What is the Pro Rata Allotment of Shares?
Pro rata, in Latin means "in proportion." It's a catch-all phrase for any situation in which something is divided into parts proportional to people's total stake. To rephrase, "pro rata" means that each person receives an amount equal to their part of the total.
Shares are allocated pro-rata when the total number of shares requested is less than the total number of shares available. An oversubscription of shares pro rata allotment means the corporation will apply any additional funds to the application stage and subsequently to the calls. After allocation and applicant contact, the balance is returned. The firm promotes allocation in all major journals.
Meaning of Pro Rata for Allotment for Shares.
Pro rata Allotment of Shares Meaning
The Latin phrase "pro rata" is frequently used to indicate a fair distribution of resources. It implies roughly "in proportion," or via a system where everything being allotted is split fairly. For example, simple pro-rata allotment of shares meaning is allocating a certain sum to each recipient in proportion to their part of the total. A pro rata computation is helpful in commercial finance but may be used to establish fair shares of any sum. For example, the pro rata allotment of shares method is applied in the insurance industry to calculate the premium price for coverage that will only cover a portion of the term. Pro rata may also allocate the relevant percentage of a yearly interest charge for a short period.
What do you Mean by Allotment of Shares in Pro rata?
Explanation of Pro Rata Allotment of Shares with help of an Example
Understand the Pro rata Allotment with an Example.
To determine the pro rata share, three factors are used:
The total of verified, possessed, or incurred goods.
Its total amount in circulation (i.e. maximum quantity possible).
The allotted number of connected components is mentioned in the second key point.
Take the hypothetical case of a worker expecting a bonus of Rs 10,000 for the year. Even if the employee quits in the middle of the bonus period, they will earn their proportionate part. This is because they'll be leaving on March 20th. So the bonus is stipulated to be paid according to the number of days performed (including the last day).
The pro rata allocation may be found by dividing the actual quantity by the maximum allowable amount. The number of days worked corresponds to the number of instances of truth in this scenario. In a year without a leap day, the span from January 1 and March 20 consists of 79 days. Also, it's worth noting that 365 days seems to be the absolute limit.
Divide 79 by 365 to get 21.64, which is your proportionate share.
Multiply the proportional share with the associated factor to get the pro rata allocation. The proportional share is Rs 2,164 i.e., (Rs 21.64% x Rs 10,000).
Therefore in case the worker resigned on March 20th, the distribution would be Rs 2,164, which is dependent on the worker's prorated total number of days worked throughout the year.
Difference between an Oversubscription and An Under-subscription
Distinction between Oversubscription and Undersubscription
Read here to know the difference between oversubscription and under subscription:
In the case of oversubscription and pro rata, when more applications are received for securities than available shares, the offering is considered to be oversubscribed.
But in an undersubscribed case, the offering is considered undersubscribed if the demand for securities is lower than the supply.
For the approval, under oversubscribed, shares supplied are fewer than the subscribed. Consequently, some applications need to be denied. But in the case of undersubscribed, there will be no rejections of any applications submitted.
Oversubscribed occurs if investors have an optimistic outlook toward the firm's success in the coming years. Conversely, Undersubscribed happens when shareholders are pessimistic about the company's prospects.
Solved Question
Ques. Arihant Ltd. Co. gives out 100,000 shares of stock with a face value of 10 at a 20% premium on June 1, 2018. These are the ways you can pay:
June 1, 2018: On Application ₹2
July 1, 2018: On Allotment including Premium ₹7
September 1, 2018: On First and final call ₹3
The business gets requests for 285,000 shares. It takes care of them in the following ways:
Those who apply for 25,000 shares get them all.
Pro-rata, the people who asked for 2,25,000 shares get one share for every three shares they asked for.
It turns down the requests for 35,000 shares.
The company gets the full amount as it should. Pass necessary journal entries.
Answer: Journal Entries: In the books of Arihant Ltd.
Working Note
Summary
When there are more applications by potential purchasers of an enterprise's shares than shares offered to the public, this is known as an over subscription of shares. When demand exceeds supply, a corporation may decide to raise share prices and issue more shares to satisfy investors.
The corporation often does not take into account a candidate's repeated applications. As a result, businesses often use the third option. During the stage of share allocation, the issue of accounting for oversubscription is often settled.
FAQs on Oversubscription and Pro Rata: Explained
1. What is meant by an oversubscription of shares in the context of a company's IPO?
An oversubscription of shares occurs when a company receives applications for more shares than it has offered to the public for subscription. For instance, if a company offers 50,000 shares but receives applications for 70,000 shares, the issue is said to be oversubscribed by 20,000 shares. This situation typically indicates strong investor confidence and high demand for the company's stock.
2. What is pro rata allotment of shares, explained with a simple example?
Pro rata allotment is a method of assigning shares 'in proportion' when an issue is oversubscribed. Instead of rejecting excess applications, the company allots shares to every applicant in a fixed ratio.
Example: A company offers 1,00,000 shares and receives applications for 1,50,000 shares. The pro rata ratio is 1,00,000:1,50,000, or 2:3. This means for every 3 shares an investor applied for, they will be allotted 2 shares.
3. What is the key difference between oversubscription and under-subscription of shares?
The main difference lies in the demand versus supply of shares.
- Oversubscription: The number of shares applied for by the public is more than the number of shares offered by the company. This signals high investor interest.
- Under-subscription: The number of shares applied for is less than the number of shares offered. This suggests weak investor interest, and the company must secure at least 90% of the issue size (minimum subscription) to proceed with the allotment.
4. Is it compulsory for a company to use pro rata allotment during an oversubscription?
No, pro rata allotment is not compulsory. As per the Companies Act, 2013, a company's board of directors has three main options to handle oversubscription:
- Full Allotment to some, Rejection to others: Accept some applications in full and completely reject the others.
- Pro Rata Allotment: Allot shares to all applicants on a proportional basis.
- Combination of Both: A mixed approach where some applications are rejected, and the remaining applicants are allotted shares on a pro rata basis.
5. How is the excess application money treated in a pro rata allotment?
In a pro rata allotment, the excess application money received from applicants is not immediately refunded. It is adjusted in a specific order:
1. First, it is used to cover the amount due on Share Allotment.
2. If a surplus still exists after the allotment adjustment, it is carried forward to cover future calls, such as the First Call and Final Call. This is treated as a 'Calls-in-Advance'.
3. Any amount remaining even after adjusting for all calls is then refunded to the shareholders.
6. Why might investors choose to oversubscribe to a company's shares?
Investors often oversubscribe to shares for several strategic reasons, including:
- Strong Company Fundamentals: The company may have a strong financial track record, good reputation, and promising growth prospects.
- Anticipation of Listing Gains: Investors may expect the share price to rise significantly on the day it lists on the stock exchange, hoping to make a quick profit.
- Favourable Issue Price: The IPO price might be perceived as lower than the company's intrinsic value, making it an attractive investment.
- Positive Market Sentiment: A bullish or optimistic overall stock market can boost investor confidence and increase participation in IPOs.
7. How are journal entries for share application money adjusted in a pro rata allotment?
The key adjustment entry for pro rata allotment happens when application money is transferred. The excess application money is not refunded but is credited to subsequent calls. The combined journal entry on allotment is:
Share Application A/c Dr. (With total application money for allotted shares)
To Share Capital A/c (With face value of allotted shares)
To Share Allotment A/c (With excess application money adjusted towards allotment)
To Calls-in-Advance A/c (With any further excess adjusted towards future calls)
To Bank A/c (With any money that is refunded)
8. Can a company legally allot more shares than it offered in its IPO prospectus?
No, a company is legally prohibited from allotting more shares than the number stated in its IPO prospectus. The concept of oversubscription deals with managing excess demand for a fixed supply of shares. Even if applications are received for ten times the offered shares, the company can only allot the original quantity specified in the offer document. The management of excess applications is done through methods like pro rata allotment or rejection.
