COMPANY ACCOUNTS

EQUITY SOURCES OF FINANCE

Characteristics of Equity:
Equity holders are the owners of the business
They buy shares – each share representing a portion of
ownership of the business
Referred to as ordinary share capital
EQUITY SOURCES OF FINANCE
Characteristics of Equity cont:
Investors earn a return referred to as a dividend
The dividend is taxable in the hands of the investor
but not tax deductible in the hands of the company ;
therefore it does not give a tax shield.
The dividend is not fixed/ regular
Dividend payments depend on:
The Company’s Profitability
The Company’s Liquidity
The Company’s policies
EQUITY SOURCES OF FINANCE
• Characteristics of Equity cont:
On profit sharing, ordinary share holders are considered
last after all the other stakeholders
On liquidation, ordinary shareholders are considered last
after all the other stakeholders
Equity forms a perennial source of finance for the
business
EQUITY SOURCES OF FINANCE

Equity is made up of:

Internal Equity
Retained Profits
External Equity
Ordinary Share Capital Issued
Irredeemable Preference Share Capital
INTERNAL EQUITY

These are:
Retained Profits/ Income
Reserves e.g Share Premium Reserve, General
Reserve, Revenue Reserve, Revaluation Reserve etc
RETAINED PROFITS/ INCOME

These are profits retained or kept within the

company and distributed to the owners of the
business.
They accumulate over time
RESERVES

These are profits set aside for a particular purpose

e.g replacement reserve
Or profits as a result of specific non – cash
adjustments e.g revaluation reserve, mark to
market reserve etc
EXTERNAL EQUITY ORDINARY SHARE
CAPITAL
Ordinary share capital is raised through an issue
of shares.
The issue can be
A new issue
A rights issue
EXTERNAL EQUITY ORDINARY SHARE
CAPITAL
A new issue of shares:
This is an issue of shares to the public
There are a number of ways shares are offered and
issued to the public
These include:
Initial Public Offer
Issue by Tender
Private Placement
Stock Exchange Introduction
EXTERNAL EQUITY ORDINARY SHARE
CAPITAL
An initial public offer
It is the first public equity issue made by a company
That is the company is being listed and appearing on
the stock market for the first time
The company engages an underwriter
EXTERNAL EQUITY ORDINARY SHARE
CAPITAL
An underwriter:
Is an investment firm (usually merchant banks) who
act as intermediaries between a company selling a
security and the investing public.
They formulate the method used to issue the securities
They price the new securities
They sell the new securities
EXTERNAL EQUITY ORDINARY SHARE
CAPITAL
An underwriter:
Buys the securities for less than the offering price
Accepts the risk of not being able to sell them
The difference between the offer price and the buying
price is referred to as the “spread”
The spread is the compensation received by the
underwriter
Due to the risk involved, underwriters pool together to
form a syndicate which also helps sell the securities
EXTERNAL EQUITY ORDINARY SHARE
CAPITAL
The Aftermarket
Is the period after a new issue is initially sold to the public
During this time the members of the syndicate cannot sell
securities for less than the offering price
If the market price falls below the offer price, the principal
underwriter is allowed to buy securities
This is to stabilise the market
If the issue remains unsold then members can leave the
group and sell the shares at whatever price the market can
allow.
EXTERNAL EQUITY ORDINARY SHARE
CAPITAL
A Prospectus
A document prepared to market the issue of shares
Informs the public about the company as well as the
issue
Contains information as required by the stock
exchange
It is a legal document
EXTERNAL EQUITY ORDINARY SHARE
CAPITAL
Issue By Tender
The public is invited to bid for the shares being issued
A minimum price is set
Allotment is done such that the highest bid gets first
consideration
Difference between set minimum price and actual
amount received is SHARE PREMIUM
EXTERNAL EQUITY ORDINARY SHARE
CAPITAL
Private Placement
Shares are not issued on the stock exchange but a
small group of people is offered the issue
This is for private companies
EXTERNAL EQUITY ORDINARY SHARE
CAPITAL
Stock Exchange Introduction
This when a listed company makes a new issue
The shares are new on the market
A stock broker, who is an agent of the stock market, is
engaged to sell the issue
EXTERNAL EQUITY ORDINARY SHARE
CAPITAL
Authorised Share Capital is the maximum amount
a company is allowed to raise through the issue of
ordinary shares.
This is included in the company’s incorporation
documents
It is usually disclosed in the notes to the Financial
Statements
EXTERNAL EQUITY ORDINARY SHARE
CAPITAL
Issued Ordinary Share Capital is the portion of the
authorised ordinary share capital that has been
issued to the public
For Example: A Ltd has an authorised share capital
of 100 000 shares par value $4 each. In issue A Ltd
has 25 000 shares.
The authorised share capital of $400 000 will be
included in the notes to the financial report
The issued share capital of $100 000 ($4x25000)
will be included under equity in the SFP
EXTERNAL EQUITY ORDINARY SHARE
CAPITAL
Ordinary shares are included in the SFP as well as
the Statement of Changes in Equity at their cost/
par value
For Example:
Extract of A Ltd’s Statement of Financial
Position as at xxx
EQUITY
Ordinary Share Capital @ $4 $100 000
EXAMPLE

J Ltd has 700 000 authorised shares with a par

value of $0.30 each.
Currently 100 000 shares are in issue

Compute the authorised share capital as well as

the issued share capital
Prepare an extract of the SFP
EXTERNAL EQUITY ORDINARY SHARE
CAPITAL
However, ordinary shares can be sold above their
cost value, in which case they are sold at a
premium.
For example A Ltd issued 10 000 shares during
the year at $6 each
In this case: the cost price is $4 and the issue
price (the price at which they have been sold at) is
$6. Thus each share has been sold at a premium
of $2 (6 – 4)
EXTERNAL EQUITY ORDINARY SHARE
CAPITAL
Thus in its SFP the following will be presented:
Extract of A Ltd’s SFP as at xxxx

EQUITY
Ordinary Share Capital @$4 $140 000
Share Premium $20 000
EXAMPLE

J Ltd has 1 million authorised shares par value

$0.50. J Ltd issues 250 000 shares at $1.00 each.
Prepare an extract of J Ltd’s SFP.
EXTERNAL EQUITY ORDINARY SHARE
CAPITAL
A Rights Issue
Is made to existing shareholders
Shareholders are offered additional shares in
proportion to their current share holding e.g. for every
5 shares currently held, a shareholder has a right to 2
rights issue shares
The rights issue price per share is below the current
market price per share so as to make it attractive
But the rights issue price per share is above the par
value
EXTERNAL EQUITY ORDINARY SHARE
CAPITAL
A Rights Issue
Example:
A Ltd makes a rights issue during the year where For
every 5 shares held a shareholder is entitled to 2
shares at a rights issue price of $10 per share.
Currently the shares have a market value of $20 per
share and a par value of $4 per share.
EXTERNAL EQUITY ORDINARY SHARE
CAPITAL
Currently A Ltd has 35 000 shares is issue (25 000 +
10 000)
For every 5 shares a shareholder is entitled to 2
additional shares
Thus shares from the rights issue = 35 000/5 x 2
=14 000 shares
After the rights issue the company will have 49 000
share (35 000 + 14 000) in issue @ $4 par value =
$196 000
EXTERNAL EQUITY ORDINARY SHARE
CAPITAL
Currently A Ltd has a share premium of $20 000
From the rights issue: Each share will be sold at a
premium of $6 each (10 – 4).
Therefore share premium from the rights issue will
be 14 000 shares x $6 = $84 000
EXTERNAL EQUITY

Extract of A Ltd’s SFP as at xxxxx

EQUITY
Ordinary share capital @ $4 $196 000
Share Premium $ 84 000
EXTERNAL EQUITY - OSC

Ordinary Dividends are returns earned by

ordinary shareholders
They are not fixed and they are not cumulative
The Finance Director tables a proposal to the
Board of Directors of the amount of ordinary
dividend to paid.
The BOD then approves the dividend. (If not
approved suggestions are taken by the accounting
department for consideration)
EXTERNAL EQUITY OSC
Once approved by the BOD the proposal is then
tabled at an AGM for authorisation by the
shareholders
Once authorised by the shareholders the dividend is
then declared and made public through public
media.
A proposed dividend – not included in the F/S
An approved dividend – not included in the F/S
An authorised dividend – disclosed in the notes
A declared dividend – a liability
EQUITY OSC

For a declared dividend if not yet paid:

Dr Dividend expense (disclosed in the SCE)
CR Dividend Payable (a current liability in the
SFP)
EXTERNAL EQUITY OSC

BONUS ISSUE is when ordinary share holders

are given additional shares instead of being paid a
dividend
This occurs when a company has low liquidity
but high profitability
The shareholders do not pay for the shares; they
are paid for out of the company’s retained
earnings.
EXTERNAL EQUITY OSC

S Ltd has an 100 000 issued ordinary share par

value $5 and a retained income of $2 500 000. The
company decides to issue bonus shares – 10 for
every 5 currently held.

Workings:
Current Shares in issue 100 000
Shares from the bonus issue
10 x (100 000/5) = 200 000
EXTERNAL EQUITY OSC

Before Bonus Issue

Ordinary Share Capital $500 000

Retained Income $2 500 000
Total equity $3 000 000
EXTERNAL EQUITY OSC

After Bonus Issue

Ordinary Share Capital $1 500 000

Retained Income $1 500 000
Total equity $3 000 000

The $1 000 000 (200 000 shares x $5) has been

funded from retained income.
EXTERNAL EQUITY OSC

External Equity is raised through capital markets.

Capital markets is a financial market where long
term securities are traded.
There are three forms of capital markets:
Share market/ stock exchange
Foreign Exchange
Commodities Market
THE STATEMENT OF CHANGES IN
EQUITY
Presents the movement or changes in equity
components
Reconciles the opening balance to the closing
balance for each equity component
Shows financial performance affecting the
ordinary share holder during the reporting period
 STATEMENT OF CHANGES IN EQUITY
EXAMPLE:
A ltd has 800 000 shares par value $1 each on 1
January 2018 and retained profit of $1,5 million. In
June 2018, A Ltd issued additional 100 000 shares
at $11 each. Total comprehensive income for the
year ended 31 December 2018 was $154 000. An
ordinary dividend of 50c per share was declared for
all shareholders in the company’s register as at 1
November 2018. A transfer of $50 000 is to be
made to the general reserve
STATEMENT OF CHANGES IN EQUITY
A Ltd’s Statement of Changes in Equity For the Year Ended 31 December 2018

Ordinary Retained Share Premium General Total

Share Capital Income Reserve

Opening $800 000 $1 500 000 ----------------- -------------- $2 300 00

Balance ---
(1/1/18)
During 2018
Issue of Shares $100 000 $1 000 000 $1 100 000

Profit for the $ 154 000 $154 000

year
Dividend ($ 450 000) ($ 450 000)
Transfer ($50 000) $50 000 -
Closing Balance $900 000 $1 154 000 $1 000 000 $50 000 $3 104 000
(31/ 12/ 18)
 EQUITY
Extract of A Ltd’s Statement of Financial Position as at 31 December 2018

EQUITY

Ordinary Share Capital $900 000

Retained Income $1 154 000

Share Premium $1 000 000

General Reserve $50 000

$3 104 000
DEBT SOURCES OF FINANCE

These are sources of finance other than those that

can be classified as equity finance.
They earn fixed returns
They are for a specified period of time (though
some can be irredeemable and thus become
permanent sources of finance)
Their returns are given consideration before those
of equity holders
DEBT SOURCES OF FINANCE

They include, but are not limited to,

Debentures/ Bonds
Preference Shares
Loans
DEBENTURES/ BONDS

Debentures are debt instruments issued to the

public by a company and are based on an
agreement referred to as an indenture
Bonds have the same properties with debentures
but they are issued by government through the
central bank
DEBENTURES

Interest earning securities

The interest is fixed
The interest provides a tax shield
Debenture holders considered before equity
holders both on profit sharing and on liquidation
Maturity period is usually fixed
DEBENTURES
A 10% debenture of $400 000 accrues interest of
$40 000 annually.
The debenture of $400 000 is disclosed as a long
term liability in the SFP
The paid interest appears as a Finance Charge in the
SPLOCI
The unpaid interest appears as a Finance Charge in
the SPLOCI and as interest payable under current
liabilities in the SFP.
 DEBENTURES
A Ltd has a 10% debenture of $400 000. During the
year $10 000 interest has been paid. (Note total
interest for the year is 10% x $400 000)
Extract of A Ltd’s SPLOCI for the year ended
xxxx

Net Profit Before Interest and Tax xxxxxxx

Finance Charges:
Debenture Interest $40 000
DEBENTURES

Extract of A Ltd’s SFP as at xxxx

CURRENT LIABILITIES
Accrued Interest $30 000

LONG TERM LIABILITIES

10% Debenture $400 000
PREFERENCE SHARES

A hybrid of Debt and Equity – but considered as

debt in finance
Earn a return referred to as a dividend
The dividend is fixed
The dividend does not provide a tax shield
They are considered before equity holders but
after debenture holders on both profit sharing and
liquidation.
PREFERENCE SHARES

They can be classified in four broad ways:

Redemption Basis
Redeemable are treated like debt
Non – redeemable are treated like equity
Convertibility Basis
Participation Basis
Cumulative Basis
PREFERENCE SHARES
A ltd has 5% non cumulative Preference Share
Capital of $100 000. During the year $10 000
dividends were paid and the remainder will be paid
just after year end.
Workings: Annual dividend = 5%(100 000)= $20
000
REDEEMABLE PREFERENCE SHARES
Note – Preference Share Capital of $100 000 is
disclosed as a long term liability in the SFP
Note – The paid preference dividend for the year is
disclosed in the SPLOCI under Finance Charges
Note – The unpaid Dividend for the year is disclosed
in the SPLOCI under Finance Charges as well as a
Current Liability in the SFP.
Note – Where last year’s cumulative dividend was
not paid in the current year simply reverse the
accrual and pay out of bank. It is not an expense in
the current year.
 PREFERENCE SHARES
Extract of A Ltd’s SPLOCI for the year ended
xxxx

Net Profit Before Interest and Tax xxxxxxx

Finance Charges:
Preference Dividend $20 000
PREFERENCE SHARES

Extract of A Ltd’s SFP as at xxxx

Current Liabilities
Accrued Preference Dividend $10 000

Long Term Liabilities

5% Preference Shares $100 000
IRREDEEMABLE PREFERENCE SHARES
Note – Preference Share Capital of $100 000 is
disclosed under Equity in the SFP
Note – The total preference dividend for the year is
disclosed in the SCE
Note – The unpaid Dividend for the year is disclosed
as a Current Liability in the SFP.
Note – Where last year’s cumulative dividend was
not paid in the current year simply reverse the
accrual and pay out of bank. It is not an expense in
the current year.
 IRREDEEMABLE PREFERENCE SHARES
Extract of A Ltd’s SCE for the year ended xxxx
Ordinary Share Irredeemable Retained Totals
Capital Preference Income
Shares
Opening xx $100 000 xx Xx
Balances
During the year ended xxxx
Preference ($20 000) xx
Dividend

Closing xx $100 000 xx xx

Balances
PREFERENCE SHARES

Extract of A Ltd’s SFP as at xxxx

Current Liabilities
Accrued Preference Dividend $10 000

EQUITY
Ordinary Share Capital xx
5% Preference Shares $100 000
LOANS
A loan is an agreement between the lender and the
borrower where the lender gives money to the
borrower.
The borrower repays the amount borrowed (referred
to as the capital or principal) as well as interest
(which is the return earned by the loan)
For example: A Ltd has a 20% long term loan of $40
000. Interest of $2 000 has been paid during the
year. (Note that total annual interest on the loan is
$8 000)
 LOANS
Extract of A Ltd’s SPLOCI for the year ended
xxxx

Net Profit Before Interest and Tax xxxxxxx

Finance Charges:
Loan Interest $8 000
LOANS

Extract of A Ltd’s SFP as at xxxx

Current Liabilities
Accrued interest $6 000

Long Term Liabilities

20% Loan $40 000