CHAPTER 4

FINANCIAL INSTRUMENTS: SHARE

CAPITAL
Learning objectives

Define the following terms:

Financial instrument
Financial asset
Financial liability
Equity instrument

Differentiate between the following:

•Ordinary shares and preference shares

•Cumulative and non-cumulative preference shares
•Participating and non- participating preference shares
•Redeemable and non-redeemable preference shares
Learning objectives…continued

Have a broad understanding of the changes affecting

share capital:
Have an understanding and application of principles in
respect of redemption of preference shares
Have an understanding of principles in respect of
distributions to equity holders
Definitions
Financial instrument is a contract that gives rise
to a financial asset of one entity and a financial
liability or equity instrument of another entity
Definitions

Financial asset is any asset that is:

Cash
An equity instrument of another entity (e.g. Investment in shares)
A contractual right:
•to receive cash or another financial
•to exchange financial assets or financial liabilities(favourable
condition)
•A contract that will or may be settled in the entity's own equity
instruments
Definitions

Financial liability is any liability that is:

A contractual obligation:
•to deliver cash or another financial
•to exchange financial assets or financial(unfavourable conditions)
A contract that will or may be settled in the entity's own equity
instruments

Equity instrument is any contract that evidences a residual

interest in the assets of an entity after deducting all of its liabilities.
Types of shares

Ordinary shares
Give the holders voting powers
Par value or no par value
Classified as equity
No obligation to pay dividends

Preference shares
Give their holders preference over ordinary shareholders on distributions
Entitled to a fixed dividend
Can be classified as equity or liability
Types of preference shares

Redeemable and non-redeemable preference shares

•Non-redeemable preference shares are classified as equity
•Redeemable (at the option of the company), also classified as
equity
•Redeemable (at the option of the shareholder),classified as
liability, an obligation exists

Cumulative and non-cumulative preference shares

•Holders of cumulative preference shares have a claim towards
the fixed preference dividend
•Holders of non- cumulative preference shares do not have a
claim towards the dividend
Types of preference shares

Participating and non- participating preference shares

•Non-participating preference shares are only entitled to their
fixed dividend
•Participating preference shares can participate in the profits of
the company after the fixed dividend has been paid

Convertible preference shares

•Option to convert them into ordinary shares
Distributions to equity holders

Dividends
Can be in the form of cash, assets or shares.
Must satisfy provisions of Section 46 of the Companies
Act, 71 of 2008
Liquidity and solvency test must be done before the
distributions
Types of dividends

Cash dividends:

On declaration date
•Dr Dividends declared SOCE
•Cr Shareholders for dividend SOFP

On Payment date
•Dr Shareholders for dividend SOFP
•Cr Bank SOFP
 Types of dividends

Example 4.1 Cash dividend

Company A has 15 000 issued ordinary shares on 01 January 2018. On 15 December 2018, the company
declared a cash dividend of 20 cents per share to all its existing shareholders. The dividend was paid on 31
December 2018.
R’s R’s
15 December 2018
Dividends declared – ordinary shares SOCE 3 000
Shareholders for dividend SOFP (Liability) 3 000
Being declaration of dividend
Note: The dividend is debited directly to the retained earnings
in the statement of changes in equity. The liability will be reversed when the cash is paid

31 April 2018
Shareholders for dividend SOFP (Liability) 3 000

Bank SOFP 3 000

Being cash payment of dividend
Types of dividends

Capitalisation issue
Company may distribute the dividend in the form of the issue of new shares to the
shareholders.

Example 4.2 Capitalisation issue

Company A had a share capital of R3 000 000 on 1 January 2018. The share capital consisted
of 1 500 000 ordinary shares. The retained earnings on 31 December 2017 amounted to R1
200 000. On 31 March 2018, the company’s directors resolved to make a capitalisation issue to
all existing ordinary shareholders. The company will give each shareholder one share for every
five shares held in the company. The shares were issued on 30 April 2018. The retained
earnings opening balance was R1200 000 on 01 January 2018. Profit after tax for the current
year amounted to R1800 000.
 Types of dividends

Example 4.2 solution

R’s R’s
31 March 2018
Retained earnings SOCE 600 000
Capitalisation reserve SOCE 600 000

(1500 000/5 = 300 000*2)

30 April 2018
Capitalisation reserve SOCE 600 000
Share capital SOCE 600 000
Types of dividends

Example 4.2 solution (SOCE)

Share Retained Total

capital Earnings

Opening balance 3 000 000 1 200 000 4 200 000

Total comprehensive income 1 800 000 1 800 000

Capitalisation issue 600 000 (600 000) 0

Dividends 0 0 0

Closing balance 3 600 000 2 400 000 6 000 000

Changes to Share Capital_ Issue of ordinary shares

Issue of ordinary shares

NB:
Application date (before issue)
The cash received will be debited to the bank account and a temporary liability
account will be created.
Dr Bank xxx
Cr Application and allotment xxx
Proceeds received from applicants for new shares

Issue date
Once the shares have been issued, the liability account should be cleared to zero
and the amount should be allocated to the share capital
Dr Application and allotment account xxx
Cr Share capital xxx
Allocation of new shares to applicants
Changes to Share Capital_ Issue of ordinary shares

Share issue costs

All share issue costs (directly attributable to the share issue,
should be netted off against the consideration received when
the shares are issued.

Examples of share issue costs:

Legal fees,
Accounting fees,
Underwriting costs,
Printing
Changes to Share Capital_ Issue of ordinary shares

Over-subscription
Two options: the company may choose to accept the
full subscription or refund the oversubscription

The authorised share capital should be taken into

account before the oversubscription can be accepted

Underwriters
They buy all the shares which are not subscribed for
Charge a set percentage of the value of all the
shares under offer
Changes to Share Capital_ Issue of ordinary shares

Lecture example 4.4 Over subscription

On 01 February 2018 Company A resolved to offer 100 000

shares to the public at R2 per share, applications for these
shares were opened on the same date. By 31 March 2018,
which was the closing date for applications, R240 000 had been
received from the applicants. The company needs the funds
from the oversubscription so it decided to accept all the
applications. The shares were allotted (issued) on 01 April 2018.
The company has enough authorised share capital to cover the
over-subscription
Changes to Share Capital_ Issue of ordinary shares

Example 4.4 Solution

R’s R’s
Before shares are issued

31 March 2018
Bank SOFP 240 000
Application and Allotment SOFP 240 000
Being consideration received from applicants

01 April 2018
Application and Allotment SOFP 240 000
Share capital SOCE 240 000
Being the allotment of shares on issue date
Changes to Share Capital_ Issue of ordinary shares

Lecture example 4.5 Underwriters

On 01 February 2018 Company A resolved to offer
100 000 shares to the public at R2 per share, applications
for these shares were opened on the same date. By 31
March 2018, which was the closing date for applications,
R180 000 had been received from the applicants. The
shares were allotted (issued) on 01 April 2018. The share
offer was underwritten at a cost of 5%, paid in cash on
issue date, the underwriters bought all the remaining
shares. The company incurred other share issue costs of
R2 000 which were also paid in cash.
Changes to Share Capital_ Issue of ordinary shares

Lecture example 4.5 Solution

R’s R’s
Before shares are issued

31 March 2018
Bank SOFP 200 000
Application and Allotment SOFP 180 000
Application and Allotment SOFP (underwriters) 20 000

Being consideration received from applicants

01 April 2018
Application and Allotment SOFP (underwriters) 20 000
Application and Allotment SOFP 180 000
Share capital SOCE 200 000
Being the allotment of shares on issue date

Share capital (Underwriters commission) 10 000

Share capital (Share issue costs) 2 000
Bank SOFP 12 000
Being the recognition of share issue costs
Changes to Share Capital_ Rights issue

Preferential rights are given to existing

shareholders to subscribe to the shares in
issue first at a specific price
Price usually lower than the market price
The journal to account for a rights issue is the
same as the normal issuing of shares
Changes to Share Capital_ Rights issue

Example 4.6 Rights issue

On 01 June 2018, the directors of company A resolved to offer

a rights issue of 2 new ordinary shares for every 5 ordinary
shares held, at R5 per share. The company had 200 000
ordinary shares at R6 per share in issue on that date. The
current market price immediately before this issue is R10 per
share. All the shareholders had accepted the offer by the last
day of the offer which was 30 June, and the shares were
issued on the same date
Changes to Share Capital_ Rights issue

Example 4.6 Solution

R’s R’s

30 June 2018

Bank SOFP 400 000

Share capital SOCE 400 000

Rights Issue to ordinary shares

(200 000/5*2= 80 000 shares)

(80 000*5)
Changes to Share Capital_ Share splits

Share splits
Increase the number of shares by subdividing the
existing shares
Proportionately decrease the value per share
No change in the total owner’s equity and in the
share capital account.
No journal entry is required.
Changes to Share Capital_ Share consolidations

Share consolidations
Opposite of a share split
Reduces the number of shares to increase the
price per share
No journal entry required
Changes to Share Capital_ Share buy back

A company may buy back its own shares from the

market to reduce its share capital
The memorandum of incorporation must allow such a
buy back
The share buy-back should be done according to the
provisions of the s46 and s48 of the companies Act
All the shares that have been bought back must be
cancelled and added back to the authorised number of
shares
Changes to Share Capital_ Share buy back

Example 4.8 Share buy back

On 15 January 2018, Company A decided to buy back 50 000

of its own shares for R2.50 each. As of 01 January 2018, the
company had 150 000 issued ordinary shares, these shares
were initially issued at R2 each. Assume that all the
requirements for a share buy-back were met.
Changes to Share Capital_ Share buy back

Example 4.8 Solution

R’s R’s

15 January 2018

Share capital SOCE 100 000

Retained earnings SOCE 25 000

Bank SOFP 125 000

Share buy-back of 50 000 shares at R2.50

 Changes to Share Capital_ Share buy back

Example 4.8 Solution SOCE

Class A Share capital Retained earnings Total
R R R

Balance at 1 January 2018 300 000 xxx xxx

Share buy-back (100 000) (25 000) (125 000)

Total comprehensive income xxx xxx

Dividends xxx xxx xxx

Balance at 31 December 2018 200 000 xxx xxx

Changes to Share Capital_ Redemption of Preference Shares

Classified as a distribution to shareholders

S46 requirements must be met before the shares can be redeemed

Redemption at a nominal
•Redeemed at the value they were initially issued for

Redemption at a discount
•Redeemed at a value lower their nominal value

Redemption at a premium
•Redeemed at a value higher than their nominal value
Financing the redemption of preference shares

Can be financed through:

Debt instruments,e.g loan

Equity instruments, e.g issue of shares
Financing the redemption of preference shares

Example 4.11 Redemption of preference shares

On 31 December 2018, the directors of Company A decided to redeem all

the preference shares at a premium of R1.20 per share. The company
had 50 000, 5% issued redeemable preference shares on that date. The
shares were issued at R4 per share. The redemption will be financed
through:

•The issue of 25 000 ordinary shares at R4 per share

•A 10% short term loan with ZBD Bank for the balance.

Dividends on preference shares for the year which were declared on 31

December 2018 are still unpaid.
Financing the redemption of preference shares

Example 4.11 solution

R’s R’s

31 December 2018
5 % Redeemable preference share capital SOCE 200 000
Retained earnings SOCE(Premium) 60 000
Retained earnings SOCE(dividends) 10 000
Preference shareholders SOFP 270 000

Being the obligation to redeem the preference shares

Bank SOFP 270 000

Share capital: ordinary shares SOCE 100 000
Loan from ZBD bank SOFP 170 000

Being the issue of ordinary shares and obtaining of loan

Financing the redemption of preference shares

Example 4.11 solution

Calculations:
How much is owed? R
Shares (50 000 x R 4) 200 000
Premium (50 000 x 1.20 cents) 60 000
Dividends (50 000 x R4 x 5%) 10 000
270 000

Finance plan (funds)

Ordinary shares (25 000 x R 4) 100 000
10 % Short term loan 170 000
270 000
End