bg financial accounting 2 chapter 9 538

CHAPTER 9 STOCKHOLDERS’ EQUITY 9 1 Overview of equity 9 2 Share Capital 9 3 Reserves in Business 9 4 Dividend 9 5 Presentation and Disclosure FINANCIAL ACCOUNTING 2 64 CHAPTER 9 STOCKHOLDERS’ EQUITY O[.]

CHAPTER 9 STOCKHOLDERS’ EQUITY

9.1 Overview of equity 9.2 Share Capital

9.3 Reserves in Business 9.4 Dividend

9.5 Presentation and Disclosure

FINANCIAL ACCOUNTING 2

64

CHAPTER 9 STOCKHOLDERS’ EQUITY

OBJECTIVE: After studying this chapter, you should be able to:

 Identify types of equity

 Recognition and accounting for shares and other reserves in business

 Identify types of dividends and accounting treatment for dividends

 Understand the requirement of disclosure of Equity

FINANCIAL ACCOUNTING 1

65

9.1 Overview of equity

9.1.1 Types of organization 9.1.2 Types of equity

Types of business organisation

Limited liability companies

6.2018 MAI ANH PHAM, ACCA, MCs

67

9.1.1 TYPES OF ORGANIZATION

Types of business

Limited liability companies:

incorporate to take advantage of : limited

liability

Sole trader: who work for themselves

Partnerships: two or more people decided

to share the risks and

rewards

6.2018 MAI ANH PHAM, ACCA, MCs

• equity capital is represented simply by ‘capital’

• A company's equity is introduced by an individual, called sole trader or owner (proprietor).

• Any expenditures for owner’s personal purpose is treated as adrawing from equity

9.1.2 TYPES OF EQUITY

Equity in the Sole trader

• equity capital is represented by share capital and reserves

• A company's initial capital is divided into units of equal size, known as shares, issued to individuals or companies, called shareholders.

• The total capital raised is referred to as equity share capital.

• Ownership of a share entitles the shareholder to receive payment

of a share of profit, or dividend.

• By law, shares must have a par value

9.1.2 TYPES OF EQUITY

Equity in the Limited company includes: Share capital and Premium share, other reserves

• A partnership agreement contains the terms of the partnership, inparticular the financial arrangements between partners and howprofit/loss should be appropriated.

• Capital: Each partner puts in a share of the capital Anyminimum fixed amount should be stated

• Drawings Partners can withdraw profits from the business justlike sole traders

• Profit-sharing ratio (PSR) Partners can agree to share residualprofits and losses after interest and salaries in any profit-sharingratio they choose

9.1.2 TYPES OF EQUITY

Equity in the Partnership

9.2 Share Capital

9.2.1 Types of shares

9.2.2 Accounting for share capital

Equity – Share capital

Ordinary share

Issued and called-up share capital

•The issued share capital of a company is the par value of the

shares that have actually been issued to shareholders

•If a company issues shares but 'calls up' the issue amounts ininstalments, instead of raising cash immediately, it then has

called-up share capital that is less than its issued share capital.

•If a company has called-up share capital, but is waiting for

payment from some shareholders, it has paid up capital of less

than its called-up capital

9.2.1 TYPES OF SHARE

Equity - Preference shares

Irredeemable and redeemable preference shares

• Preference shares which the company is not entitled to buy back

or redeem at some stage in the future, known as irredeemable preference shares, are treated as share capital.

• Preference shares which the company is entitled to buy backfrom its shareholders or 'redeem' at some future time are called

redeemable preference shares, treated as non-current liabilities (debt capital).

9.2.1 TYPES OF SHARE

Right issues

 A rights issue provides a way of raising new share capital by means of an offer

to existing shareholders, inviting them to subscribe cash for new shares in

proportion to their existing holdings.

 Advantages of a rights issue:

 Rights issues are cheaper than IPOs to the general public

 Rights issues are more beneficial to existing shareholders than issues to the general public (as right issues usually at a discount to market price)

 Relative voting rights are unaffected if shareholders all take up their rights

 The finance raised may be used to reduce gearing in book value terms

9.2.1 TYPES OF SHARE

Stock split

 A stock split simply involves the division of existing shares into smaller denominations, making the share capital more marketable

 A stock split does not raise extra cash

 There is possibly an added psychological advantage, in that investors may expect a company doing stock split is to plan for substantial earnings growth in future

Ex : if one existing share of $1 has a market value of $6, and is then split into two shares of 50c each, the market value of the new shares might settle at, say, $3.10 instead of the expected $3,

in anticipation of strong future growth in earnings and dividends

9.2.1 TYPES OF SHARE

SHARE REPURCHASE

Purchase by a company of its own shares can take place for various reasons and must be in accordance with many requirements of legislation.

1 Finding a use of surplus cash, this may be

a ‘dead assets’.

2 Increase in earnings per share EPS

through a reduction in the number of shares

in issue.

3 preventing a takeover or enabling a

quoted company to withdraw from the

stock market.

5 Increase in gearing ratio

1 It can be difficult to choose a price that will be fair both to the vendors and to any shareholders who are not selling shares to the company.

2 as a signal that the company can not make better use of funds than the shareholders.

3 Some shareholders may suffer from being taxed on capital gains following the purchase of their shares rather than receiving dividend income.

9.2.1 TYPES OF SHARE

Equity - Accounting for preference share

When shares are issued at their par value and they are fully paid:

When shares are issued at a premium to their par value, and the full

CREDIT Share premium (excess over par value) X

When shares are issued at their par value but an amount remains uncalled

by the company

CREDIT Preference share (called-up amount of issued

shares)When shares are issued and called-up at their par value but an amount remains X

Other receivables (unpaid capital) X

9.2.2 ACCOUNTING FOR SHARE CAPITAL

Equity – Right issue

Accounting treatment

Amounts from retained earnings and share premium may be reclassified as share capital in a bonus issue: DEBIT:

Share premium

DEBIT: Retained earnings

CREDIT: Share capital

9.2.2 ACCOUNTING FOR SHARE CAPITAL

9.3 Reserves in Business

9.3.1 Types of reserves

9.3.2 Accounting for Retained earning 9.4.3 Accounting for other reserves

9.3.1 TYPES OF RESERVES

A company might have a number of different reserves, each set

up for a different purpose, including the following which are

examinable in Accounting:

 retained earnings

 share premium

 other reserves

These are profits earned by the company and not appropriated

by dividends, taxation or transfer to another reserve account

Provided that a company is earning profits, this reserve generally increases from year to year, as most companies do not distribute all their profits as dividends Dividends can be paid from it: even if

a loss is made in one particular year, a dividend can be paid

from previous years' retained earnings

(a) Statutory reserves, which are reserves which a company is

required to set up by law, and which are not available for the

distribution of dividends

(b) Non-statutory reserves, which are reserves consisting of profits which are distributable as dividends, if the company so wishes.Statutory reserves are capital reserves (share premium,

revaluation) and non-statutory reserves are revenue reserves

Other reserves

DEBIT Retained Earning

CREDIT Other Reserves

9.3.3 ACCOUNTING FOR OTHER RESERVES

9.4 Dividend

9.4.1 Types of Dividends

9.4.2 Accounting for dividends

9.4.1 TYPES OF DIVIDENDS

• Dividends are appropriations of profit after tax

• Many companies pay dividends in two stages during the course of their accountingyear

 (a) In mid-year, after the half-year financial results are known, the company mightpay an interim dividend

 (b) At the end of the year, the company might propose a further final dividend

• The total dividend to be included in the financial statements for the year is the sum

of the dividends actually paid in the year

• At the end of an accounting year, a company's managers may have proposed afinal dividend payment, but this will not yet have been paid The proposeddividend does not appear in the accounts but will be disclosed in the notes inaccordance with IAS 10 Events after the reporting period

9.4.1 TYPES OF DIVIDENDS

-Dividends by cash

The terminology of dividend payments can be confusing, since they may beexpressed either in the form, of 'x cents per share' or of 'y% In the latter case, themeaning is always 'y% of the par value of the shares in issue'

For example, suppose a company's issued share capital consists of 100,000 50cordinary shares which were issued at a premium of 10c per share

The company's statement of financial position would include the following:

Scrip issue (bonus issue)

 A scrip issue occurs when a company issues new shares to exisiting shareholders in proportion to their existing holdings at

no charge The issue is made out of reserves.

 The different between a stock split and a scrip issue is that

scrip issue converts equity reserves into share capital, whereas

a stock split leaves reserves unaffected.

 An issue of fully paid shares to existing owners, free of charge,

in proportion to their existing shareholdings.

 A bonus issue does not involve any cash inflow for the company The company converts some of its reserves (share premium or retained earnings or both) into new fully-paid share capital issued at its par value

9.4.1 TYPES OF DIVIDENDS

Dividends by cash

When dividend is declared:

Debit Retained Earning

Credit Dividend payable

When dividend is paid:

Debit Dividend payable

Credit Cash

9.4.2 ACCOUNTING FOR DIVIDENDS

Bonus issue

Accounting treatment

The double entry for the par value of the bonus shares issued is:

DEBIT: Share premium OR retained earnings (OR both)

CREDIT: Share capital

The balance on share premium cannot (by law) be paid to owners as dividends There are only a few transactions that can ever reduce share premium One of these is a bonus issue of shares.

In general, you should assume that a company uses the share premium account as fully as it can before using retained earnings, unless told otherwise

9.4.2 ACCOUNTING FOR DIVIDENDS

9.5 Presentation and Disclosure

In the statement of changes in equity