Conducting a Statutory Audit of Share Capital in India [Company Law]
We covered Introduction, Regulatory framework, Objectives, scope, Roles & Responsibilities and Benefits of Statutory audit in our earlier blogs.
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Now let us go a bit deep in the practical aspects of statutory audit.
Conducting a Statutory Audit of Share Capital in India: A Comprehensive Guide
Auditing share capital is a critical aspect of the statutory audit for any company in India. This process involves verifying the accuracy and completeness of the share capital recorded in the company’s financial statements. Share capital represents the equity investment by shareholders and appears as the first item on the balance sheet. This guide provides detailed directions on how to audit share capital under Indian laws, addressing common queries and confusions related to this balance sheet item.
Understanding Share Capital
Before diving into the audit procedures, it’s essential to understand the various components of share capital:
- Authorized Share Capital: The maximum amount of capital that a company can issue as per its memorandum of association (MoA). (Section 2(8))
- Issued Share Capital: The portion of authorized capital that has been issued to shareholders. (Section 2(50))
- Subscribed Share Capital: The portion of issued capital that shareholders have agreed to take and pay for. (Section 2(86))
- Paid-up Share Capital: The portion of subscribed capital that shareholders have paid for. (Section 2(64))
Share Capital will fall into the category of account balances at period end as per SA 315, hence following assertions need to be used to identify any potential misstatement:
- Existence
- Rights and Obligations
- Completeness
- Valuation and allocation
Step-by-Step Guide to Auditing Share Capital
1. Verifying Authorized Share Capital
Document Verification:
- Memorandum of Association (MoA): Review the MoA to confirm the authorized share capital limits.
- Board Resolutions: Verify any resolutions that involve changes to the authorized share capital.
- Registrar of Companies (RoC) Filings: Check for proper filings with the RoC, particularly for any alterations to the authorized share capital.
Procedures:
- Obtain a copy of the MoA and Articles of Association (AoA).
- Review board meeting minutes where changes to the authorized capital were discussed.
- Ensure Form SH-7 as per The Companies (Share Capital and Debentures) Rules, 2014 read with section 61 of the Act has been filed for any increases or decreases in authorized capital.
2. Auditing Issued and Subscribed Share Capital
Shareholder Register:
- Register of Members: Verify the accuracy of the register, ensuring it reflects the correct number of issued and subscribed shares.
- Share Certificates: Confirm that issued share certificates are properly recorded and match the register of members.
Board Resolutions and AGM Minutes:
- Review Minutes: Check the minutes of board meetings and annual general meetings for resolutions related to share issuance.
- ROC Filings: Ensure Form PAS-3 (Return of Allotment) is filed for shares issued during the year.
Procedures:
- Cross-check the register of members with the issued share certificates.
- Verify that the total shares issued match the details recorded in the financial statements.
- Review AGM and board meeting minutes for authorizations regarding share issuance.
3. Confirming Paid-up Share Capital
Bank Statements and Payment Records:
- Verify Payments: Check bank statements and receipts to ensure that payments for issued shares have been received.
- Call Money Records: Verify if there are any unpaid calls on shares and ensure they are correctly recorded.
Procedures:
- Match the cash received as recorded in bank statements with the paid-up capital reported.
- Ensure any calls in arrears are correctly noted and disclosed in the financial statements.
4. Cross-Verification with Financial Statements
Balance Sheet:
- Cross-Check Entries: Ensure that the share capital amounts recorded on the balance sheet align with the company’s register and issuance records.
- Notes to Accounts: Review the notes to accounts for detailed disclosures related to share capital, including the number of shares, par value, and any changes during the year.
- As per Schedule III – General instruction for preparation of Balance sheet Statement of Profit & Loss of a Company Division I, some disclosures for each class of shares required are:
- Number and amount of shares authorised
- The number of shares issued, subscribed and fully paid, and subscribed but not fully paid
- Par value per share
- A reconciliation of the number of shares outstanding at the beginning and at the end of the reporting period
- the rights, preferences and restrictions attaching to each class of shares including restrictions on the distribution of dividends and the repayment of capital
- shares in respect of each class in the company held by its holding company or its ultimate holding company including shares held by or by subsidiaries or associates of the holding company or the ultimate holding company in aggregate
- shares in the company held by each shareholder holding more than 5 per cent. shares specifying the number of shares held
- shares reserved for issue under options and contracts/commitments for the sale of shares/disinvestment, including the terms and amounts
- for the period of five years immediately preceding the date as at which the Balance Sheet is prepared:
- Aggregate number and class of shares allotted as fully paid-up pursuant to contract(s) without payment being received in cash
- Aggregate number and class of shares allotted as fully paid-up by way of bonus shares
- Aggregate number and class of shares bought back.
- terms of any securities convertible into equity/preference shares issued along with the earliest date of conversion in descending order starting from the farthest such date
- calls unpaid (showing aggregate value of calls unpaid by Directors and officers)
- forfeited shares (amount originally paid-up)
- A company shall disclose Shareholding of Promoters with the details of number of shares held at year end, % change during the year
Procedures:
- Verify the consistency of share capital figures between the balance sheet and the share register.
- Check for detailed and accurate disclosures in the notes to the financial statements as required by Schedule III of Companies Act 2013.
5. Compliance with Laws
Companies Act, 2013:
- Section 43: Confirm compliance regarding the types of share capital.
- Section 44: Verify adherence to provisions stating that shares are movable property.
- Section 45: Ensure compliance with the numbering of shares.
Procedures:
- Ensure the company complies with sections of the Companies Act concerning share capital.
6. Reviewing Compliance with SEBI and RBI Regulations
SEBI Regulations:
- Listing Obligations: For listed companies, ensure compliance with SEBI’s Listing Obligations and Disclosure Requirements (LODR) regulations.
- Disclosure Requirements: Verify that all required disclosures related to share capital are made to SEBI and the stock exchanges.
RBI Guidelines:
- Foreign Investments: Ensure compliance with RBI guidelines on foreign investments, including the Foreign Exchange Management Act (FEMA) provisions related to share capital.
Procedures:
- Review SEBI filings for compliance with LODR regulations.
- Ensure disclosures regarding share capital changes are accurate and timely.
- Check for compliance with RBI guidelines if the company has foreign shareholders.
Common Queries and Confusions Regarding Share Capital
- Difference Between Authorized and Paid-up Capital: Authorized capital is the maximum amount a company can issue, while paid-up capital is the amount shareholders have paid for.
- Treatment of Calls in Arrears: Calls in arrears represent the unpaid portion of the subscribed share capital. These should be deducted from the subscribed capital to reflect the actual paid-up amount.
- Bonus Shares and Rights Issues: Bonus shares are issued out of reserves and should be audited to confirm proper authorization and recording. Rights issues are offered to existing shareholders and require verification for compliance with terms and conditions.
- Preferential Allotment: Verify that all preferential allotments comply with the rules and regulations, including necessary board and shareholder approvals and adherence to SEBI guidelines.
- Employee Stock Option Plan (ESOP): Ensure that ESOPs are properly accounted for and disclosed, particularly when options are exercised and impact share capital.
- Buy-back of Shares: Ensure compliance with Section 68 of the Companies Act, 2013, and SEBI (Buy-back of Securities) Regulations for any share buy-back, and confirm the proper reduction in share capital.
- Changes in Shareholding Structure: Review and verify any changes in the shareholding structure during the year, including new issuances, transfers, and forfeitures of shares.
Here are some real-world scenarios and practical cases related to share capital:
Case 1: Unauthorized Increase in Share Capital
Scenario: ABC Limited, a medium-sized manufacturing company, increased its authorized share capital from ₹10 crore to ₹15 crore without obtaining the necessary board approval or filing the required forms with the Registrar of Companies (RoC).
Audit Findings:
- The auditor discovered discrepancies between the company’s records and its filings with the RoC.
- The increase in authorized share capital was not documented in the minutes of board meetings or annual general meetings.
Resolution:
- The company was advised to immediately hold a board meeting to ratify the increase in authorized share capital.
- Necessary forms (SH-7) were filed with the RoC to rectify the oversight.
Lessons Learned:
- Ensure that all changes to share capital are duly approved and documented in board resolutions.
- Timely filings with regulatory authorities are crucial to maintaining compliance.
Case 2: Issuance of Bonus Shares
Scenario: XYZ Ltd., a listed IT company, decided to issue bonus shares to its existing shareholders in a ratio of 1:1. However, the announcement created confusion among shareholders regarding the impact on their holdings and the company’s share capital.
Audit Findings:
- The auditor confirmed that the issuance was properly authorized by the board and approved in the annual general meeting.
- The company had sufficient reserves to issue the bonus shares.
- Proper disclosures were made in the financial statements and communicated to shareholders.
Resolution:
- Detailed explanations and FAQs were provided to shareholders to clarify the impact of the bonus issue.
- The share capital in the balance sheet was updated to reflect the new issuance, doubling the number of shares while keeping the total value unchanged.
Lessons Learned:
- Clear communication and transparency with shareholders are vital during significant corporate actions like bonus issues.
- Ensure all necessary approvals and proper accounting treatment for bonus shares.
Case 3: Share Buy-back
Scenario: PQR Ltd., a consumer goods company, decided to buy back 10% of its outstanding shares to enhance shareholder value and improve financial ratios. The buy-back process needed to comply with Section 68 of the Companies Act, 2013, and SEBI (Buy-back of Securities) Regulations.
Audit Findings:
- The auditor reviewed the board and shareholder resolutions approving the buy-back.
- Verification of the source of funds used for the buy-back (free reserves and securities premium account).
- Compliance with the debt-equity ratio after the buy-back was within the prescribed limits.
Resolution:
- All necessary documents were filed with SEBI and the stock exchange.
- The reduction in share capital was accurately reflected in the financial statements.
- Appropriate disclosures were made in the annual report.
Lessons Learned:
- Strict adherence to regulatory requirements is essential for share buy-backs.
- Proper documentation and timely filings are critical to avoid regulatory scrutiny.
Conclusion
Auditing share capital involves a comprehensive review of records, compliance with legal requirements, and ensuring financial transparency. This meticulous process ensures the accuracy and integrity of share capital disclosures in a company’s financial statements. By following the detailed steps outlined above, auditors can effectively verify share capital, fulfilling statutory requirements while enhancing stakeholder confidence in the company’s financial health and governance practices. A thorough audit of share capital not only ensures regulatory compliance but also supports strategic decision-making and operational efficiency, positioning companies for sustainable growth and success.
Author
CA Sourabh Kothari (C.A., B.Com)
He is currently working as Partner – Risk and Transaction advisory with a renowned firm in Jaipur having experience in Internal Audit, IFC Audit, Business consultancy, Due Diligence and Management consultancy.
E-mail: Sourabh.kothari@jainshrimal.in | LinkedIn: Sourabh Kothari