CAPITAL STRUCTURE AND FINANCE COSTS
Contents CAPITAL STRUCTURE OF A LIMITED COMPANY .................................................................................... 2 Preference Shares ............................................................................................................................... 3 ORDINARY SHARES .............................................................................................................................. 5 BONUS ISSUE....................................................................................................................................... 6 Rights Issue ......................................................................................................................................... 7 SUNDRY JOURNALS FOR LIMITIED LIABILITY COMPANIES ................................................................ 10
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CAPITAL STRUCTURE OF A LIMITED COMPANY
(i)
Issued Capital – the par value of shares bought by ordinary shareholders in company. Authorised share capital is the max amount of shares the company is permitted to sell. Issued share capital is the amount of shares the company has actually sold to the public in order to raise finance.
(ii)
Share premium – represents the excess over the par value paid by ordinary shareholders for shares in the company.
E.g: If X co issues 1,000 $1 ordinary shares @ $2.60 each , the accounting entry will be
Dr
Bank
Cr
Ordinary Shares
Cr
Share Premium
2600 1000 1600
Note: The share premium account cannot be distributed as a dividend under any circumstances.
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(i)
Retained Earnings– shows the profits/losses the company has earned over its life. These are ultimately owed to the shareholders.
(iv)
Reserves – money owned by ordinary shareholders, example, other reserves, revaluation reserve
Preference Shares • Preference shares – are sold by a company to raise finance. • Despite the name, preference shares have more in common with debt than with shares. This is because the company must pay preference shareholders dividend annually. • In contrast to ordinary dividend, preference dividend is the same every year, guaranteed and is paid before ordinary dividend.
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• Also, when companies liquidate, the preference shareholders are entitled to receive their capital back before the ordinary shareholders. • Preference Shares carry no voting rights and therefore preference shareholders have no say in how the company is run. • If preference shares are cumulative, it means that before a company can pay an ordinary dividend it must not only pay the current years preference dividend, but must also make good any arrears of preference dividend unpaid in previous years
Preference shares can be o Redeemable: Where the issuing company will buy back the preference shares issued at a future date – treated like loans (i.e. in liabilities as opposed to equity) and the “Dividend” on a redeemable preference share is treated as “finance cost”
o Irredeemable: Treated just like other shares. They form part of equity and their dividends are treated as distributions of profit
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ORDINARY SHARES • Have voting rights and therefore ordinary shareholders have a say in the day-to-day running of the business • The holders of ordinary shares receive ordinary dividends. BUT ordinary dividends do not have to be paid every year by the company. When a company performs poorly, its usual that no ordinary dividends are paid.
• In addition to the risk of not receiving dividends, the holders of ordinary shares face the risk that the trading performance of the company will deteriorate and cause the share price to fall and therefore the value of their investment. • Also, when companies liquidate, preference shareholders receive their capital back before the ordinary shareholders. Ordinary shareholders are the last to be repaid their capital invested and usually will end up with very little or nothing.
Dividends Paid are never shown as expense in the SOPL (unless they are redeemable preference share dividends) and Dividends Proposed are not included in the Statement of Changes in Equity until they are declared
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BONUS ISSUE Where shares are issued but no cash is received.
Other reserves (e.g. share premium or revaluation reserve) can be transferred to ordinary share capital as part of a bonus issue.
Example: Bubbles Co SOFP Extract
$000
Equity Share Capital ($1) Share Premium Retained Earnings
$000
1000 500 2000 3500
Bubbles made a “3 for 2” bonus issue
1000/2*3 = 1500
Dr Share Premium Dr Retained Earnings
500 1000
Cr Share Capital
1500
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Rights Issue A Rights issue is an issue of shares for cash . This is beneficial for existing shareholders in that the shares are usually issued at a discount to the current market price.
Example: X Co has the following capital structure
X Co SOFP Extract
$
Equity Share Capital (400,000 Ordinary Shares @ 50c) Share Premium Retained Earnings
$
200,000
70,000 230,000 500,000
Show its Capital Structure following (A) A “1 for 2 “ bonus issue 400,000/2*1 = 200,000 * 0.5 = 100,000 Dr
Share Premium
70,000
Dr
Retained Earnings
30,000
Cr
Ordinary Share Capital
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100,000
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X Co SOFP Extract
$
Equity Share Capital (600,000 Ordinary Shares @ 50c) Share Premium Retained Earnings
$
300,000
200,000 500,000
(B) A rights issue of “ 1 for 3” at $ 0.75 following the bonus issue, assuming all rights are taken up.
600,000/3 = 200,000 * 0.75 = 150,000
Dr Cr Cr
Bank Ord Share Cap. ($0.50 Nominal) Share Premium
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150,000 100,000 50,000
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X Co SOFP Extract Equity Share Capital (800,000 Ordinary Shares @ 50c) Share Premium Retained Earnings
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$
$
400,000
50,000 200,000 650,000
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SUNDRY JOURNALS FOR LIMITIED LIABILITY COMPANIES
i.
Dividends Paid
Cr
Bank Dr
ii.
Retained Earnings
X
Interest Payable on Loan Stock/Finance Costs
Cr paid)
Interest Payable (A Current Liability until eventually Dr
iii.
X
Interest Expense
Taxation 1) Tax Charged Against Profits will be accounted for by: Dr Cr X
SOPL Taxation Liability
X
2) Tax Paid Dr Cr
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Taxation Liability Bank/Cash
X X
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