WEEK 2 Lecture 2 Chapter two Further

WEEK 2 – Lecture 2 Chapter two Further Financing company operations Compiled by: Maheshwari Chand; in Tri 2, 2013 1

Subsequent issues of shares Issued to raise funds to support expansion 1. RIGHTS ISSUE Offer of shares to existing shareholders Rights dependent on the number of shares held Rights may be renounceable or non-renounceable 2. PRIVATE PLACEMENTS Offer of shares to one entity only Usually issued to institutional investors Accounting for these types of issues is similar to public issues but does not use application/cash trust accounts The entry required is: Dr Cr Cash xx Share capital xx Compiled by: Maheshwari Chand; in Tri 2, 2013 2

Subsequent issues of shares 3. BONUS ISSUE Shares granted only to existing shareholders Issued at no cost in lieu of cash dividend Number based on shareholding at date of declaration No change in the net equity of the company. The entry required is: Dr Retained earnings/reserve xx Cr Share capital xx Compiled by: Maheshwari Chand; in Tri 2, 2013 3

Subsequent movements in share capital - options Ø Options: A right (not obligation) to buy a certain number of shares by a set date at a set price. Options may be issued for free – eg options may be issued to employees in lieu of cash bonuses. Options may be sold to investors – similar to normal shares. Where options are not exercised by a specific date they lapse. Compiled by: Maheshwari Chand; in Tri 2, 2013 4

Subsequent movements in share capital options (Example 6) On 30 June 2011, ABC issued 10, 000 options valued at $1 each to the CEO as payment for past services Each option entitles the CEO to acquire a share in the company for $3 The options must be exercised within 12 months of issue date - after this time they will lapse Compiled by: Maheshwari Chand; in Tri 2, 2013 5

Subsequent movements in share capital - options (Example 6) Required: Prepare the journal entries to account for the issue and exercising of the options assuming: a) The options are issued for no consideration. On 1 May 2012, when the share price is $3. 10, the CEO exercises the options. b) The options are issued for no consideration. The options are not exercised by the CEO and lapse on 30 June 2012. c) The options are issued for $1 each. By 30 June 2012, 9, 000 of the options have been exercised. Compiled by: Maheshwari Chand; in Tri 2, 2013 6

Subsequent movements in share capital - options (Example 6) 30 June 2012 (same entry for a) and b)) Dr Wages expense 10, 000 Cr Options Issue of options to CEO for past services a) 1 May 2012 Dr Cash 30, 000 Dr Options 10, 000 Cr Share capital Exercising of options by CEO 10, 000 10 ooo @ 3. 00 10 ooo @ 1. 00 40, 000 b)30 June 2012 Dr Options 10, 000 Cr Reserve 10, 000 Transfer of balance to a reserve account on the lapsing of the options Could also be credited to Retained Earnings or Share Capital Compiled by: Maheshwari Chand; in Tri 2, 2013 7

Subsequent movements in share capital options (Example 6) c) 30 June 2012 Dr Cash Cr Options Issuing of options 10, 000 (10, 000 x 1. 00) 10, 000 1 July 2011 - 30 June 2012 (9, 000 x $3) Dr Cash 27, 000 (10, 000 x 1. 00) Dr Options 10, 000 Cr Share capital 36, 000 (1, 000 x $1) Cr Reserve 1, 000 lapsed options Exercising of 9, 000 options to 30 June 2012 and transfer of balance to a reserve account on the lapsing of the options Compiled by: Maheshwari Chand; in Tri 2, 2013 8

* Redeemable preference shares Such shares either: Give the holder the right to be repaid his/her capital Or Give the company the right to repay the capital Main issue is the classification of such shares Are they equity or liabilities? Compiled by: Maheshwari Chand; in Tri 2, 2013 9

Redeemable preference shares - equity Shares can be redeemed from: 1. Proceeds of a fresh issue of shares Or 2. Retained earnings Additionally, the constitution may specify payment of a redemption premium which is paid from profit On redemption the shares are cancelled and cannot be reissued Compiled by: Maheshwari Chand; in Tri 2, 2013 10

Redeemable preference shares - equity Dr Share Capital - Preference $x Cr Shareholders redemption $x Transfer of preference capital to redemption account Dr Shareholders redemption Cr Cash Redemption of preference shares Dr $x Cash/ Retained earnings $x Cr Share Capital - Ordinary Receipt of cash on issue of new shares $x $x Cash a/c applies to issues of new shares; retained earnings a/c applies to redemption from profits Compiled by: Maheshwari Chand; in Tri 2, 2013 11

Redeemable preference shares - liabilities Redeemable preference shares with the following characteristics are more in the nature of liabilities: Redeemable in cash on a certain date or at the option of the holder Cumulative as to the payment of dividends Non-participating in further dividends distributions Priority capital return rights Accounting process required when accounting for redeemable preference shares that are classified as liabilities depends on whether the redemption is: 1. From a fresh issue of shares (Fig 2. 12 of text) 2. From profits at a premium (Fig 2. 13 of text) Compiled by: Maheshwari Chand; in Tri 2, 2013 12

Ø Redemption of P/shares liability from a fresh issue of shares: Ø Ø Dr Cr (The shares are to be redeemed in cash out of a fresh issue of 15 000 redeemble preference shares issued for $2 each) Journal entry : Preference Shares Liability 30 000 Shareholders’ Redemption 30 000 (Tranfer of P/shares liability to redemption account) Dr Cr Cash 30 000 Preference Shares Liability (Issue of 15000 preference shares for $2 each) 30 000 Dr Cr Shareholders’ Redemption 30 000 Cash (Redemption of preference Shares) 30 000 Compiled by: Maheshwari Chand; in Tri 2, 2013 13

Ø Redemption of P/Shares Liability out of profits at a premium: Ø Ø Dr Cr (The P/ shares are to be redeemed out of profits in cash for a price of $1. 10 per share. Journal entry : Preference Shares Liability 30 000 Shareholders’ Redemption 30 000 (Tranfer of P/shares liability to redemption account) Dr Cr Redemption Premium Expenses Shaeholders’ Redemption (Premium on redemption) 30 00 Dr Cr Retained Earnings 30 000 Share Capital (equity) 30 000 (Transfer R/Earnings to capital to preserve the capital of the company under the law) Dr Cr Shareholders’ Redemption 33 000 Cash (Redemption of preference Shares at premium) Compiled by: Maheshwari Chand; in Tri 2, 2013 30 00 33 000 14

Conversion of shares A company may change its issued capital by: Consolidation Involves grouping issued shares into larger parcels Eg; 2 x $1. 00 consolidated into 1 x $2. 00 share Split Involves splitting issued shares into smaller parcels Eg; 1 x $2. 00 share split into 2 x $1. 00 shares Conversion Involves converting an ordinary share to a preference share or vice versa Governed by constitution Compiled by: Maheshwari Chand; in Tri 2, 2013 15

Share buy-backs WHY BUY BACK SHARES? Change debt/equity ratio Defence against takeover Clear odd lots or employee share schemes LEGAL REQUIREMENTS Covered by Section 257 A of Corporations Act Allowed only if not prejudicial to creditors Limited types of buy-backs allowed ACCOUNTING FOR BUY-BACKS Shares must be cancelled Buy-back may generate a premium or a discount These are adjusted against either reserves, retained profits or both (UIG Abstract 22) Each company must adopt an accounting policy in respect of premiums or discount on buy-backs Compiled by: Maheshwari Chand; in Tri 2, 2013 16

Share buy-backs 1. At a premium: 120 000 shares initially issued at $1. 20 were bought back for $1. 50 each Dr Dr Cr Share Capital Retained earnings Cash 144, 000 36, 000 180, 000 2. At a discount: 120 000 shares initially issued at $1. 20 were bought back for $1. 00 each. Write back firstly against reserves (balance $20, 000) Dr Cr Cr Cr Share Capital 144, 000 Reserves Retained earnings Cash Compiled by: Maheshwari Chand; in Tri 2, 2013 20, 000 4, 000 120, 000 17

Accounting for debentures Issuing debentures May be issued at par/premium/discount Issue preceded by disclosure document Application monies held in trust until allotment Can be listed on the stock exchange Redemption of debentures May be redeemable at company’s option before maturity Redeemable on a set date or after a set period of time Debentures may be redeemed at par/premium/discount Premiums and discounts are treated as expenses and revenues Funds to redeem debentures may come from: Proceeds of new share issue or borrowing Proceeds of asset sale Assets currently held May be convertible into shares Compiled by: Maheshwari Chand; in Tri 2, 2013 18

Issuing debentures (liability) Ø Debentures payable in full on application. Ø Journal Entry: Ø Cash Trust Ø Application – Debentures ( for application money received on Debenture) App- Debentures Debenture Holders ** only if on instalment Debentures (Allotment of Debentures) Cash Trust (transfer to general cash on Allotment) Debentures Cash (Transaction costs of issuing debentures) *Cash Debenture Holders ** only if instalment money received Compiled by: Maheshwari Chand; in Tri 2, 2013 19

Redemption of debentures REDEMPTION AT A PREMIUM (LOSS) Dr Dr Cr Cr Debentures $x Redemption expense $x Redemption revenue Cash $x $x Expense = redemption at a premium (loss) Revenue = redemption at a discount (gain) CONVERSION TO EQUITY Dr Cr Debentures $x Share Capital Compiled by: Maheshwari Chand; in Tri 2, 2013 $x 20

Convertible notes Debt convertible to equity on maturity Initial classification as liability or equity depends on characteristics. Some may be partly debt, partly equity Accounting for redemption depends on initial classification Compiled by: Maheshwari Chand; in Tri 2, 2013 21

End of Lecture 2 Recap the corporate accounting regulations Recap the company formation process & accounts Thank you. Compiled by: Maheshwari Chand; in Tri 2, 2013 22