UNIT 1_Lesson 2_ Share transactions and dividends transcript

Path 1: Introduction
In this Prezi presentation we will do a quick recap on all the entity forms. Then our focus will move
to companies and specifically how the equity is structured.

Path 3: Sole proprietor

In Accounting 11, our focus was on a sole proprietor. This type of business is owned by one
person and is not a separate legal entity apart from its owner. The funding is limited to what the
owner can contribute in the form of capital and any capital withdrawn is known as drawings.

Path 4: Partnership
A way for a sole proprietor to expand, is to consider a partnership. It however also has no legal
status and the partners are jointly and severally liable for the debts of the partnership. A
partnership agreement stipulate how the business will be administered and how the profits will be
shared. The equity is also in the form of capital and drawings.

Path 5: Private company

A company is a legal entity distinct from the persons who own it. They are called shareholders.
In South Africa we have different types of companies, one of which is a private company. The
shares in a private company cannot be offered to the public and once you are a shareholder there
is restrictions on who you can sell your shares to.

Path 6: Public company

A public company can offer shares to the public and if such a company is listed their shares are
traded on a stock exchange. A public company is distinguished from a private company their
abbreviations at the end. A private company has (Pty) Ltd after its name, whereas Ltd is used for
public companies.

Path 7: Personal liability company

A personal liability company is often used for audit firms and their directors, present and past, are
liable for the company’s debts. Our focus will be on private and public companies in Accounting
12.

Path 9: Share
The capital of a profit company is divided into units called shares. These shares are held by
shareholders who then effectively own the company. Can the owner of a company sell shares to
someone else? Hopefully you can answer this questions. The answer is yes, but the owners of a
private company is restricted to who they can offer their shares to and will have to follow the rules
of the company.

Path 10: Shares in a public company

A public company’s shares can however be traded in different ways. Firstly the company can offer
the shares to the public and in turn can buy it back from the shareholders. The shareholders can
also trade their shares on the stock market or sell it to another individual.

Path 11: Managing of the company

So the question begs as to who manages the company. Is it the shareholders? No, the
shareholders do not manage the company. That is done by the directors and managers of the
company. As you can see, the shareholders do maintain a form of control by appointing the
directors that will manage the company.

Path 13: Classes of shares

There is two classes of shares that a company can issue – ordinary or preference. The differences
in the classes of shares has to do with the respective rights. The ordinary shareholders are those
that will vote at the AGM regarding the issues that we encountered in the previous slide. They will
vote in proportion to their shareholding, for instance if you own 10% of the shares, then you have
10% of the vote. This percentage also applies to their dividend distribution.

As the name suggests, preference shares enjoy preference i.r.o. their dividend distribution. They
can also vote at shareholder meetings, but only i.t.o. issues that affect their rights.

Path 14: Authorised and issued shares

A company has to stipulate the total amount of shares that they expect to issue. This is called the
authorized shares and is set out in the Memorandum of Incorporation (or MOI). The MOI is
specific to South Africa and the Companies Act of other countries can specify another document.

A company can issue shares at any time, but only to the extent that it has been authorized. They
therefore cannot issue more than the authorized number of shares, but they do not have to issue
all the authorized shares.

Path 16: Share issue process

We will not look at how share are issued. Please read the following slide and then we will plot this
on a timeline.

Path 18: Timeline 1

On 10th July the company is incorporated.

Path 19: Timeline 2

They offer 1 000 000 ordinary shares to the public at R30 per share.

Path 20: Timeline 3

Until 15 August, they receive subscription from the public. The public would state the amount of
shares that they want to subscribe to and they will pay the amount due. The company, receiving
the money will debit the bank and the question is what do we credit. See if you can find the credit
account.

Path 21: Timeline 4

Now the shares must be issued, also known as the allotment of shares. The directors will issue
the shares that the public applied for. What would the journal entry be?

Part 23: Example

Let’s look at the following example. Khoza Bazaar has an authorized share capital of 5 000 000
ordinary shares. On 1 June they invited the public to apply for 2 000 000 shares at R45 per share
and the closing date is 30 June.

In the first scenario we will consider that we have received applications for the full issue of
2 000 000 shares. In scenario 2 we will consider the journal entries when we have an over-
subscription, meaning that more applications were received.

Path 24: Scenario 1

Here are the journal entries for scenario 1. When the public applies for the shares, Khoza Bazaar
receives the necessary amounts for the shares and therefore they debit the bank. They will credit
a temporary account, the application and allotment account. This account is used from the date
of issue to the closing date, to ‘store’ all the amounts received until they can issue the shares.
After the closing date, the directors will decide how many of the applications they will allot or
issue. They then debit the temporary account and credit the share capital account. The temporary
account will therefore fall away and Khoza Bazaar will be left with the money in the bank and the
issued share capital.

Path 25: Scenario 2

For scenario 2 we follow the same principle. In this case, Khoza Bazaar received more
applications than the 2 000 000 that they invited the public to take up. So once again, they receive
the money and place it in an applications and allotment account. Then after the closing date, they
decide to only issue 2 000 000 shares and the amount that was over-subscribed must be paid
back. In this case 1 500 000 shares at R45 per share is paid back.

Path 30: Dividends

In a sole proprietorship or partnership, the owners or partners withdraw fund which is called
drawings. In the case of a company, the shareholders are paid dividends. These dividends are
paid in proportion to their shareholding and must be declared by the directors before they are
recognised. The Companies Act in South Africa states that a company must pass the solvency
and liquidity test before a dividend can be declared. The company must prove that they are
solvent – their assets exceed their liabilities – and that they are liquid – their current assets exceed
their current liabilities. Does the same principle apply in your country?

Path 33: Example

Please read the following example and then we will consider the journal entries.

Path 34: Example solution 1

The issued preference share capital is R700 000 and they have a dividend percentage of 10%.
Their dividend, even though it is a fixed percentage, will only be paid once a dividend is declared
by the directors. The declaration took place on the 15th of January – that is the date of recognition.
And we debit the dividend account and credit the shareholders for dividend account, which is a
liability account.

Look at the calculation of the amounts. For the preference dividend you take the percentage
multiplied with the Rand amount of the share capital. Here’s a tip: a percentage must always be
multiplied by a Rand amount. The ordinary share dividend is the number of shares multiplied with
the price per share.

Path 35: Example solution 2

On 30 January the dividends are paid, so we debit the liability, shareholders for dividend and
credit the bank account with the payment.

Take note of the following important principles:

• Ordinary dividend can only be declared after the preference dividend (remember that we
stated that preference shares enjoy preference ito their dividend distribution);
• A dividend is not an expense, you should therefore not have a dividend paid in the profit
or loss statement. It is a distribution of their share of the profit and will therefore appear
in the statement of changes in equity.