Question

Several theories try to explain and defined equities but lead to different application in accounting, explain these theories and some applications in accounting? Use equity components in your explanation to define equity and its main characteristics?

Answer 1

Equity represents the shareholders' stake in the company, identified on a company's balance sheet. The calculation of equity is a company's total assets minus its total liabilities, and is used in several key financial ratios such as ROE.

Shareholders are the real owner of the company

Equity means money of some other person at risk that is the reason , profit and loss as the case may be are high , the risk appetit has to be high for dealing in stock ma

Characteristics of equity

Equity Shares: Characteristic # 1. Maturity:

Equity shares provide permanent capital to the company and cannot be redeemed during the life time of the company. Under the Companies Act, 1956, a company cannot purchase its own shares. Equityshareholders can demand refund of their capital only at the time of liquidation of a company. Even at the time of liquidation, equity capital is paid back after meeting all other prior claims including that of preference shareholders.

Equity Shares: Characteristic # 2. Right to Income:

Equity shareholders have a residual claim on the income of a company. They have a claim on income left after paying dividend to preference shareholders. The rate of dividend on these shares is not fixed; it depends upon the earnings available after paying dividends on preference shareholders.

In many cases, they may not get anything if profits are insufficient; or may get even a higher rate of dividend. That is why, equity shares are also known as ‘variable income security’. Even if the company is left with sufficient profits after meeting all obligations including that of preference shareholders, equity shareholders cannot legally force the company to pay dividends to them.

The distribution of income as dividend to equity shareholders is left to the discretion of the Board of Directors of the Company under the Companies Act, 1956. But, even when the residual income is not distributed to equity shareholders by way of cash dividends, they stand to benefit in future by way of enhanced earning capacity of the company resulting in higher dividends in future as well as capital appreciation.

Equity Shares: Characteristic # 3. Claim on Assets:

Equity shareholders have a residual claim on ownership of company’s assets. In the event of liquidation of a company, the assets are utilised first to meet the claims of creditors and preference shareholders but everything left, thereafter, belongs to the equity shareholders. Thus, equity shares provide a cushion to absorb losses on liquidation and may, usually, remain unpaid.

Equity Shares: Characteristic # 4. Voting Rights:

ADVERTISEMENTS:

Equity shareholders are the real owners of the company. They have voting rights in the meeting of the company and have a control over the working of the company. The control in case of a company rests with the Board of Directors who is elected by the equity shareholders. Directors are appointed in the Annual General Meeting by majority votes.

Each equity share carries one vote and a shareholder has votes equal to the number of equity share held by him. Hence, equity shareholders exercise an indirect control over the working of the company. But, often, such indirect control is weak and ineffective because of the indifference of most of the shareholders in casting their votes.

Equity Shares: Characteristic # 5. Pre-emptive Right:

To safeguard the interest of equity shareholders and enable them maintain their proportional ownership, section 81 of the Companies Act, 1956 provides that whenever a public limited company proposes to increase its subscribed capital by the allotment of further shares, after the expiry of two years from the formation of the company or the expiry of one year from the first allotment of shares in the company, whichever is earlier, such shares must be offered to holders of existing equity shares in proportion, as nearly as circumstances admit, to the capital paid up on these shares. Shares so offered to existing shareholders are called Right Shares and their prior right to such is known as pre-emptive right.