chapter 13

Copyright © 2012 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 7e 13-1

Chapter 13

Share capital and reserves


Objectives of this lecture• Understand that the equity of an organisation can consist of

several different accounts

• Understand that within 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

• Be able to provide the journal entries to account for distributions

• Know what a preference share is and be able to identify factors that would determine whether they should be disclosed as debt or equity


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

• Be able to provide the journal entries to account for rights issues and option issues

• Understand what constitutes a share split and a bonus issue of shares

• Know the disclosure requirements of AASB 101 Presentation of Financial Statements in relation to share capital and reserves


Relevant accounting standards and other guidance

• AASB 101 Presentation of Financial Statements

• AASB 132 Financial Instruments: Presentation

• AASB 2 Share-Based Payments

• AASB 108 Accounting Policies, Changes in Accounting Estimates, and Errors

• The AASB Conceptual Framework


Equity as a residual claim on net assets• Equity

– 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 Conceptual Framework defines equity as:

– the residual interest in the assets of the entity after deducting all of its liabilities


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 surplus, general reserve, forfeited share reserve)

– Retained earnings (or accumulated losses)


Retained earnings• Retained earnings often makes up a significant proportion

of shareholders’ funds– Represents the accumulation of prior period profits and losses

– Reduced by dividends declared and paid

– Reduced by any transfers to other reserves

– Could be reduced by a bonus issue of shares

– Changes in accounting policies as the result of the initial adoption of a new accounting standard can result in a direct adjustment in retained earnings in accordance with AASB 108

– The recognition of prior period errors can result in a reduction in retained earnings in accordance with AASB 108


Retained earnings (cont.)

Exhibit 13.1 Components of BHP Billiton’s equity as at 30 June 2011


Accounting for the issue of share capital

• Share capital

– Balance of owners’ equity within a company comprising the capital contributions made by owners

• When shares are issued then the amount received from the issue is added to ‘share capital’

Refer to Worked Examples 13.1—Determination of share capital and 13.2—Public issue of shares (pp. 439–40)


Partly paid shares• A company might issue shares on an instalment basis

• Where shares are partly paid

• When no future date has been specified for calling up the unpaid portion

• Where shares have been issued on an instalment basis

Refer to Worked Examples 13.3, p. 441—Issue of partly paid shares


Issue of shares other than for cash• Where shares are to be issued for a consideration other

than cash, the fair value of the consideration for the issue must be determined

• Fair value is defined in the accounting standards as

– ‘the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date’

Refer to Worked Example 13.4, p. 44— Issue of shares other than for cash


Oversubscription of shares• When more shares are applied for than the number to be

issued—quite common

• Two approaches to manage oversubscription:

1. Satisfy full demand of a certain number of subscribers and refund the funds advanced by others

2. Issue shares to all subscribers on a pro rata basis

• Excess monies on application can either be refunded or used to reduce further monies owing on allotment

Refer to Worked Example 13.5, p. 442—Oversubscription for shares issued as partly paid


Share issue costs• Costs involved with the issue of equity

instruments– Legal– Promotional– Accounting– Underwriting and brokerage

• Indirect costs during a share issue– Management time– Research– Feasibility studies

Refer to Worked Example 13.6, p. 444— Accounting for share issue costs


Accounting for dividends

• Directors decision on the amount of final dividends allocation

• Recognition of a dividend at the end of the reporting period as prescribed by the Australian Accounting Standards

• Rationale for dividend recognition

• Types of dividends


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


Different classes of shares (cont.)

• Preference shares

– Subject to preferential treatment

– Voting rights

– Participating preference shares

– Convertible preference shares

– Redeemable preference shares

– Equity versus debt characteristics

– If disclosed as debt then the ‘dividend’ payments will be classified as treated as expenses (interest)


Redemption of preference shares• Under section 254 (J) and (K) of the Corporations Act

shares are to be redeemed:

– out of profits that would otherwise be available for dividends, or

– out of proceeds of a fresh issue of shares made for the purposes of the redemption

Refer to Worked Example 13.7, p. 447—Redemption of preference shares


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 monies paid before forfeiture


Forfeited shares (cont.)• Various outcomes

– If company is listed on the ASX or if company’s operating rules allow it, a refund is paid to the investor less costs incurred in reissuing shares

– If company is not listed on the ASX and constitution says nothing about refunds, company can retain the amounts paid less costs of reissuing shares

Refer to Worked Example 13.8, p. 449—Forfeiture of shares


Share splits and bonus issues

• Share splits

– 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


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

– Bonus shares from retained earnings often referred to as a bonus share dividend


Rights issues and share options

• A rights issue provides existing shareholders with the right to acquire additional shares typically at an ‘attractive’ price

• Some rights might be tradeable, some are not

Refer to Worked Example 13.9, p. 451—A rights issue


• Share options give the holder the right to acquire shares in the future at a particular price

• Typically sold by the entity, or provided to employees as part of their salary

• If shares are issued to employees then they will be treated as part of salaries expense (with a credit to share capital)

See Worked Example 13.10, p. 452—Share options provided to employees

Rights issues and share options (cont.)


Required disclosures for share capital

AASB 101 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


Required disclosures for share capital (cont.)

• For each class of 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


Reserves• Include:

– revaluation surplus

– general reserve—may be used as a means of transferring profits out of retained profits for future expansion plans

• Required to disclose (AASB 101):

– Reconciliation between carrying amount of each reserve at the beginning and end of the period, separately disclosing each change


Summary• The lecture addresses various issues associated with

share capital and reserves

• 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

chapter 13

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