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Chapter 12

Chapter 12. Ownership interest. Structure of a statement of financial position. Notes. Year 7. Year 6. £m. £m. Capital and. Called-up share capital. 12. 19.6. 19.5. Reserves. Share premium account. 13. 8.5. 5.5. Revaluation reserve. 14. 4.6. 4.6. Retained earnings. 15.

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Chapter 12

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  1. Chapter 12 Ownership interest

  2. Structure of a statement of financial position

  3. Notes Year 7 Year 6 £m £m Capital and Called-up share capital 12 19.6 19.5 Reserves Share premium account 13 8.5 5.5 Revaluation reserve 14 4.6 4.6 Retained earnings 15 431.6 340.8 464.3 370.4 Equity holders’ funds Statement of financial position of Safe and Sure plc

  4. Issue of shares at the date of incorporation When company first comes into existence: • it issues shares to the owners, • who become shareholders. • Each share has a named value • which is called its nominal value (par value)

  5. Public Company plc SHARE CERTIFICATE This is to certify that J A Smith is the registered owner of 100,000 ordinary shares of 25 pence each, Given under Seal of the Company the 15th day of August 1985 P McDowall J Jones Signed W Brown Company Secretary Directors Share certificate Certificate number 24516

  6. Share certificate (Continued) J A Smith has paid £25,000 to the company. That is the limit of this person's liability if the company fails. The company issues 100,000 shares to J A Smith at a price of 25 pence each. The shares represent the ownership interest in the company. ­ ­

  7. Some time later… • Company has traded profitably: Company wishes to raise as much funds as possible. • Will issue shares at their market value. • Nominal value remains the same, the market value may be quite different. • Nominal value 25 pence but the shares are selling in the market at 80 pence each.

  8. Share premium • Share Premium = Amount per share above nominal value = (80p – 25p) = 55p per share. • Company issues 200,000 new shares. It will collect (200,000 shares x 80p) = £160,000 in cash. Total share premium 55 pence per share × 200,000 shares = £110,000 Total nominal value 25 pence per share × 200,000 shares = £50,000

  9. Assets – Liabilities = Ownership interest ­ ­ Increase in cash £160,000 Increase in nominal value of shares £50,000 and increase in share premium £110,000 Share premium (Continued)

  10. Revaluation Hotel cost is £560,000. The hotel is run successfully for a period of three years and at the end of that period a professional valuer confirms that the hotel, if sold, would probably result in sale proceeds of £620,000. The directors of the company may wish to tell shareholders about this increased market value of the company's (fixed) asset.

  11. Revaluation – choices • Keep the reported value at £560,000 (the historical cost) but include a note to the statement of financial position explaining that the market value is £620,000. 2. Alternative treatment is to RECOGNISE in financial statements the increase in value. But not a realised profit.

  12. Assets – Liabilities = Ownership ­ ­ Interest Increase in value of non-current (fixed) asset £60,000 Increase in revaluation reserve as part of the ownership interest £60,000 Recognise increase in value – not ‘realised’

  13. Foreign currency gains & losses Gains or losses resulting from changes in the rates of exchange with regard to assets held and liabilities owed and denominated in a different currency. • Loans $6m when rate of exchange is £1 = $2Liability expressed in £ = (6 × 1/2) = £3m • Rate of exchange changes to £1 = $3 • Liability expressed in £ = (6 × 1/3) = £2m

  14. Foreign currency (Continued) • Assets – Liabilities↓ = Ownership interest↑ Gain of £1m but not a realised gain

  15. Example • A company,Office Owner Ltd, is formed on 1 January Year 1 by the issue of 4m ordinary shares of 25 pence nominal value each. • The cash raised from the issue is used on 2 January to buy an office block which is rented to a customer for an annual rent of £50,000. The tenant carries all costs of repairs. • The company's administration costs for the year are £10,000. • At the end of the year the office block is valued by an expert at £1,015,000. • On the last day of the year the company issues a further 2m ordinary shares at a price of 40 pence each, to raise cash for expansion plans in Year 2.

  16. Analysis of transactions for Year 1 Increase asset of cash Table 12.1 Office Owner Ltd – analysis of transactions for Year 1

  17. Analysis of transactions for Year 1 (Continued) Table 12.2 Office Owner Ltd – spreadsheet of transactions for Year 1

  18. Balance sheet at end of year Year 1

  19. Additional primary financial statements • IASB standards: Statement of changesin equity. (B) UK ASB standards: Statement of total recognised gains and losses (STRGL).

  20. Statement of changes in equity Must report (a) Profit or loss for the period (b) Items of income and expense for the period required to be reported directly through equity • Effects of changes in accounting policies and correction of errors. A statement reporting (a) + (b) + (c) also called a statement of comprehensive income.

  21. Statement of changes in equity (Continued) Must also report (d) Transactions with equity holders (e.g. dividend). (e) Retained earnings at start and end of period. • Explanation of changes in each class of equity. A statement showing (a) to (f) is called a statement of changes in equity.

  22. UK Statement of total recognised gains and losses (STRGL) • Statement that helps to bridge the gap between income statement (profit and loss account) and balance sheet. • STRGL shows the extent to which shareholders’ funds have increased or decreased from the various gains and losses of the period. • Income statement (profit and loss account) only reports realised profits (the results of transactions with third parties.)

  23. STRGL (Continued) Income statement (profit and loss account) only reports realised profits (the results of transactions with third parties.) Add to this unrealised gains and losses, e.g. • Revaluations of fixed assets. • Effect of exchange rates on foreign currency translation.

  24. UK movements in shareholders’ funds Shows all changes in shareholders’ funds. Could include: • Issue of new shares. • Repurchase and cancellation of shares. • Profit of the period. • Dividends of the period. • Effect of exchange rates on foreign currency translation. • Revaluations of fixed assets.

  25. Dividends Reward to the owner (usually cash) Questions: 1. Does the company have sufficient cash to pay a dividend? 2. Has the company made sufficient profits (increase in ownership interest) to justify a dividend? The decision is taken by the Directors. It is approved by shareholders at Annual General Meeting.

  26. Dividends paid Might be: • Dividend proposed for previous year, now paid. • Interim dividend as part of dividend for current year, A ↓ – L = OI ↓ Decrease in asset of cash, Decrease in ownership interest reported in income statement (profit and loss account).

  27. Final dividend • At end of accounting year, after profits have been calculated, directors decide whether to pay a final dividend and, if so, how much. • This is not a liability because it has not been approved by shareholders. It is a proposal from directors. • The proposal to pay the dividend is reported as an item in the directors’ report.

  28. Issue of further shares (1) Capitalisation issue (Bonus issue or Scrip issue) A company decides to increase the number of shares with no change to assets or liabilities.

  29. Capitalisation issue • Share price tends to outperform the market after the announcement of a capitalisation issue. • There tends to be an acceptable range of prices for listed shares. £20 per share maximum. Increase number of shares, to scale down the price per share. • Capitalisation issue is often made out of reserves (of retained profits). Message given to shareholders that these are now part of the long-term funds of the company. No longer available to cover the payment of dividends.

  30. Issue of further shares (2) Rights issue When a public (quoted) company raises finance by the issue of shares, this is normally done by way of a ‘rights issue’. This gives existing shareholders the choice of subscribing for new shares in the company and so maintain their proportional shareholding in the company. The issue price is set at below the current market price of the shares.

  31. Capitalisation issue Assume that Office Owners Ltd wishes to make a 1 for 5 capitalisation issue. Share capital is 6 million 25 p shares Nominal value £1.5 million New shares: 6,000,000/5 = 1,200,000 Nominal value: 1,200,000 × 25 p = £300,000

  32. Capitalisation issue (Continued) Assets – Liabilities = Ownership interest Increase in share capital £300,000 decrease in reserves £300,000

  33. Capitalisation issue in Jan Year 2

  34. Rights issue Company has 400 million shares in issue of nominal value 25 pence per share. It wishes to issue a further 100 million shares. This means a rights issue of 1 for 4, for example, a holder of 8,000 shares will be given the right to subscribe for 2,000 new shares.

  35. Rights issue (Continued) A shareholder who does not wish to invest any more in the company is able to sell the ‘rights’. Assume an issue price of 150 pence per share. This is split for accounting purposes into the nominal value of 25 pence and the premium of 125 pence.

  36. Rights issue (Continued) • In terms of the accounting equation the effect of the rights issue on the balance sheet is: • Total cash raised by the issue £1.5 x 100 million shares = £150m • Nominal value of shares issued will be 25 pence × 100 million shares = £25m • Share premium on issue of shares will be £1.25 × 100 million shares = £125m.

  37. Assets – Liabilities = Ownership interest Increase in cash £150m increase in share capital £25m increase in share premium £125m Rights issue (Continued)

  38. Assets – Liabilities = Ownership interest ¯ ¯ Inventory (stock) decreases by £500 Expense of £500 for inventory (stock) damaged Year-end adjustments (a) At the end of the month it is found that the roof has been leaking and rainwater has damaged goods worth £500.

  39. ­ ¯ Assets – Liabilities = Ownership interest Obligation to pay for gas consumed £80 Expense of £80 for gas consumed Year-end adjustments (Continued) (b) The business uses gas to heat a water boiler and it is estimated that consumption for the month amounts to £80.

  40. Illustration • See Supplement to Chapter 12 in the book

  41. Chapter 12 Bookkeeping supplement

  42. Debit and credit entries

  43. Assets – Liabilities = Ownership interest Inventory (stock) decreases by £500 Expense of £500 for inventory (stock) damaged Year-end adjustments (a) At the end of the month it is found that the roof has been leaking and rainwater has damaged goods worth £500. ¯ ¯

  44. Year-end adjustments (Continued) Dr Cost of goods sold £500 Cr Inventory (stock) of goods £500

  45. Assets – Liabilities = Ownership interest ­ ¯ Obligation to pay for gas consumed £80 Expense of £80 for gas consumed Year-end adjustments (Continued) (b) The business uses gas to heat a water boiler and it is estimated that consumption for the month amounts to £80.

  46. Year-end adjustments (Continued) Dr Expense of gas £80 Cr Accruals £80

  47. Illustration • See Supplement to Chapter 12 in the book

  48. Extract from balance sheet

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