Introduction to Company Accounts and Issue of Shares

Introduction to Company Accounts and Issue of Shares and Debentures 1

Companies Unlimited Companies Limited Companies Authorized Capital Issued Capital Called up Capital Share Capital Preference Share Other Funding Ordinary Share Debenture Reserves Issue of shares and debenture Revenue Reserve Capital Reserve Paid Up Capital Price: - at par - at premium - at discount Payment: - Payable in full - by instalments 2

Introduction A limited liability company is a legal entity and the existence of the limited liability companies The owners of a limited liability company will be named as “members” or “shareholders” of the company Each company is governed by two documents, known as the Memorandum of Association and the Articles of Association 3

Types of Limited liability companies A. Unlimited Company - Companies do not have limited liability. B. Limited Company - The liability of a company can be limited by shares. - A limited company has a separate legal personality. This means that it can sue or enter into contracts in its own name. 4

Types of Limited Liability Companies There are two types of limited liability companies as follows: (I) Public Limited Company (II) Private Limited Company Descriptions Public Limited Company Share Transfer Private Limited Company No restriction Restriction Number of Shareholders No restriction (2 to unlimited) Restriction (2 to 50) Raising fund from Public No restriction Shares can be traded on Stock Exchange or not Yes Restriction No 5

Distinction between Partnerships and Limited Liability Companies Description Partnerships Limited Companies Number of Members 2 to 20 (except in certain professional business) 2 to Unlimited (except private limited companies up to 50) Liabilities of Members Unlimited liability of each partner (except Limited Partners) Limited liability of each shareholder to their agreed amounts of contributions on their shares held Amount of Capital Stated in the Partnership Agreement and subject to each partner’s financial resources Restricted to the amount of Authorized Capital Management of the Business Partners are entitled to take part in the operations of the business Directors are appointed on behalf of shareholders to manage the business Distribution of Profits and losses are shared to each partner in their agreed profit and loss sharing ratio By way of dividend, profits are shared to shareholders in respect of their shares held Part of the profits may be unappropriated and retained by the company for future business purposes 6

Classification of Capital Authorized Capital is the total number of shares and the total amount of Share Capital which a limited liability company is allowed to issue and it is stated in the Memorandum of Association. Authorized Capital may be changed and increased to cope with the growth of the company by the approvals of the shareholder Issued Capital is the part of the Authorized Capital actually issued to the shareholders. Called-Up Capital is the amount of the Issued Capital that the limited liability companies request their shareholders to pay. Paid-up Capital Paid-up capital is the actual amount received from the Called-Up Capital. The amounts of the Called-Up Capital which has not yet been received will be named as “Calls in Arrears”. Calls in Advance”refers to the advance payment of the Un-called Capital from the shareholders. 7

Types of Share Capital A. Preference Shares Preference shareholders are entitled to fixed % of dividends before any ordinary dividends are paid. No voting rights. I) Cumulative preference shares Any unpaid dividends on cumulative preference shares can be carried forward to a later year. II) Non-cumulative preference shares the unpaid dividends cannot be carried forward to later years. B. Ordinary Shares - The dividends of ordinary shares are not fixed. They depend on the return of the company. - Ordinary shareholders are paid only after all other claims have been met. - Ordinary shareholders usually have voting rights. 8

Example: Cumulative preference shares Net Profit / (Loss) for the year before appropriations Year 1 $ Year 2 $ Year 3 $ (1, 000) (2, 000) 50, 000 Nil 1, 500 5, 000 10% Cumulative Preference Shares of $1 each Dividend Nil 9

Example: Non-cumulative preference shares Net Profit / (Loss) for the year before appropriations Year 1 $ Year 2 $ Year 3 $ (1, 000) (2, 000) 50, 000 Nil 5, 000 10% Cumulative Preference Shares of $1 each Dividend 500 10

Ordinary Shares -The dividends of ordinary shares are not fixed. They depend on the return of the company. -Ordinary shareholders are paid only after all other claims (e. g, loan interest and preference share dividends ) have been met. - Ordinary shareholders usually have voting rights 11

Other Means of Funding A. Debentures are long-term loans evidenced by deeds which set out the rate of interest payable and the date of redemption. B. Reserves - Reserves are profits or gains which accrue to ordinary shareholders. - They are undistributed profits which have been retained within the company. - There are two types of reserves, revenue reserves and capital reserves. I) Revenue reserves - They are undistributed trading profits. - They can be used to pay dividends. - Examples are the balance on the profit and loss account and general reserve. II) Capital reserves - They are gains or profits arising from non-trading or non-operating activities. - They are not available for distribution as dividends. 12

- e. g. 1. Share premium a) to write off preliminary expenses b) to write off expenses of issuing shares c) to write off commissions paid and discounts on shares d) to pay up a bonus issue e) to provide premium on redemption of debentures. 2. Revaluation reserve This is the unrealized gain from an increase in the value of an asset after revaluation. 3. Capital redemption reserve and debenture redemption reserve This arises as a result of a company redeeming its shares or debentures by using its retained profits. 13

Distinction between Shares and Debentures Description Ordinary Shares Preference Shares Debentures Relationship between the holders and the company Members/Shareholders Member/Shareholders Creditors of the companyof the company Dividends/Interest No fixed percentage or amounts of dividends The dividends will be subjected to the profitability and dividends policy of the company A fixed rate of dividends A fixed rate of interest will paid whether or not the company makes a profit Priority of Distribution After the distribution of the dividends to Preference Shareholders Before to Ordinary Shareholders Before any dividend distributable to Ordinary and Preference Shareholders Treatment in Balance Sheet Ordinary Share Capital Preference Share Capital Treated as a long term liability if the period of repayment is longer than one year Treated as a current liab. If repayment < 1 yr. 14

Raising of Capital-Issue of shares and debentures Issue Price Issue at Par -The issue price is same as the “PAR”, “NOMINAL” or “FACE” value of the shares and debentures. Issue at a Premium -The issue price may be HIGHER than the par value of the shares and debentures. The difference between the issue price and the par value of the shares or debentures is named as “SHARE PREMIUM” Issue at a Discount -The issue price may be LOWER than the par value of the shares and debentures. The difference between the issue price and the part value of the shares or debentures is named as “SHARE DISCOUNT’ 15

Methods of Payment in Full Payable by instalments 16

Payment in full The full amount of the issue price of the shares and debentures should be paid to the company on application whether or not the applicants will allot the shares and debentures. 17

Descriptions Accounting entries Application Monies Received Dr. Bank Cr. Ordinary Share Applicants *”No. of Application” X “Issue Price” Issue of Ordinary Shares Capital (a) Issue at Par Dr. Ordinary Share Applicants Cr. Ordinary Share Capital • “No of Shares Actually Issued” X “Par Value of Each Share” (b) Issue at a Premium Dr. Ordinary Share Applicants Cr. Ordinary Share Capital Cr. Share Premium * “No. of Share Actually Issued” X “Par Value of Each Share” will be recorded in Ordinary Share Capital * “No. of Shares Actually Issued” X “The Value of Share Premium per Each Share” will be recorded in Share Premium 18

Descriptions Accounting entries ( c) Issue at a Discount Dr. Ordinary Share Applicants Share Discount Cr. Ordinary Share Capital * “No. of Shares Actually Issued” X “Par Value of Each Share” will be recorded in Ordinary Share Capital * “No. of Shares Actually Issued” X “The Value of Share Discount per Each Share” will be recorded in Share Discount Refund of Oversubscribed Dr. Ordinary Share Applicants Cr. Bank * “No. of Application Oversubscribed” X “Issue Price” 19

Payable by instalments The full amount of the issue price of the shares and debentures will be paid to the company by instalments in following steps: Step 1 Step 2 Step 3 Step 4 Step 5 Step 6 Receipt of application money Return of application money to unsuccessful applicants Allotment of shares Receipt of allotment money Call on shares Receipt of call money These steps are demonstrated in the following example: 20

Descriptions Accounting entries Application Monies Received Dr. Bank Cr. Ordinary Share Applicants * “No. of Application” X “Issue Price” Issue of Ordinary Shares (a) Issue at Par Dr. Ordinary Share Applicants Capital Cr. Ordinary Share Capital * “No. of Shares Actually Issued” X “Par Value of Each Share” (b) Issue at a Premium Dr. Ordinary Share Applicants Cr. Ordinary Share Capital Cr. Share Premium * “No. of Share Actually Issued” X “Par Value of Each Share” will be recorded in Ordinary Share Capital * “No. of Shares Actually Issued” X “The Value of Share Premium per Each Share” will be recorded in 21 Share Premium

Descriptions Accounting entries ( c ) Issue at a Discount Dr. Ordinary Share Applicants Share Discount Cr. Ordinary Share Capital * “No. of Shares Actually Issued” x “Par Value of Each share” will be recorded in Ordinary Share Capital * “No. of Shares Actually Issued” x “The Value of Share Discount per Each Share” will be recorded in Share Discount Refund of Oversubscribed Dr. Application and Allotment or Rejected Application Cr. Bank Monies * “No. of Application Oversubscribed or Rejected” x “Issue Value of Application” 22

Descriptions Accounting entries Allotment Monies Received Dr. Bank Cr. Application and Allotment * “No. of Share Actually Issued” X “Issue Value at Allotment”* Sometimes, oversubscribed application monies may be carried forward and offset against the allotment monies due. The difference between original allotment monies received and oversubscribed application monies will be recorded in these entries Issue of Ordinary Shares at Call Dr. Call Cr. Ordinary Share Capital * “No. of Shares Actually Issued” x “Par Value of Each Share at Call” will be recorded in Ordinary Share Capital 23

Descriptions Accounting entries Call Monies Received Dr. Call Cr. Ordinary Share Capital * “No. of Shares Actually Issued” x “Par Value of Each Share at Call” will be recorded in Ordinary Share Capital 24

Example 1 25

Example 1 Tai Fat Limited made a public offering of its 1, 700, 000 ordinary shares of $1 each at $1. 4 per share. The shares were issued on the following terms: Application Allotment First and final call Per share $ 0. 3 0. 6 $1. 4 0. 5 • On 1 February 1997, applications for 3, 000 shares were received. • Applications for 300, 000 shares were unsuccessful and the money involved was returned on 3 February 1997. • Applications for 700, 000 shares were given full allotment. • The remainder of the available shares were allotted among the other applicants on a pro-rata basis. • The balance of the sums received on application was applied to the amounts due on allotment. • The balances due on allotment were received on 1 March 1997. • On 1 April 1997, the first and final call was made and paid in full. 26

Bank Application and Allotment 900, 000 Application and Allotment 720, 000 First and Final Call 850, 000 Application and Allotment Bank (300, 000*$0. 3) Ordinary Shares (1, 700, 000*$0. 5) Share Premium (1, 700, 000*$0. 4 ) Balance c/f Ordinary Shares 90, 000 850, 000 680, 000 90, 000 Bank 900, 000 (3, 000*$0. 3) Bank 720, 000 (1, 700, 000*$0. 6 -1, 000*$0. 3) 1, 620, 000 Ordinary Shares 1, 700, 000 Application and Allotment First and Final Call 1, 700, 000 Share Premium 680, 000 Application and Allotment First and Final Call 850, 000 Bank 1, 620, 000 850, 000 1, 700, 000 680, 000 850, 000 27

Journal Dr $ 1. Bank (3, 000 X $0. 30) 900, 000 Application and Allotment Being money received for 3, 000 shares on application 2. Application and Allotment 90, 000 Bank (300, 000 X $0. 3) Being return of application money to unsuccessful applicants for 300, 000 shares 3. Application and Allotment ($0. 9 X 1, 700, 000) Ordinary Shares ($0. 5 X 1, 700, 000) Share Premium ($0. 4 X 1, 700, 000) Being allotment of 1, 700, 000 ordinary shares 4. Bank (1, 700, 000 X $0. 60 - 1, 000 X $0. 30) Application and Allotment Being receipt of the amount due on allotment Cr $ 900, 000 90, 000 1, 530, 000 850, 000 680, 000 720, 000 28

Journal Dr $ 5. First and Final Call Ordinary Shares (1, 700, 000 X $0. 5) Being call on shares 850, 000 6. Bank 850, 000 First and Final Call Cr $ 850, 000 29

Forfeiture and Reissue of Shares If a member fails to pay the calls requested from him, the directors may declare the shares as the ‘ Forfeited Shares’ and reissue the shares to another shareholder 30

Descriptions Accounting entries Declaration of Forfeited Shares (a) Forfeited Shares were Declared when they were not paid Dr. Bank Forfeited Shares Cr. Application and Allotment, OR Call * “No. of Shares Declared as Forfeited” x “Issue Value at that Stage” will be recorded in Forfeited Shares. (b) Forfeited Shares were NOT Declared when they were not paid Dr. Bank Allotment / Call in Arrears Cr. Application and Allotment, OR Call * “No. of Shares Unpaid” x “Issue Value at that Stage” will be recorded in Allotment / Call in Arrears Unpaid Value Declared as Forfeited Shares Dr. Forfeited Shares Cr. Allotment / Call in Arrears Transfer the Value of Allotment / Call in Arrears to Forfeited Shares 31

Descriptions Accounting entries Transfer the call-up value of Forfeited share from issued share capital to Forfeited shares Dr. Ordinary Share Capital Cr. Forfeited Shares *”No. of shares Declared as Forfeited” x “Call-up value of Shares Forfeited” will be transferred to Forfeited Shares Transfer the called-up value of Forfeited share from issued share capital to Forfeited shares Dr. Ordinary Share Capital Cr. Forfeited Shares *”No. of shares Declared as Forfeited” x “Call-up value of Shares Forfeited” will be transferred to Forfeited Shares Reissue of Forfeited Shares are “NOT Reissued” or not Dr. Forfeited Shares Cr. Share Premium Any paid amount of the Forfeited Shares will be transferred to the Share Premium Forfeited Shares Account is closed 32

Descriptions Accounting entries Reissue of Ordinary Shares Dr. Forfeited Shares Cr. Ordinary Share Capital * “No. of Shares Reissued” x “Called-up value of shares forfeited” will be recorded in Ordinary Share Capital Receipts from the reissue of Dr. Bank shares Cr. Forfeited Shares *”No. of shares Reissued” x “Issue Value of Each Reissued Share” Transfer of the excess amount over the called-up nominal value of the shares reissued Dr. Forfeited Shares Cr. Share Premium Any balance of the Reissue of Forfeited Shares will be transferred to the Share Premium 33

Example 2 34

Example 2 Tai Cheong Limited made a public offering of its 1, 000 ordinary shares of $1 each at $1. 5 per shares The shares were issued on the following terms: Per share $ Application 0. 6 Allotment on 1 April 1997 0. 2 $1. 5 First call on 1 June 1997 0. 5 Final call on 1 September 1997 0. 2 On 1 March 1997, applications for 1, 000 shares were received. They were given full allotment. All sums due on received on 10 April 1997. All money for the first call was received on 10 June, except for one shareholder who had been allotted 1, 000 shares. 35

Case 1 All money for the final call was received on 15 September 1997, except for the shareholder who failed to pay the first call. The directors had not declared the shares forfeit by 31 December 1997. Case 2 All money for the final call was received on 15 September 1997. Except for the shareholder who failed to pay the first call. The directors declared the shares forfeit on 1 October 1997. Case 3 The directors declared the shares forfeit on 1 July 1997. On 1 August 1997, 600 shares were reissued for $0. 9 each, subject to a final call. On 1 September 1997, the directors made the final call and all sums due were received. 36

Case 1 37

Case 1 Apr 1 Ordinary Shares (1, 000*$0. 3) Apr 1 Shares Premium (1, 000*$0. 5) Application and Allotment 300, 000 Mar 1 500, 000 Bank (1, 000 X $0. 60) 600, 000 Apr 10 Bank (1, 000 X $0. 20) 200, 000 800, 000 Ordinary Shares Apr 1 Application and Allotment 300, 000 Share Premium Dec 31 Balance c/f Mar 1 Application Apr 15 Allotment 500, 000 Apr 1 Application and Allotment 500, 000 Bank 600000 200000 38

First Call June 1 Ordinary Shares 500, 000 June 10 Bank (1, 000 - 1, 000) x $0. 5 499, 500 Calls in Arrears 500, 000 Final Call Sep 1 Ordinary Shares 200, 000 Sep 15 Bank (1, 000 - 1, 000) X $0. 2 199, 800 Calls in Arrears 200, 000 Calls in Arrears June 10 First Call Sep 15 Final Call 500 Dec 31 200 700 700 Bank Mar 1 Application Apr 15 Allotment June 1 First call Final call 600000 200000 499500 199800 39

Ordinary Shares Apr 1 Application and Allotment June First call Sept 1 Final call 300, 000 500000 200000 Balance Sheet as at 31 December 1997 (Extract) $ Current Assets Called-up Capital not yet paid Share Capital Issued and Fully Paid 1, 000 Ordinary Shares of $1 each Reserves Share Premium 700 1000000 500000 40

Case 2 41

Case 2 Ordinary Shares Oct 1 Forfeited shares (1000*$1) 1000 Apr 1 Application and Allotment 300, 000 June First call 500000 Dec 31 Bal c/d 999000 Sept 1 Final call 200000 1000000 June 10 First Call Sep 15 Final Call 1000000 Calls in Arrears 500 Oct 1 Forfeited shares 200 700 700 Forfeited shares Oct 1 Call in Arrears Dec 31 Bal c/f 700 Oct 1 Ordinary shares 300 (1000*$1) 1000 42

Balance Sheet as at 31 December 1997 (Extract) Share Capital Issued and Fully Paid 999, 000 Ordinary Shares of $1 each Reserves Share Premium Forfeited Shares 999000 500000 300 43

Case 3 44

Case 3 July 1 Dec 31 Forfeited Shares (1, 000 x $0. 80) Balance c/f Ordinary Shares 800 Apr 1 June 1 999, 600 Aug 1 Sept 1 1, 000, 400 Application and Allotment First Call Forfeited Shares (600 x $0. 80) 300, 000 500, 000 480 Final Call (999, 600 X $0. 2) 199, 920 Reissue 1, 000, 400 Share Premium Dec 31 Balance c/f 500, 240 Apr 1 Application and Allotment 500, 000 Aug 1 Forfeited Shares 240 500, 240 June 10 First Calls in Arrears 500 July 1 Forfeited Shares (1000*$0. 5) 500 Forfeited shares July 1 Calls in arrears Aug 1 Ordinary shares (600*$0. 8) Aug 1 Share premium Dec 31 Bal c/d 500 July 1 Ordinary shares (1000*$0. 8) 800 480 Aug 1 Bank (600*$0. 9) 540 240 120 1340 45

Final call Sept 1 Ordinary shares (999600*$0. 2) 199920 Sept 15 Bank 199920 Bank Mar 1 Application Apr 10 Allotment June 10 First call Aug 1 Forfeited shares Sept 15 Final call 600000 200000 499500 540 199920 *Amount transferred to share premium: Receipt from original holder (600*$0. 8) Less: Share premium (600*$0. 5) Add: Receipt from second holder (600*$0. 9) Less: Called-up nominal value (600*$0. 9) 480 300 180 540 720 480 46 240

Balance Sheet as at 31 December 1997 (Extract) Share Capital Issued and Fully Paid 999, 000 Ordinary Shares of $1 each Reserves Share Premium Forfeited Shares 999600 500240 120 47

Right issue is an offer to the existing shareholders to subscribe for more shares, in proportion to their existing shareholding, usually at a relatively cheap price. 48

Bonus issue Bonus shares are issued when there is a build-up of reserves (e. g. undistributed profits) in the company. Those profit will often not be represented by cash, since the profits have been invested in other assets to expand the business. It is done by changing the company’s reserves into share capital and allotting shares to existing shareholders por rata, e. g. one share for every two shares held This decrease the amount of retained earnings and increases the share capital. There is no entry on cash or bank account because mp cash changes hands, the bonus shares are issued free. Dr. Profit and Loss (retained earnings) account Cr. Share Capital account (with the nominal value of shares allotted as fully paid bonus shares) 49

Debenture A debenture is a written acknowledgement of debt. Debenture are long-term loans which attract a large number of investors. The terms of debentures such as the rate of interest payable, the date of redemption (if applicable) and security given by the borrowing company are governed by a trust deed 50

Issue of debenture The accounting treatment of debenture is the same as that of shares, except for the change in the name of the accounts Debenture may be issued payable in full or payable by instalments Debenture can be issued at par, at premium or at a discount 51

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Better Enterprises Ltd was formed with the legal right to be able to issue 100, 000 shares of $1 each. The company has actually issued 75, 000 shares. None of the shares has yet been fully paid up. So far the company has made calls of $0. 80 per share. All the calls have been paid by shareholders except for $200 owing from one shareholder. Authorised share capital = Called-up capital = Paid-up capital Issued share capital = Calls in arrear = = 56

$1, 000 $75, 000 $60, 000 $200 59, 800 57