1 INCORPORATED ENTERPRISES (Company Accounts)

1.1 Key features

1.2 Advantages

1.2 Advantages	v Disadvantages
Limited liability Business entity concept separates business from owners (therefore less risk to owners) Participation via shareholdings less cumbersome than partnership Shares more easily transferred May be tax advantages (eg investment incentives) Commercial credibility of company status Increased access to sources of finance.	Formation costs (but not prohibitive) Costs of compliance (eg annual audit, accounting returns etc) Responsibility and control of operational activities delegated to management Difficult to return capital to shareholders (on winding up) May be tax disadvantages (eg if income tax rate greater than personal tax rate) Loss of privacy of information (due to a/cs filing requirements).

2 SOURCES OF FINANCE

2.1 Major sources

2.2 Winding up

• Net assets

3 SHARE CAPITAL

3.1 Terminology

• Shares represent ownership of incorporated enterprise ie rights to receive

• a share of profits
• a share of assets if incorporated enterprise is "wound up".

In the comparison of terms which follows:

^* Denotes minimum disclosure requirement on face of the balance sheet

^† Indicates disclosure required for each class of share capital either on face of the balance sheet or in notes.

Preferred (or "preference") shares – fixed rate of dividend has prior claim on profits available for distributions	v	Ordinary shares – entitled to remaining profits (and assets in a liquidation) when creditors and all prior claims have been satisfied.
· Authorised † – maximum number of shares an enterprise can issue	v	Issued * – actual number issued (all or a portion of authorised)
· Called up– nominal value paid plus further amounts agreed to be paid on set future dates	v	Paid up † – nominal value paid to date. Will be less than called up if there are further calls (ie "partly paid"†)
· Bonus ("scrip") issue no consideration (therefore NO CASH) capitalisation of reserves to existing shareholders in proportion to existing holdings	v	Rights issue first offered to existing shareholders in proportion to existing holding often at price less than MV if not taken up, shareholders sell rights of purchase to outsiders new investors/existing shareholders pay CASH
Market value (MV) reflects perceived MV of business price quoted on Stock Exchange	v	Nominal (par†) value (NV) stated ("book") value used to calculate dividends

Advantages of small denomination shares

• Appeal to smaller investors
• Result in more widespread ownership
• Improved marketability (eg 100 $1 rather than 1 $100)

3.2 Issue

Illustrations 1

Example 1

You are supplied with the following extract from balance sheets at 31 January 1999 and 1998.

Notes

(1)   On 1 July 1998 there was a bonus issue of 1 for 10.
(2)   On 30 September 1998 there was a rights issue.
(3)   There are no other reserve balances.

Required:

Calculate the total amount received from the issue of shares for the year ended 31 January 1999.

Solution

Bonus issue 1 for 10. Therefore, $10m issued

Dr Share premium

   Cr Share capital

Increase on share premium account represents rights issue at a premium

Therefore premium	=
Nominal value of shares issued	=
Total amount received	=

3.3 Relative advantages of bonus v rights issues

Changes structure of share capital	Raises capital and cash
· MV per share falls (not necessarily pro rata)	Cheapest way of raising new finance by issue of shares (but more expensive than issuing debt)
· Signals strength to stock market.	Rights issue to existing shareholders more likely to be successful than new issue to public.

Illustration 2

K has two $1 shares (ie $2)
Bonus issue 1 for 2
K now has three $1 shares.

Example 2

A 1 for 5 bonus issue is made followed by a 1 for 1 rights issue. The market value of the share is $3 and the shares are issued for $1.80.

Required:

Show the balance sheet after each issue.

Solution

		Bonus	Rights
	$000	$000	$000
Fixed assets	20	20	20
	^___	^___	^____
Current assets
Inventories	5	5	5
Trade receivables	5	5	5
Cash	4
	^___	^___	^____
	14
	^___	^___	^____
Total assets	34
	^___	^___	^____
Capital and reserves
$1 Ordinary shares	10
Share premium
Reserves	8
Accumulated profits	6	6	6
	^___	^___	^____
	24
Current liabilities
Trade payables	10	10	10
	^___	^___	^____
Total equity and liabilities	34
	^___	^___	^____

3.4 Leverage

• When an enterprise has borrowed funds (and/or preferred shares) the shareholders have the benefits and costs of "financial leverage"

Illustration 3

Two enterprises, A & B have the same total assets, but B has twice as much debt as A. For example

Leverage is the percentage of total assets financed by equity, ie

100%

For A = 100% = 60%

For B = 100% = 40%

The risks and rewards of B’s shareholders are greater than A’s because their returns are more variable. For example, if both enterprises earn the same low profit, B will have twice as much debt interest to pay than A before any distribution can be made.

Alternatively, this "gearing" may be calculated as 100%

where debt = all liabilities (or just long-term).

4 RESERVES

4.1 Capital                    v          revenue

Non-distributable	Named	"Retained profit"
Share premium Revaluation Capital redemption	Fixed asset replacement General Distribution not prohibited	Accumulated unappropriated profits

4.2 Share premium

• Not available for distribution.
• Uses

• fully-paid bonus shares
• preliminary expenses on formation
• expenses incurred in share or debenture issues
• premium payable on redemption of shares or debentures.

4.3 Revaluation reserve

• Unrealised gain on revalued fixed assets
• Not for dividend payment (ie "non-distributable") until realised
• Can finance fully paid bonus shares.

4.4 Capital redemption

• Redemption – buying back of own shares
• Capital redemption reserve (CRR) is a buffer to protect creditors

6 BALANCE SHEET

6.1 Proforma

6.2 Disclosure on face of balance sheet or in notes

6.2.1 Tangible assets

• As described in IAS 16

Illustration 4

A freehold site was revalued during the year by Messrs ABC, Chartered Surveyors, on the basis of its current use as a car park. The historic cost of the site was $x and it was revalued to $y. No provision for depreciation has been made. Net tangible fixed assets of $x are pledged as security for financial creditors.

6.2.2 Shareholders’ interests

• For each class of share capital

• Number of shares authorised
• Number of shares issued and fully paid/but not fully paid
• Par value per share (or no par value)
• Rights, preferences, and restrictions on dividends and repayment of capital
• "Own" shares held
• Shares reserved for issuance under options etc

• Nature and purpose of each reserve
• Proposed dividends included (or not included) in liabilities
• Cumulative preference dividends not recognised.

7 INCOME STATEMENT

7.1 Proformas

7.1.1 Classification by function (= "cost of sales" method) Revenue Cost of sales Gross profit/(loss) Other operating income Distribution costs Administrative expenses Other operating expenses		7.1.2 Classification by nature Revenue Other operating income Changes in inventories of finished goods and WIP Work performed by enterprise and capitalised Raw materials and consumables used Staff costs Depreciation and amortisation expense Other operating expenses
Profit from operations Net financing cost Income from investments Profit before tax Income tax expense Profit after tax Net profit or loss from ordinary activities Extraordinary items Net profit for the period		the same

7.2 Additional disclosure

When expenses classified by function

7.3 Income tax

Accounting entries

• When the amount of tax on income is calculated

• When tax is paid (usually in the next financial year)

8 STATEMENT OF CHANGES IN EQUITY

8.1 Proforma

8.2 Dividends

8.2.1 Descriptions

An appropriation of distributable profits to shareholders.

• Dividends are proposed by the management (eg board of directors) and approved ("declared") by the company in general meeting.
• May be expressed as

• a percentage
• an amount per share.

8.2.2 Accounting entries

• Interim dividend (paid during the year)

• Final dividend (proposed but not approved at balance sheet date and paid in the following financial year)

8.2.3 Disclosure

• On face of balance sheet or in the notes

• amount of dividends proposed but not formally approved for payment included (or not included) in liabilities
• amount of cumulative preference dividends not recognised.

Illustration 5 – Cadbury Schweppes 1996

EXAMPLE SOLUTIONS

Solution 1 – Issue of shares

Bonus issue 1 for 10. Therefore, $10m issued

Dr Share premium	$10m
Cr Share capital		$10m

Increase on share premium account represents rights issue at a premium

Therefore premium	=	(260 – 220 – 10)
	=	$50m
Nominal value of shares issued	=	(120 – 110)
	=	$10m
... Total amount received	=	10 + 50
	=	$60m

Solution 2 – Bonus and rights issues

		Bonus	Rights
	$000	$000	$000
Fixed assets	20	20	20
	^____	^____	^____
Current assets
Inventories	5	5	5
Trade receivables	5	5	5
Cash	4	4	25.6
	^____	^____	^____
	14	14	35.6
	^____	^____	^____
Total assets	34	34	55.6
	^____	^____	^____
Capital and reserves
$1 Ordinary shares	10	12	24
Share premium			9.6
Reserves	8	6	6
Accumulated profits	6	6	6
	^____	^____	^____
	24	24	45.6
Current liabilities
Trade payables	10	10	10
	^____	^____	^____
Total equity and liabilities	34	34	55.6
	^____	^____	^____