In this article we will discuss about the accounting treatment for rights issue of shares, explained with the help of suitable illustrations.
Sec. 81 of the Companies Act, 1956 provides that where a Public Company decides to increase its subscribed capital by issue of additional shares, at any time after the expiry of two years of its formation or one year of the first allotment of shares, whichever is earlier, by allotment of further shares.
(a) Such further shares must be offered to the holders of the equity shares of the company in proportion to the capital paid up on those shares at the date of offer;
(b) The offer aforesaid must be made by notice specifying the number of shares offered and limiting a time not less than 15 days from the date of offer within which the offer, if not accepted, will be deemed to have been declined;
(c) Unless the articles of the company otherwise provide, the offer aforesaid shall be deemed to include a right exercisable by the person concerned to renounce the shares offered to him or any of them in favour of any other person; and the notice shall contain a statement of this right; and
(d) After the expiry of the time specified in the notice aforesaid or on receipt of earlier intimation from the person to whom such notice is given that he declines to accept shares offered, the Board of Directors may dispose them of in such a manner as they are most beneficial to the company.
Thus, the issue of shares by an existing Company to the existing shareholders is known as “Right Issue“. The shareholders are not bound to accept the offer but if the shares of the Company have a high market value, then they definitely do so.
Moreover, the shareholders’ right to receive such shares may be sold or otherwise transferred, thus making a profit out of it. Such shares must first be issued to the existing equity shareholders of the company in proportion to the capital paid up on those shares. The shares so offered are known as “Right Shares”. This provision does not apply to a Private Company.
In right issue, no prospectus is issued, instead, existing shareholders are given “Rights Certificate”, in proportion to the existing holding, which authorises them to take up a specified number of shares at a specified price.
And Shareholders enjoy the following rights against rights offer:
(a) They may buy whole of the shares offered to them as right shares.
(b) They may renounce the right in favour of company which may sell the shares to the public.
(c) They may sell their right to subscribe to third parties wholly or partially.
Accounting entries in the books of company for right issue are the same as those required for a new issue of shares to the public. However, there is only one exception, that is, the existing share-holders know, in advance, the number of shares to which they will be entitled. Therefore, there is no question of over or under subscription arises.
Since the right issue is being offered at a concessional price, an existing shareholder can make a profit by selling his right to apply for the new shares. He may sell this right with or without selling his existing shareholding. The price of the shares may therefore be either cum-right price or an ex-right price.
The cum-right price gives the buyer, besides the ownership of the shares already held, the right to apply for new shares offered by the company, while the ex-right price gives the buyer only the ownership of the existing shares held by the seller and not the right to apply for additional shares offered by the company.
Ex-right price is quoted either after the right shares have already been allotted by the company or the time to apply for right shares has already expired. The cum-right price is higher than the ex-right price of the shares since the former includes the value of the right also.
The value of the right can be calculated by applying the following procedure:
1. Calculate the total market value of shares which an existing shareholder is required to have in order to get fresh shares.
2. Add to the above price the amount paid to the Company for the fresh shares.
3. Find out the average.
4. Compare the average price with the market price and find out the difference. The difference is called the value of right.
Value of Right = Right Shares/Total Shares x (Cum- right Market Price – Issue Prices)
OR = Market Prices – Issue Prices/[No. of old shares required for one right share] + 1
Advantages of Rights Issue:
The following advantages may derive from Rights Issue:
1. The price of shares offered under Rights Issue is usually much less than the market price.
2. The cost of issuing such shares is very low.
3. The control of the Company is retained in the hands of the existing share-holders.
4. It increases the goodwill of the Company.
5. The Directors cannot misuse the opportunity of issuing new shares to their friends and relatives at low price.
6. It reflects the sound financial position of the Company.
7. The Company can dispose of its shares easily.
A Company offers to its existing equity shareholders the right to buy one share of Rs. 10 each at Rs. 12 for every three shares held. The cum rights quotations in the market for the company’s shares are Rs. 18. Calculate the value of rights.
X Co. Ltd. which has been in existence for 10 years, decide to increase its share capital by the issue of additional shares to the existing share-holders in proportion of one new share for every five shares held. The cum-right market price of a share is Rs. 300 at the time of announcement of the right issue. The price at which a new share is offered is Rs. 150 including Rs. 50 premium. What is the value of right?