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Chapter 17:
Introduction to company
accounting
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What you will learn?

 Limited liability and accounting records

 Share capital

 Reserves

 Bonus and rights issues

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Limited liability and accounting records

Limited liability

Limited liability
The maximum amount that an owner stands to lose, in
the event that the company becomes insolvent and
cannot pay off its debt is their share of the capital in the
business

Owners = shareholders or members

Large number of owners

Owner/Manager split

Owners appoint directors to run business on their behalf

Owners receive share of profits in form of dividends

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Share capital
The capital of limited liability companies

The proprietors’s capital in a limited liability company consists

of share capital

When the company is set up for the first time, it issues shares,
which are paid for by investors, who then become
shareholders of the company.
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Share capital
Example: The capital of limited liability companies

Example 1:

A company is set up with a share capital of $100,000, it may be

decided to issue:
 100,000 shares of $1 each par value
 200,000 shares of 50c each
 400,000 shares of 25c each
 250,000 shares of 40c each.
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Share capital
The capital of limited liability companies

 An arbitrary value assigned to a share,

which is often perceived as the share’s
Nominal/
minimum value (often $1, 50c or 25c)
par value
 Remains fixed, whereas the market value
of the shares fluctuates over time

 The price at which shares are sold by a

Issue price
company in the first instance

Market  The value at which the shares are trading

value on the open market
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Share capital
Example: The capital of limited liability companies

Example 2:

A company might issue 100,000 $1 shares at a price of $1.20 each

Subscribers will then pay a total of $120,000.
 Par value: $1/share
 Issued share capital of the company would be shown in its
accounts at par value: $100,000
 The excess of $20,000 is described as share premium or
capital paid up in excess of par value
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Share capital
Authorised, issued, called-up and paid-up share capital

Authorised
The maximum amount of share capital that a
(or legal
company is empowered to issue
capital)

 The par amount of share capital that has

Issued been issued to shareholders
capital  The amount of issued capital cannot
exceed the amount of authorised capital

When shares are issued or allotted, a company

does not always expect to be paid the full
Called-up
amount of shares at once.
capital
Instead, it call up only a part of the issue
price. Call up the remainder later.

When capital is called up, some shareholders

Paid-up might delay their payment.
capital Paid-up capital is the amount of called-up
capital that has been paid.
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Share capital
Preference shares and ordinary shares

Two types of shares most often encountered

Preference Shares which confer certain preferential rights

shares on their holder

Shares which are not preferred with regard to

dividend payments.
Ordinary
Thus a holder only receives a dividend after
shares
fixed dividends have been paid to preference
shareholders
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Share capital
Preference shares

The rights attaching to preference shares are set out in the

company’s situation. They may vary, but typically:

 Right to fixed dividend with priority over ordinary shares

 Preference shares do not carry a right to vote

 Generally priority for capital in winding up

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Share capital
Classification of Preference shares

Redeemable preference Irredeemable preference

shares shares

The company will redeem

the nominal value of those Treated just like other
shares at a later date shares.

They form part of equity and

Treated like loans, included their dividends are treated
as non-current liabilities in as appropriations of profit.
SOFP

Dividends paid on
redeemable preference
shares, treated like interest
paid on loans, included in
financial costs in SOPL
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Share capital
Ordinary shares

The most common type of share, has such features:

 No right to fixed dividend

 Entitled to remaining profits after preferred dividend

 Entitled to surplus on repayment of capital

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Share capital
Loan stock or bonds

Long-term liabilities – a means of raising finance, in the same

way as issuing share capital raises finance

Different from share capital in the following ways:

Providers of loan capital are creditors

Holders of loan capital are entitled to a fixed rate of interest

Loan capital holders can take legal action against a company if

their interest is not paid when due

Loan stock is often secured on company assets, whereas

shares are not
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Share capital
Exam focus point 1

Which of the following items may appear as current liabilities

in a company’s statement of financial position?
1 Revaluation surplus
2 Loan due for repayment within one year
3 Taxation
4 Preference dividend payable on redeemable preference
shares

A. 1,2 and 3 B. 1,2 and 4

C. 1,3 and 4 D. 2,3 and 4

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Share capital
Exam focus point 1

Which of the following items may appear as current liabilities

in a company’s statement of financial position?
1 Revaluation surplus
2 Loan due for repayment within one year
3 Taxation
4 Preference dividend payable on redeemable preference
shares

D. 2,3 and 4

 The revaluation surplus is part of equity.

 Dividends paid on redeemable preference shares are treated like
interest paid on loans, and are therefore accrued for as finance
costs in the financial statements
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Reserves

Shareholders’ equity

Share capital Other equity

(The par value of
issued capital
minus any amounts Share premium
not yet called up on
issued shares)
Revaluation surplus

Reserves

Retained earnings
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Reserves
Share premium account

An account into which sums received as payment for shares in

excess of their nominal value must be placed

Example

If X Co issues 1,000 $1 ordinary shares at $2.60 each the book

entry will be:

DR Cash $2,600
CR Ordinary shares $1,000
CR Share premium account $1,600
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Reserves
Reserves

Statutory reserves Non-statutory reserves

 Reserves which a
company is required to set  Reserves consisting of
up by law profits

 Not available for the  Distributable as dividends,

distribution of dividends if the company so wishes

 Capital reserves (share  Revenue reserves

premium. revaluation)
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Reserves
Example: Reserves

$ $

Profit after tax 100,000

Appropriations of profit

Dividend 60,000

Transfer to general reserves 10,000 70,000

Retained earnings for the year 30,000

Retained earnings b/f 250,000

Retained earnings c/f 280,000
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Reserves
Retained earnings

This is the most significant reserve and is variously described as:

Revenue reserves Retained earnings

Accumulated profits Undistributed profits

Unappropriated profits

These are profits earned by the company and not appropriated

by dividends, taxation or transfer to another reserve account

 To enable the company to pay dividends even when profits are low
 Shortage of cash
 ....
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Bonus and rights issues

Bonus issues
A bonus (or capitalisation) issue uses reserves to pay for the
issue of share capital

Example: $’000 $’000

Shareholders’ equity
Share capital
$1 ordinary shares (fully paid) 1,000
Reserves
Share premium 500
Retained earnings 2,000 2,500
3,500
Bubbles decided to make a ‘3 for 2’ bonus issues
(ie 3 new shares for every 2 already held)

DR Share premium $500,000

DR Retained earnings $1,000,000
CR Ordinary share capital $1,500,000
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Bonus and rights issues

Rights issues

A rights issue enables existing shareholders to acquire further shares

Example: $’000 $’000

Shareholders’ equity
Share capital
$1 ordinary shares (fully paid) 1,000
Reserves
Share premium 500
Retained earnings 2,000 2,500
3,500
Bubbles decided to make a right issue, shortly after the bonus issue (above).
The terms are ‘1 for 5 @ $1.20’ (ie 1 new share for every 5 already held, at a
price of $1.20).
Assuming that all shareholders take up their rights
DR Cash (2,500 / 5 x $1.20) $600,000
CR Ordinary share capital $500,000
CR Share premium $100,000
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Bonus and rights issues

Exam focus point 1

A company made an issue for cash of 1,000,000 50c shares at a premium

of 30c per share.

Which one of the following journal entries correctly records the issue?
A. Dr Share capital $500,000
Dr Share premium $300,000
Cr Bank $800,000
B. Dr Bank $800,000
Cr Share capital $500,000
Cr Share premium $300,000
C. Dr Bank $1,300,000
Cr Share capital $1,000,000
Cr Share premium $300,000
D. Dr Share capital $1,000,000
Cr Share premium $300,000
Cr Bank $1,300,000
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Bonus and rights issues

Exam focus point 1

A company made an issue for cash of 1,000,000 50c shares at a premium

of 30c per share.

B. Dr Bank $800,000
Cr Share capital $500,000
Cr Share premium $300,000
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Bonus and rights issues

Exam focus point 2
At 30 June 20X2 a company’s capital structure was as follow:
$
Ordinary share capital
500,000 shares of 25c each 125,000
Share premium account 100,000
In the year ended 30 June 20X3 the company made a rights issue of one
share for every two held at $1 per share and this was taken up in full.
Later in the year the company made a bonus issue of one share for
every five held, using the share premium account for the purpose.
What was the company’s capital structure at 30 June 20X3?
Ordinary share capital Share premium account
$ $

A. 450,000 25,000

B. 225,000 325,000

C. 225,000 250,000

D. 212,500 262,500
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Bonus and rights issues

Exam focus point 2

Ordinary share capital Share premium account

C. $225,000 $250,000
$
Ordinary shares
Opening balance 125,000
Right issue 250,000 x 25c 62,500
Bonus issue 150,000 x 25c 37,500
225,000
Share premium
Opening balance 100,000
Rights issue 250,000 x 75c 187,500
Bonus issue 150,000 x 25c (37,500)
250,000