Capital and reserves Chapter 13 Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a New Zealand Financial Accounting 3e by Grant Samkin Slides prepared by Grant Samkin and Annika Schneider

Learning objectives Understand that the owners’ equity of an organisation can consist of several different accounts Understand that within owners’ 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 (Continues) Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a New Zealand Financial Accounting 3e by Grant Samkin Slides prepared by Grant Samkin and Annika Schneider

Learning objectives (cont.) Be able to provide the journal entries necessary when preference shares are to be redeemed Be able to provide the necessary journal entries when shares are forfeited by their owners Understand what constitutes a share split and a bonus issue of shares Know the disclosure requirements of NZ IAS 1 ‘Presentation of Financial Statements’ in relation to share capital and reserves Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a New Zealand Financial Accounting 3e by Grant Samkin Slides prepared by Grant Samkin and Annika Schneider

Owners’ equity as a residual claim on net assets owners’ share of the business calculated by subtracting the entity’s liabilities from its assets Shareholders’ funds in a company this represents the difference between total assets and total liabilities The NZ Framework defines equity as: the residual interest in the assets of the entity after deducting all of its liabilities (Continues) Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a New Zealand Financial Accounting 3e by Grant Samkin Slides prepared by Grant Samkin and Annika Schneider

Owners’ equity as a residual claim on net assets (cont.) The definition and recognition of equity are directly a function of the definition and recognition of assets and liabilities 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 reserve, general reserve, forfeited share reserve) retained profits (or accumulated losses) Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a New Zealand Financial Accounting 3e by Grant Samkin Slides prepared by Grant Samkin and Annika Schneider

Accounting for the issue of share capital balance of owners’ equity within a company comprising the capital contributions made by owners Par value the face value of a security Share premium the difference between the issue price of a share and its par value Under the Companies Act 1993 shares of a company have no par value Shares no longer issued at a premium or a discount (Continues) Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a New Zealand Financial Accounting 3e by Grant Samkin Slides prepared by Grant Samkin and Annika Schneider

Accounting for the issue of share capital (cont.) To recognise receipt of application moneys: Debit Bank trust Credit Application To recognise the issue of shares and to close application account: Debit Application Credit Share capital (Continues) Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a New Zealand Financial Accounting 3e by Grant Samkin Slides prepared by Grant Samkin and Annika Schneider

Accounting for the issue of share capital (cont.) To transfer cash from trust account to general operating bank account: Debit Cash at bank Credit Bank trust Refer to Worked Examples 13.1, 'Determination of contributed equity', p. 534 and 13.2, 'Public issues of shares', pp. 534–5. Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a New Zealand Financial Accounting 3e by Grant Samkin Slides prepared by Grant Samkin and Annika Schneider

Oversubscription of shares When more shares are applied for than the number to be issued e.g. Telstra and the Commonwealth Bank Two approaches to manage oversubscription include: satisfy full demand of a certain number of subscribers and refund the funds advanced by others issue shares to all subscribers on a pro rata basis excess moneys on application can either be refunded or used to reduce further moneys owing on allotment Refer to Worked Example 13.3, 'Issue of partly paid shares', pp. 535–6 (Continues) Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a New Zealand Financial Accounting 3e by Grant Samkin Slides prepared by Grant Samkin and Annika Schneider

Oversubscription of shares (cont.) Accounting for oversubscription of shares partly paid: Recognise aggregate applications for shares: Debit Bank trust Credit Application To allot shares as partly paid: Debit Application Credit Share capital (Continues) Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a New Zealand Financial Accounting 3e by Grant Samkin Slides prepared by Grant Samkin and Annika Schneider

Oversubscription of shares (cont.) To recognise amount due on allotment: Debit Allotment Credit Share capital To offset excess amounts paid on application against amount due on allotment: Debit Application Credit Allotment (Continues) Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a New Zealand Financial Accounting 3e by Grant Samkin Slides prepared by Grant Samkin and Annika Schneider

Oversubscription of shares (cont.) To transfer funds to operating bank account: Debit Cash at bank Credit Bank trust To recognise receipt of amounts due on allotment: Credit Allotment (Continues) Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a New Zealand Financial Accounting 3e by Grant Samkin Slides prepared by Grant Samkin and Annika Schneider

Oversubscription of shares (cont.) Accounting for call made on shares subsequent to allotment: To record call: Debit Call Credit Share capital To record receipt of amounts due on call: Debit Cash at bank Credit Call Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a New Zealand Financial Accounting 3e by Grant Samkin Slides prepared by Grant Samkin and Annika Schneider

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 (Continues) Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a New Zealand Financial Accounting 3e by Grant Samkin Slides prepared by Grant Samkin and Annika Schneider

Different classes of shares (cont.) 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 (Continues) Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a New Zealand Financial Accounting 3e by Grant Samkin Slides prepared by Grant Samkin and Annika Schneider

Different classes of shares (cont.) Preference shares (cont.) if convertible, have a right of conversion to ordinary shares if redeemable, have the ability to redeem shares for cash at later date some have the characteristics of equity and others have the characteristics of debt Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a New Zealand Financial Accounting 3e by Grant Samkin Slides prepared by Grant Samkin and Annika Schneider

Redemption of preference shares The Companies Act 1993, ss 68–75, requires: Where the shares are redeemed at the option of the company, the directors must be satisfied that, immediately after the redemption of the shares has occurred, the solvency test is passed If the redemption of the shares is done at the option of the shareholder, or on a specified date, there is no necessity for the solvency test to be passed If the redemption involves a consideration other than cash, the fair value of the consideration must be determined. If the fair value of the asset given up differs from its carrying value, the difference is recognised as a component of revenue or expense in the income statement Refer to Worked Example 13.8, 'Redemption of preference shares', p. 543 (Continues) Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a New Zealand Financial Accounting 3e by Grant Samkin Slides prepared by Grant Samkin and Annika Schneider

Redemption of preference shares (cont.) To recognise issue of preference shares: Debit Cash at bank Credit Share capital — preference shares To eliminate preference shares and create ‘capital redemption reserve’: Debit Share capital — preference shares Credit Capital redemption reserve (Continues) Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a New Zealand Financial Accounting 3e by Grant Samkin Slides prepared by Grant Samkin and Annika Schneider

Redemption of preference shares (cont.) To redeem shares out of profits: Debit Retained profits Credit Cash Further entry required pursuant to amendments to the Corporations Law: Debit Capital redemption reserve Credit Share capital Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a New Zealand Financial Accounting 3e by Grant Samkin Slides prepared by Grant Samkin and Annika Schneider

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 moneys paid before forfeiture (Continues) Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a New Zealand Financial Accounting 3e by Grant Samkin Slides prepared by Grant Samkin and Annika Schneider

Forfeited shares (cont.) Various outcomes If company is listed on the NZX 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 If company is not listed on the NZX and constitution says nothing about refunds, company can retain the amounts paid less costs of reissuing shares amounts paid are held in a forfeited shares reserve (part of shareholders’ funds) Refer to Worked Example 13.10, 'Forfeiture of shares', pp. 556–7 (Continues) Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a New Zealand Financial Accounting 3e by Grant Samkin Slides prepared by Grant Samkin and Annika Schneider

Forfeited shares (cont.) To record the call: Debit Call Credit Share capital To record receipt of call moneys: Debit Cash at bank Credit Call (Continues) Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a New Zealand Financial Accounting 3e by Grant Samkin Slides prepared by Grant Samkin and Annika Schneider

Forfeited shares (cont.) To record forfeiture of shares: Debit Share capital Credit Call Credit Forfeited shares account To recognise amount received on sale of forfeited shares: Debit Cash at bank Debit Forfeited shares account Credit Share capital (Continues) Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a New Zealand Financial Accounting 3e by Grant Samkin Slides prepared by Grant Samkin and Annika Schneider

Forfeited shares (cont.) To recognise payment of costs relating to sale of shares: Debit Forfeited shares account Credit Cash at bank To recognise return of remaining moneys to original shareholders: Debit Forfeited shares account Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a New Zealand Financial Accounting 3e by Grant Samkin Slides prepared by Grant Samkin and Annika Schneider

Share splits and bonus issues 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 no journal entries required company must amend share register (Continues) Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a New Zealand Financial Accounting 3e by Grant Samkin Slides prepared by Grant Samkin and Annika Schneider

Share splits and bonus issues (cont.) Bonus shares Existing shareholders receive additional shares, at no cost, in proportion to their shareholding at the date of the bonus issue Journal entry: Debit Retained profits Credit Share capital — ordinary shares Bonus shares from retained profits often referred to as a bonus share dividend Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a New Zealand Financial Accounting 3e by Grant Samkin Slides prepared by Grant Samkin and Annika Schneider

Required disclosures for share capital NZ IAS 1 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 (Continues) Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a New Zealand Financial Accounting 3e by Grant Samkin Slides prepared by Grant Samkin and Annika Schneider

Required disclosures for share capital (cont.) 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 Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a New Zealand Financial Accounting 3e by Grant Samkin Slides prepared by Grant Samkin and Annika Schneider

Reserves Include: Required to disclose (NZ IAS 1): revaluation reserve general reserve: may be used as a means of transferring profits out of retained profits for future expansion plans Required to disclose (NZ IAS 1): reconciliation between carrying amount of each reserve at the beginning and end of the period, separately disclosing each change Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a New Zealand Financial Accounting 3e by Grant Samkin Slides prepared by Grant Samkin and Annika Schneider

Summary The chapter addresses various issues associated with share capital and reserves Owners’ equity is the residual interest in the assets of an entity after deduction of its liabilities When shares are issued to the public, funds must be placed in trust prior to allotment of shares Preference shares should be disclosed as debt or equity depending on the conditions of issue Forfeiture of shares, share splits and bonus issues were also discussed Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a New Zealand Financial Accounting 3e by Grant Samkin Slides prepared by Grant Samkin and Annika Schneider

Summary of main changes to accounting standards A number of new accounting standards have superseded former ones But only minor changes to requirements have resulted: NZ IAS 39 ‘Financial Instruments: Recognition and Measurement’ imposes new requirements for measurement of equity and liability component of preference shares Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a New Zealand Financial Accounting 3e by Grant Samkin Slides prepared by Grant Samkin and Annika Schneider