9 Equity

Question 1

Example for

1. Non distributable reserves?
2. distributable reserves?

Answer 1

1. share premium account; revaluation reserve
2. retained earnings

Question 2

What are…

1. Ordinary Shares?
2. Preference Shares?

Answer 2

1. entitled to dividend from: 1. residual profits, 2. after payments of any fixed interest, 3. after fixed dividend to other stakeholders (incl. preference shareholders)
2. have a FIXED RATE of dividend: expressed as % of nominal value; dividend is pair BEFORE any distribution to ordinary shareholders

Question 3

What tyoes of preference shares are there?

1.
2.
3.
4.

Answer 3

1. Cumulative vs. Non cumulative preference shares: unpaid dividends due to lack of profitability are accumulated for payment in the future or not
2. participating shares: holder gets fixed dividend as usual + if the company has surplus profits after paying ordinary shares, they can also get some of these additional profits
3. redeemable shares: the company can buy back these shares at agreed future date and price (gives flexibilit for company to return capital when needed; to raise funds temporarily; accessing capital now and redeem shares later)
4. convertible shares: option to convert shares into ordinary shares at specific date in future and under agreed conditions (if company grows, then shareholder gets to win bc ordinary share price grows)

CPRC

Question 4

What are reasons for issuing shares? (getting money in without taking debt)

1.
2.
3.
4.

Answer 4

1. rasising funds
2. to fund acquisitions (e.g. offering shares as currency)
3. issued instead of dividends (not giving out cash but still giving value to shareholders)
4. director/employee share option schemes (they are offered to buy shares at discounted price )

Question 5

What are methods for issuing shares?

1.
2.
3.

Answer 5

1. OFFER FOR SUBSCRIPTION: shares offered directly to public
2. A PLACING: shares placed with financial institutions
3. A RIGHTS ISSUE: new shares offered to existing shareholders

Question 6

Whats a creditor?

Answer 6

• e.g. lender, supplier, bondholder
• provides financial resources or services to a business, expecting payment

Question 7

What can we say about creditor protection in terms of unincorporated businesses?

Answer 7

• sole traders and partnerships
• unlimited liability: owner = business
• owners are personally liable for the liabilities incurred by the business

Question 8

What can we say about creditor protection in terms of limited liability companies?

Answer 8

• creditors have restricted rights against shareholders
• need to ensure that shareholders do not make distributions to themselves

Question 9

What are the risks that creditors face?

1.
2.

Answer 9

1. company will not be able to repay them
2. risk that a company will successfully, but pay its shareholders rather than creditors (for this: companies act 2006 protects them)

Question 10

Define “Capital Maintenance” and what it involves

1. Definition
2. Involves what?
3. general rule?
   4./5. what directors can and cannot do

Answer 10

• the requirement to safeguard the interests of creditors
• involves legislation regarding: (non-)distributable reserves; minimum capital requirements; reduction of capital
• general rule: the paid in share capital is not repayable to shareholders
• directors have discretion: amount of distributable profits they recommend for distribution as a dividend to shareholders
• directors have NO discretion as to the treatment of the non distributable funds

Question 11

Normally, once the shares have been issued and paid up, the contributed capital together with any share premium…. permanent

Explain this
1.
2.
3.
4.

Answer 11

• when company issues shares, investors buy them and pay for them
• amount investors pay depends on contributed capital (par) and share premium (any above nominal value)
• once the shares are paid for, the contributed capital and share premium become part of the companys equity
• can usually not be returned bc: forms companys financial foundation + paying bck can weaken company´s ability to repay creditors

Question 12

What are commercially sound reasons for a company to reduce its capital?

Answer 12

• to write off capital already lost and not represented by assets -> reduce share capital to eliminate negative balance in retained earnings -> shareholders bear losses bc their equity is reduced
• purchase of own shares

Question 13

Writing off capital already lost due to accummulated trading losses

1. Whats the issue here?
2. Whats the general approach here?

Answer 13

1. when company has accummulated retained losses, there is no dividend payment possible
2. eliminating the debit balance on retained earnings, by setting if off against the share capital and non distributable reserves

-> use of a capital reduction account

Question 14

180,000 neagitve retained earnings

Show the journal entries of

1. Transfer of trading losses
2. Reduction of share capital

Answer 14

1. DR Capital reduction account 180k CR retained earnings 180k
2. DR share capital 180 k CR capital reduction account 180k

Question 15

What is important when it comes to capital reduction where losses are borne by more stakeholders?

1. Scope of consequences
2. Solution
3. Stakeholders help
4. Goal
6. why is it unfair to reduce the nominal value of all calsses of shares and debentures proportionately?

Answer 15

• its not just the shareholder who experience a loss in value but also other stakeholders, like creitors or preference shareholders
• then, a company may develope a scheme to compensate the other stakeholders by offering them EQUITY SHARES
• creditors may exchange part of their debt for new equity shares, aligning their interests with the companys future success
• goal: improve the companys financial structure while offering fair treatment to stakeholders + avoid liquidation and maximize recovery prospects for all parties
• total amount to be written off is borne in agreed ratios
  6. different priorities on stakeholders (creditors > shareholders; contractual agreememnts

Question 16

Illustration of capital reconstruction

1. Which things would i show if i let the company liquidate?
2. Which things if i continue without reconstruction?
3. which things is i continue with reconstruction?

Answer 16

1. assets realised; LESS prior claim to those that have to be satisfied first; LESS ordinary shareholders
2. Expected operating profit; LESS debenture interest; EQUALS ordinary dividend; GLEICH annual income (probs 0)
3. expected operating profit; LESS (new) debenture interest; LESS dividend on shares; EQUALS ordinary dividend

Question 17

What are the three types of purchases of own shares?

1.
2.
3.

Answer 17

1. redemption of redeemable preference shares (company repurchases shares from shareholders): reqiorements: either replace with other shares OR transfer from distributable to non distribtuable reserves (to maintain permanent capital)
2. buyback of own shares with intention to cancel: Returning funds due to lack of investment opportunities + Protecting against hostile takeover + Signaling that shares are undervalued.
3. Ordinary shares bought back by the company but not canceled: Held as “treasury shares” for future use, e.g., for reissue or employee compensation.

Question 18

What are the benefits of holding treasury shares?

1. advantage
2. advantage
3. common approach
4. where can u do it

Answer 18

1. Offers flexibility to re-issue if gearing is seen as too high
2. Can re-issue shares without diluting existing shareholding, e.g. to provide employee share options
3. Two common accounting treatments for treasury shares
   – the cost method and the par value method
4. In Europe and the USA it is permissible to buy back shares, known as treasury shares

Question 19

Accounting Treatment using the Cost Method | What do we do in the following scenarios:

1. If on resale: sales price > cost price: selling for more than we got it
2. If on resale: sales price < cost price: selling for less than we got it
3. What do we do if the debit balance > credit balance on paid in capital

Answer 19

1. treasury stock is CREDITED at cost price and the excess is CREDITED to paid in capital from treasury stock
2. treasury stock account is CREDITED with cost price and the balance is DEBITED to paid in capital (treasury stock)
3. the difference is deducted from retained earnings

Question 20

What do the accounting entries look like for an illustration of a capital reconstruction?

1.
2.
3.

Answer 20

1. Transfer accummulated loss and rev loss
   DR reconstruction account (a+b) CR accummulated loss (c) CR net assets (c-assets=b)
2. cancellation of existing share capital and old debentures
   DR OLD share capital DR 10% debentures CR reconstruction account (sum)
3. issuing of new share capital and debentures
   DR reconstruction account CR share capital (ct*amount) CR debentures