Charge in Accounting

Definition of Charge in Accounting

In accounting and financial contexts, a charge refers to a legal or equitable interest in property or company assets granted to secure a debt. This charge gives the creditor, known as the chargee, the rights to the proceeds from the sale or income of the secured assets, ahead of other claims made by unsecured creditors.

Types of Charges

Fixed Charge: This is a charge that attaches to specific, identifiable assets, such as property, machinery, or equipment. Once a fixed charge is in place, the company cannot sell or deal with the charged assets without the consent of the chargee (creditor). This type of charge offers stronger security to creditors.
Floating Charge: Unlike a fixed charge, a floating charge hovers over all of the company’s assets and is not tied to any specific asset. It becomes a fixed charge upon a ‘crystallization event,’ such as the company entering liquidation. Prior to crystallization, the company can freely use and dispose of the assets.

Examples of Charge

Land Charge: A mortgage or lien placed on a property to secure a loan. The lender (chargee) can claim proceeds from the property’s sale to repay the loan.
Debenture: A type of charge wherein a bond issued by a company is secured against the company’s assets rather than specific physical assets.
Share Charge: A company member or shareholder might charge their shares to secure a debt owed to a third party, either through a transfer agreement or by depositing the share certificate.

Frequently Asked Questions (FAQs)

1. What is the purpose of creating a fixed charge?

A fixed charge is created to secure a creditor’s interest in specific assets, ensuring that the creditor has priority access to those assets or their proceeds over other unsecured creditors in case of default or liquidation.

2. How does a floating charge differ from a fixed charge?

A floating charge is not attached to any specific asset initially and allows the company to deal with its assets freely. It becomes a fixed charge upon certain events like liquidation. In contrast, a fixed charge is tied to specific assets from the beginning and restricts the company’s ability to dispose of those assets.

3. What is crystallization in the context of a floating charge?

Crystallization is the event that converts a floating charge into a fixed charge, usually triggered by the company’s liquidation or other stipulated circumstances.

4. Who is a chargee?

A chargee is the creditor in whose favor a charge is created, giving them the right to claim payment from the income or proceeds of the charged assets.

5. Can shares be subject to a charge?

Yes, shares can be charged by depositing share certificates or through transfer agreements to secure debt.

6. What is a debenture?

A debenture is a type of debt instrument that is secured against the assets of a company. It does not stipulate any specific asset but rather the general assets of the company.

7. What happens to fixed and floating charges in liquidation?

In liquidation, fixed charge holders are paid before preferential creditors, who are then paid before floating charge holders.

8. What is a lien in respect of unpaid calls?

A lien in respect of unpaid calls allows a company to retain possession of shares as security for the unpaid amounts owed by shareholders.

9. Are all charges required to be registered?

Yes, most charges must be registered with the relevant authority, such as the Registrar of Companies, to be enforceable.

10. What are preferential creditors?

Preferential creditors are those who have priority over other unsecured creditors for repayment, often including employees owed wages and certain taxes.

Debenture: A long-term security yielding a fixed rate of interest, issued by a company and secured against assets rather than specific property.
Crystallization: The process by which a floating charge becomes a fixed charge.
Registrar of Companies: The authority responsible for registering charges and overseeing company compliance.
Preferential Creditor: A creditor who has preferential access to payment from the assets of a bankrupt or liquidated entity.
Lien: The legal right to keep possession of property belonging to another person until a debt owed by that person is discharged.

Online Resources

Suggested Books for Further Studies

“Principles of Corporate Finance” by Richard A. Brealey, Stewart C. Myers, and Franklin Allen - A comprehensive guide on corporate finance including in-depth discussions on charges and other financial instruments.
“Financial Accounting and Reporting” by Barry Elliott and Jamie Elliott - Offers clear explanations on various accounting principles, including the treatment of charges.
“Advanced Accounting” by Joe Ben Hoyle, Thomas Schaefer, and Timothy Doupnik - Provides detailed insights into complex accounting topics, including secured debts and charges.

Accounting Basics: “Charge” Fundamentals Quiz

### What is a fixed charge? - [x] A charge attached to specific identifiable assets. - [ ] A charge that floats over a company’s general assets. - [ ] A charge that applies only to personal property. - [ ] A type of debt with no specific security. > **Explanation:** A fixed charge is one that attaches to specific, identifiable assets, such as property or equipment, securing the interests of the creditor. ### When does a floating charge crystallize? - [ ] Annually - [ ] Only during an accounting audit - [x] Upon a significant event, like company liquidation. - [ ] When the company reaches a certain profitability level > **Explanation:** A floating charge crystallizes, or converts to a fixed charge, upon a specified event such as the company entering liquidation. ### Who has the priority in repayment during liquidation? - [ ] Floating charge holders before fixed charge holders - [x] Fixed charge holders before preferential creditors - [ ] Preferential creditors before fixed charge holders - [ ] Unsecured creditors before all others > **Explanation:** During liquidation, fixed charge holders are paid before preferential creditors, who are then paid before floating charge holders. ### Which is an attribute of a floating charge? - [ ] Immediately attaches to a specific asset - [ ] Restricts company dealings with its assets - [ ] Does not need to be registered - [x] Floats over company’s current and future assets > **Explanation:** A floating charge initially "floats" over the company’s assets and does not attach to any specific asset until crystallization. ### Can shares in a company be used to create a charge? - [x] Yes, through share deposits or transfer agreements - [ ] No, shares cannot be used for this purpose - [ ] Only when a fixed charge exists - [ ] Only in large corporations > **Explanation:** Shares can indeed be charged to secure a debt either by transferring ownership or depositing share certificates as collateral. ### What is the primary purpose of creating a charge? - [ ] To freely dispose of assets - [ ] To avoid taxes - [x] To secure the payment of money owed to creditors - [ ] To increase shareholder value > **Explanation:** The primary purpose of creating a charge is to secure the payment of money owed to creditors, who gain a priority interest in the proceeds of charged assets. ### What document enforces most corporate charges? - [x] Registrar of Companies registration - [ ] Internal revenue service filing - [ ] State legislation - [ ] Issue of company shares > **Explanation:** Most charges must be registered with the Registrar of Companies to be enforceable and to establish priority. ### What must a company avoid to freely deal with a fixed charge asset? - [ ] Generating profits - [x] Disposing of or altering the secured asset without chargee consent - [ ] Expanding business operations - [ ] Increasing employee wages > **Explanation:** A company must avoid disposing of or significantly altering a fixed charge asset without the consent of the chargee. ### What typically triggers the crystallization of a floating charge? - [x] Insolvency or other specified events - [ ] Signing a new business contract - [ ] Quarter-end financial review - [ ] Changing board members > **Explanation:** Insolvency or other stipulated events like the company's liquidation usually trigger the crystallization, converting the floating charge to a fixed charge. ### Who ensures the registration of charges? - [ ] The company’s HR department - [x] The Registrar of Companies - [ ] The marketing team - [ ] External audit firms > **Explanation:** The Registrar of Companies is responsible for ensuring that charges are registered, which validates and enforces the priority of those charges.

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