SOLUTION: Lecture 2:Share capital and reserves

Lecture 2:Share capital and reserves
HI5020 Corporate Accounting
Holmes Institute
Applied Business Statistics for Managers
Topics Covered
After completing this session, you will:
Understand that the equity of an organisation can consist of several different accounts
Understand that within equity there can be various classes of shares, each providing different
rights to holders
Be able to provide the journal entries to recognise the issue of both fully paid and partly paid
shares by a company
Be able to provide the necessary journal entries when shares are forfeited upon non-payment of
instalment money by their owners
Be able to provide the journal entries necessary when preference shares are to be redeemed
Understand the concepts of rights issues and option issues
Understand what constitutes a share split and a bonus shares
Know the disclosure requirements of AASB 101 Presentation of Financial Statements in relation
to share capital
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Equity as a residual claim on net assets
Equity
The Conceptual Framework defines equity as:
➢ the residual interest in the assets of the entity after deducting all of its
liabilities
➢ Assets -liabilities = Equities
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Component of Owner’s Equity
Total owners’ equity is made up of a number of accounts
➢ Share capital relating to one or several classes of shares
➢ Reserves (e.g. revaluation surplus, general reserve, forfeited share
reserve)
➢ Retained earnings (or accumulated losses)
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Example of owner equity
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Retained earnings
Retained earnings often makes up a significant proportion of shareholders’ funds
➢ Represents the accumulation of prior period profits and losses
➢ Reduced by dividends declared and paid
➢ Reduced by any transfers to other reserves
➢ Could be reduced by a bonus issue of shares
➢ Changes in accounting policies as the result of the initial adoption of a new accounting
standard can result in a direct adjustment in retained earnings in accordance with AASB 108
➢ The recognition of prior period errors can result in a reduction in retained earnings in
accordance with AASB 108
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Reserves
A range of reserves recognising adjustments that result in
increases (generally) in equity (or adjustments to existing
reserves)
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Creating reserves
If an organisation revenues its land from $700 000 to $850 000, ignoring tax implications, the accounting entry to record the
revaluation would be:

Dr	Land	150 000
Cr	Gain on revaluation (part of OCI)	150 000

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(to recognise the gain as part of other comprehensive income)
At the end of the accounting period, the gain on revaluation recognised within other comprehensive income would be transferred
to equity in the form of a transfer to the revaluation surplus account:

Dr	Gain on revaluation (part of OCI)	150 000
Cr	Revaluation surplus	150 000

(to transfer the gain to revaluation surplus)
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Creating reserves
Companies often create reserves that they label ‘general reserves’. Some companies establish general
reserves as a means of transferring profits out of retained earnings for future expansion plans.
For example, a company might consider that it needs to put aside $750 000 per year for three years to fund
the restructuring of the organisation in three years’ time. The entry each year would be:

Dr	Retained earnings	750 000
Cr	General reserve	750 000

(transfer from retained earnings to the general reserve)
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Accounting for the issue of share capital
Share capital
➢ Balance of owners’ equity within a company comprising the capital
contributions made by owners
When shares are issued, then the amount received from the issue is added to ‘share
capital’
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Accounting for issue of fully paid share capital
To recognise receipt of application monies:

Dr	Bank trust	x
Cr	Application	x

To recognise the issue of shares and to close application account:

Dr	Application	x
Cr	Share capital	x

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Accounting for the issue of share capital
To transfer cash from trust account to general operating bank
account:

Dr Cash at bank
Cr Bank trust

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Partly paid shares
A company might issue shares on an instalment basis
Where shares are partly paid, the paid portion of the shares is accounted for in the
same manner as fully paid shares, while the balance, the deferred consideration, is of
the nature of a receivable
Where no future date has been specified for calling up the unpaid portion, an asset is
not recognised until the company has specified a future date or dates for calling up the
unpaid portion and informs shareholders of these dates
However, where shares have been issued on an instalment basis, with an amount to
be paid on issue and with further amounts payable at specified future dates, a
receivable must be recognised
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Worked Example 13.3—Issue of partly paid shares
Yeates Ltd commenced operations on 1 July 2023 by issuing 15 million ordinary shares by way of a
direct private placement and at an issue price of $1.50 per share.
Shareholders were required to pay $1.00 on application, with a further $0.35 payable on 1
September 2023 and a further $0.15 payable on 1 December 2023:
1 July 2023

Dr Cash
Cr Share capital

15 000 000

1 July 2023

Dr	First call	5 250 000
Dr Second call	2 250 000
Cr Share capital	7 500 000

1 September 2023

Dr Cash	5 250 000
Cr	First call	5 250 000

1 December 2023

Dr Cash
Cr Second call

2 250 000

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Oversubscription of shares
When more shares are applied for than the number to be issued—quite common
Two approaches to manage oversubscription:
1. Satisfy full demand of a certain number of subscribers and refund
the funds advanced by others
2. Issue shares to all subscribers on a pro rata basis
– Excess monies on application can either be refunded or used to
reduce further monies owing on allotment
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Worked Example 13.5—Oversubscription for shares
In July 2023, ABC Ltd calls for public subscriptions for 10 million shares. issued as partly paid
The issue price per share is $1.20, to be paid in three parts, these being $0.50 on
application, $0.40 within one month of the shares being allotted and $0.30 within two
months of the first and final call, with the call for final payment being payable on 1
September 2023.
By the end of July, when applications close, applications have been received for 12
million shares; that is, two million in excess of the amount to be allotted:
1–31 July 2023

Dr	Bank trust	6 000 000
Cr	Application	6 000 000

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Worked Example 13.5—Oversubscription for
shares
We will assume that the excess funds are used to offset the amount due on allotment ($0.40 per
share), and that all subscribers will receive an allotment of shares on a pro rata basis:
1 August 2023

Dr	Application	5 000 000
Cr	Share capital	5 000 000

(to allot the shares as partly paid to $0.50)

Dr	Allotment	4 000 000
Dr	Call	3 000 000
Cr	Share capital	7 000 000

Dr	Application	1 000 000
Cr	Allotment	1 000 000

Dr	Cash at bank	6 000 000
Cr	Bank trust	6 000 000

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Worked Example 13.5—Oversubscription for shares
30 August 2023

Dr	Cash at bank 3 000 000
Cr	Allotment	3 000 000
(to recognise the receipt of amounts due on allotment) It is assumed that all amounts due on allotment are paid:
1 September 2023
Dr	Cash at bank 3 000 000
Cr	Call	3 000 000

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Forfeited shares
Shares can be forfeited if:
➢ shares are issued as partly paid and shareholders do not
subsequently pay the amounts due on allotment or on calls
➢ a shareholder ceases to be a member of the company at that time
Shareholders who have forfeited shares might be entitled to a full or partial refund of
monies paid before forfeiture
Various outcomes
➢ If company is listed on the ASX or if company’s operating rules allow
it, a refund is paid to the investor less costs incurred in reissuing
shares
• amounts paid are recorded in a forfeited shares account
(liability) until refunded
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Forfeited shares (cont.)
Various outcomes (cont.)
➢ If company is not listed on the ASX and constitution says nothing
about refunds, the company can retain the amounts paid less costs
of reissuing shares:
• amounts paid are held in a forfeited shares reserve (part of
shareholders’ funds)
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Forfeited shares (cont.)
Refer to the ABC ltd example that we have just discussed,
If holders of 1 Million shares fails to pay the allotment money.
Directors forfeit those shares and reissue them as fully paid at a
price of $1.00 per share. Cost associates with the issue is
$5000.
Directors refund the remaining amount to the shareholders
whose shares were forfeited on 1 November.
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Forfeited shares (cont.)
To record forfeiture of shares:

Dr Cr	Share capital Call	$1200,000 $300,000
Cr	Forfeited shares account $900,000
To recognise amount received on sale of forfeited shares:
Dr Dr Cr	Cash at bank Forfeited shares account Share capital	$1000,000 $ 200,000 $ 1200,000

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Forfeited shares (cont.)
To recognise payment of costs relating to sale of shares:

Dr Cr	Forfeited shares account Cash at bank	$5000 $5000
To recognise return of remaining monies to original
shareholders:
Dr Cr	Forfeited shares account Cash at bank	$695,000 $695,000

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Issue of shares other than for cash
Where shares are to be issued for a consideration other than cash, the fair value of the
consideration for the issue must be determined
Fair value is defined in the accounting standards as:
➢ the price that would be received to sell an asset or paid to transfer a
liability in an orderly transaction between market participants at the
measurement date
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Rights issues
A rights issue provides existing shareholders with the right to
acquire additional shares typically at an ‘attractive’ price
Some rights might be tradeable, some are not
• A rights issue must be underwritten, basically a guarantee
that all shares on offer against existing shares will be taken
up.
• Where there is an under-subscription, the underwriter will be
required to acquire the balance (will be a receivable),
meaning that the share capital increases by the “required”
amount
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Share options
Share options give the holder the right to acquire shares in
the future at a particular price
Typically sold by the entity, or provided to employees as part
of their salary
If shares are issued to employees then they will be treated as
part of salaries expense (with a credit to share capital)
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Share splits
Share splits
Subdivision of the company’s shares into shares of smaller
value
Result in no change to owners’ equity
Companies may undertake share splits because they feel that
lower priced shares will be more marketable
A company with 20 million shares may split them down to 40 million
shares.
There is NO change to equity and as such, no journals required. They
just need to amend their share register.
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Bonus issues
Bonus shares
• Existing shareholders receive additional shares, at no cost, in
proportion to their shareholding at the date of the bonus issue
• Journal entry
Dr Retained earnings x
Cr Share capital—ordinary shares x
• Bonus shares from retained earnings often referred to as a bonus
share dividend
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Accounting for dividends
Once the final profit for the year has been calculated, the
directors decide on the amount of final dividends to allocate
to shareholders
Australian Accounting Standards (and IFRS) prohibit the
recognition of a dividend at the end of the reporting period
unless the dividend has been declared and ratified by
appropriate party prior to year end.
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Different classes of shares
Ordinary shares
• Provide a claim against the entity that ranks behind the claims of
creditors and some preference shareholders
• Confer voting rights on shareholders
• Entitle their owners to distribution of profits in the form of dividends
• Entail, however, no guarantee of dividends
• If dividends not paid in one year, do not accrue the right to dividends
until dividends are paid
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Different classes of shares
Preference shares
• Subject to preferential treatment, often with receipt of dividends or
order of ranking for asset distributions
• Some have voting rights
• Some have voting rights if dividends unpaid
• Others have no voting rights
• If participating, holders may, after receiving preference dividend at
fixed rate, participate with ordinary shareholders in further profits
distributed
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Redemption of preference shares
Under s. 254 (J) and (K) of the Corporations Act, shares are to be redeemed:
– out of profits that would otherwise be available for dividends,
or
– out of proceeds of a fresh issue of shares made for the purposes of the redemption
– Finally, it should be noted that the Corporations Act 2001 requires that a
redemption of preference shares should not reduce total share capital.
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Redemption of preference shares
To recognise issue of preference shares:

Dr	Cash at bank
Cr	Share capital—preference shares

x
x
To eliminate preference shares and create ‘capital redemption reserve’:

Dr
Cr

Share capital—preference shares
Capital redemption reserve

x
x

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Redemption of preference shares
To redeem shares out of profits:

Dr	Retained earnings
Cr	Cash

x
x
Further entry required pursuant to amendments to the Corporations Act:

Dr	Capital redemption reserve	x
Cr	Share capital	x

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Required disclosures for share capital
AASB 101 requires disclosure of the following:
For each class of share capital
➢ Number of shares authorised
➢ Number of shares issued and fully paid, and issued but not fully paid
➢ Par value per share, or that shares have no par value
➢ Reconciliation of number of shares outstanding at beginning and end of period
➢ Rights, preferences and restrictions of the class
➢ Shares reserved for issue under options and contracts for sale of shares
➢ Shares in the entity held by the entity or by subsidiaries or associates
Description of nature and purpose of each reserve within equity
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Summary of the Lecture
In this session you have learned the following:
Understand that the equity of an organisation can consist of several different accounts
Understand that within equity there can be various classes of shares, each providing different rights to holders
Provide the journal entries to recognise the issue of both fully paid and partly paid shares by a company
Provide the necessary journal entries when shares are forfeited upon non-payment of instalment money by their owners
Provide the journal entries necessary when preference shares are to be redeemed
Understand the concepts of rights issues and option issues
Understand what constitutes a share split and a bonus shares
Know the disclosure requirements of AASB 101 Presentation of Financial Statements in relation to share capital