written elements

Question 1

what is the difference bwteeen authorised capital and issued capital

Answer 1

authorities capital - the maximum number of shares allows to be issued according to the company’s memorandum of association, this figure can only be exceeded if existing shareholders approve, must be shown in the published accounts of a plc. It could be used as an additional source of finance-if all of the authorised capital has not been previously used

issued capital - issued capital cannot exceed authorised capital
, any previously issued existing capital forms the balance b/d in the ordinary share capital account: this is the capital figure used to calculate: capital employed, share dividends and ratios

Question 2

should you use authorised or issued capital in calculations

Answer 2

only use issued capital for all calculations

Question 3

explain the importance of the auditors report

Answer 3

1. required by companies act 2006
2. carried out by independent auditors
3. the concept of prudence must have been followed
4. confirms/denies that the accounts give a true and fair view of the company’s affairs
5. shareholders and potential investors will make financial decisions based on the accounts of the company

Question 4

what is the purpose of notes to the accounts

Answer 4

final accounts give brief summary information. ‘notes to the accounts’ are additional pages in the annual report attached to the final accounts in order to give more detailed information such as:
1. depreciation policy
2. details of sources of income if the company sells a range of products/services
3. details of employees and directors pays and pensions
4. non-current assets - schedule of NCA (SONCA)

Question 5

where may profit be distributed in the statement of changes in equity

Answer 5

the soCE of a limited company has the following columns:
1. ordinary share capital
2. share premium
3. revaluation
4. retained earnings

Question 6

what are liabilities

Answer 6

amounts owed for goods/services supplied to the business, they are known as amounts and can be calculated with accuracy
example: trade payables

Question 7

what are provisions

Answer 7

amounts set aside out of profits for a known expense, the amount cannot be calculated with accuracy
example: provision for doubtful debts

Question 8

what are reserves

Answer 8

any amounts set aside by the directors that cannot be described as provisions
example: capital reserves

ALL RESERVES BELONG TO THE ORDINARY SHAREHOLDERS

Question 9

note about reserves

Answer 9

reserves are not reserves of cash, no bank entries are made, there’d been no inflow of money

Question 10

what are revenue reserves

Answer 10

made up of retained profits which have arisen through revenues derived from normal trading activities
they CAN be transferred to the statement of changes in equity
they CAN be paid out as dividends

Question 11

example of revenue reserves

Answer 11

retained earnings balance c/f

Question 12

uses of revenue reserves (4)

Answer 12

1. pay dividends to shareholders
2. reduce profits available for dividend payments
3. fund a bonus share issue
4. strengthen the financial position of the company

Question 13

what are capital reserves

Answer 13

HAVE NOT BEEN created from trading activities of profits, they CANNOT be transferred to the statement of changes in equity, company law states that they cannot be paid out as dividends, this conserves cash and therefore protects the payables of the company

Question 14

examples of capital reserves (3)

Answer 14

1. share premium (reserve)
2. revaluation reserve
3. capital redemption reserve

Question 15

what can the share premium account be used for (2)

Answer 15

1. to fund a bonus share issue
2. to write off ‘preliminary expenses’ (the expenses incurred in the initial formation of a limited company)

Question 16

what is a revaluation reserve

Answer 16

NCA’s may change in value over time and should be valued appropriately
without reval land/buildings would be shown in the SOFP at historical cost(original) which would not reflect the true up to date asset value to the company
revaluations increase the net asset value of thr business and must be shown as an increase in the reserves on the SOFP

Question 17

what is a capital redemption reserve (capital reserve)

Answer 17

when a company buys back it’s shares, it must make a tryna fee of the buy-back amount to the CRR from the P&L account, this transfer will reduce the amount of profit available to be appropriated to shareholders as a dividend, reducing the dividend keeps more cash in the company, thus more cash is available to pay the creditors of the company, so the interests of the creditors are protected

Question 18

what is the capital structure of a limited company

Answer 18

it’s shown by the contents of the ‘capital and reserves’ equity section of the SOFP
it should include the following:
(O) ordinary share capital
(S) share premium
(R) revaluation reserve
(C) capital redemption reserve
(P) retained earnings

Question 19

what is a rights issue

Answer 19

offered only to existing shareholders - based on their existing shareholdings
creates a cash inflow - bank assets increase by value of share
cheaper for shareholders than a general share issue
cheaper for company to administer than a general share issue

Question 20

why do directors issue bonus issue shares given that no cash is received from shareholders

Answer 20

• the company may have insufficient liquidity(not enough cash) to pay a dividend
• they may want to reward the loyalty of existing shareholders
• the company may have large capital reserves
• bonus shares may be used to reward mangers of the business as part of a bonus system
• they may wish to dilute the market value of the shares to make them more attractive

Question 21

bonus shares

Answer 21

• always issued at the PAR price
• issued to existing shareholders in proportion to the number of shares they hold
• no cash will flow in because they are FREE
• will lower the market share price of the share - means the company’s shares may therefore become more attractive to investors
• improves liquidity if given instead of cash dividend

Question 22

what can a bonus share issue be funded from

Answer 22

share premium account, retained earnings balance or revaluation reserve

Question 23

where funds the bonus issue if the company wants to maintain reserves in their most distributable form

Answer 23

share premium first and the revaluation reserve

Question 24

rights share issue features

Answer 24

• generates cash inflows from selling shares to existing shareholders
• only possible if “issued capital’ has not exceeded ‘authorised capital’

Question 25

advantages of rights share issue

Answer 25

-inflow is from existing shareholders - therefore doesn’t increase gearing ratio because external debt (%) is not increased
-possible to generate additional inflows by charging a share premium
- cheaper than a full issue

Question 26

disadvantages of rights share issue

Answer 26

• incurs administration costs (reducing profit and liquidity)
• dilutes dividends for shareholders
• available as source of finance for limited companies only

Question 27

featured of ordinary share issue to the public (new issue)

Answer 27

• ordinary shareholders have voting rights in annual general meetings (AGM)
• ordinary shareholders receive any dividends AFTER the preference shareholders have been paid their dividends (only if there are sufficient bank funds to pay them)
• ordinary shareholders receive their capital back after the preference shareholders and debenture holders in the event of the company becoming bankrupt and ‘liquidated’

Question 28

advantages of ordinary share issue to the public (new issue)

Answer 28

-doesn’t increase gearing so will not disadvantage ordinary shareholders if profit/cash is low
- possible to generate further inflows through charing investors a share premium

Question 29

disadvantages of ordinary share issue to the public (new issue)

Answer 29

• a full issue is very expensive with high administration costs - reducing profits
• unsuitable if economy is in recession- possibility that not all the shares will be bought by the potential shareholders
• available as a source of finance for limited companies omlym

Question 30

issue of debentures (%) features

Answer 30

• long term loans to a limited company
• holders receive a fixed rate of interest(%) per annum (entered as an expense)
  -holders do not have voting rights in annual general meetings (AGM)
  -holders take repayment priority if company closes
• debenture interest must be paid whether or not the company makes a profit
• appear as long term liabilities unless they are within one year of being redeemed (cashed in) - in which case they are CL

Question 31

disadvantages of issue of debentures

Answer 31

• they increase the gearing ratio because they are ‘fixed interest’ (%age) loans
• highly geared businesses can damage the interests of ordinary shareholders
• debenture interest must be paid whether or not the company makes a profit
• interest expense payments will reduce profit