Capital Maintenance Flashcards
What are the types of Capital Maintenance?
There are two types
- Financial
- Operating
What is Financial Capital Maintenance?
This means the capital is maintained in monetary terms.
In times of rising prices caused by inflation the capital might be maintained in monetary terms. But may not be maintained in physical operating terms.
Due to reduced purchasing power of their money.
What is Physical/Operating capital maintenance?
This means the company is able to operate at the same level.
When talking about Capital maintenance under the Companies Act 2006
We are referring to financial capital maintenance
Capital Maintenance
Governing Rules (5)
1) Share issue at discount
2) Capital reduction
3) Company distributions (dividend)
4) Purchase of own shares
5) Financial assistance (to anyone buying shares)
Capital Maintenance
What is the main aim of Governing Rules
To protect creditors of the company (referring to Limited Liability Companies)
The rules relating to public limited companies are more restrictive than those governing private companies!
Governing Rules
Share issue at discount
The company may not issue shares at discount.
The company cannot issue shares less than the nominal value.
The nominal value is the minimum amount that must be paid for the shares.
Governing Rules
Capital Reduction
(s.641) Share capital can be reduced “in any way” … in particular:
1) Removing or reducing liability for any capital remaining as yet unpaid → thus, the company will not need to make any call on that unpaid capital in the future
2) Cancelling any paid up share capital which has been lost through trading and is unrepresented in the current assets of the company → thus, bringing the BS into balance at a lower level by reducing the capital liabilities in acknowledgment of the loss of assets. For example DR:Capital & CR: Returned earnings
3) Paying off any already paid up share capital that is in excess of the company’s requirement (now or in the future) → thus, giving the shareholders back some of the capital that they have invested in the company
In the case of Number 1 & 3 the creditors of the company are potentially in a much worse position before the reduction.
Governing Rules
Capital Reduction
Public & Private Companies
The reduction will have to go through
- Special resolution and this must be confirmed by the court
The court can protect the interest of the creditors and minority shareholders.
It is possible that the court will require the company to add the words “and reduced” after its name → to warn the general public
General rule: all limited companies may reduce their share capital by a special resolution confirmed by the court
The Registrar of companies
- Will need a statement of capital after the reduction.
- Court order
Governing Rules
Capital Reduction
Private Companies
The reduction must go through
- Special resolution
- Solvency statement from directors
Solvency statement confirms that each of the directors is of the opinion that the company is not only currently able to pay its debts, but that it will remain able to pay it debts in the coming 12 months
This is an alternative procedure. Less costly and time consuming.
Registrar of companies require
- Special resolution
- Insolvency statement
- Statement of capital
Governing Rules
Company Distributions (dividends)
Fundamental Rule
- Capital must be maintained &
- Any reduction in capital is strictly controlled
Dividends may
- only be paid out of profits
- not be paid out of capital
Governing Rules
Company Distributions (dividends)
Rules (s.830)
(s.830) any distribution of a company’s assets to its members must come from “profits available to that purpose”
Add: accumulated realised profits (which have not been distributed or capitalised previously)*
Less: accumulated realised losses (which have not been written off in a reduction of capital previously)
Key requirement: REALISED! (profits must be realised)
*: as by being applied in financing a bonus issue or the purchase or redemption of the company’s shares with a transfer to a capital redemption reserve
What are capitalised shares?
These are bonus issue shares from the retained earnings.
Governing Rules
Company Distributions (dividends)
Rules
- Unrealised profits are not distributable (eg revaluation of assets under IS 16, or a change in market value of investment properties if there is an gain then its unrealised)
- A realised capital loss following, for example, the actual sale of an asset at a loss will reduce the profit available for distribution
- “accumulated”: the position in the current year cannot be regarded in isolation. The P&L account is a continuous account! (returned earnings in SOFP)
- Undistributed profits of previous years cannot be brought forward and distributed without taking into account a revenue loss on the current year’s trading (accumulated+realised profits)
- An unrealised capital profit cannot be applied in writing off a realised revenue loss
Profit Realisation
Profits will only be realised when the company decides to sell their assets.
If not then the profits will remain unrealised.
Unrealised profits
Cannot be distributed to shareholders.
Distributed profits calculation
Accumulated realised profit
LESS: Accumulated losses
Company distributions (dividend)
Rules (s.831) (must cover for net unrealised losses too)
Public Companies
(s.831) Additional requirements for public companies (BS approach)
NET ASSETS at the time of distribution (must be higher than..)
The total of called up capital + undistributable reserves*
*: share premium account, capital redemption reserve fund, excess of accumulated unrealised profit
AND
The distribution must not reduce the value of the net assets below the aggregated amount of the total called up capital plus undistributable reserves
The share premium account
Is undistributable
Private Company distribution of profits
Only rule we need to follow is that we need to check on the Accumulated profits - Accumulated losses
Public Company distribution of profits
We need to check two additional requirements.
- Must cover for net unrealised losses (this must be deducted from the unrealised loss)
- The share capital & undistriutable reserves (net assets) must not be less than the original share capital
The distribution cannot reduce the value of the net assets
Public companies distributions calculation
Accumulated realised profits - Accumulated realised losses
Less: Net Unrealised losses
After this we must check that after the distribution the Net Assets aren’t less than the share capital. As we cannot reduce the value of the net assets
Company Distributions (dividend)
Common Law Rule
Directors who knowingly paid dividends out of capital were liable to the company to replace any money so paid out, although they could seek to be indemnified by shareholders who knowingly received the payments.
Directors responsibility to make a decision of the dividends. If they pay dividends out of the capital then they become liable to the company for the amount.
Company Distributions (dividend)
s.847) (From Companies Act 2006
The companies act 2006 additionally provides that shareholders who receive payments, with reasonable grounds to know that they are made in breach of the rules, shall be liable to repay the amount received to the company
