CORPORATE ACCOUNTING

KAMAL INSTITUTE OF HIGHER EDUCATION

AND ADVANCE TECHNOLOGY

SUMITTED TO:
DR. SEEMA

SUBMITTED BY:
ROSHNI ADHIKARI
ENROLLMENT NUMBER: 70296788823
ASSIGNMENT QUESTIONS
ASSIGNMENT – 1

ROSHNI ADHIKARI | CORPORATE ACCOUNTING | BCOM HONS

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 ASSIGNMENT QUESTIONS

QUES. Differentiate between reserve capital and capital reserve.

ANS.

Differentiation between Reserve Capital and Capital Reserve:

In the domain of corporate finance, distinguishing between reserve capital and capital
reserve is essential for understanding the nuanced mechanisms by which companies
manage their financial resources and bolster their financial stability. Both concepts play
pivotal roles in shaping a company's capital structure, yet they serve distinct purposes
and undergo differential accounting treatments. Below, we present a comprehensive
analysis elucidating the disparities between reserve capital and capital reserve, delving
into their nature, purpose, and accounting treatment.

Reserve Capital:

Reserve capital embodies the unissued portion of a company's authorized share capital,
earmarked for potential future issuance to shareholders. It constitutes a strategic
reservoir of capital, poised for deployment in response to evolving business needs and
strategic imperatives.

Purpose: Reserve capital serves as a strategic lever, affording companies the flexibility
to capitalize on emerging opportunities or address exigencies without the immediate
necessity of resorting to additional share issuances. This reservoir of untapped capital
underpins the company's agility and responsiveness to market dynamics and strategic
imperatives.

Accounting Treatment: Reserve capital, being the unissued portion of authorized

share capital, does not find explicit representation on the company's balance sheet.
Instead, it resides in the company's articles of association or memorandum of
association, delineating its potential utility and regulatory constraints.

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Capital Reserve:

Capital reserve constitutes a segment of a company's retained earnings or surplus,

segregated for specific purposes distinct from routine dividend distributions or share
capital redemption. It represents a reservoir of surplus capital generated from non-
operational activities or one-time transactions.

Purpose: Capital reserves are designated for specific strategic objectives, such as
funding future expansion initiatives, fortifying the company's financial resilience, or
absorbing potential losses. They serve as bulwarks against economic volatility and
underpin the company's long-term financial sustainability and strategic viability.

Accounting Treatment: Capital reserves are integral components of the company's

balance sheet, disclosed within the shareholders' equity section as a subset of retained
earnings. They are demarcated from revenue reserves to delineate their earmarked
nature and specific utilization purposes, ensuring transparency in financial reporting.

Key Differences:

• Nature: Reserve capital embodies unissued authorized share capital, whereas

capital reserve constitutes surplus retained earnings designated for specific
purposes.

• Purpose: Reserve capital fosters flexibility and responsiveness to future

capitalization needs, while capital reserve bolsters financial resilience and
underpins strategic objectives.

• Accounting Treatment: Reserve capital is not explicitly reflected on the balance

sheet, while capital reserve is disclosed within the shareholders' equity section,
delineating its earmarked nature and strategic significance.

In essence, while reserve capital and capital reserve both contribute to a company's
financial architecture, their divergent roles, and accounting treatments underscore their
nuanced significance in corporate finance. Reserve capital empowers companies with
flexibility and agility in capital management, while capital reserve fortifies financial
stability and strategic resilience, engendering robustness in the face of dynamic market
conditions and strategic imperatives.

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QUES. What is meant by buy-back of shares? What are the objectives
and sources of buy-back of shares?
ANS.

Definition of Buy-Back of Shares:

The buy-back of shares, commonly known as share repurchase, pertains to the process
wherein a company purchases its own outstanding shares from shareholders either
through open market transactions or negotiated deals. This strategic initiative results in
a reduction of the total number of shares outstanding, consequently impacting the
equity base of the company.

Objectives of Buy-Back of Shares:

1. Enhancement of Shareholder Value: One of the primary objectives behind

share repurchases is the enhancement of shareholder value. By executing buy-
back programs, companies can efficiently return surplus cash to shareholders,
potentially increasing earnings per share (EPS) and return on equity (ROE),
thereby bolstering overall shareholder value.

2. Capital Structure Optimization: Another key objective of buy-backs is to

optimize the company's capital structure. By utilizing excess cash or surplus
capital to repurchase shares, companies can streamline their capital structure,
leading to improved financial metrics and enhanced efficiency in capital
allocation.

3. Signal of Confidence: Share repurchases serve as a signal of management's

confidence in the company's future prospects. Through buy-backs, management
communicates their belief that the company's shares are undervalued, and they
anticipate favourable returns in the future, thereby instilling confidence among
shareholders and the market.

4. Prevention of Hostile Takeovers: Share repurchases can act as a defense

mechanism against hostile takeovers. By reducing the number of shares available
for acquisition, companies make it more challenging for external entities to gain

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 control through accumulating a significant ownership stake, thereby
safeguarding the company's independence and strategic direction.

5. Employee Stock Option Programs: Companies may undertake share

repurchases to offset dilution resulting from the issuance of shares under
employee stock option programs. By buying back shares on the open market,
companies can mitigate the dilutive impact of stock-based compensation on
existing shareholders, thereby aligning the interests of employees and
shareholders.

Sources of Buy-Back of Shares:

1. Cash Reserves: Companies typically utilize their cash reserves accumulated from
retained earnings, operating cash flows, or proceeds from asset sales to fund
share repurchase programs. Cash reserves provide the necessary flexibility and
liquidity for executing buy-back transactions.

2. Debt Financing: Another source of funding for share repurchases is debt

financing. Companies may issue debt securities, such as bonds or notes, to raise
capital for buy-backs. Debt financing allows companies to leverage their balance
sheet and take advantage of favourable interest rates and tax benefits associated
with interest expense deductibility.

3. Equity Financing: Share repurchases can also be financed through equity

financing, wherein companies issue new equity securities, such as preferred
shares or convertible bonds. Equity financing provides an alternative source of
capital while preserving cash reserves for other strategic initiatives.

4. Operating Cash Flows: Companies may use their operating cash flows to finance
share repurchases, particularly if they possess robust cash generation capabilities
and a stable revenue stream. Utilizing operating cash flows for buy-backs allows
companies to return capital to shareholders without resorting to external
financing sources.

5. Asset Sales: Finally, companies can fund share buy-back programs by divesting
non-core assets or subsidiaries and utilizing the proceeds to repurchase shares.
Asset sales provide a one-time infusion of cash, which can be deployed for share

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 repurchases or other strategic purposes, aligning with the company's overall
capital allocation strategy.

In summary, the buy-back of shares represents a strategic financial initiative aimed at

optimizing capital structure, enhancing shareholder value, and signalling confidence in
the company's future prospects. The objectives of share repurchase encompass various
aspects of shareholder value creation and strategic positioning, while the sources of
buy-back financing offer companies flexibility and options for executing their capital
allocation strategies effectively.

QUES. Explain by giving entries the sinking fund method of

redemption of debentures.
ANS.
The sinking fund method of redemption of debentures involves setting aside funds
periodically to retire debentures at their maturity date. This method ensures that funds
are available when debentures mature, thus mitigating the risk of default and providing
investors with assurance regarding repayment. Here's an explanation along with the
journal entries for the sinking fund method:

• Creation of Sinking Fund: The company establishes a sinking fund by

allocating a portion of its profits or raising funds through a separate sinking
fund account.
• Investment of Funds: The sinking fund is invested in low-risk, interest-
bearing securities such as government bonds or fixed deposits to generate
returns over the redemption period.
• Periodic Contributions: The company makes regular contributions to the
sinking fund, typically on an annual basis, to ensure that sufficient funds are
available for debenture redemption at maturity.
• Redemption of Debentures: When debentures mature, the company utilizes
the funds accumulated in the sinking fund to retire the debentures, either
partially or entirely, depending on the outstanding amount.

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Journal Entries:

1. To record annual contribution to sinking fund:

• Dr. Sinking Fund Account (Amount contributed to sinking fund) Cr. Bank
Account (Amount transferred to sinking fund)

2. To record interest income earned on sinking fund investments:

• Dr. Bank Account (Interest received on sinking fund investments) Cr. Sinking
Fund Account (Interest income)

3. To record transfer of interest income to sinking fund:

• Dr. Sinking Fund Account (Interest income transferred to sinking fund) Cr.
General Reserve/Profit and Loss Account (Interest income utilized for
sinking fund)

4. To record redemption of debentures using sinking fund:

• Dr. Debenture Redemption Account (Amount redeemed using sinking fund)

Cr. Debenture Account (Amount of debentures redeemed) Cr. Sinking Fund
Account (Amount utilized for debenture redemption)

Example Journal Entries:

1. For annual contribution to sinking fund:

• Dr. Sinking Fund Account 10,000 Cr. Bank Account 10,000

2. For interest income earned on sinking fund investments:

• Dr. Bank Account 5,000 Cr. Sinking Fund Account 5,000

3. For transfer of interest income to sinking fund:

• Dr. Sinking Fund Account 5,000 Cr. General Reserve/Profit and Loss Account
5,000

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 4. For redemption of debentures using sinking fund:

• Dr. Debenture Redemption Account 50,000 Cr. Debenture Account 50,000

Cr. Sinking Fund Account 50,000

These entries illustrate the process of setting up and utilizing a sinking fund to
systematically retire debentures over time, ensuring financial stability and investor
confidence in the company's ability to honour its debt obligations.

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