What are Escrowed Shares?
Escrowed shares are securities that are maintained in a special type of account until a specific business transaction is completed. The special type of account is called an escrow account.
- Escrowed shares are shares that are transferred to an escrow account when certain financial transactions, such as mergers and acquisitions, restructuring, or bankruptcy of a company, are ongoing.
- The escrow account is managed by an escrow agent who helps both parties to achieve the terms and conditions of the transaction. The escrow account is usually a third party.
- An escrow protects all the parties involved in the transaction. The seller is protected by getting the money deposited in the account, while the buyer is protected by the escrow because it ensures that the goods have been delivered by the seller.
What is an Escrow Account?
An escrow account is a type of account where assets/funds are maintained when transactions like mergers and acquisitions, restructuring of the organization, or bankruptcy of the company are ongoing and until all prearranged conditions are satisfied. The party who maintains the said assets are called escrow agents.
Example of an Escrow Share Transaction
When a company issues shares to the public, in countries like India, the subscription of shares should be 90% and above. In such a case, the company will open an escrow account and deposit the money received from the investors in the account. After the issue of shares, if the total subscription is 90% and above, the investors will get the shares, else the money will be returned to them.
Example of an Escrow Account
Suppose Party A enters into a business transaction with Party B to sell goods for $1 million. The risks are that Party A does not get paid for the goods and Party B does not receive the goods. Hence, an escrow account is opened where Party B deposits $1 million into the escrow account, which guarantees payment to Party A upon delivery and receipt of the goods.
The above journal entry indicates that the escrow deposit made by Party B is an asset. It is because Party B doesn’t need to pay the money in the future. It can be treated as a prepaid expense for Party B.
Also, to fulfill the accounting equation, Asset = Liabilities + Equity, the cash account is credited, as shown below. It also fulfills the double bookkeeping rule of accounting – for a debit entry, there should be a corresponding credit entry.
When is an Escrow Helpful?
Below are instances when dealing in an escrow account is helpful:
1. Real estate transaction
Escrow is commonly used during the process of buying and selling a house. To provide confidence to the seller, the buyer put the value of the house in an escrow account.
The escrow account doesn’t just protect the seller; it also protects the buyer in case there is an issue in the transaction from the seller’s side. In such a case, the escrow will make the refund of the funds back to the buyer.
2. Equated monthly installments
When money is borrowed from the lender, the borrower is required to pay back the money in equal monthly installments. Therefore, to provide confidence to the lender that the borrower can pay the money back, the borrower is required to save a portion of the principal and interest amount in an escrow account until they become due.
Steps in the Escrow Process
- The buyer and seller enter into a transaction to buy and sell goods. Certain terms and conditions are set, which need to be agreed to by both parties.
- To provide comfort to the seller, the buyer transfers the amount of the transaction to an escrow account. The escrow agent then reviews the payment and confirms to the seller that the funds have been deposited.
- Once the payment notification is made, the seller must send the goods to the buyer and also provide the tracking information. The escrow agent must ensure that the buyer has received the goods.
- After receiving the goods, the buyer needs to check that the goods are in the same conditions as per the terms of the agreement. The buyer is given a set number of days to confirm the conditions.
- Once the escrow agent receives confirmation from the buyer, they then release the funds to the seller.
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