Lesson 13: Shareholder's equity

Question 1

What are the features of a Company?

Answer 1

a) Separate legal entity
b) Limited liability
c) Continuous life and transferability of ownership
d) Separation of management and ownership
e) Corporate taxation
f) Government regulation
g) Ability to raise capital

Question 2

What are the two major parts of the Shareholder’s equity?

Answer 2

a) Issued share Capital
b) Reserves

Question 3

What are the types of Capital Reserves?

Answer 3

-Capital Reserves
-Revenue Reserves

Question 4

What are the types and issues of shares?

Answer 4

a) Ordinary shares
-Rights of ordinary shareholders
i. Vote
ii. Dividends
iii. Liquidation
iv. Transfer of shares
-Issue of Ordinary share by subscription

b) Preference Shares
TBC

Question 5

Note:
The liability of a company’s owners is LIMITED TO THE CAPITAL THEY HAVE CONTRIBUTED.

If the company is unable to pay its debts, ITS CREDITORS CANNOT CLAIM PAYMENT FROM THE SHAREHOLDERS’ PERSONAL ASSETS

Question 6

Note:
Personal transfer of shares from one to another does not affect the continuity of the company or the resources of the company

Question 7

What are Retained Earnings?

Answer 7

Retained earnings is the total amount of net profit (and loss) over the life time of the company which has not been distributed as dividends to its shareholders.

Question 8

What are Capital Reserves?

Answer 8

Capital reserves are profits arising from capital gains.

e.g. Gains arising from revaluation of non-current assets and ARE NOT to be distributed to shareholders IN THE FORM OF CASH DIVIDENDS. They can only be used to ISSUE BONUS SHARES

Question 9

What are Preference Shareholders?

Answer 9

Preference Shareholders are entitled to dividends before ordinary shareholders and upon liquidation of the company

Question 10

What are assets revaluation reserves representing the gain on revaluation of non-current assets?

Answer 10

These are unrealised gains which will only be realised upon the sale or disposal of the non-current asset

Question 11

How do you raise more capital without bringing in outside investors and at the same time making sure that the proportion of share ownership is maintained across shareholders and ownership and control remains undiluted?

Answer 11

Have a rights issue. Existing owners are able to buy shares at a discounted price, resulting in proportion of share ownership is maintained across shareholders and ownership and control remains undiluted.

Question 12

What is the Final Dividend?

Answer 12

The final dividend is the dividend that follows the end of the financial year

Question 13

What are Interim Dividends?

Answer 13

Dividends declared DURING the financial year.

Note:
The payment of Interim dividends will be made in the financial year it is DECLARED.

Question 14

Note:
Dividends for preference shares are described as a percentage of the share’s issue price

Question 15

Note:
After declaration of final dividend, on the accounting equation, liabilities increase and retained earnings decrease according to how much is declared to pay.

After payment of final dividend, cash at bank decreases and liabilities decrease according to how much the final dividend amount was

(Note: on accounting equation, under liabilities would be ‘Dividend payable -preference and ordinary’ if the company declares to pay for both ordinary and preference shareholders.
While equity would be ‘retained earnings’, during declaration, before payment
And assets would then be ‘cash at bank’, after payments)

Question 16

What are cumulative preference shares?

Answer 16

Cumulative preference shares have a right to be paid both the CURRENT year’s dividend and ALL PRIOR YEARS’ UNPAID DIVIDENDS

Question 17

Note:
Cumulative preference shares must be paid before any dividend can be paid to ordinary shareholders

Question 18

Note:
When the directors do not declare dividends on cumulative shares, the unpaid dividend is called DIVIDEND IN ARREARS

Question 19

What are dividend in arrears?

Answer 19

It is when directors do not declare dividends on cumulative shares

Question 20

Note:
Dividends in arrears are NOT A LIABILITY UNTIL THEY HAVE BEEN DECLARED

Answer 20

Accumulation of dividend in arrears does not guarantee that they will be paid

Question 21

What are non-cumulative preference shareholders?

Answer 21

Non-cumulative preference shareholders are NOT entitled to any dividends not declared in prior periods

Question 22

Why would a company want to issue share dividends rather than cash dividends>

Answer 22

-To continue dividends but conserve cash
-To reduce the market price of shares to keep them affordable (To make sure prices don’t hike and deter investors due to the not issuing cash dividends after high profit has been made, High supply will result in lowered pricing due to same level of demand)
-To reduce retained earnings -> to avoid the impression of excess profits and expectations of cash dividends

Question 23

What are the reasons for cash buy-backs?

Answer 23

-To have shares available to reissue them to employees as remuneration
-To ACCUMULATE SHARES in preparation for a merger or business acquisition
-To AVOID A HOSTILE TAKEOVER by removing shares from the open market, it reduces the opportunity for outsiders to obtain enough voting shares to gain control of the company
-To REDUCE THE NUMBER OF SHARES to INCREASE EARNINGS PER SHARE
-To KEEP THE MARKET PRICE OF SHARES HIGH when it appears to be falling