8/26/2008. Chapter 2 Financing company operations. Issue of shares. Key features of share capital. Prepared by Emma Holmes

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Chapter 2 Financing company operations Prepared by Emma Holmes Issue of shares A company can issue shares on any terms or conditions it determines Share capital may include different classes:

1 Chapter 2 Financing company operations Prepared by Emma Holmes Issue of shares A company can issue shares on any terms or conditions it determines Share capital may include different classes: Ordinary Preference To issue preference shares a constitution setting out the rights is necessary (s254a(2)) Shares can be issued at any price, payable in full or by instalment Key features of share capital Shares may have different rights in respect of voting, sharing in profits or return of capital Rights of shareholders include: The right to vote for directors of the company The right to share in assets on the winding-up/liquidation of the company The right to share in new share issues (for the same class of shares) Ordinary shareholders have no specific right to dividends. 1

2 Accounting for share issues The following slides contain a number of examples of the accounting process involved when a company issues new shares. Most of the following examples assume that shares are issued via an IPO Initial Public Offering /prospectus process. Such processes involve the shareholders applying for a number of shares in response to a prospectus issued by the company. The company will then issue the shares to new shareholders based on the applications it has received. Accounting for share issues Such share issues are accompanied by disclosure documents. Commonly the disclosure documents specify a minimum number of applications which must be received in order for the share issue to proceed. The Corporations Act requires: That the minimum subscription be achieved within 4 months of the issue of the disclosure document; and shares be allotted within 13 months of the issue of the disclosure document. Accounting for share issues On issuing new shares the company may require the full amount owing on the shares to be paid at the time of application. Alternatively it may require a portion to be paid on application, with the balance being due at some time in the future (on allotment and/or at call). There are a number of different account used to facilitate this application, allotment and call process. 2

3 Issue of shares Payable in full on application (Example 1) ABC issued a prospectus for the issue of 100,000 $5 shares on 1 January The prospectus specified that the $5 was payable in full on application. The company received applications for a total of 100,000 shares these applications were received throughout the month of January. On 31 January 2008 ABC issued 100,000 shares. Share issue costs of $1,500 were incurred by ABC. Required: Prepare the journal entries to account for the issue of shares by ABC. Issue of shares Payable in full on application (Example 1) 1-30 January 2008 Dr Cash trust 500,000 Cash account trust is used to record cash prior to the shares being issued - the cash is held in a trust account on behalf of the applicants Cr Application 500,000 Represents a liability of the company prior to the shares being issued To record receipt of application monies prior to issuing the shares (100,000 shares x $5) Issue of shares Payable in full on application (Example 1) 31 January 2008 Dr Application 500,000 Cr Share capital 500,000 Issue of shares applied for Dr Cash 500,000 Cr Cash trust 500,000 Transfer from cash trust on issue of shares Dr Share capital 1,500 Cr Cash 1,500 To record share issue costs Share issue costs are not expensed, but offset against the proceeds of the equity issue in accordance with AASB 132 3

4 Issue of shares Deposit on application, balance on allotment (Example 2) ABC issued a prospectus for the issue of 100,000 $5 shares on 1 January The prospectus specified that $3 was payable on application, with the balance payable on allotment. The company received applications for a total of 120,000 shares these applications were received throughout the month of January. The Directors decided to issue 5 shares for every 6 applied for, refunding the money in relation to unsuccessful applications. On 31 January 2008 ABC issued 100,000 shares. Required: Prepare the journal entries to account for the issue of shares and the subsequent receipt of allotment monies. Issue of shares Deposit on application, balance on allotment (Example 2) 1 January 2008 Dr Cash trust 360,000 Cr Application 360,000 To record receipt of application monies prior to issuing the shares (120,000 shares x $3) 31 January 2008 Dr Application 300,000 Dr Allotment 200,000 The allotment account is a temporary account used when further amounts are owing when shares are issued represents a receivable of the company Cr Share capital 500,000 Issue of shares applied for (100,000 shares x $5) Issue of shares Deposit on application, balance on allotment (Example 2) 31 January 2008 Dr Application 60,000 Cr Cash trust 60,000 Refund of application monies to unsuccessful applicants (20,000 shares x $3) Dr Cash 300,000 Cr Cash trust 300,000 Transfer from cash trust on issue of shares (100,000 shares x $3) Dr Cash 200,000 Cr Allotment 200,000 Cash received on allotment (100,000 shares x $2) 4

5 Issue of shares Deposit on application, instalment on allotment, balance on call (Example 3) ABC issued a prospectus for the issue of 100,000 $5 shares on 1 January The prospectus specified that $2.50 was payable on application, a further $1.25 was payable on allotment and the final $1.25 was payable at call. On 31 January 2008 ABC issued 100,000 shares. On 31 May 2008, the company made the call for the outstanding balance of $1.25 per share. The call was payable by 30 June At 30 June 2008, the call on 10,000 shares remained unpaid. Required: Prepare the journal entries to account for the issue of shares and the subsequent receipt of allotment monies. Issue of shares Deposit on application, instalment on allotment, balance on call (Example 3) 1 January 2008 Dr Cash trust 250,000 Cr Application 250,000 To record receipt of application monies prior to issuing the shares (100,000 shares x $2.50) 31 January 2008 Dr Application 250,000 Dr Allotment 125,000 Cr Share capital 375,000 Issue of shares applied for (100,000 shares x $3.75) Dr Cash 250,000 Cr Cash trust 250,000 Transfer from cash trust on issue of shares Issue of shares Deposit on application, instalment on allotment, balance on call (Example 3) 31 January 2008 Dr Cash 125,000 Cr Allotment 125,000 Cash received on allotment 31 May 2008 Dr Call 125,000 The call account is a temporary account used when further amounts are owing when a call is made represents a receivable of the company Cr Share capital 125,000 Call of $1.25 per share on 100,000 shares issued Balance of share capital a/c now $500,000 5

6 Issue of shares Deposit on application, instalment on allotment, balance on call (Example 3) 30 June 2008 Dr Cash 112,500 Cr Call 112,500 Cash received on allotment (100,000 10,000 = 90,000 shares x $1.25) At 30 June 2008 the balance in the call account is $12,500, representing $1.25 per share on 10,000 shares. Such unpaid calls are referred to as calls in arrears and are shown as a reduction of share capital in the company s financial statements. As such the balance in the share capital account at 30 June is as follows: Share capital (100,000 ordinary $5 per share) 500,000 Less: Calls in arrears (10,000 $1.25 per share) (12,500) TOTAL SHARE CAPITAL 487,500 Oversubscription The number of shares applied for may exceed the number of shares that the company has available for issue. In such cases the directors of the company may decide to: Reduce the number of share to be issued to each applicant (on a pro-rata basis) To issue shares only to certain applicants (eg on a firstin-first-served basis) The treatment of excess application monies depends on the terms of a company s constitution. Options include: Refunding excess application monies to unsuccessful applicants; or Retaining the excess application money as an advance on future calls The calls in advance account is treated as contributed equity even though it is legally a liability Oversubscription (Example 4) ABC issued a prospectus for 100,000 $5 shares on 1 January The prospectus required payment of $3 on application and $2 in one years time. The company received applications for a total of 125,000 shares these applications were received throughout the month of January. On 31 January 2008 ABC issued 100,000 shares. Required: Prepare the journal entries to account for the issue of shares assuming the excess money was offset against the call due in one years time. 6

7 Oversubscription (Example 4) 1-30 January 2008 Dr Cash trust 375,000 Cr Application 375,000 To record receipt of application monies prior to issuing the shares (125,000 x $3) 31 January 2008 Dr Application 375,000 Cr Calls in advance 75,000 (25,000 x $3) Cr Share capital 300,000 Issue of shares applied for and transfer of excess to calls in advance account Dr Cash 375,000 Cr Cash trust 375,000 Transfer from cash trust on issue of shares Forfeiture of shares Directors may be given the power under the company s constitution to forfeit (cancel) shares in respect of which calls are not made. Possible actions that can be taken in such circumstances are: 1. The balance of paid monies may be retained by the company. In this case the balance is retained in an equity account (Forfeited Shares Reserve) Forfeiture of shares 2. The amount paid may be refunded back to the forfeiting shareholder. In this case the balance is recorded in a liability account (Forfeited Shares Account). Prior to refunding the balance the company could reissue the shares as fully paid shares to new shareholders with the new shareholders paying less than the fully paid value of the share. The difference, as well as any costs of reissue are deducted from the amount to be refunded back to the forfeiting shareholders. This option is only available if the company s constitution states this fact. Where the constitution is silent, the company is entitled to keep any excess (option 1 above). 7

8 Forfeiture of shares (Example 5) This example continues on from example 3. On 1 July 2008 the directors of ABC decided to forfeit the 10,000 shares in respect of which the call of $1.25 was not made. The shares were cancelled and reissued as fully paid to $5 per share on payment of $4 per share. Costs of $500 were incurred to reissue the shares. Required: Prepare the journal entries to account for the forfeiture and re issue of the 10,000 shares. Forfeiture of shares (Example 5) 1 July 2008 Dr Share capital 50,000 (10,000 x $5) Cr Call 12,500 Cr Forfeited shares a/c 37,500 Cancel of forfeited shares (10,000 x $1.25) (10,000 x $3.75) Dr Cash 40,000 Dr Forfeited shares a/c 10,000 Discount of $1/share Cr Share capital 50,000 Re-issue of forfeited shares for $4 per share (10,000 x $5 - fully paid) Dr Forfeited shares a/c 500 Cr Cash 500 Costs incurred to reissue shares Dr Cash 2,000 12,500 10, Cr Forfeited shares account 2,000 Refund of balance to forfeiting shareholders Share issue and formation costs Underwriting costs: Arranging for the issue to be underwritten will avoid having to refund monies due to under-subscription Underwriter agrees to purchase all excess shares in return for an upfront payment of an underwriting commission Treated as a reduction against contributed equity Other share issue costs: Includes costs such as stamp duty, legal fees etc Treated as a reduction against contributed equity Formation costs: Treated as an expense 8

9 Contributed Equity - summary The contributed equity total shown on the Balance Sheet is the net of: $ Share Capital x Less Calls in Arrears (x) Add Calls in Advance x Less Underwriting commission (x) Less Share issue costs (x) Total share capital x Subsequent issues of shares Issued to raise funds to support expansion 1. RIGHTS ISSUE Offer of shares to existing shareholders Rights dependent on the number of shares held Rights may be renounceable or non-renounceable 2. PRIVATE PLACEMENTS Offer of shares to one entity only Usually issued to institutional investors Accounting for these types of issues is similar to public issues but does not use application/cash trust accounts The entry required is: Dr Cash xx Cr Share capital xx Subsequent issues of shares 3. BONUS ISSUE Shares granted only to existing shareholders Issued at no cost in lieu of cash dividend Number based on shareholding at date of declaration No change in the net equity of the company. The entry required is: Dr Retained earnings/reserve xx Cr Share capital xx 9

10 Subsequent movements in share capital - options A right (not obligation) to buy a certain number of shares by a set date at a set price. Options may be issued for free eg options may be issued to employees in lieu of cash bonuses. Options may be sold to investors similar to normal shares. Where options are not exercised by a specific date they lapse. Subsequent movements in share capital - options (Example 6) On 30 June 2007, ABC issued 10,000 options valued at $1 each to the CEO as payment for past services Each option entitles the CEO to acquire a share in the company for $3 The options must be exercised within 12 months of issue date- after this time they will lapse Subsequent movements in share capital - options (Example 6) Required: Prepare the journal entries to account for the issue and exercising of the options assuming: a) The options are issued for no consideration. On 1 May 2008, when the share price is $3.10, the CEO exercises the options. b) The options are issued for no consideration. The options are not exercised by the CEO and lapse on 30 June c) The options are issued for $1 each. By 30 June 2008, 9,000 of the options have been exercised. 10

11 Subsequent movements in share capital - options (Example 6) 30 June 2007 (same entry for a) and b)) Dr Wages expense 10,000 Cr Options 10,000 Issue of options to CEO a) 1 May 2008 Dr Cash 30,000 Dr Options 10,000 Cr Share capital 40,000 Exercising of options by CEO b) 30 June 2008 Dr Options 10,000 Cr Reserve 10,000 Transfer of balance to a reserve account on the lapsing of the options Could also be credited to Retained Earnings or Share Capital Subsequent movements in share capital - options (Example 6) c) 30 June 2007 Dr Cash 10,000 (10,000 x 50c) Cr Options 10,000 Issuing of options 1 July June 2008 Dr Cash 27,000 (9,000 x $3) Dr Options 10,000 Cr Share capital 36,000 (1,000 x $1) - Cr Reserve 1,000 lapsed options Exercising of 9,000 options to 30 June 2007 and transfer of balance to a reserve account on the lapsing of the options Redeemable preference shares Such shares either: Give the holder the right to be repaid his/her capital Or Give the company the right to repay the capital Main issue is the classification of such shares Are they equity or liabilities? 11

12 Redeemable preference shares - equity Shares can be redeemed from: 1. Proceeds of a fresh issue of shares Or 2. Retained earnings Additionally, the constitution may specify payment of a redemption premium which is paid from profit On redemption the shares are cancelled and cannot be reissued Redeemable preference shares - equity Dr Share Capital - Preference $x Cr Shareholders redemption $x Transfer of preference capital to redemption account Dr Shareholders redemption $x Cr Cash $x Redemption of preference shares Dr Cash/ Retained earnings $x Cr Share Capital - Ordinary $x Receipt of cash on issue of new shares Cash a/c applies to issues of new shares; retained earnings a/c applies to redemption from profits Redeemable preference shares - liabilities Redeemable preference shares with the following characteristics are more in the nature of liabilities: Redeemable in cash on a certain date or at the option of the holder Cumulative as to the payment of dividends Non-participating in further dividends distributions Priority capital return rights Accounting process required when accounting for redeemable preference shares that are classified as liabilities depends on whether the redemption is: 1. From a fresh issue of shares (Fig 2.12 of text) 2. From profits at a premium (Fig 2.13 of text) 12

13 Conversion of shares A company may change its issued capital by: Consolidation Involves grouping issued shares into larger parcels Eg; 2 x $1.00 consolidated into 1 x $2.00 share Split Involves splitting issued shares into smaller parcels Eg; 1 x $2.00 share split into 2 x $1.00 shares Conversion Involves converting an ordinary share to a preference share or vice versa Governed by constitution Share buy-backs WHY BUY BACK SHARES? Change debt/equity ratio Defence against takeover Clear odd lots or employee share schemes LEGAL REQUIREMENTS Covered by Section 257A of Corporations Act Allowed only if not prejudicial to creditors Limited types of buy-backs allowed ACCOUNTING FOR BUY-BACKS Shares must be cancelled Buy-back may generate a premium or a discount These are adjusted against either reserves, retained profits or both (UIG Abstract 22) Each company must adopt an accounting policy in respect of premiums or discount on buy-backs 1. At a premium: shares initially issued at $1.20 were bought back for $1.50 each Dr Share Capital 144,000 Dr Retained earnings 36,000 Cr Cash 180, At a discount: Share buy-backs shares initially issued at $1.20 were bought back for $1.00 each. Write back firstly against reserves (balance $20,000) Dr Share Capital 144,000 Cr Reserves 20,000 Cr Retained earnings 4,000 Cr Cash 120,000 13

14 Accounting for debentures Issuing debentures May be issued at par/premium/discount Issue preceded by disclosure document Application monies held in trust until allotment Can be listed on the stock exchange Redemption of debentures May be redeemable at company s option before maturity Redeemable on a set date or after a set period of time Debentures may be redeemed at par/premium/discount Premiums and discounts are treated as expenses and revenues Funds to redeem debentures may come from: Proceeds of new share issue or borrowing Proceeds of asset sale Assets currently held May be convertible into shares Redemption of debentures REDEMPTION AT A PREMIUM (LOSS) Dr Debentures $x Dr Redemption expense $x Cr Redemption revenue $x Cr Cash $x Expense = redemption at a premium (loss) Revenue = redemption at a discount (gain) CONVERSION TO EQUITY Dr Debentures $x Cr Share Capital $x Convertible notes Debt convertible to equity on maturity Initial classification as liability or equity depends on characteristics. Some may be partly debt, partly equity Accounting for redemption depends on initial classification 14

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