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Study Unit 6
Introduction to Companies
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Introduction to Companies
Study Unit 6: Introduction to Companies
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Introduction
• Company is a form of business registered and operated under
the Companies Act 71 of 2008
• Separate legal person
• Owners called shareholders who own a number of shares
• Main reason for Company as a form of business as compared
to other types is the need to raise larger amounts of capital.
• Two Types of Companies
– “Not for Profit” or
– “For Profit” (four forms of For Profit Companies)
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Share Capital Structures
• Maximum number of shares (authorised):
– MOI (Memorandum of Incorporation)
• Previously Memorandum and Articles
• Authorised vs Issued
– Company is not obliged to issue all its authorised shares (authorised
share capital);
– Issued share capital is what is shown in Statement of Financial Position
– Authorised number of shares is disclosed in notes only
• No more par / nominal value shares (old companies act)
– Therefore no more share premium
– All shares = no par value
– Often called the Stated Share Capital
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Equity in the SFP……
Sole Proprietor Partnership Close Corporation Company
Capital Account Capital Account(s) Members Contribution Share Capital
Current Account(s) Retained income Retained income
Reserves Reserves Reserves Reserves
Note that in the Sole Proprietor and the Partnership we referred to
Drawings when owners took cash out of the business.
For Close Corporations we refer to Distributions.
For Companies we refer to Dividends
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PROFIT COMPANIES
Study Unit 6: Introduction to Companies
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Profit Companies
• An association of persons who work together with
the aim of making a profit.
• A profit company is established by registration and
complying with legal requirements.
• Four types of companies if the aim is to make a profit
1. Private Company
2. Public Company
3. State Owned Company
4. Personal Liability Company
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Formation = Incorporation
• Apply to reserve proposed name with CIPC (Companies &
Intellectual Property Commission) – if name is rejected then
the registration number becomes the name of the company.
• Once the name is approved the MOI (CoR 15.1 Memorandum
of Incorporation) and other prescribed forms (most notably
CoR14.1 Notice of Incorporation) must be submitted and
approved.
• Once approved:
– Company name entered into the Companies Register
– Certificate of Registration is issued to the company
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SHAREHOLDERS
Study Unit 6: Introduction to Companies
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Shareholders
• A share is one of the units of priority interest into which the
proprietary (ownership) in a profit company is divided
– ? What does this mean……
– For instance you may own 25 out of 100 shares in a company, shown
on a share certificate
• Represents a share in the equity of the business (remember
equity = assets – liabilities)
• Shareholders can be legal persons – ie a company may own
shares in another company.
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Shareholders rights…..
1. Right to buy or sell shares in a company
2. Right to vote
3. Right to receive a share of the profits
4. Right to share in the net assets (assets –
liabilities)
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SHARE TRANSACTIONS
Study Unit 6: Introduction to Companies
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Public Companies and the
Prospectus• Majority of a public company share capital is raised by inviting
the public to buy shares
• A prospectus is the document used to invite public
shareholders to invest in the shares of the company
• Upon purchase of the shares, the shareholder is issued a
share (often referred to as securities) certificate which
indicates:
– Name of shareholder
– Number of shares owned
– Identification number of shares (eg shares 56 to 75)
– If listed on the JSE, there are no share certificates as the details are
recorded electronically on STRATE (Share Transfer Records All
Transactions Electronic)
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TYPES OF SHARES
Study Unit 6: Introduction to Companies
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Types of shares
1. Ordinary shares
2. Preference shares
– Cumulative preference shares
– Participating preference shares
– Convertible preference shares
– Redeemable preference shares
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Ordinary Shares
• Do not have a fixed dividends
– Only paid after Preference Shareholders have
been paid their dividends
– Dividends (sometimes called distributions) are
paid out of available profits
• If recommended by directors and approved by
shareholders
• No limits, but some restrictions in terms of regulation
(Companies Act and Common Law)
• Also consider the Framework concept of Capital
Maintenance.
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Preference Dividends
• Normal preference dividends bear a fixed %
– For example, XYZ Ltd issues 100, R15 000 preference
shares that bear dividend at 10% per annum
• Issued preference share capital in the SoFP will be 100 shares x
R15 000 = R1 500 000
• Every year XYZ will pay preference dividend of 100 shares x R15
000 x 10% = R150 000
• Preference dividend will be paid before any dividend paid to
ordinary shareholders
• CUMULATIVE preference dividend
– Different to normal preference shares in that any preference dividends
that are not paid annually will accumulate and the company is obliged
to make payment of outstanding preference dividends before paying
any ordinary dividend.
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Redeemable preference shares
• Preference shares can be redeemable
– This means that the company may have the choice or be
required to buy the preference shares back (i.e. redeem).
– The choice of redemption may be with the company itself,
or the holder of the shares (the person who purchased the
shares), this will depend on the individual preference
shares and agreements.
– Note that later on in your studies this choice will be very
important as to the classification of the preference share
as either equity or possibly a liability!
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Participating preference shares
• Participating preference shares have two
components for dividend:
– a fixed % dividend (usually lower than a normal
preference share)
– A share of the ordinary dividends (called a
participation in the ordinary dividend)
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Convertible preference shares
• Convertible preference shares will (or may be)
converted into ordinary shares:
– Not always a compulsory conversion, sometimes it
may be optional (either by issue or holder)
– Needs a ratio of ordinary shares to preference
shares for conversion, for example 3 preference
shares will be converted into one ordinary share.
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Combination of the above
• Preference shares may have a large number of
variations – and most of the variations refer to
the types of dividends linked to the preference
share;
• All of the types of preference shares listed
above may be combined
– For example:
– Cumulative, redeemable preference shares; or
– Non cumulative, convertible participating
preference shares
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ISSUE OF SHARES
Study Unit 6: Introduction to Companies
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Issue of Shares• First issue of shares is always to the “incorporators” of the company
• Procedure for issuing shares:
– Investor wishing to subscribe for shares must complete an application form (usually
included in prospectus)
– Application form submitted to company along with payment for full amount of shares
being subscribed for by investor
– Applications and payments received after closing date will be returned
– When applications have been accepted, shares are allotted to the new shareholders
– Shareholders are issued with securities certificates (if listed on JSE STRATE used) and
their names are entered into the securities register.
– If oversubscribed – ie more applications for shares than that being offered as available
for issue – money from unsuccessful applicants must be refunded
– If under subscribed – ie not enough applications for shares to raise the required capital –
the company would normally make use of an underwriter to overcome this risk.
• Note, the company cannot is shares that are not fully paid up and is also
prohibited from issuing more shares than were originally offered to the
public.
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Recording the issue of shares
• Three basic transactions:
1. Record the receipt of monies from
application to subscribe for shares
2. Allot shares
3. Refund money to unsuccessful applicants
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RECORDING ISSUE OF SHARES
INCORPORATORS (FOUNDERS)
Study Unit 6: Introduction to Companies
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Journals - Incorporators
Bank
Incorporators: Ordinary Shares
Incorporators: x% Preference shares
Receipt of application money from incorporators
Incorporators: Ordinary Shares
Incorporators: x% Preference shares
Share Capital: Ordinary Shares
Share Capital: x% Preference shares
Allotment of shares to incorporators of the company
NOTE: Highly unlikely to be a different amount from application money for incorporators
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ISSUE OF SHARES TO THE PUBLIC
APPLICATION = ALLOTMENT
Study Unit 6: Introduction to Companies
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Illustration 1
Application equal to allotment
• ABC Ltd offered 100 shares at R1 each to the
public in a prospectus
• Exactly R100 was received along with
matching application forms.
• Underwriters commission is calculated at 5%
of the shares offered and underwritten.
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Underwriters Commission
Underwriters Commission
Creditor – Name of Underwriter
Underwriters commission raised as a creditor
Note: Often calculated as a percentage of the total shares to be underwritten
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Receive cash for applications and
allot successful applicants sharesBank
Application and allotment: Ordinary Shares
Application and allotment: x% Preference shares
Receipt of application money from public
Application and allotment: Ordinary Shares
Application and allotment: x% Preference shares
Share Capital: Ordinary Shares
Share Capital: x% Preference shares
Allotment of shares to successful applicants
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Pay Underwriters Commission
Creditor – Name of Underwriter
Bank
Underwriters commission paid
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ISSUE OF SHARES TO THE PUBLIC
APPLICATION GREATER THAN ALLOTMENT
Study Unit 6: Introduction to Companies
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IF MORE SHARES WERE APPLIED
FOR BY THE PUBLIC THAN THE
NUMBER OF SHARES OFFERRED
TO THE PUBLIC
NO PAYMENT BY UNDERWRITERS,
JUST REFUND UNSUCCESSUL
APPLICANTS
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Illustration 2
Application greater than allotment
• ABC Ltd offered 100 shares at R1 each to the
public in a prospectus (R100 worth of shares
offered to the public)
• R120 was received along with matching
application forms.
• Underwriters commission is calculated at 5%
of the shares offered and underwritten.
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Underwriters Commission
Underwriters Commission
Creditor – Name of Underwriter
Underwriters commission raised as a creditor
Note: Often calculated as a percentage of the total shares to be underwritten
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Receive cash for applications and
allot successful applicants sharesBank
Application and allotment: Ordinary Shares
Application and allotment: x% Preference shares
Receipt of application money from public
Application and allotment: Ordinary Shares
Application and allotment: x% Preference shares
Share Capital: Ordinary Shares
Share Capital: x% Preference shares
Allotment of shares to successful applicants
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Refund unsuccessful applicants
Application and allotment: Ordinary Shares
Application and allotment: x% Preference shares
Bank
Cash refund to unsuccessful applicants
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Pay Underwriters Commission
Creditor – Name of Underwriter
Bank
Underwriters commission paid
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ISSUE OF SHARES TO THE PUBLIC
APPLICATION LESS THAN ALLOTMENT
Study Unit 6: Introduction to Companies
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IF LESS SHARES WERE APPLIED
FOR BY THE PUBLIC THAN THE
NUMBER OF SHARES OFFERRED
TO THE PUBLIC
UNDERWRITERS TAKE UP
REMAINING SHARES – BUT DO
NOT PAY IMMEDIATELY
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Illustration 3
Application less than allotment
• ABC Ltd offered 100 shares at R1 each to the
public in a prospectus (R100 worth of shares
offered to the public)
• R90 was received along with matching
application forms.
• Underwriters commission is calculated at 5%
of the shares offered and underwritten.
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Underwriters Commission
Underwriters Commission
Creditor – Name of Underwriter
Underwriters commission raised as a creditor
Note: Often calculated as a percentage of the total shares to be underwritten
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Receive cash for applications and
allot successful applicants sharesBank
Application and allotment: Ordinary Shares
Application and allotment: x% Preference shares
Receipt of application money from public
Application and allotment: Ordinary Shares
Application and allotment: x% Preference shares
Share Capital: Ordinary Shares
Share Capital: x% Preference shares
Allotment of shares to successful applicants
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Underwriters take up shortfall
Debtor – name of Underwriter
Share Capital: Ordinary Shares
Share Capital: x% Preference shares
Allotment of shares to the underwriter
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Final settlement or receipt with
underwriter
Creditor – Name of Underwriter
Debtor – Name of Underwriter
Bank (balancing figure)
Underwriters commission paid – if the Creditor > Debtor amount
Creditor – Name of Underwriter
Debtor – Name of Underwriter
Bank (balancing figure)
Underwriters commission paid – if the Creditor < Debtor amount
OR
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SHARE ISSUE EXPENSES TO BE
WRITTEN OFF AGAINST RETAINED
INCOME
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WRITE OFF SHARE ISSUE EXPENSES TO
RETAINED EARNINGS
Study Unit 6: Introduction to Companies
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Share issue expenses
Share issue expenses
Bank
Pay share issue expenses
Retained Earnings
Share issue expenses
Underwriters commission
Write off all share issue expenses to Retained Earnings in Equity
NOTE: Don’t forget about the underwriters commission expense from the first journal
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HOMEWORK – Exercise 6.3 page 100 SG
Study Unit 6: Introduction to Companies
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ISSUE OF CAPITALISATION SHARES
Study Unit 6: Introduction to Companies
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Capitalisation shares
• No cash is paid out
• Shareholders receive shares
– Usually done instead of dividends
• Also referred to as a Bonus Issue
• No real benefit if issued to all shareholders in
proportion to current shares held
– Just a book entry to convert reserves into share capital
• If shares not issued in proportion to current
shareholding then there is economic substance
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Changing the number of pieces in
the pie?
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Accounting entry?
Debit Credit
Dr Retained Earnings* RXX
Cr Issued Share Capital RXX
* This may be any distributable reserves account not just Retained Earnings.
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HOMEWORK – Exercise 6.2 page 99 SG
Study Unit 6: Introduction to Companies
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DIVIDENDS
Study Unit 6: Introduction to Companies
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Dividend Overview
• Dividends are paid out of profits to shareholders (owners)
• Preference dividends paid first before ordinary dividends
• Dividends are paid equally per share (proportionate)
– can be paid via assets (in specie) or as capitalisation (bonus) share
issue
• Process:
– Directors recommend the amount of dividends to be paid
– Companies Act requirement – liquid and solvent after dividend paid
– Dividend approved and therefore declared at the Annual General
Meeting (AGM)
– At AGM shareholders can declare a dividend lower than that
recommended by Directors
• May NOT be paid from Capital
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Two Kinds of Dividends
• Interim Dividends
– Declared before the end of the year
– Declared by directors, but ratified at AGM by shareholders
– CanNOT be declared until all outstanding dividends are
paid in full
• Final (Annual) Dividends
– Declared at year end
– Recommended by directors, approved and declared by
shareholders
– Reduce available profit / reserves by any interim dividends
declared during the year
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Accounting Journals
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