of an annuity table and each
same amount is invested along with interest income. On the date of maturity of debentures such investment are
sold and debentures are redeemed.
14. Write a short note on GAAP.
Ans:Generally accepted, accounting principles [GAAP] includes accounting conventions, rules, procedures and
accounting stands, accepted accounting practices both promulgated and non-promulgated. GAAP are those
principles, which have substantial authoritative support. Indian GAAP consists of statements, standards,
guidance notes issued by the Institute of Chartered Accountants of India in combination of other accounting
practices followed in India.
15. Define Preferential Creditors?
Ans:Preferential creditors are those unsecured creditors who are paid in priority to creditors having a floating
charge and other [non-preferential] unsecured creditors. As per section 530 of the Companies Act 1956,
preferential creditors include the following:-
1. All revenue, taxes, ceases and rates due to central or state government or local authorities within 12 month
prior to date of winding up order.
2. All wages and salaries due to employee not exceeding Rs. 20,000 due for not more than 4 months.
3. All accrued holiday remuneration payable to employee,
4. All amount payable in respect of Employees State Insurance Act 1948 or the law, due for 12 months,
5. All compensation due to employees under Workmen’s Compensation Act 1923.
6. All sums due to any employees from provident fund, a pension fund and a gratuity fun.

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7. The expenses of any investigation held in pursuance of section 235 or 237 in so far as they are payable by
the company.
16. What is the need for consolidated balance sheet?

Ans:Preparation consolidated balance sheet by a parent company is not legally obligatory in India. Though it is
prepared to serve the following needs-

a. Investors of parent company are really concerned about the performance of the group , they can be
informed through consolidated balance sheet.
b. It helps in estimating economic resources available to the group.
c. Transparent true affairs of the business is reflected which is requested by the users of financial information.
17. Define intrinsic value of shares?
Ans:Intrinsic value of shares refers to the value per share estimated on the basis of internal valuation base upon
the assets available per share. According to this method per value of share is calculated as follows:-
Net assets available for shareholders
No . of shareholders issued ∧by held by shareholders
18. Explain the yield method of valuation of shares by giving an example.
Ans:Yield is the effective rate of return on investment, which is invested by the investors. It is always expressed
in terms of percentage. Under yield method valuation shares are valued either on profit basis or Dividend basis.
Under profit basis, first the profit available to shareholder is calculated. Then the capitalized value of such profit
is followed by taking into account normal rate of return.
Profit available for shareholders
Capitalized value of profit = X 100
Normal rate of return
Capitalized value of profit
Value per share=
No . of shares
Under dividend basis valuation, the value per share is as follow:-
Rate of Dividend
x Paid up value per share
Normal rate of return
¿
Where Rate of dividend= Profit available¿ shareholders x 100
Paid up share capital
19. Explain the need for and the method of ascertaining the fair value of shares.
Ans:There is controversy over net assets valuation and rate of return valuation of shares. Two methods take
care of two aspects of a business i.e. future growth and current earnings. A dual aspect is suggested by some
accounts, which is called fair value method and under this method shares are valued as follows:-
Intrinsic Value∧Yield value
2
OBJECTIVE QUESTION [2 MARKS EACH]
1. Write two difference between shares and debentures.

A. SHARES DEBENTURES
a. Shares are owned capital of a Debentures are loan fund of a company and do
company and participate in risk not take part in the risk of the business.
b. Shareholders earn dividend. Debenture holders earn interest.

2. Write two difference s between equity shares and preference shares

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Equity Shares Preference Shares
a. Equity shares are not redeemable Preference shares are redeemable within a
except in case of winding up of the period of ten years from the date of their issue.
company
b. Equity shareholders do not get ant Preference shareholders get preference over
preference over dividend and their dividend at a fixed rate.
dividend rate fluctuate.

3. Define Authorized share Capital.

Ans:The maximum capital a company can raise as per the “Capital clause” of the “Memorandum of Association”
registered with the Register of Companies, is known as Authorized Share Capital.
4. Define Capital Reserve.
Ans:Any Capital profit forms part of right of equity shareholders. These profits are transferred to reserve called
Capital Reserve.
5. What is Reserve Capital?
Ans:AS per section 99 of the Companies Act 1956 a company may decide by passing a special resolution that a
certain portion of its subscribed uncalled shall not be called up except in the event of building up of the
company. This portion of the capital is known as Reserve Capital.
6. What is minimum subscription?
Ans:A public limited company cannot make any allotment of shares unless the amount stated in the prospectus
as minimum subscription has been subscribed and the sum payable as application money for such shares has
been paid to and received by the company. As per guideline of the Securities Exchange Board of India [SEBI], a
company must receive a minimum of 90% subscription against the entire issue before making any allotment of
shares to the public.
7. Why Right shares are issued?
Ans:For an existing company issuance of new shares to the existing shareholders before issuing them to the
public is ob; obligator.
Secondly, the existing shareholders get a monetary benefit by subscribing to right shares since these shares are
issued at a price lower than the market price.
8. What is convertible debenture?
Ans:Sometimes debentures are issued on the condition of their convertibility into shares after a specified
period. These debentures are known as Convertible debenture.
9. Under what circumstances a company can withhold its public issue of shares?
Ans:A company can withhold its public issue of shares in case of:-
a. If minimum subscription is not reached.
b. If 5the amount of application i.e. at least 25% of the issue price is not received.
10. Name various sources of finance for redemption of preference shares?
Ans: Preference share can be redeemed
a. The proceed of a fresh issue of shares;
b. The capitalization of undistributed profits , or
c. Out of combination of ‘a’ and ‘b’
11. What is capital Redemption Reserve A/C?
Ans:When preference Share are redeemed out of profit of the company an amount equal to the nominal value
of preference shares redeemed out of profit, is transferred to an account called Central Redemption Reserve

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A/c. The transfer is made out of General Reserve, P/L A/C or share premium A/C [existing]. This Capital
Redemption Reserve A/C can be utilized at the time of issue of Bonus Shares.
12. What is Debenture Redemption Fund?
Ans:A fund created by debiting P/L Appropriation A/C under Sinking fund method for redeeming the debenture
after expires of a certain period of time is called Debenture Redemption Fund.
13. How is value of right computed?
Ans:The monetary benefit to the existing shareholders due to right issue is known as “Value of Right”. It is
calculated as follows:-
Value of right= Market price of share – Average price of a share.
Where average price per share=Market price per share+ Issue price of one right share/2
Alternatively
¿ Shares x [Cum¿marke t price−¿ issue price]
Value of right=
Total No. of shares
14. Define External reconstruction.
Ans:When a new company is formed with the same name in order to take over the business of an existing
company by writing off past losses and by reducing the share capital of the existing company, it is known as
external reconstruction.
15. Define internal reconstruction.
Ans:When a company is recognized by way of alteration and reduction of share capital and without out
liquidation of the old company and formation of a new one, it is called Internal Reconstruction.
16. How statutory reserves are treated in case of Amalgamation in the nature of merger/
Ans:The identity of the statutory reserve is kept intact in the books of the transferee company after amalgation
in the nature of merger.

17. Why is external reconstruction carried out?

Ans:Company suffering from huge accumulated losses may not show the true value of its assets as shown in the
balance sheet. In order to reengineer the entire financial structure of the company and also get investor
attention, the company may resort external reconstruction, which results into the liquidation of the old
company and formation of a new one.
18. Why is internal reconstruction carried out?
Ans:A company suffering from bad financial health, but whose future prospect is quite good, may resort upon
internal reconstruction i.e. without liquidating the old company the financial reconstruction is carried out .

19. When does flow of funds take place ?

Ans –According to the working capital concept of funds, the term ‘flow of fund’ refers to the movement of funds
in the working capital. If any transaction results in the increase in working capital, it is said to be a source of
inflow of funds and if it results in the decrease of working capital, it is said to be an application or out-flow of
funds. The flow of funds takes place when a transaction changes on the one hand a non-current account and on
the other a current account and vice-versa. When a change in non-current account e.g., fixed assets, long term
liabilities, reserves and surplus etc., is followed by a change in another non-current, it does not amount to flow
of funds. This is because of the fact that in such cases neither the working capital increase nor decreases.
Similarly, when a change in one current account results in a change in another current account, it does not affect
funds. Funds move from non-current to current transactions or vice-versa only. In simple language funds move
when a transaction affects (i) a current asset and a fixed asset, or (ii) a fixed and a current liability, or (iii) a
current asset and a fixed liability, or (iv) a fixed liability and current liability; and funds do not move when the
transaction affects fixed assets and fixed liability or current assets and current liabilities.
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20. Write a note on importance of fund flow statement?

Ans –It helps in the analysis of financial operations. The financial statements reveal the net effect of various
transactions on the operational and financial position of a concern. The balance sheet gives a static view of the
resources of a business and the uses to which these resources have been put at a certain point of time. But it does
not disclose the causes for changes in the assets and liabilities between two different points of time. The funds flow
statement explains causes for such changes and also the effect of these changes on the liquidity position of the
company. Sometimes a concern may operate profitably and yet its cash position may become more and more
worse. The funds flow statement gives a clear answer to such a situation explaining what has happened to the
profits of the firm. It helps in the formation of a realistic dividend policy. Sometimes a firm has sufficient profits
available for distribution as dividend but yet it may not be advisable to distribute dividend for lack of liquid or cash
resources. In such cases, a funds flow statement helps in the formation of a realistic dividend policy.

(a) It helps in the proper allocation of resources. The resources of a concern are always limited and it wants to
make the best use of these resources. A projected funds flow statement constructed for the future helps in making
managerial decisions. The firm can plan the deployment of its resources and allocate them among various
applications.
(b) It acts as a future guide. A projected funds flow statement also acts as a guide for future to the management.
The management can come to know the various problems it is going to face in near future for want of funds. The
firm’s future needs of funds can be projected well in advance and also the timing of these needs. The firm can
arrange to finance these needs more effectively and avoid future problems.It helps in appraising the use of working
capital.
(c) It helps in appraising the use of working capital. A funds flow statement helps in explaining how efficiently the
management has used its working capital and also suggests ways to improve working capital position of the firm.
(d) It helps knowing the overall creditworthiness of a firm. The financial institutions and banks such as State
Financial Institution , Industrial Development Corporation, Industrial Finance Corporation of India, Industrial
Development Bank of India , etc. all ask for funds flow statement constructed for a number of years before granting
loans to know the creditworthiness and paying capacity of the firm. Hence, a firm seeking financial assistance from
these institutions has no alternative but to prepare funds flow statements.

21. Distinguish between ‘Fund flow’ and ‘cash flow’.

Ans:
Points of Difference Fund Flow Statement Cash Flow Statement
1. Basis of concept It is based on a wider concept of It is based on a narrower concept of
funds, i.e. working capital. fund, i.e., cash.
2. Basis of accounting It is based on accrual basis of It is based n cash basis of accounting.
accounting.
3. Basis of usefulness It is useful in planning intermediate It is more useful for short term
and long term financing. analysis and cash planning of the
business.
4. Mode of information It is much more informative since it It is not so informative like funds flow
informs about the fund. statement since it informs only about
cash.
5. Changes It shows the changes of not only the It shows the changes of opening cash
cash but also the changes job other & bank balance and does not show
assets and records the changes of the changes of current liabilities and
current liabilities. other assets.
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Corporate Accounting Course -Essay type Questions :

1. What is Goodwill? What are its features? What are the different types of goodwill ? What are needs for
valuation for goodwill?

Ans: Goodwill and its Features

Goodwill is the reputation which a business builds up over years by maintaining and improving the quality of its goods
sold or services rendered. An established business develops an advantage of good name and wide business connections.
This helps the business to earn more than a similar business that has entered recently into the business world. Goodwill
is that advantage translated into monetary value. It is an invisible possession of a reputed business that helps it to earn
more. It is intangible. But it is a real asset because its existence is reflected through the superior earning capacity.

Its features are:

1. It is a non-physical.

2. It is inseparable from a business unit. Any separable asset can be realized separately. But Goodwill cannot be
sold out easily.

3. Its value is subject to wide fluctuations. Different internal and external reasons contribute to such fluctuations.

4. Whether it exists and what is its value depend on the subjective judgement of the valuer.

5. It is intangible but a real asset and stands pari passu with any other fixed asset on liquidation.

Types of Goodwill

1.Purchased goodwill : It is the excess amount payable over the fair value of the separable net assets acquired from
another person or business. It depends on the future prospects of the business unit acquired as a whole. AS-10
concerning “Accounting for Fixed Assets” states in para 36 that “Goodwill should be recorded in the books only
when some consideration in money or money’s worth has been paid for it.” Factors like market dominance,
economies of scale, fiscal advantages, etc, contribute towards the value of Purchased Goodwill.

2.Inherent or non-purchased or latent Goodwill : It is the good name built up over years and generated internally
by a business. It is not reflected by the financial accounts or by the purchase consideration. Its valuation depends on
the subjective judgement of the valuer. Factors like superior management, sales policies, good public image, etc.,
contribute towards the development of this type of goodwill.

Reasons for valuation for of goodwill or where valuation is needed :

1. Purchase of a block of share of a company;

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2. Purchase of a block of shares for acquiring controlling interest on amalgamation or merger of companies;

3. Purchase of shares by employees of the company deciding to retain such shares during the tenure of service;

4. Purchase of interest of shareholders dissenting on a scheme of reconstruction;

5. Assessments under Gift Tax Act, etc.

6. Nationalisation of a company whose shareholders are to be compensated by the government.

7. Conversion of the form of shares from of shares preference shares to Equity Shares or debentures, etc.

8. Shares used as a security against loan taken.

9. Distribution among the partners of a liquidating firm of the shares jointly held by them.

5)Define External Capital Reduction. What are the principles that are generally applied in preparing a scheme for
internal Reconstruction of a company to write off past losses and fictitious assets ?

Ans : External Capital Reduction : External Capital Reduction (External Reconstruction) is an event which takes place
when an existing company goes into liquidation for the purpose of selling its assets and liabilities to a newly formed
company which is generally owned named alike when a company shows huge amount of fictitious assets in the asset
side of the balance sheet and it is not possible to make up the loss of fictitious assets through internal reconstruction
only then the Company authority will think about the internal reconstruction.

PRINCIPLES THAT ARE GENERALLY APPLIED IN PREPARING A SCHEME FOR INTERNAL RECONSTRUCTION OF A
COMPANY :

At the time of formulation a scheme of Capital reduction, the following points must be kept in mind :

i)The Scheme must give an incentive to creditors, debenture holders, lenders and share holders. Creditors and
debenture holder must be convinced that they will be better off by accepting the Scheme rather than participating in a
liquidation of the company.

ii) The Scheme must be ‘fair’ and ‘equitable’ as between different types of share holders, creditors, and lenders.

iii)Capital Reduction Scheme is worth considering only if the company has recovery prospects.

iv)The Scheme must provide for adequate working capital by injecting cash by way of right issue or loan.

The following steps are followed at the time of formulating a Scheme of Capital Reduction-

STEP 1 : the first step is to determine total amount of the losses to be written off All fictitious assets, eg : preliminary
expenses, discount an issue of shares and debentures are to be written-off in addition to the debit balance of profit and
loss A/C. If there is any goodwill in the Balance sheet, it is also to be written-off. All assets are to be revalued . Loss on
revaluation is to be written off. Any liabilities are also to be taken into consideration.
STEP 2 : The next step is to spread the burden of the losses amongst debenture holder, creditors and various classes of
share holders. The main burden of losses should be borne primarily by the equity share holders because ultimately they
are responsible for all residuary losses.

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STEP 3 : For Successful implementation of the Scheme of Capital reduction, arrangement of adequate working Capital
is must. Any or some of the following sources can provide working capital.
i)Issue of rights share.
ii)By reducing the fully paid-up equity shares into partly paid-up and then asking the equity shareholders to make these
shares fully paid-up by paying the balance money.
iii)Issue of new debenture to existing debenture holders by offering higher rate of interest.
iv)Issue of Commercial paper.

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