M5: Financial Instruments 1-4,8 Flashcards
(37 cards)
What are the types of shares issued by a company?
Companies may issue two types of shares:
1) Ordinary shares (also known as equity shares).
2) Preference shares.
What are the characteristics of ordinary and preference shares?
- Voting rights
- Rewards
- Risks
Ordinary shares:
- Have right to vote at Company general meetings
- Entitled to profit after all other claims are met
- High risk, last to be paid out if the company fails. May result in 0.
Preference shares:
- No voting rights generally but may be given if preference dividend in arrears/vote relates to change in terms for preference shares
- First right to a dividend, may be discretional/fixed
- If company fails, preference are paid after creditors and before ordinary shareholders.
What are redeemable and irredeemable preference shares?
Redeemable shares are Shares that are to be redeemed or are liable to be redeemed at the option of the company or the shareholder. (May be repurchased by the company)
When are shares classified as a financial liability or an equity instrument?
We determine if there is a contractual obligation to delivery cash via a fixed return or repay an amount on a given date.
IF THERE IS OBLIGATION TO DELIVER = FINANCIAL LIABILITY
IF THERE IS NO OBLIGATION = EQUITY INSTRUMENT
How does the classification of shares determine how related dividends and gains or losses are recognised and presented?
If the issued shares are classified as financial liability, we recognise dividends within finance cost in SPL and other gain or losses are recognised in SPL
If the issued shares are classified as equity, dividends are charged to Equity and presented in SOCIE. Other gains or losses are recognised in equity.
Explain if ordinary, preference shares can be redeemable in the future
Ordinary - NO cannot be redeemable UNLESS in the company articles they can be repurchased.
Preference - YES can be either redeemable / irredeemable at the option of the entity issuing the shares/fixed date/option of the holder.
What are equity shares? What is their nominal value?
Nominal value is the minimum amount the company must sell shares for e.g. £1. But they may be sold for more, which is called the “share premium” above the nominal value.
What are the 2 main principles of the Companies Act in relation to equity instruments?
Dividend payment: Dividends can ONLY be paid out of distributable profits. THERE MUST generate profits to pay dividends.
Preservation of permanent capital: The equity section of the SoFP must be preserved excluding Distributable profits.
When can the share premium account be used?
ONLY IN RARE CIRCUMSTANCES.
- To write off expenses arising on the share issue that gave rise to the original premium
- To fund new shares in a bonus issues
- To write off the premium on certain repurchases or redemptions of equity shares.
What is a bonus issue?
& what’s the journal entry to account for this
A bonus issue of shares is an issue of shares to existing shareholders in proportion to their existing shareholding, for no consideration.
DR Reserves (share premium or retained earnings) X
CR Share capital X
Journal entry for a bonus issue of shares.
What are the 5 steps and accounting entries to account for a repurchase of equity shares?
1) Consider legality. Is there sufficient reserves to fund the premium paid on repurchases shares/required capital redemption reserve without reducing permanent capital.
2) Record the repurchase via Dr Share Cap, Dr Premium on purchases, Cr Bank
3) Record any new issue. Dr Bank (Proceeds), Cr Share cap (Nom Value) Cr Share premium (Balance)
4) Climate premium on the purchase account. Dr Share premium (permissible amount), Dr Retained Earnings (Balance), Cr Premium on purchase
5) Replace nominal value of the purchases shares. Dr Retained Earnings Cr Capital redemption reserve.
What are financial instruments?
IAS 32 defines a financial instrument as follows:
Any contract that gives rise to a financial asset of one entity and a financial liability or equity instrument of another entity.
What is an equity instrument?
An equity instrument is: A contract that evidences a residual interest in the assets of an entity after deducting all of its liabilities.
What are the potential types of a financial asset?
- Cash
- An equity instrument of another entity
- A contractual right to receive cash/financial asset from another entity
- A contractual right to exchange financial instruments with another entity under conditions that are potentially favourable
What are the potential types of a financial liability?
- A contractual obligation to deliver cash/another financial asset to another entity
- A contractual right to exchange financial instruments with another entity under conditions that are potentially unfavourable.
What does it mean if a company issues equity shares for non-cash consideration?
Issuing the shares for something other than Cash. I.E. Property or shares in another company. No cash is being transferred.
What are the rules around issuing equity share for non-cash consideration?
The non-cash consideration must be EQUAL to the nominal amount of the shares being issued.
Listed company MUST have independent valuation of the non-cash element.
Why do companies issue bonus shares if they receive no money for doing this?
They do this to increase shares thus each share is worth less. This decrease in value means they are more marketable and attractive to investors.
OR
Issuing extra shares in lieu of a dividend if there is not enough liquidity (Cash) that it wants to pay out.
What is the best way to check if the repurchase of share is legal?
Compare the distributable reserves (retained earnings) is greater than the repurchase price. If > Then it’s legal.
If the RE is not more than repurchase we need to see if the proceeds of new shares issued will then result in the total going above the repurchase price. If so, then it’s legal aswell.
If the company cannot create a capital redemption reserve (where the nominal value of the repurchased shares is held) then its ILLEGAL.
If the company cannot fund the premium paid on the repurchased shares, then its ILLEGAL.
If the repurchase of shares is being partly/wholly funded from the issuance of new shares. To what extend can we use the share premium account to cover the initial premium purchase account?
We can use share premium to the MAXIMIUM of the lower between:
- The premium received on original issuance of the shares being repurchased. e.g. 100,000 shares repurchased that were originally 1.25 but not 1. Thus 0.25 per share
OR
- The balance on the share premium account AFTER crediting any premium on the new issue/
If there is no issuance of new shares, can we use the share premium account when repurchasing shares?
NO. ONLY USE SHARE PREMIUM IF THERE IS NEW SHARES AND FOLLOW THE LOWER OF RULES.
What is the exception granted to private companies regarding taking money out of permanent capital to purchase shares?
Private companies can use permanent capital to purchase share WITH ADDITIONAL SAFEGUARDS to limit the amount to the smallest amount possible. aka PERMISSIBLE CAPITAL PAYMENT
What are the legally required disclosures under IAS 1 regarding shares?
A company must disclose:
- The number of shares authorised
- The number of shares issued and fully paid, and
- The number of shares issued and not fully paid
- The nominal (par) value of shares.
- A reconciliation of the number of shares outstanding at the beginning and end of the period.
- The rights, preferences and restrictions attached to a class of shares, including restrictions on the distribution of dividends and repayment of capital.
- Shares in the entity held by the entity or by its subsidiaries or associates.
- Shares reserved for issue under options and other contracts for the sale of shares.
What are compound instruments?
A compound instrument is an instrument that has characteristics of both equity and financial liability.
e.g. convertible debt with option to convert to equity if bondholder wants OR convertible redeemable preference shares where investor can choose cash or ordinary share at redemption.
