Chapter 9 Statutory Items

Learning Objectives  1. Explain the unique characteristics of the corporate form of business.  2. Record transactions that involve dividends and shares subscriptions and explain the effect of share subscriptions on the balance sheet.  3. State the differences between ordinary and preference share of a corporation.  5. Describe convertible preference share and explain the meaning of the par value, call price, market value, and book value of corporate shares.  6. Explain the redemption

Maximum Authorized Capital  Maximum Authorized Capital is popular practice in international community to confine rampant business, it is an arbitrary value assigned to the shares when the number of shares is authorized.

Minimum Legal Capital  The par value of a corporation’s share also establishes the Minimum legal capital for the corporation. Business Laws that establish minimum legal capital normally require shareholders to invest assets equal in value to at least that amount. Otherwise, the shareholders are liable to the corporation’s creditors for the deficiency. Usually, the minimum legal capital is defined as the par value of the issued shares. In other words, person who buy shares from a corporation must give the corporation assets equal in value to at least the par value of the shares or be subject to making up the difference latter.

The function of Minimum legal capital The main function of Minimum legal capital is to protect the creditors interest, which required that assets equal to the amount of the minimum legal capital can not be used as distributed to the shareholders before the all creditors’ claim have been met.

Ordinary Shares  Voting power  Par value  Quotation value  Share premium

Preference Share  1) Cumulative preferred stock and  2) Non-cumulative preferred stock.

Capital Premium  Capital Premium and  Capital Reserve.

Revaluation Reserve  Revaluation Reserve can not be including the Capital Reserve  Accounting treatment for revaluation

Accounting for the revaluation Step 1. Revaluation of Assets and credit the revaluation reserve. Step 2. reverse the revaluation reserve to the profit and loss a/c at the date of disposal or at the end of useful life.

Dividend in Arrears  For non-cumulative, the right to receive dividends is forfeited in any year that dividends are not declared. When preferred stock is cumulative and the board of directors fails to declare a dividend to the preferred stockholders, the unpaid dividend is called a dividend in arrears. The accumulation of dividends in arrears on cumulative preferred stock does not guaranteed that they will be paid. However, the cumulative preferred stockholders must be paid both the current dividend and all dividends in arrears before any dividend can be paid to the common stockholders.

Example 9.2 Company A has following capital structure and earnings : Year 1 Year 2 $ Ordinary shares 2,000,000 2,000,000 Un-deferred preference share (10%) 1,000,000 1,000,000 Total capital 3,000,000 3,000,000 The Current profit after tax 200, ,000 Retained profit b/d 20, ,000 Profit available for dividend 220, ,000

Example 9.2 Retained profit b/d 20, ,000 Profit available for dividend 220, ,000 Dividend proposal 80, ,000 Retained profit c/d 140, ,000 Preference dividend --current dividend 80, ,000 --deferred dividend 20,000 Ordinary dividend 0 20,000

Example 9.2 If it were the un-cumulative preferred stock, the dividend would be: Dividend proposal 80, ,000 Preference dividend --current dividend 80, ,000 --deferred dividend 0 Ordinary dividend 0 40,000

Participating and Nonparticipating preference share Once the preferred stockholders receive dividend, the common stockholders share all additional equity. Preferred stocks that have this limitation are called nonparticipation. However, if the owners of preferred stock have the right to share with the common stockholders in any additional dividends paid in excess of the stated percentage dividend on the preferred, it is participating preferred stock

Defend Strategy Although many corporations are authorized to issue participating preferred stock, the shares are issued only rarely. That is, companies obtain authorization to issue the shares even though management does not expect to ever sell them. They do this to defend against a takeover of corporation by an unfriendly investor who would by enough voting common stock to gain control over operation. Using terminology from spy novels, the financial world refers to this kind of a plan as a poison pill that the company will “swallow” if it is threatened with capture by an enemy.

Poison Pill Working 1 1) The common stockholders on a given date are granted the right to purchase a large amount of participating preferred stock at very low price. This right cannot be transferred. Even if the stock is sold, the buyer does not gain the right. In addition, this right cannot be exercised unless the directors identify a buyer of a large block of common shares as an unfriendly buyer.

Poison Pill Working 2 1) If an unfriendly investor were identified and the preferred stock were issued, future dividends would be divided between the preferred shares and the common shares to the preferred shares. This would transfer some of the value of the common shares to the preferred shares. As a result, the stock owned by the unfriendly buyer would lose much of its value and be worth much less than the buyer’s cost. The ultimate effect is to eliminate the potential benefit of attempting a hostile takeover.

Reduction of Share Premium  paying up fully paid bonus shares  writing off preliminary expenses writing of the expenses on the issue of shares  writing off commission paid, of discount allowed, on the issue of shares  providing for the premium payable on the redemption of redeemable preference shares.  payment of dividends in the form of shares.

Redeemable Preference Shares Redeemable Preference share is issued usually on following conditions: 1). For redemption in the future 2). Set up a capital redemption reserve from un-distributable profit

Balance sheet of Anderson before the Redemption Security amount=Total assets 350- Profit and loss a/c150=200

Balance sheet of Anderson after the Redemption Now, the security amount is: Total assets 300-profit 150=150 Compare the previous situation the creditors would feel something threat their security.

Balance sheet of Anderson after preparing the Redemption Reserve In this case, the security amount would be: =200 that comes back to the situation before the redemption

Reduction of Share Capital According to the business laws, in many countries, a company may, subject to approval by the Court, reduced its share capital in any way such as the: a) Extinguishments of liability on any of its unpaid shares; b) Cancellation of any paid-up capital which is lost or unrepresentative by available assets; c) Payment of any paid-up capital which is in excess of the needs of the company.

Balance sheet when shares are not fully represented by the net assets $’000 Net assets 800 Share capital Ordinary shares 1,000 Profit and loss (200) 800

Balance sheet before the Reduction of share capital $’000 Net assets 598 Share capital Ordinary share of $1 each 400 Less calls in arrears (2) Profit and loss

Journal entries for the Reduction $’000 $’000 DR CR Share capital 8 Calls in arrears 2 (8,000×0.25) Profit and loss account 6 (8,000 ×0.75) Being forfeiture of 8,000 shares on account of failure to pay last call on shares. Share capital 196 {(400-8) ×0.5} Cash 196 Being reduction of capital to $0.50 per share.

Balance sheet after the Reduction $’000 Net assets 402* Share capital Ordinary share of $0.50 each 196** Profit and loss 206 *** 402 * =402, ** =196, ***200+6