Forfeited Shares

When a shareholder doesn't adhere to a set of conditions or restrictions, the issuing corporation can cancel their shares, known as forfeited shares. As a result, the shareholder will no longer have a balance due and will no longer be able to realize capital gains on their claims.

When a person does not comply with the purchase requirements, such as when the allotment money or call money is not paid.

When the shares are sold or transferred during the restricted period or when other conditions apply, the company may, with the board of directors' approval, cancel or forfeit that person's shares.

Investor shares are forfeited due to broken conditions in the purchase agreement, such as failure to pay call money within the company's specified time frame. Again, it is possible to proceed only with the board of directors' consent.

Examples 

If a shareholder fails to uphold the terms of their purchase agreement, the corporation's board of directors may cancel any forfeited shares. 

You lose ownership when your shares are forfeited; therefore, you are no longer eligible to receive dividends and capital gains. However, you will also have any remaining balance canceled.

A stock subscription agreement is one circumstance where shares might be liable for Forfeiture. When a firm enters into this kind of agreement, it consents to sell and issue its stock ahead of time; payments could be made in several installments.

However, the corporation's board of directors has the authority to revoke the shares if the shareholder fails to make the agreed-upon payments.

Additionally, employee stock option plans (ESOPs) frequently contain these shares. Through ESOPs, employees can purchase a set number of shares at a defined price.

These plans frequently adhere to a vesting schedule, which specifies how long an employee must work for a company before becoming fully entitled to benefits.

A portion or all of an employee's shares may be forfeited if they leave their position or are fired before reaching full vesting.

Generally, you must adhere to the T+2 timetable when purchasing shares with a cash account. Therefore, you will have the trade date plus two days to complete your transaction.

You won't receive your shares, and the brokerage firm is normally forced to freeze your account for 90 days if you don't deposit enough money to cover the T+2 trade.

You will forfeit any stock you got, even if it isn't legally Forfeiture; in some circumstances, you might be given an extension to pay for the purchase.

Procedure for Forfeiture of shares

The most likely circumstance in which you might experience share loss is an ESOP. An offering corporation must adhere to one of two minimum vesting schedules. (Minimum) indicates that these are the tightest criteria the organization can set.

If a company's standards are less strict, it may adopt an alternative vesting timetable.

• In the first years, there is no vesting; after three years of service, there is full vesting. If you left your job after two years, you'd forfeit all of your shares.
• After the completion of the second year of service, employees can vest 20% per year until they have 100% of their rights by the end of the sixth year.

In this case, if you quit your work after two years, you would forfeit the remaining 80% of your shares while keeping 20% of them.

Your corporation cannot ask you to give up your shares once you've satisfied the vesting conditions. As with any stock you possess, you have the option to sell or hold them.

Typically, a year of service is defined as a plan year during which the employee worked at least 1,000 hours. You normally have 90 days to vest your stock before it becomes forfeited if you decide to quit the company after your shares have vested.

Key executives' success may occasionally be linked to their stock remuneration. The employee might have to give up their shares if they don't achieve a set of objectives.

After falling short of performance goals, former GameStop CEO George Sherman lost more than 587,000 company shares in April 2021.

This amounted to a loss of more than $80 million in equity at the time of his Forfeiture, based on the corporation's closing share price of $141.09.

Shares surrendered by a shareholder become the issuing company's property. After that, the corporation may reissue such shares. Unvested shares forfeited by an employee are normally transferred to the remaining participants.

Occasionally, the corporation may be able to use it for office costs.

Forfeiting shares results in the termination of the shareholder's rights and the payment made. As a result, there are particular requirements for share forfeiture.

• Articles of Association

• Share forfeiture must take place by the rules outlined in the articles of the organization.

• Proper Notice - The defaulting shareholders must get a proper notification specifying the amount due, and the notice must be delivered at least 14 days before the payment deadline.

The notice's goal is to give shareholders time to pay off the call money and any associated interest so that the shares won't be forfeited.

• Resolution by Board of Directors - If the shareholders fail to make the required payments despite receiving a valid notice, the board of directors may take the following action.

• Can adopt a resolution forfeiting the shares.

Share forfeiture

As it is well known, if the calls are not paid, the corporation may forfeit shares, but there are certain steps that the corporation must take before going for any further action, as may be discussed ahead.

Before Forfeiture, the corporation must first provide the defaulting shareholder a clear 14-day notice that he must pay the overdue amount plus interest.

Shares must be paid for before the deadline, or they will be forfeited. If the shareholder is still delinquent, the corporation may lose the shares by adopting the necessary resolution.

We must cancel shares in the event of Forfeiture, which reduces share capital to some extent. The sum that the business received is not reimbursed.

The sum of the Shares forfeited account is added to paid-up capital under Subscribed Capital in the Notes to Accounts on "Share Capital" until the corporation reissues the shares.

We list it within the Equity and Liabilities section of the balance sheet because it is part of the shareholder funds.

Journal Entries

The corporation may issue shares that were forfeited at par or at a premium. Depending on the circumstance, different accounting entries will be made for forfeiture.

1. When Shares Issued at Par Become Forfeited

• The sum called up until the date of Forfeiture on shares is, in this case, deducted from the share capital account by the corporation.

• The money called up on shares but owed from the shareholders is credited to the Shares Allotment Amount or Shares Call Account. We credit the Calls-in-Arrears Account if it is being kept up to date.

By receiving payment for the shares that were forfeited, the corporation credits the Forfeited Shares Account.

Forfeiture of shares is recorded in the journal as

Instead of crediting the "Shares Allotment Amount" and "Shares Call Account," if we maintain a Calls-in-Arrears Account, we shall do so.

This will be noted in the journal as

2. Shares that were initially issued at a premium must be forfeited.

There are two possibilities when shares that were issued at a premium are forfeited:

a. Amount of the Securities Premium has been received:

In this scenario, the amount called up will be deducted from the Share Capital Account.

It will also be credited to the accounts for Forfeited Shares (amount received less premium), Shares Allotment (amount not received on allotment), First Call (amount not received on calls), and Final Call in the same way.

The Journal entry will read:

b. The Securities Premium amount is still outstanding:

In this instance, the amount called up will be deducted from the Share Capital Account. We will deduct Securities Premium to cancel it if it has not been received.

In the same way, we will credit the accounts for Forfeited Shares (amount received less premium), Shares Allotment (amount not received on allotment), First Call (amount not received on calls), and Final Call.

Example of Share Forfeiture Solved

Give a journal note for the following under "Forfeiture of Shares."

1. At a premium of $2 per share, ABC Ltd. issued 10,000 equity shares of $10 each. The payment is due in three installments: $4 per share upon application, $5 per share (including premium) upon allotment, and $3 per share upon the first and last calls.

Gaurav is granted 200 shares by the corporation.

Case 1: The corporation forfeits Gaurav's shares if he fails to pay the allocation fee and then fails to pay the first and last call.

Case 2: If Gaurav doesn't pay the first and last call, his shares are forfeited to the corporation.

2. XYZ Ltd. issued 5,000 equity shares of 10 dollars each at par, payable as 2 dollars per share upon application, 3 dollars per share upon allocation, 3 dollars per share upon first and final call, and 2 dollars per share upon second and final call.

Ashish is granted 40 shares by the corporation.

Case 1: If Mr. Ashish fails to pay the allotted fee and the business loses his shares.

Case 2: The corporation forfeits Mr. Ashish's shares if he doesn't pay the first call and the subsequent final call.

Solution 

1. Journal entries IN THE BOOKS OF ABC LTD.

2. Journal entries IN THE BOOKS OF XYZ LTD.

Accounting treatment of Forfeited Shares

The issuing corporation acquires ownership of these shares and is free to reissue them at par, at a premium, or at a discount (at a price below their nominal value). 

The board of directors of a firm has the authority to make this choice, and it typically reissues it at a discount.

The maximum discount for the reissued stock, however, is the amount forfeited on the shares if the shares were initially issued at par.

The board may also if permitted by the articles of association of the firm, reissue it to a third party but not to the defaulting shareholder.

The cancellation of shares owing to unpaid calls is referred to as Forfeiture of shares. However, the corporation can only lose shares if the company's articles of association permit it.

The firm may use its authority to forfeit the shares on which a shareholder cannot pay the amount of the call if they are unable to do so.

The corporation has two alternatives when shares are forfeited; either they can sell the shares, or they can be issued again. The entries for reissuing these shares at par, premium, and discount are as follows:

1. If the reissue is at par

2. If the reissue is at a premium

3. If Reissue is at Discount

It is critical to realize that while shares can only be issued at par or premium, they can also be reissued at a discount by using the proceeds of share forfeiture.

4. Transfer of balance share forfeiture to Capital Reserve

Transferred to the Capital Reserve A/c is the sum obtained from the aforementioned calculation less the Share forfeiture amount applied in the event of a reissue at a discount.

Effects of Share Forfeitures

• Membership Termination - The shareholder whose shares are forfeited is no longer a shareholder of the company, and his name is removed from the register of shareholders.

An individual whose shares have forfeited no longer qualifies as a member of those shares. It has been stated in the Companies Act of 2013's regulation 32(1) of Table F of Schedule 1.

• Liability Termination - Following the Forfeiture of the shares, the member's obligation to pay future calls comes to an end.

The person can appear in the company's books as a standard debtor rather than a contributing, but they are still responsible for paying the company any outstanding call money.

When the firm obtains complete payment of all such money in respect of shares forfeited, the obligation of the owner of these shares is discharged. This is stated in Table F's Regulation 32(2).

As a result, even after the loss of shares, the obligation to pay calls continues.

• Liability as a Past Member - A person whose shares are forfeited may be regarded as a List B contributory if the firm enters liquidation within a year of the share loss.

If the firm is dissolved within a year following the Forfeiture, the former shareholder's obligation to pay calls continues as an obligation of a former member.

Forfeiture of employee stock

Companies occasionally offer employee stock purchase schemes, allowing workers to use a portion of their pay to buy shares of the company's stock at a discount. These programs, however, frequently have limitations.

A stock frequently cannot be transferred or sold after the initial acquisition for a specific amount of time.

Additionally, if an employee leaves the company before a predetermined required waiting period, he can be required to give up any shares he bought.

On the other hand, if an employee stays with the company for a predetermined amount of time, he is completely entitled to those shares and is free to cash them in.

If the corporation reissues shares that were forfeited by an employee via an employee stock purchase plan, the employee might never again be eligible to receive those shares.

Example

Companies encourage employee loyalty via stock purchase programs. In a similar spirit, businesses provide bonuses to workers in the form of restricted stock units that are gradually distributed over time.

An employee might get 80 restricted stock units as part of their annual bonus, for instance. However, the stock vests over five years, with the first 20 units becoming fully vested in the second year after the bonus, 20 more in the third, 40 in the fourth, and 60 in the fifth.

Only 20 of the stock units would vest if the person left their position after the second year; the remaining 60 would be forfeited.

Researched and authored by Deeksha Pachauri | LinkedIn

Reviewed and edited by Priyansh Singal | LinkedIn

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