ACF 1101

Financial Accounting

Week 08 & 09: Companies Share

Capital, Dividends, Retained
Earnings
Academic Year 2020/2021
Semester 1
Department of Business Finance
Faculty of Management
University of Peradeniya
 Components of shareholders’ equity
• Shareholders’ Equity section of a company’s
Statement of Financial Position includes:
– Share capital
– Retained earnings
– Reserves
– (Dividends)
 Companies: An overview
• Company is a business formed under
Companies Act No 7 of 2007
– Subject to duties and responsibilities of a person
– Classified by ownership (public or private)
 Characteristics of a company (that
separate it from sole trader or
partnership)
• Separate legal entity
• Limited liability of shareholders
• Continuous life
• Separation of ownership and control
• Subject to regulation
• Pays tax as a company
 Shareholders as owners
• They have the right to:
– vote for directors, auditors, etc;
– equal share in company's profit through dividends;
– equal share in residual claim on assets upon
liquidation.
 Share issue considerations
• Issue of shares:
– a company can issue Ordinary shares directly to
investors or through an underwriter; or indirectly
to publicly held companies
• Price of the share will be influenced by:
– anticipated future earnings
– expected dividend rate
– current financial position/state of the
economy/market
Share issue considerations cont’d
• Market value of shares
– Shares of publicly held companies are traded on
stock/share markets
– Market price is an exchange value
– All shares on CSE traded through a stockbroker

• Issue of shares results in Share Capital which is

part of Shareholders’ Equity on the Statement
of Financial Position
 Shareholders equity
ABC PLC
Statement of Financial Position
Shareholders’ equity
Stated Capital
Ordinary shares
Reserves
Revaluation reserve
Retained earnings
Total shareholders’ equity
 Accounting for share issues
• The primary objective in accounting for the
issue of (ordinary) shares are:
– Identify source of share capital
– Maintain distinction between share capital and
retained earnings/reserves
• Issue of (ordinary ) shares only creates/affects
Share capital account
 Types of share capital
• Ordinary
– Full voting rights
– Right to receive dividends
• Preference
– Fixed percentage of dividends
– Reduced (participative Preference share) or no voting
rights
– May be cumulative and redeemable
• Founder or deferred
– Receive dividends after other shareholders

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 Components of share capital
• Issue price
– Full price allocated to a share

• Called-up amount
– Cumulative amount of instalments payable

• Paid-up amount
– Should equal to called-up amount, any unpaid amount is
referred to as call in arrears

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 Payments for shares
• Application – paid when submitting application form

• Allotment – paid at share issue date

• Call – for partly paid shares only, payment date is at directors’

discretion

Example: A PLC invites applicants for 1 million shares for an issue price of
Rs.15, payable Rs.7 on application and Rs.4 on allotment.
Payment per share: application (Rs.7), allotment (Rs.4), call (Rs.4)

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 Accounting for initial share issue
• Step 1: Receive share application
Dr Trust account
Cr Application
(Monies are held in trust until allotment date)

• Step 2: Issue paid-up capital

Dr Application
Dr Allotment
Cr Paid-up capital
(Paid-up capital is funded by application and allotment monies)

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 Accounting for initial share issue
• Step 3: Recognise cash received
Dr Bank
Cr Trust account
(To transfer monies from trust to company bank account)

• Step 4: Receive allotment monies

Dr Bank
Cr Allotment
• Note: After Step 1 – 4, cash and paid-up capital increase,
other temporary accounts are reversed

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 Accounting for initial share issue
• Step 5: Call made on partly paid shares
Dr Call no. 1
Cr Paid-up capital
(Paid-up capital is funded by call monies)

Dr Bank
Cr Call no. 1
(To receive call monies)

• Note: The above journals assume that there is no under or

oversubscription

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 Example 1
Wade PLC was registered on 30 June 20X0. The directors
issued a prospectus calling for applications for 100,000 shares
with a full issue price of Rs.10 per share, payable Rs.5 on
application, Rs.2 on allotment and the balance when needed
to be called at a later date. By 31 July, the closing date for
application, exactly 100,000 applications were received. The
directors allotted the shares to these applicants on 1 August.
Outstanding allotment monies are received by 31 August. On
1 October, the directors made a call of Rs.3 per share,
Rs.200,000 of the call monies was received by end of
October.

Required: Prepare general journal entries to record all of the

above events.

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 Under or oversubscription
• Under subscription
– Shares can be allotted if minimum subscription condition is
met
– No accounting complications

• Over subscription
– Directors make all allotment decisions.
– Company may keep the excess application monies and
apply them to allotment and future calls; OR
– Return monies to unsuccessful applicants

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 Oversubscription - Journals
• Step 1 and 3: No change
• Step 2: three possible scenarios:
1. Excess monies returned to applicants
Dr Application
Cr Trust account
2. Excess monies retained and offset against allotment
Dr Application
Dr Allotment
Cr Paid-up capital
Dr Application
Cr Allotment
(To transfer application monies to allotment)
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 Oversubscription – Journals
3. Excess monies retained and offset future calls
Dr Application
Dr Allotment
Cr Paid-up capital

Dr Application
Cr Allotment
Cr Call in advance

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 Oversubscription – Journals
• Step 4: If application monies are enough to cover allotment,
then no further journal is required
• Step 5:
Dr Call no. 1
Cr Paid-up capital
Dr Bank
Cr Call no. 1

If call is partly covered by application monies, then:

Dr Call in advance
Cr Call no. 1

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 Example 2
Duncan PLC was registered on 1 January 20X0. The directors
issued a prospectus calling for applications for 100,000 shares
with a full issue price of Rs.20 per share, payable Rs.8 on
application, Rs.4 on allotment and the balance when needed to
be called at a later date. Under the prospectus, in case of
oversubscription, the directors can apply excess application
monies to pay the uncalled issue price. By the 31 January
closing date, applications for 200,000 shares were received. The
directors met the next day and decided to allot the shares on a
one-for two basis. On 1 May, the directors made a further call
of Rs.5 per share. All outstanding call monies were received by
30 May.
Required: Prepare general journal entries to record all of the
above events.

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 Example 3
The directors of Cathy PLC issued a prospectus on
January 20X9 calling for applications for 20,000 shares
with a full issue price of Rs.100 per share, payable
Rs.30 on application, Rs.30 on allotment and the
balance when needed to be called at a later date. By
the 31 January closing date, applications for 30,000
shares were received. The directors met the next day
and decided to reject applications for 5,000 shares and
return money. Remaining shares were allotted pro rata
basis and excess application money was adjusted
towards some due on allotment. On 1 May, the
directors made a further call of Rs.40 per share. All
outstanding call monies were received by 30 May.
Required: Prepare general journal entries to record all
of the above events.
 Forfeiture of shares
• Cancellation of a shareholder’s rights as a member, with
respect of particular shares

• Company may forfeit shares only for reason of non-payment

of calls

• Forfeiture of shares ≠ capital reduction

• Forfeiture shares can be “reissued” to new holders or used to

make bonus issue of shares

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Accounting for Forfeiture and ‘reissue’
• Step 1: Forfeiture of shares
Dr Paid-up capital – ordinary shares
Cr Call no.1(unpaid)
Cr Forfeited ordinary share capital (paid)

• Step 2: To record the ‘resale’ of shares

Dr Bank
Dr Forfeited ordinary share capital (shortage/ discount allowed on
reissued shares)
Cr Paid-up capital – ordinary shares

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Accounting for Forfeiture and ‘reissue’
• Step 3: Proceeds surplus (keep or return)
Dr Forfeited ordinary share capital (surplus)
Cr Stated Capital (keep the surplus)
OR
Cr Bank (return the surplus to former holders)

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 Example 4
On 1 September 2019, the director of Boozer PLC decided to
forfeit 10 000 ordinary shares with an issue price of Rs.10,
called to Rs.7 inclusive of calls in arrears of Rs.2. On 10
September, the directors decided to ‘reissue’ the 10 000
forfeited shares, as paid to Rs.7 per share, for a consideration of
Rs.5 per share. The allotment monies were received by 1
October. Boozer PLC’s constitution requires the company to
return any surplus amount on reissue to original shareholder.

Required: Prepare general journal entries to record all of the

above events.

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 Accounting for Share Buy-backs
• The repurchase of a company's shares by the
company from its shareholders.
• Reasons for buying back shares:
- Surplus cash but insufficient profitable
investment opportunities
- Avoid a takeover by an outside entity
- Support higher market price
 Preference Shares
• Preference shares have contractual provisions
that give them priority over ordinary shares in
certain areas:
– distribution of dividends
– assets in the event of liquidation
• Preference shares
– May be issued for cash or non-cash assets
– Usually do not have voting rights
– Are identified separately from other share capital in
shareholder’s equity
 Dividend preferences
• Preference shareholders have the right to
share in the distribution of profits before
ordinary shareholders
• However, this does not ensure they will
receive any dividend
• The per share dividend amount is stated as a
rupee amount per share or a specified rate
 Dividend preferences continued
• Cumulative dividend
– Preference shareholders must be paid both
current and prior year dividends before ordinary
shareholders receive any dividends
• Dividends in arrears
– Preferred dividends not declared in a given period
– Not considered a liability
– Amount to be disclosed in the notes to financial
statements
 Liquidation preference
• Most preference shares have a preference on
company assets if the company fails
• This provides security for the preference
shareholder
• Preference to assets is usually equal to the
amount originally paid for the preference
shares plus any dividends in arrears
 Reserves
• Reserves: restricts the ability of directors to make a
distribution to the owner
• Discretionary reserves
– Created by management’s wish, e.g. general reserve
• Obligatory reserve
– Required by contractual obligation or regulation, e.g. Asset
revaluation reserve (required by a/c standards)

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 Retained Earnings
• Retained earnings is profit that is retained in
the company
• The balance in retained earnings is part of the
shareholders’ claim on the total assets of the
company
• It does not represent a claim against any
specific asset
 Distribution to owners
• Share return = capital gain + distribution

• Distribution
– Cash dividend
– Non-cash dividend, e.g. dividend reinvestment plan
– Bonus issue/ Share dividend
Journal:
Dr Retained Profits/reserve
Cr Paid-up capital

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 Dividend
• Dividend is a distribution by a company to its shareholders
on a proportional basis. They can be expressed as either %
of the stated value of the share or Rs. per share
• Directors have rights to declare dividends, shareholders
only have rights to receive.
• Recognition of dividend
– Appropriation of profit and recognition of a liability
– Dividend declared must be recognised as a liability
– Dividend proposed will not be recognised as a liability, but should
be disclosed as a contingent liability in the notes

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 Dividend - Journals

1. Dr Interim/Final dividend (temporary account)

Cr Interim/Final dividend payable
(To recognise a liability)
2. Dr Retained profits
Cr Interim/Final dividend
(To clear the temporary account to retained profits)
3. Dr Interim/Final dividend payable
Cr Bank
(To record the payment of dividend)

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 Example 5

Nash PLC
Extract of Statement of Financial Position
As at 30 June 2020
Equity
Stated Capital
1 000 000 ordinary shares, fully paid 1 000 000
General reserve 100 000
Retained profits 700 000
Total Equity 1 800 000

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 Example 5 Cont…

• On 30 June, the directors proposed a final dividend of five cents

per share
• On 15 August, the final divided was approved at the AGM and
the dividend was paid on 10 September
• On 30 October, the directors decided to transfer Rs.100 000 to
general reserve
• On 31 December, the directors decided to issue bonus shares to
all ordinary shareholders. The bonus shares were issued at Rs.1
on a one-for-four basis. The bonus issue was to be funded by the
available balance of the general reserve, and the remaining
balance supported by retained profits.
Required: Prepare general journal entries to record all of the
above events.
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 Share dividends – Bonus Shares
• A share dividend is pro rata distribution to
shareholders of the company’s own shares
• Results in a decrease in retained earnings and
an increase in share capital
• Does not decrease total assets or total
shareholders’ equity
 Share dividends cont …
• Reasons for issuing share dividends
– To satisfy shareholders’ dividend expectations
without spending cash
– To increase the marketability of company’s shares
by increasing the number of shares and therefore
reducing market price per share
– To emphasize that a portion of shareholders’
equity has been permanently reinvested in the
business and unavailable for cash dividends
 Share dividends cont …
• Effects of share dividends
– The composition of shareholders’ equity changes:
• Retained earnings decreases and
• Share capital increases
– But total shareholders’ equity remains unchanged