Week 5 - Equity in Limited Companies

Question 1

How many forms of limited company are there?

Answer 1

2

Question 2

What types of limited company are there?

Answer 2

1) Public Limited Company (plc)
2) Private Limited Company (Ltd)

Question 3

What are the differences between public limited companies (plc) and private limited companies (Ltd)?

Answer 3

1) plc’s are allowed to offer their shares to the public to raise capital and can they can be listed on a stock exchange (organised market in which securities e.g. stock/shares, bonds etc are bought and sold) whereas Ltd’s are not allowed to offer their shares to the public
- as a result plc’s have to satisfy more difficult regulations and are also prone to greater scrutiny over their financial situation (UK entities need to submit accounts to Companies House)
2) plc’s need to submit their accounts within 6 months after their year end whereas Ltd’s have until 9 months after their year end to submit their accounts
3) plc’s need to issue a minimum of £50,000 in share capital (funds that a company raises from selling shares to investors- amount shareholders/owners have invested in entity) whereas Ltd’s don’t need to issue any
4) plc’s need to have a minimum of 2 directors and a qualified company secretary whereas Ltd’s only need to have a minimum of 1 director and there isn’t a need for a company secretary

Question 4

What is the difference between stock and share?

Answer 4

Essentially mean the same thing but stock is plural and share is singular

Shares are the smallest unit of ownership of an individual entity whereas stock is a collection of something or a collection of shares in more than 1 entity

Question 5

What is a private limited company (Ltd)?

Answer 5

Any company that’s isn’t a public company (plc)

Question 6

List the advantages of being a plc

Answer 6

1) Easier to access capital e.g. banks more likely to be convinced by larger firm that is doing well than smaller firm, also capital can be gained by issuing shares/share capital
2) There are more possibilities to assess the value of the company as you can look at the entity’s market capitalisation (total value of stocks/shares issued … amount invested into entity by shareholders/owners)
3) Easier to make acquisitions (when an entity gains control over another entity by purchasing most or all of the other entity’s shares)
4) Possibly gives company a more prestigious profile

Question 7

What does equity consist of in public limited companies?

Answer 7

1) Ordinary share capital
2) Share premium
3) Retained earnings
4) General capital reserves

Question 8

What is ordinary share capital?

Answer 8

1) It is the capital (money/cash) invested in an entity by investors to buy shares (holding/ownership in that company) … making the investors the owners or shareholders
- the more ordinary shareholding you have in an entity, the more control you have over the company and owning more than 50% of the ordinary shares makes you the majority shareholder

2) It is treated as equity in the Statement of Financial Position (SoFP)- REMEMBER SoFP is the summation of all the final balances

3) Ordinary shares come with voting rights at general meetings and AGMs (annual general meetings- yearly/annual gathering of an entity’s shareholders, executives, and directors)

Question 9

What is share premium and share premium account?

Answer 9

1) All ordinary shares have the same nominal value which is determined by the entity
BUT a company can choose to sell its shares for a higher price than the nominal value originally set by the entity
SO any amounts received in addition to the nominal value of the shares is the share premium which goes into the share premium account
2) Treated as equity in the Statement of Financial Position (SoFP)

Question 10

How would you show the following activity by an entity:

The Entity issues 1 million ordinary shares that have a nominal value of 50p each. The public pays 85p for each share

Answer 10

So you need to break the activity down into the increase in ordinary share capital and the increase in the share premium account

Ordinary share capital increases by 1,000,000 x 0.5 = £500,000 as nominal value of share is equal to 50p

This means public pays 35p more than the nominal value of 50p and … the share premium increases by 1,000,000 x 0.35 = £350,000

Record each transaction separately under ordinary share capital and share premium account respectively (both under equity) and then an increase in cash by £850,000

Question 11

What are retained earnings?

Answer 11

The amount of an entity’s net income that is kept within its accounts rather than being paid as dividends to shareholders- it is the remainder that is kept after paying dividends to shareholders- can be used to finance further growth

Question 12

How do you calculate retained earnings?

Answer 12

(Balance at the beginning of the year + profit for the year) – dividend payments to shareholders = Retained Earnings

Question 13

What are general capital reserves?

Answer 13

A general capital reserve account can be used to store an entity’s retained earnings/revenue reserves
- typically moved after dividends paid to shareholders as once in this account it means that the reserves are no longer available to pay shareholder dividends
- general capital reserves could be used for further investments or as savings for future years

Question 14

What are the options when it comes to equity financing?

Answer 14

1) Revenue reserves/Retained earnings
2) General capital reserves
3) Share capital

Question 15

Which of the equity financing options are viable?

Answer 15

Revenue reserves (retained earnings)- ONLY the reserves/earnings that arise from realised profits and gains can be withdrawn and used to fund a dividend or a share repurchase (reacquisition/buying back of an entity’s own shares that were previously sold to the public)

Share capital and capital reserves (general capital reserves) are not available for withdrawal

Question 16

What is the structure of the Statement of Changes in Equity (SCE)?

Answer 16

On the top row of headings you have (starting from the left):
Share capital, share premium, general capital reserve, retained earnings, total
- there is usually a key under each of the top row of headings suggesting whether the data is in millions of pounds etc- this is denoted as £m

On the leftest column of headings you have a brief summary of each transaction/activity- every new activity/transaction is on a new row
- the first (top left) row heading will probably be titled the ‘balance as at initial time period’- here you would place your initial values which should be given in the question along that row (DENOTE ANY BLANKS WITH A DASH)
- the row heading underneath that will be labelled ‘changes in equity for the year in question:’ and then you follow with the transactions/activities
- the bottom left heading will typically be titled ‘balance as at final time period’ and the totals for each column should follow along the bottom row
- the heading above the bottom left row will be ‘profit for the year’- and the profits will follow across the row

Additions are written as the integer only but subtractions are written in brackets

The bottom row total up each individual column separately whereas the rightest column totals up each individual row

Question 17

What are the sources of long term finance?

Answer 17

1) retained earnings
2) long term borrowings e.g. loans

Question 18

What groups can the sources of long term finance fall under?

Answer 18

Share issues and retained earnings (revenue reserves) are equity whereas long term borrowings e.g. loans etc is debt

Question 19

What is share issuing?

Answer 19

Entities (usually plc’s) can issue more shares to be purchased by the general public/invited individuals

Question 20

How may an entity offer more shares to existing shareholders?

Answer 20

Incentives may be given to existing shareholder’s to buy more shares- 2 of the ways in which this could occur are:

1) Bonus issue- shareholders given extra shares for free in proportion to their existing shareholding e.g. a 1:4 bonus issue means that existing shareholders will get 1 share for free for every 4 they already own

2) Right’s issue- entity gives existing shareholders the right to purchase extra shares at a price lower than the market value- the number of shares offered is in proportion to the shareholders existing shareholding e.g. the more shares owned/the greater the shareholding, the greater number of shares offered to the shareholder for purchase (price of share is not in proportion)

Question 21

How many elements are there of companies accounts?

Answer 21

5

Question 22

What are the elements of a companies accounts?

Answer 22

1) Statement of Financial Position (SoFP)
2) Income Statement or Profit and Loss Account
3) Cashflow Statement or Statement of Changes in Cashflow
4) Statement of Changes in Equity
5) Narrative Reporting- NEW

Question 23

What does narrative reporting include?

Answer 23

2 reports:
1) Director’s report
2) Strategic report

Question 24

What does the directors report include?

Answer 24

1) Names of those who were directors during the period
2) Any recommended dividends to give to shareholders
3) The involvement of employees in the affairs of the company
4) The employment and training of disabled people
5) Important events affecting the company since the year end
6) Likely future developments in the business
7) Research and development (R & D) activities

Question 25

What does the strategic report include?

Answer 25

Includes 3 main factors which can be broken down further:
1) Strategic management- how the entity intends to generate and preserve value
- includes strategy and objectives
- includes business model (company’s plan to make a profit)

2) Business environment- the internal and external environment in which the entity operates
- includes trends and factors
- includes principal risks and uncertainties
- includes environmental, employee, social, community and human rights matters

3) Business performance- how the entity has developed, performed and its position at the year end
- includes analysis of performance and position
- includes key performance indications (KPIs)- refer to quantifiable measurements used to gauge a company’s overall long-term performance
- employee gender diversity