3. Equity: share premium, retained earnings and other reserves

Question 1

What is the par value of shares?

Answer 1

The par value of shares, or the stated value per share, is the lowest legal price for which a company sells its shares.

Question 2

What is a share premium?

Answer 2

The companies Act 2006 prohibits shares from being issued at a price below (‘at a discount to’) their par value.

Commonly they are issued at a price above par value. When this happens, the excess of the issue price above the par value is recorded in a separate share premium account.

Question 3

What is the accounting treatment (journal entry) for share premium in a share issue?

Answer 3

Debit - Cash
Credit - Share capital: equity shares
Credit - Share premium

Question 4

Define retained earnings.

Answer 4

Retained earnings are a reserve used to accumulate the company’s retained earnings.

Retained earnings comprise the income (profits and gains less losses) that the company retains within the business, i.e., income that has not been paid out as dividends or transferred to any other reserve.

Question 5

What does the balance carried down on the retained earnings account represent?

Answer 5

The balance carried down on the retained earnings ledger account represents the company’s accumulated profits and losses over time out of which it may, if it wishes, pay dividends to its shareholders in the future.

Question 6

What are ‘other reserves’?

Answer 6

A company might have other reserves in it financial statements, often as a result of following the requirements of IFRS Accounting Standards, such as a revaluation surplus that arises when the non-current assets are revalued upwards.

It is sufficient to know at this stage that such reserves might exist without needing to know why and how they are used.