Company Financial Statements

A company's equity capital consists of shares issued to investors. The two principal types are:

Ordinary shares

• Carry voting rights (normally one vote per share) — ordinary shareholders control the company
• Entitled to dividends, but only if declared by the directors and approved by shareholders. The amount is variable and at the board's discretion.
• Have a residual claim on assets in a liquidation — they receive whatever is left after all creditors and preference shareholders have been paid
• Bear the greatest risk but also have the greatest potential for reward (capital gains and dividends)
• Each share has a nominal (par) value — the minimum price at which it can be issued (e.g., 25p, 50p, £1). The nominal value has no direct relationship to the market value.

Preference shares

• Carry a fixed dividend rate (e.g., 6% of nominal value), paid in priority to ordinary dividends
• Have priority over ordinary shareholders for the return of capital on liquidation (but after all creditors)
• Usually carry no voting rights (or limited voting rights only when dividends are in arrears)
• Cumulative preference shares: if a dividend is not paid in one year, it accumulates and must be paid before any ordinary dividend in a future year. Most preference shares are cumulative unless stated otherwise.
• Non-cumulative preference shares: unpaid dividends are lost — they do not carry forward
• Participating preference shares: in addition to the fixed dividend, participate in surplus profits alongside ordinary shareholders (rare)
• Redeemable preference shares: the company has the right or obligation to buy them back at a specified date or price. Under IAS 32, redeemable preference shares are classified as financial liabilities (not equity), because the issuer has an obligation to transfer cash. The "dividends" are treated as interest expense.

Authorised vs issued share capital: Under the Companies Act 2006, there is no longer a requirement for authorised (maximum) share capital. Companies simply have issued share capital — the shares actually allotted to shareholders.

The equity section of the SoFP typically includes several reserves alongside share capital:

Distributable reserves are those from which dividends may legally be paid. For a company with share capital, distributable profits = accumulated realised profits less accumulated realised losses (s.830 CA 2006). In practice, retained earnings are the primary distributable reserve. Share premium, revaluation surplus, and capital redemption reserve are all non-distributable.

Accounting for a share issue at a premium:

Example: A company issues 200,000 ordinary shares with a nominal value of £0.50 at a price of £3.20 per share.

• Cash received: 200,000 × £3.20 = £640,000
• Dr Cash £640,000
• Cr Share capital £100,000 (200,000 × £0.50 nominal)
• Cr Share premium £540,000 (200,000 × £2.70 premium)

A bonus issue (scrip issue, capitalisation issue) distributes free additional shares to existing shareholders in proportion to their holdings. No cash is received by the company. The issue converts reserves into permanent share capital.

Mechanics:

• Expressed as a ratio: e.g., a "1-for-4" bonus issue means 1 new share for every 4 currently held
• The bonus can be made from: share premium, retained earnings, revaluation surplus, capital redemption reserve, or other undistributable reserves
• Journal entry: Dr Reserve used (at nominal value of new shares) / Cr Share capital

Example: A company has 1,000,000 shares of £1 nominal in issue. It makes a 1-for-5 bonus issue from share premium.

• New shares: 1,000,000 ÷ 5 = 200,000 shares
• Dr Share premium £200,000 (200,000 × £1 nominal)
• Cr Share capital £200,000

Effects:

• Number of shares increases (from 1,000,000 to 1,200,000)
• Share price falls proportionally (to maintain the same total market capitalisation)
• Total equity is unchanged — it is merely reclassified within equity (reserve → share capital)
• Existing shareholders' percentage ownership is unchanged
• No cash enters or leaves the company

EPS impact: Under IAS 33, bonus shares are treated as if they had always been in issue. The prior-period EPS comparative must be restated (dividing by the larger number of shares) to ensure comparability.

A rights issue offers existing shareholders the right to buy additional shares at a price below the current market price, in proportion to their existing holdings. Unlike a bonus issue, a rights issue raises new cash for the company.

Example: A company with 800,000 shares in issue (market price £5.00) makes a 1-for-4 rights issue at £3.50 per share.

• New shares: 800,000 ÷ 4 = 200,000
• Cash raised: 200,000 × £3.50 = £700,000
• Dr Cash £700,000
• Cr Share capital (200,000 × nominal value)
• Cr Share premium (200,000 × (£3.50 − nominal value))

Theoretical ex-rights price (TERP):

After the rights issue, the market price adjusts. The TERP is the theoretical price per share after the new, cheaper shares are mixed in with the existing shares:

TERP = (Existing shares × Market price + New shares × Rights price) ÷ Total shares after issue

Using the example: TERP = (800,000 × £5.00 + 200,000 × £3.50) ÷ 1,000,000 = (£4,000,000 + £700,000) ÷ 1,000,000 = £4.70

Shareholder options: Each shareholder can (a) exercise the rights and buy the new shares, (b) sell the rights to a third party in the market, or (c) allow the rights to lapse (not recommended, as the shareholder's proportional ownership is diluted).

EPS impact: Rights issues have a bonus element (because the issue price is below market price). Under IAS 33, the EPS calculation uses a bonus fraction to adjust the weighted average shares for the period before the rights issue. The bonus fraction = Market price before rights ÷ TERP.

Dividends are distributions of profit to shareholders. Key rules and principles:

Legal requirements:

• Dividends can only be paid from distributable profits (s.830 CA 2006) — primarily accumulated realised profits less accumulated realised losses. In practice this means retained earnings.
• A company cannot pay a dividend from share premium, revaluation surplus, or capital redemption reserve
• A company cannot pay a dividend if doing so would reduce net assets below the aggregate of called-up share capital plus undistributable reserves

Interim vs final dividends:

• Interim dividends are paid during the financial year. They are declared by the board of directors and do not require shareholder approval. Recognised as a reduction in retained earnings when paid.
• Final dividends are proposed by the board after the year end and approved by shareholders at the Annual General Meeting (AGM). Under IAS 10, a final dividend proposed after the reporting date is a non-adjusting event:
• It is NOT recognised as a liability at the reporting date (because there is no obligation until shareholders approve it)
• It is disclosed in the notes to the financial statements
• It is recognised as a liability only when approved at the AGM (typically in the following period)

Preference dividends: Preference shareholders receive a fixed dividend (e.g., 6% of nominal value) before any ordinary dividend is paid. For cumulative preference shares, any arrears must be paid before ordinary dividends. For IAS 33 EPS purposes, preference dividends are deducted from profit to arrive at earnings available to ordinary shareholders.

Dividend per share: Often expressed in pence per share (e.g., "a final dividend of 12p per share") rather than as a total amount.

Redeemable shares are shares that the company can (or must) buy back from shareholders at a future date or on the occurrence of a specified event.

Key rules under CA 2006:

• Redeemable shares may only be issued if the company also has non-redeemable shares in issue
• Redemption must be funded from: (a) the proceeds of a new share issue made for the purpose of redemption, or (b) distributable profits
• The nominal value of shares redeemed out of distributable profits must be transferred to a capital redemption reserve (CRR) — this maintains the company's capital base and is non-distributable
• Any premium payable on redemption must come from distributable profits, UNLESS the shares were originally issued at a premium, in which case the premium on redemption can come from the share premium account (up to the amount of the original share premium on those shares)

Example: A company redeems 50,000 preference shares of £1 nominal at £1.20 per share, funded entirely from distributable profits.

• Dr Preference share capital £50,000
• Dr Share premium (or Retained earnings) £10,000 (premium on redemption: 50,000 × £0.20)
• Cr Cash £60,000
• Dr Retained earnings £50,000 / Cr Capital redemption reserve £50,000 (to maintain capital)

IAS 32 classification: If the company has an obligation to redeem (mandatory redemption), the shares are classified as financial liabilities, not equity. The "dividends" are treated as finance costs (interest expense). Only shares where redemption is at the holder's option (puttable shares) or where there is no contractual obligation may remain as equity (depending on specific circumstances).

IAS 33 applies to entities whose ordinary shares or potential ordinary shares are traded on a public market, or that are in the process of issuing such shares. It requires disclosure of basic and diluted EPS on the face of the statement of profit or loss.

Basic Earnings Per Share

Diluted Earnings Per Share