Chapter 13

capital structure

and finance costs

Chapter learning objectives

•understand the capital structure of a limited

liability company

•record movements in share capital and share premium

accounts

•define, discuss and record bonus issues and rights

issues

•record dividends and finance costs in the ledger

accounts

•identify and record other reserves

•record income tax in the accounting ledgers.

Reserves loans Shares

1. Introduction - Methods for a company to finance

Interest

Dividend

2. shares

Share capital

Ordinary shares 普通股

Preference shares 优先股

- Carry voting rights

- Shareholders receive dividends

- Dividend is paid out of profits after the preference shareholders receive their dividend

- Do not carry voting rights

- Receive a fixed dividend (%*nominal value)

- Dividend paid out in priorityto ordinary dividend

股本

ordinary shares

2. shares

• This is the equity as the company has no

obligation to repay the investors(shareholders)

or to pay them a dividend.

• Ordinary shares are shown under equity on the

statement of financial position

Redeemable preference shares are preference shares which are repayableby the company to shareholders at a specified future date.

-the obligation to repay shows the characteristics of debt.

-They are therefore classified as a liability on the statement of financial position.

Preference shares

2. shares

Irredeemable preference shares are

preference shares which are not

redeemable. They remain in existence

indefinitely. No obligation to repay this is

the evidence of equity

-These shares are classified as equity on

the statement of financial position.

Preference shares

2. shares

Issue price. Shares may be issued at more than their nominal value, but may not be issued by the company for less than nominal value.

Share premium. If shares are issued for more than their nominal value, the premium on issue is credited to the share premium account.

Market value. the value at which the shares are trading on the open market. It reflects value of company as a whole but does not affect underlying financial records.

Terminology of share capital

2. shares

Issued share capital. The share capital actually issued by the company. Note that share capital is recorded at its nominal (or face) value(often $1 or $0.5/share). Sometimes called issuing shares “at par”.

Called-up share capital. This is the amount of the nominal value paid by the shareholder plus any further amounts that they have agreed to pay in the future.

Paid-up share capital. This is the amount of the nominal value which has been paid at the current date.

Terminology of share capital

2. shares

2. Share

Issue of shares at a premium

Dr Cash issue price x volume of shares

Cr Share capital nominal value x volume of

shares

Share premium (issue price - nominal value)

x shares No.

2. Shares

Issue of shares at a premium

2. Shares

Issue of shares at a premium

Share premium account has limited uses:

Cost of issuing shares can be debited to

the share premium account

Bonus issue

2. Shares

Bonus issue

the issue of new shares to existing shareholders in proportion to their existing shareholding.

It is the “free” issue. A bonus issue is not a means of raising additional finance, thus no cash is received from a bonus issue.

2. Shares

Bonus issue

The advantage

• reduce the value of shares to increase their marketability.e.g. investors may be more inclined to buy 2,000

shares at $10 than 1,000 shares at $20.

• Issued share capital is brought more into line with assets employed in the company by reducing stated reserves and increasing share capital.

The disadvantage

• The admin costs is high.

Accounting treatment:

Dr Share premium /retained earning

Cr Share capital Nominal value

* share capital和share premium都属于SFP的equity部分。

Bonus issue are always made at nominal value.

2. Shares

Bonus issue

之前每持有2股，在bonus issue的时候就发行1股

2. Shares

Bonus issue

已经发行

- Before:

Share capital: 20,000 x 0.5 = $10,000

Share premium 20, 000 x (1.25 - 0.5) =

$15,000

Analysis:

- Bonus issue:

Dr share premium （Nominal value）

Cr share capital（Nominal value）

Nominal value: 票面价值

∴ Share capital: 10,000 + 20,000/4 x 0.5 = $ 12,500

∴ Share premium: 15,000 - 20,000/4 x 0.5 = $ 12,500

2. Shares

Bonus issue

2. Shares

Rights issue

The offer of new shares to existingshareholders in proportion of their existingshareholding (below market price).低于市场发行价格，向现有股东新发股票

It is a means of raising additional financefrom existing investors.

2. Shares

Rights issue

The advantage

• Cheapest way for a company to raise finance through the issuing of further shares.

• Greater chance of success compared with a share issue to the public.

The disadvantage

• More expensive than issuing debt.

• It may not be successful in raising the finance required.

2. Shares

Rights issue

2. Shares

2. shares

Dividends are an appropriation of profit, not an expense in the statement of profit or loss.

They are paid out of post-tax profits.

Dividends

Mid-year/ interim dividend 年中分红

Final dividend 年末分红

dividends

• Ordinary share dividends are usuallyexpressed as an amount per share.

e.g. 10 c per share.每持有一股，就分红10分钱

• Dividends on preference shares（优先股） areusually based on a pre-determined amount.

• e.g. 5% nominal value（票面价） of shareholding.

2. shares

dividends

2. shares

dividends

1. Proposed:

no recording

2. approved/declared:

Dr: retained earning

Cr: dividend payable

3. Paid:

Dr: dividend payable

Cr: cash/bank

Dividends declared/approved are debited to retained earnings and shown in the Statement of Changes in Equity.

Dividend paid not affect retained earnings.

2. shares

dividends

Dividends proposed or declared after the year end (but before the accounts are issued) are not recorded in the accounts at all but are disclosed by note.

2. shares

dividends

2. shares

dividends

2. shares

dividends

Preference shares

（优先股）

Redeemable(可赎回)

Irredeemable(不可赎回)

Treated the same as loan

Treated the same as ordinaryshares

-SFP: liability

-P/L: interest expense

-SFP: equity

-SFP: dividends

Preference shares

2. shares

illustration 1/2

illustration 2/2

3. Loan capital

Loan notes or bonds are long term liabilities which accrue interest. Holders of loan notes are creditors of the company.

• Receive interest at fixed rate• Can enforce payment• No voting rights• Less risky than shares• Normally redeemable at a future date

Interest is paid out of pre-tax profits.

• Interest is charged to the statement of profit or loss as finance expense when it falls due, rather than when it is actually paid, i.e. companies may have to accrue interest costs at the year-end. (accrual basis)

• If loan is purchased or sold mid-way through an accounting period, the interest charge will be calculated according to the number of months the loan notes were in issue.

3. Loan capital

have a set nominal value

Loan notes will

require interest(利息) to be paide.g. 5% of nominal

value per annum

e.g. $100

Issuing loan notes

Dr cash（SFP）X

Cr non-current liability（SFP） X

Recognize interests

Dr expense- finance charge (P/L) X

Cr cash/current liability（SFP）X

3. Loan capital

Loan capital -IllustrationCustard Creameries is an incorporated business which needs to raise funds to purchase plant and machinery. On 1 March 20X5 it issues $150,000 10% loan notes, redeemable in 10 years’ time. Interest is payable half yearly at the end of August and February.

What accounting entries are required in the year ended 31 December 20X5?

1 March 20x5:

Dr Cash $150,000

Cr Long term Loan notes $150,000

31 August 20x5:

Dr Finance cost $7,500

Cr Cash $7,500

31 December 20x5:

Dr Finance cost $5,000

Cr Interest accrual $5,000

3. Loan capital

Loan capital -Illustration

Statement of financial position

Non-current liabilities

10% Loan notes $150,000

Current liabilities

Loan note interest payable $5,000

3. Loan capital

4. Other Reserves

4. Other Reserves

Retained earnings (Revenue reserves)

Retained earnings contain the accumulated retained profits(or loss), after appropriation of dividends, of the company.

Dr Statement of profit or loss

Cr Retained earnings

Retained earnings are fully distributable. Even if a company makes a loss in one year, it may still pay a dividend out of retained earnings from previous years.

Retained earnings (Revenue reserves)

4. Other Reserves

Created when a company revalues its non-current assets upwards.

Revaluation surpluses or reserves are non-distributable, because the gain represented by the revaluation has not been realised.

4. Other Reserves

Revaluation surplus/reserve (Revenue reserves)

5. Tax in company accounts

At the year end,

a company estimates its tax bill for the year.

Dr tax expense $1,000

Cr tax liability $1,000

A few months after the year end,

a company pays its tax.

Dr tax liability $1,200

Cr cash $1,200

5. Tax in company accounts

Adjust

Dr tax expense $200

Cr tax liability $200

Under provision

Increase tax expense in the following year

5. Tax in company accounts

At the year end,

a company estimates its tax bill for the year.

Dr tax expense $1,000

Cr tax liability $1,000

A few months after the year end,

a company pays its tax.

Dr tax liability $800

Cr cash $800

5. Tax in company accounts

Over provision

Adjust

Dr tax liability $200

Cr tax expense $200

Decrease tax expense in the following year

5. Tax in company accounts

Chapter summary