Issuing Shares for Non-Cash Consideration

1. Issuing Shares to Vendors

A company often purchases assets like machinery or land, or even acquires a whole running business from another entity, known as the vendor. Instead of paying in cash, the company might settle the payment (known as Purchase Consideration) by issuing its own shares.

Let's start by understanding the basic concept.

The accounting treatment involves two main steps: first, recording the purchase, and second, recording the settlement by issuing shares.

Case A: Purchase of Individual Assets

When a company buys specific assets, the process is straightforward.

1. On Purchase of Assets: We record the asset coming into the company and create a liability to the vendor.

   • Sundry Assets A/c Dr.
   •     To Vendor's A/c

2. On Issue of Shares to the Vendor: We settle the liability to the vendor by issuing shares. The shares can be issued at par or at a premium.

   • Vendor's A/c Dr.
   •     To Equity Share Capital A/c
   •     (To Securities Premium A/c) (if issued at a premium)

A crucial step here is to calculate the number of shares to be issued. The formula is:

$\text{Number of Shares}=\frac{\text{Amount Payable (Purchase Consideration)}}{\text{Issue Price per Share}}$

Where the Issue Price is the face value if issued at par, or face value + premium if issued at a premium.

Case B: Purchase of a Running Business

Sometimes, a company acquires not just an asset, but a whole business, taking over its assets and liabilities. This adds a layer to the initial purchase entry.

1. On Purchase of Business: We debit all assets taken over, credit all liabilities assumed, and credit the vendor with the agreed Purchase Consideration (PC).

   • Sundry Assets A/c (Agreed Value) Dr.
   •     To Sundry Liabilities A/c (Agreed Value)
   •     To Vendor's A/c (Purchase Consideration)

   This entry often doesn't balance on the first go. The difference between the Net Assets (Assets - Liabilities) and the Purchase Consideration has a specific meaning:

   • Goodwill: If PC > Net Assets, the company is paying more than the net value of the assets. This extra payment is for the seller's reputation or name, and the balancing figure is debited to Goodwill A/c.
   • Capital Reserve: If Net Assets > PC, the company is paying less than the net value of the assets. This is a capital profit for the purchasing company, and the balancing figure is credited to Capital Reserve A/c.

The settlement by issuing shares follows the same logic as in Case A.

To see these journal entries and calculations worked out, let's continue with the video.

2. Issuing Shares to Promoters and Underwriters

Besides vendors, a company may also issue shares to other parties for their services.

• Promoters are the individuals who undertake the initial work of setting up the company. The cost of their services is treated as a formation expense.
• Underwriters are firms (often investment banks) that guarantee the sale of the company's shares to the public. For this service, they receive a commission.

In both cases, the company can pay them with shares instead of cash.

For a detailed explanation of the journal entries, let's watch the final segment of the video and supplement it with a clear article.

For a consolidated written summary and example, the following resource is very helpful.

Summary of Journal Entries

For Issue to Promoters:

1. To record the expense:
   • Incorporation Cost A/c (or Formation Expenses A/c) Dr.
   •     To Promoters' A/c
2. To issue shares:
   • Promoters' A/c Dr.
   •     To Equity Share Capital A/c

For Issue to Underwriters:

1. To record the commission due:
   • Underwriting Commission A/c Dr.
   •     To Underwriters' A/c
2. To issue shares:
   • Underwriters' A/c Dr.
   •     To Equity Share Capital A/c

Conclusion

Excellent work today! You have now learned how to account for shares that are issued not for cash, but in exchange for assets, a business, or valuable services. This is a very practical topic that shows the versatility of shares as a form of payment.

Key Takeaways:

• Shares can be issued for consideration other than cash to vendors, promoters, and underwriters.
• The first step is always to record the asset, business, or service received and create a liability to the party providing it.
• The most critical calculation is the Number of Shares to be Issued, found by dividing the amount payable by the issue price per share.
• When purchasing a business, a debit difference results in Goodwill, while a credit difference results in Capital Reserve.
• When issuing shares to promoters, the expense is Incorporation Cost. For underwriters, it is Underwriting Commission.

In our next lesson, we will bring together everything we've learned about share capital. We will see how to present share capital in the company's Balance Sheet as per Schedule III, including how to prepare the crucial 'Notes to Accounts' that provides details on authorized, issued, subscribed capital, and shares issued for consideration other than cash.