Using share premium account to set off loss

Indian Overseas Bank (IOB) said its board had approved using the ₹7,650 crore in its share premium account to write off accumulated losses worth ₹6,978.94 crore. Here is all you need to know about it:

What is the share premium account?

The amount under share premium account represents the additional amount shareholders of a company pay on the face value (original cost) of the shares. If a firm issues one lakh shares at a face value of ₹1 but the purchase price is ₹10 per share, then its share premium account will have a balance of ₹9 lakh. Investors pay a premium to buy shares of the company based on their estimation of its future prospects.

In the financial statement of a firm, where does share premium account fit in?

The share premium account appears on the liability side of a firm’s balance sheet after share capital (funds raised by issuing shares).

Another important head is reserves and surplus which includes a portion of the profits the company has accumulated and retained overtime. A company’s share capital, share premium plus the reserves and surplus accounts form shareholders equity.

Why is IOB’s move to use share premium account to set off losses unusual?

According to Amarjit Chopra, past president, Institute of Chartered Accountants of India, the provisions of the Banking Regulation Act allow the share premium account to be used for setting off losses, provided due procedure is followed and approvals are given. In normal course of business, losses are set off against profits. In the absence of profits, losses are set of against reserves. Share premium is generally used for issue of bonus shares, buyback of shares and setting off some preliminary expenses.

Possible reasons for IOB to have taken such a step

IOB has been in a difficult financial position due to its mounting non-performing assets’ situation and the government, which owns 82.41% stake, has imposed strict conditions on the bank for giving further capital. One of the conditions is cutting down losses and shedding non-core assets.

IOB has also been put under RBI’s prompt corrective action framework, greatly limiting its lending ability. Under the circumstances, IOB has opted for using the share premium account to write off the losses, which does not involve any cash outgo or change in shareholding pattern.

Alpesh Mehta, deputy head, research, Motilal Oswal Securities, said the move would impact the capital adequacy ratio of IOB and increase its chances of getting higher capital from the Centre.

What are implications of such a move?

Mr. Chopra points out the move amounts to reduction in capital and is a worrisome trend. With more than 50% of listed public sector banks under prompt corrective measure, many of them are likely to follow suit. It is unfair on part of shareholders who pay premium to buy shares of the company, he added.

Shriram Subramanian, founder and managing director, InGovern Research Services, a proxy advisory firm pointed out that the move comes at the cost of shareholders. He also noted that while this is one-off, there is no guarantee that there won’t be any bad loans in the future. Shareholders can gain provided that the bank turns around after the move and grows.

Link: The Hindu- January 07, 2018