Accounting for Forfeited Shares
Forfeited shares are the share that the issuer can cancel when the holders are unable to make subsequent payments. This payment is a part of the agreement when investors purchase the shares. It is the obligation that investors must follow, otherwise, they lose ownership over the shares.
Shares are forfeited means the owner fails to fulfill their obligation regarding the agreed payment term. The company will revert back the share and the previous owner will lose all money that they have invested, it includes the initial payment and capital gain.
Forfeited Shares usually apply to the employee and the company allows them to pay installments depending on their salary. The company wants to use the condition to prevent the employee from resigning.
The company can forfeit shares unless they have stated the policy in the article of association. And it must be aware by the investors. The company must inform the investors regarding their payment due date before canceling the share.
The company will need additional money from the investors while the operation cannot make enough cash flow. However, not all investors are able to put additional cash into the company. It is when the forfeited exist.
Process of Forfeited Share
The company needs to comply with the standard procedure in order to forfeit shares as it will result in the cancelation of shareholders’ rights and payments made. The company must follow the three steps followed:
- Article of Association: The forfeited share condition must be included in the company’s article of association.
- Notice: The company must give notice to the investors before share cancelation. The proper notice should be given 14 days before the due date. So the investors have enough time to prepare the payment.
- Resolution by Board of director: The company will arrange the board resolution to forfeit the share after the investor fails to make payment.
Forfeited Share Example
Mr. A purchases 10,000 shares from company ABC at $ 10 per share. Mr. A must pay an initial payment of 40% and the remaining will be paid in five annual payments. After inial payment, Mr. A has obligation to pay the remaining amount otherwise he will lose all the investment. In the 2nd year, Mr. A fails to make payment, so he loses the initial 40% and the payment at the end of the 1st year.
Forfeited Share Journal Entries
- If share issue at par value
| Account | Debit | Credit |
|---|---|---|
| Share Capital | 000 | |
| Share Forfeited | 000 | |
| Share Called account | 000 | |
| Share Allotment account | 000 |
Example: Company EFG issue 10,000 shares at $ 10 per share to Mr. B at par value. Mr. B has to pay 30% initial payment. However, he fails to pay the allotment 20% and the final 50%. The company decides to forfeit the share.
Paid amount = 10,000 share * $10 * 30% = $ 30,000
Fail Allotment amount = 10,000 share * $ 10 * 20% = $ 20,000
Fail called amount = 10,000 shares * $ 10 * 50% = $ 50,000
| Account | Debit | Credit |
|---|---|---|
| Share Capital | 100,000 | |
| Share Forfeited | 30,000 | |
| Share Called account | 50,000 | |
| Share Allotment account | 20,000 |
This transaction will remove the share capital which belongs to Mr. B as he fails to make payment and the company forfeited his share. At the same time, they need to credit other accounts depending on the amount.
- Share Issue at Premium, but not yet paid
| Account | Debit | Credit |
|---|---|---|
| Share Capital | 000 | |
| Share Premium | 000 | |
| Share Forfeited | 000 | |
| Share Called account | 000 | |
| Share Allotment account | 000 |
Example: Company XYZ decides to forfeit 10,000 shares with the following information:
- Share issue at $ 12, par value $ 10
- Investors have paid 50,000 in cash
- The premium is payable on the allotment
- Investors fail to pay allotment of $ 40,000 and the final $ 30,000
| Account | Debit | Credit |
|---|---|---|
| Share Capital | 100,000 | |
| Share Premium | 20,000 | |
| Share Forfeited | 50,000 | |
| Share Called account | 30,000 | |
| Share Allotment account | 40,000 |
This transaction is different from the above example due to the share premium. We need a debit share premium account as the share is issued about the par value. The difference between the issued price and par value is the premium. So it is separate in another account.
- Share Issue at Premium, already paid
| Account | Debit | Credit |
|---|---|---|
| Share Capital | 000 | |
| Share Forfeited | 000 | |
| Share Called account | 000 |
- Share Issue at Discount
| Account | Debit | Credit |
|---|---|---|
| Share Capital | 000 | |
| Share Forfeited | 000 | |
| Share Called account | 000 | |
| Share Discount | 000 |
When the company issues a price at a lower price compared to the par value, it is a discount. So when the company forfeited shares, they need to credit the share discount account to balance the transaction.