Lecture 4 - Capital Maintenance, Share Capital & Creditor Protection

Question 1

Using the ‘Balance Sheet View’, income can be defined as:

Answer 1

Balance Sheet = Change in assets and Liabilities

Income = Change between opening and closing balance sheets

Question 2

What is the ‘Financial Concept of Capital’?

Answer 2

• Net assets of a firm
• Invested money
• Invested Purchasing power

Question 3

What is the ‘Physical concept’ of capital?

Answer 3

• Operating capacity of a firm

- Productivity capacity

Question 4

What is meant by the term ‘Financial Capital Maintenance’?

Answer 4

Maintain the equity investment of the owner of an enterprise

Question 5

What is meant by the term ‘Physical Capital Maintenance’?

Answer 5

Physical capital maintenance focuses on the ABILITY of a firm to continue to operate at a particular LEVEL of activity

Question 6

What does ‘Fixed asset maintenance’ refer to when thinking about physical capital maintenance?

Answer 6

The ability of firms to replace assets as they’re used up

Question 7

What does ‘Operating Capability’ refer to when thinking about physical capital maintenance?

Answer 7

The ability to generate a level of fixed output using the most efficient arrangement of assets

Question 8

What are ‘Real Holding gains’?

Answer 8

A real holding gain occurs when the cost of replacing an asset has increased in ‘REAL’ terms when compared to the RPI (inflation)

Question 9

What is the formula for calculating whether there has been a real holding gain or loss?

Answer 9

Real holding gain/loss = Price of replacement - Historical cost - Loss in purchasing power (£)

Question 10

What are the two types of shares that can be offered to shareholders?

Answer 10

• Ordinary/Equity shares

- Preference shares

Question 11

What are some of the key characteristics of Ordinary shares?

Answer 11

• Share proportionally in the reward/risk
• Entitled to residual profits after Fixed dividend
• Right to new issues of shares in the same class
• Voting/Non-Voting rights

Question 12

What are some of the characteristics of ‘Preference shares’?

Answer 12

• Fixed rate of dividend (% of nominal value)
• Paid before distribution to ordinary shareholders
• Non-voting rights

Question 13

What are the three methods of share issuing? And describe each of them.

Answer 13

Offer for subscription
- shares offered directly to the public
Placings
- shares arranged for purchase by financial institutions
Rights issue
- shares offered to existing shareholders at under market value

Question 14

What reasons are there for issuing shares?

Answer 14

Future investment
As consideration on an acquisition
To avoid paying out cash from company funds to shareholders

Question 15

What are the two approached to calculating the amount of money needed to meet creditor claims?

Answer 15

Direct approach:
Requires the asset side of the balance sheet to contain assets with a realisable value sufficient to pay creditors.

Indirect approach:
Requires the liability side of the balance sheet to classify reserves into distributable and non-distributable reserves.

Question 16

What are the three general rules for distributable profits?

Answer 16

1) Unrealised profit cannot be distributed
2) All accumulated net realisable profits (realised profits less realised losses) on a balance sheet must be considered
3) There is no difference between REALISED REVENUE and REALISED CAPITAL PROFITS