2. Equity: Share Capital

Question 1

What are the two categories of shares?

Answer 1

• Equity (ordinary) shares
• Preference shares

Question 2

What are ordinary shares and what rights are granted to their holders? How are they treated in the financial statements?

Answer 2

Ordinary shares are shares in a company that are owned by people who have a right to vote at the company’s meetings and to receive part of the company’s profits after the holders of preference shares have been paid

Ordinary shares grants the shareholder:
- a share of the business
- voting rights (i.e. to appoint directors)
- no entitlement to dividends (at the discretion of the directors, i.e. can the company afford it)

Ordinary shares are treated as capital in the equity section of the SOFP

Question 3

How are the dividends of ordinary shares accounted for?

Answer 3

Dividends charged to retained earnings

Debit Retained Earnings
Credit Cash/accrual*

*if declared before period end

Question 4

What are preference shares and what rights are granted to their holders? What are the two types?

Answer 4

Preference shares are shares which entitle their holders to a dividend out of profits (preference dividend) before equity shareholders are entitled to any equity dividend.

Preference shares grants the shareholder:
- no share of the business
- no voting rights (i.e. to appoint directors)
- an entitlement to dividends

There are two types:
- Redeemable
- Irredeemable

Question 5

What are redeemable preference shares and how are they treated in the financial statements?

Answer 5

Redeemable preference shares are shares which the company is entitled to buy back from its shareholders or ‘redeem’ at some future time

Redeemable preference shares are treated as non-current liabilities in the liability section of the SOFP

Question 6

How are the dividends of redeemable preference shares accounted for?

Answer 6

Dividends charged to an expense account called ‘finance charge’ - treated as interest expense

Debit Finance charge
Credit Cash/accrual*

*if declared before period end

Question 7

What are irredeemable preference shares and how are they treated in the financial statements?

Answer 7

Irredeemable preference shares are shares which the company is not entitled to buy back or redeem at some stage in the future

Irredeemable preference shares are treated as capital in the equity section of the SOFP

Question 8

How are the dividends of irredeemable preference shares accounted for?

Answer 8

Dividends charged to retained earnings

Debit Retained Earnings
Credit Cash/accrual*

*if declared before period end

Question 9

List the journal entries used to account for dividends issued for the 3 different share types

Answer 9