ACCT5001 2022 S1 - Module 10 - Lecture Slides Student

ACCT5001:
Foundation in Accounting
Module 10:
COMPANY FORMATION,
SHAREHOLDERS’ EQUITY
AND CAPITAL MANAEMENT
Reading: Textbook
Chapter 14 (14.1-14.5) pp.587-601
Chapter 15 (15.1-15.4) pp.625-633
Slide 1
Copyright © 2016 Pearson Australia (a division of Pearson Australia Group Pty Ltd) – 9781486018000 Nobles/Horngren’s Accounting 8th edition
ACCT5001:
Module 10 - Part A
Company characteristics,
formation and share capital
Learning objectives 14.1, 14.2 and 14.3
Slide 2
Module 10 Companies – Formation, Shareholders’ equity
and capital management
Reading: Textbook Chp 14 (14.1 – 14.5 only) pp. 587-601 and

Chp 15 (15.1 – 15.4 only) pp. 625-633
Relevant Textbook Learning Objectives

14.1 Identify the characteristics of a company
14.2 Describe the sources of shareholders’ equity and the classes of shares
14.3 Journalise the simple issue of shares (not in instalments) and
prepare the shareholders’ equity section of a company balance sheet
14.4 Illustrate retained earnings transactions
14.5 Account for cash dividends
15.1 Account for share dividends
15.2 Account for share splits
15.3 Account for share buy-backs
15.4 Report transfers to reserves
3
Characteristics of a company - See pp.22-23, 588-589
1. Separate legal entity (not just a separate accounting entity).

2. Ability to raise more capital and loan funds than other business forms
through issue of shares and debentures
3. Shareholders have limited liability for the company’s debts.
4. Indefinite life and easier transferability of ownership
5. No mutual agency (unlike a partnership)
6. Often ownership and management are separate
Government regulation through and regulatory bodies
- e.g. Corporations Law, ASIC, AASB, ASX
- If a reporting entity, required to publish audited financial reports
using AASB accounting standards
8. Separate tax entity and tax rate
4
Forming a company
• Application by promoters to Australian Investments Commission (ASIC)
• ASIC registers and incorporates the company making it a legal entity.
Given ACN (Australian Company Number) and a certificate of registration.
• The Corporations Act (2001) regulates companies with laws/rules.
Has replaceable rules that can be adopted in place of a constitution.
• To raise capital (equity) the promotors will issues a prospectus and
invite the public to purchase shares that will form the share capital
to start up the company and buy assets to commence operations.
• Shareholders vote (one vote per share) to elect a board of directors
each year to set the strategy and appoint a CEO/managing Director.
• Public companies must have the letters “Ltd” after their name to let the
public and lenders/creditors know that liability of shareholders is limited
• In Australia there are also ‘proprietary limited’ (Pty Ltd) companies are
smaller companies (maximum of 50 shareholders, unless also employees
5
that cannot offer their shares to the general public
Shares
Shares - Capital is divided into shares to reflect proportion of ownership.
There may be different classes of shares:
• Ordinary shares – have ordinary rights such as:
 A vote per share at the Annual General Meeting to elect the Board of Directors
 A proportionate part of a dividend if one is declared (and to a new share issue)
 A proportionate part of net assets after the debts have been paid on liquidation
• Preference shares – may have some preferential rights such as:
 Fixed rate of dividend to be received before ordinary share dividends
 May have a priority right to net assets before ordinary shares in a liquidation
 BUT preference shares usually do not usually have a vote at the AGM
6
Shareholders’ Equity
Owners’ equity = Shareholders’ equity
Capital = Share capital
Drawings = Dividends
Profit – dividend = Retained earnings
As at 30 June 2021
7
Shareholders’ Equity
Share capital - is externally generated contributions paid up from the
initial sale/issue of shares by the company (Dr. Cash; Cr. Share capital)
Retained earnings - are internally generated funds from retaining some
of the profits for use in the business rather than distributing them all to
shareholders as dividends (i.e. = Profits earned – dividends)
Accumulated Losses - where past dividends and losses exceed profits,
and therefore reduce (debit) shareholders equity
Shareholders equity = Share capital + Retained earnings / -Acc’d Losses

= Assets – Liabilities (i.e. net assets or wealth)
8
Issuing shares
• A company can sell its shares to applicants or to an underwriter.
• Shareholders can then sell their shares on the share market
to transfer ownership, but this has no financial effect on the company,
who only receive cash (or other assets) from the initial issue
• The issue price received is determined by the market (influenced by a
company’s past profits, financial position and future prospects)
• To record a new issue of shares we debit Cash (or other asset
received at fair value), and credit Ordinary share capital a/c.
e.g. Issued 1,000, 000 shares at an issue price of $20
Date Account title Dr Cr
Jan 2
Issued ordinary shares.

* Note: the textbook uses Q to denote Shareholders equity accounts,
whereas we use A, L or OE to categorise all types of accounts.
9
End of part A
Slide 10
ACCT5001:
Module 10 - Part B
Retained earnings and
dividend distributions
Learning objectives 14.4, 14.5, 15.1
Slide 11

Chp 15 (15.1 – 15.4 only) pp. 625-633

Slide 12
12 Copyright © 2016 Pearson Australia (a division of Pearson Australia Group Pty Ltd) – 9781486018000 Nobles/Horngren’s Accounting 8th edition
Retained earnings
• Is increased from profits and decreased from losses and dividends
• Revenues and expenses are closed to the Income summary account,
then the profit/loss balance is transferred to the Retained earnings a/c
Account title Dr Cr
Jun 30
To close profit to Retained earnings.

OR
Jun 30
To close loss to Retained earnings.
• Dividends are declared from retained earnings, which reduce it in a

similar way that drawings did, when it was closed to the capital account.
13
Accounting for cash dividends
– There are 3-4 dividend dates that may be relevant to recording dividends
1) declaration date, 2) ex-dividend, 3) date of record, 4) payment date.
• We record dividends as payable when declared at declaration date, and

reduce cash and the payable when it is paid on the payment date.
• E.g. Declared a 6-cent dividend on 1,000,000 shares on May 1, Paid on May 31
May 1
Declared a cash dividend.
May 31
Paid the cash dividend.
• Ultimately, it reduces retained earnings (OE-) and cash (A-)

14
Share dividends
• A share dividend (sometimes called a bonus share issue)
is a distribution of a company’s own shares to its shareholders.
 Unlike cash dividends, share dividends don’t give cash to shareholders.
 Once distributed they only affect shareholders’ equity accounts
They have no overall effect on total shareholders’ equity, assets or liabilities
• There are two different methods of recording share dividends:
(1) Recognition of dividend declared at declaration date.
Dr Retained earnings
Cr Share dividend payable
and settlement of the liability by issuing the shares at payment date
Dr Share Dividend Payable
Cr Share Capital
(2) Only recognition of dividend when the shares are issued:
Dr Retained earnings (OE-)
Cr Share capital (OE+)
We prefer Method 1, but the Text may use one or the other
15
Share dividends
Both methods are a result of different timing of recognition.
After issue of the shares, both methods give the same result (see below).
(1) Recognition of dividend declared at declaration date.

Dr Retained earnings
Cr Share Dividend payable
Settlement of the liability by issuing the shares at payment date
Dr Share Dividend Payable
Cr Share Capital
OR
(2) Only recognition of dividend when the shares are issued:

Dr Retained earnings (OE-)
Cr Share capital (OE+)
16
Share dividends?
Why Issue Share dividends (bonus shares)?

• A company may not have the cash or
• may need to keep its cash for operations rather than for dividends.
• Investors feel as though they have received something of value
when they get a share dividend.
Note: Depending on its size, a share dividend may cause the company
market price per share to fall because of an increased supply of shares.
17
End of part B
Slide 18
ACCT5001:
Module 10 - Part C
Other equity events and
transactions
Learning objectives 15.2, 15.3, 15.4
Slide 19

Chp 15 (15.1 – 15.4 only) pp. 625-633

Slide 20
20 Copyright © 2016 Pearson Australia (a division of Pearson Australia Group Pty Ltd) – 9781486018000 Nobles/Horngren’s Accounting 8th edition
Share split
• A share split is fundamentally different from a share dividend,
although both increase the number of issued shares.
• A share split increases the number of shares and proportionately
decreases the market price of the shares – with the intention of
making the shares more affordable.
• Because a share split doesn’t affect any accounts, no formal journal
entry is needed (only the new number of issued shares is noted).
• The split is recorded in a memorandum entry, an entry in the journal
that ‘notes’ a significant event but has no debit or credit amount
Date
Feb 2
21
Share splits
Smart Touch Learning Ltd’s shareholders’ equity before and after a

2-for-1 ordinary share split (see exhibit 15.3)
22
Comparison of dividends and share splits (after completed)
Effects of cash dividends, ordinary share dividends and
ordinary share splits on account balances
EFFECT ON CASH DIVIDEND SHARE SHARE SPLIT

DIVIDEND
Total assets
Total liabilities
Ordinary capital
Retained earnings
Total shareholders’ equity
23
Share buy-backs
• A company may buy back its own shares to cancel them,
but it cannot then resell those shares.
• Reasons for a buy-back include:
○ The company has surplus cash but cannot see good profitable
investment opportunities for use of that cash.
○ It may want to replace some share capital with borrowings
○ The directors believe the shares are priced below their true value.
Buying back shares may lead to an increase the share price.
○ Help avoid a takeover from an outside party by reducing the issued

shares with voting rights and using up cash.
24
Transfers to reserves
• Appropriations are transfers of a portion of retained earnings to
signal that they are not available for dividends but are retained for a
specific use or reserved for general purposes other than dividends.
• This is transferred by a formal journal entry, called a ‘book entry’
because it is simply a change in account name not a cash flow.
• An appropriation does not decrease total shareholders’ equity
 as it decreases retained earnings (OE-) and
 increases a reserve account (OE+)
May 1
Transferred portion of retained

earnings to general reserve.
25
Transfers to reserves
• A company may appropriate (segregate in a separate account) a portion of

retained earnings for a specific use or as a general reserve
• An appropriation does move funds around or decrease total retained earnings.
It simply means it intends to retain some net assets represented by retained
earnings are earmarked for a specific purpose or to maintain wealth security
(not distribute it as dividends)
• When the specific appropriation is no longer needed, the reserve account is
closed and its amount returned to Retained earnings
26
End of part C
Slide 27

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ACCT5001:

Learning objectives 14.1, 14.2 and 14.3

Reading: Textbook Chp 14 (14.1 – 14.5 only) pp. 587-601 and

Relevant Textbook Learning Objectives

1. Separate legal entity (not just a separate accounting entity).

Shareholders equity = Share capital + Retained earnings / -Acc’d Losses

Issued ordinary shares.

Learning objectives 14.4, 14.5, 15.1

Reading: Textbook Chp 14 (14.1 – 14.5 only) pp. 587-601 and

Relevant Textbook Learning Objectives

To close profit to Retained earnings.

To close loss to Retained earnings.

• Dividends are declared from retained earnings, which reduce it in a

• We record dividends as payable when declared at declaration date, and

Declared a cash dividend.

Paid the cash dividend.

• Ultimately, it reduces retained earnings (OE-) and cash (A-)

(1) Recognition of dividend declared at declaration date.

(2) Only recognition of dividend when the shares are issued:

Why Issue Share dividends (bonus shares)?

Learning objectives 15.2, 15.3, 15.4

Reading: Textbook Chp 14 (14.1 – 14.5 only) pp. 587-601 and

Relevant Textbook Learning Objectives

Smart Touch Learning Ltd’s shareholders’ equity before and after a

EFFECT ON CASH DIVIDEND SHARE SHARE SPLIT

Total shareholders’ equity

• Reasons for a buy-back include:

○ It may want to replace some share capital with borrowings

○ Help avoid a takeover from an outside party by reducing the issued

Transferred portion of retained

• A company may appropriate (segregate in a separate account) a portion of

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