Accounting for Raising Capital.doc

8/14/2019 Accounting for Raising Capital.doc

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10B

ACCOUNTINGFORRAISINGCAPITAL

Learning Objectives

After studying this chapter you should be able to:

1. Understand the process of raising capital, issuing of

shares and bonds.

2. Understand concept of authorised capital, issued

and paid-up capital share premium and forfeited

share capital.

3. Pass entries and prepare ledger accounts for the

issuance of shares and bonds.


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Scenario

conomies of scale has become the secret ofindustrial and economic development ofmodern era. Mass production is needed forachieving economies in cost, market, finance,

management, etc. It is necessar to remaincompetitive in domestic and internationalmarkets.

!


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he memorandum of association prescribes the maximumamount of each cass of share capita !hich the compan"!ants to raise throu#h issuance of shares$ The amount isdetermined b" the promoters %eepin# in &ie! the initia and

subse'uent needs of the business and is re'uired to be specifica"mentioned in the memorandum aon# !ith the t"pe of shares to beissued$ Once appro&ed b" (Re#istrar of Companies) the specifiedamount becomes the authori"ed capital of the compan"$ This is

the maximum share capita that compan" can raise b" issuin# thespecified shares$

T

The nominal value* aso %no!n aspar valueor face value, of ashare is the denomination assi#ned to the share$ This is !ritten onthe face of share certificate that a sharehoder recei&es a#ainst hisin&estment$ It is decided b" the compan" in the i#ht of #uideinespro&ided b" e#a authorit"$ For exampe the acceptabedenominations prescribed b" Companies Ordinance are Rs$+* Rs$,*and Rs$+- for ordinar" shares and Rs$+-- for preference shares$ Theauthori.ed capita is di&ided b" the nomina &aue to #et theauthori.ed number of shares in each cass$ At the first sta#e acompan" !i #enera" issue shares in a number much ess than itsauthori.ed number of shares$ Subse'uent issues are made as and!hen need arises$

A compan" ma" issue ordinar" shares direct" or throu#h abro%era#e house$ The bro%era#e houses speciai.e in foatin# theshares$ In an" case a prospectus has to be issued expainin# thesaient features of the compan" and outinin# the past histor"* ifan"* and future prospects in order to inform and attract theprospecti&e in&estors to purchase the shares of the compan"$ Theprospectus is a ca for appication for the shares$ As per CompaniesOrdinance appro&a of the competent authorit" to issue prospectusmust be obtained sixt" da"s precedin# to the date of its issue$ The

shares ma" be issued at nomina &aue or an amount !hich is#reater or esser than it$ If the shares are issued at hi#her thannomina &aue* it is said to be issued at premium.If issued at esserthan nomina &aue* it is issued at discount. Furthermore* theamount ma" be pa"abe fu" aon# !ith the appication or ininstaments$ The issue of shares* ho!e&er* is re#uated b" thecountr"/s a!$ For exampe under Companies Ordinance in Pa%istan*fu pa"ment is re'uired to be made at the time of appication$ TheCompanies Act of the United 0in#dom ao!s the pa"ment ininstaments$


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Issuin# of Shares

Companies #enera" issue shares throu#h issuin# houses %no!n as(under!riters)$

The under!riter bu"s the entire issue on a fixed price from thecompan" and then ses it to the pubic$ The process is %no!n asOffer for sale (at a fixed price). It co&ers the ris% of an issue bein#undersubscribed$ That is if #enera pubic does not bu" a theshares issued* the eft o&er shares !i be pic%ed up b" theunder!riter$ The compan" is certain to raise the funds re'uired$Issuin# houses are usua" part of an in&estment ban% and areremunerated for their ser&ices in either of the foo!in# !a"s1

i A fee is char#ed to the compan"$ii The price paid b" the issuin# house for the shares is si#ht"

beo! the price sod to the pubic$

Under!ritin# is re'uired for pubic offerin#s !here a premium isbein# char#ed under the pro&isions of rue 23iii4 of the Companies3Issue of Capita4 Rues* +225$ A reaxation from the re'uirements ofthe said rue ma" be obtained b" the Offerer from the S6CP$Usua" the issues of ne! shares are o&ersubscribed and the issuin#house has to determine ho! the shares are to be aotted$ In doin#so the" !i need to ensure that the shares are !ide" hed but asothat the administrati&e costs are reduced$

Another !a" is Offer for sale by tender.This difference from sae at a fixedprice is that the issuin# house sets a minimum price in the prospectus andthe in&estors bid at a price hi#her than that$ Once the offer period iscosed* the issuin# house sets a stri%e price and this is the hi#hest price at!hich the shares are aocated$ Appications at the stri%e price or abo&eare aotted the shares at the stri%e price* re#ardess of the bid$ The offerfor sae b" tender ma" not attract smaer in&estors* but ma" raise moremone" because in&estors offers to pa" more than the minimum price setin the prospectus$

In order to sa&e cost the Placement method ma" be used b" a compan"$ Theentire issue is sod to an issuin# house and it !i then approachinstitutiona in&estors* such as pension funds* to se the shares to them$Appications are not in&ited from the pubic$

Green Shoe Option


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An Example of Green Shoe Option

In July 2004, the Government successfully concluded a 15% offer for sale

and IPO of the comany on the domest!c stoc" e#chan$es at P& 55 er

share. 'he (as!c !ssue )as for 10% shares )!th a $reen*shoe ot!on of

another 5% and the ent!re !ssue )as 3.+ t!mes oversu(scr!(ed. 'he current

shareholders of PP are the Government of Pa"!stan -+%/, Internat!onal

!nance ororat!on -%/ and !nst!tut!onal and !nd!v!dual !nvestors -15%/.

7ar%et 8aue of Shares

The market value of a share is the amount at !hich a share isbein# sod or bein# traded on the stoc% exchan#e$ This ma" beradica" different from the nomina &aue$ In&estors purchaseshares of a compan" to earn a rate of return on their in&estment$ Atan" #i&en time* an in&estor has man" options for ma%in#in&estment$ The easiest in&estment a&aiabe to e&er"one is todeposit the mone" in a ban%$ The decision of an in&estor topurchase shares of a particuar compan" at a certain price !idepend on the expected rate of return and its comparison !ith

other a&aiabe aternati&es$ An in&estor determines the expectedrate of return for a particuar compan" b" ana".in# the foo!in#factors1

i The past earnin# recordii The di&idend poic"iii The nature of business and its future prospects in the #i&en

poitica and e#a en&ironmenti& The reputation of the promoters& The current state of econom"&i The nationa and internationa trends in the stoc% mar%et

Pricin# of issues is crucia !hen shares are sod b" offers to thepubic$ A baance must be struc% bet!een raisin# as much cash aspossibe and ensurin# that the offer is successfu$ The marketpriceof the share depends upon the demand of the share$ Thedemand depends upon the expected rate of return and ho! itcompares !ith other a&aiabe aternati&es$ If the in&estor beie&esthat a particuar share offers him a #reater return* he !oud be!iin# to pa" a hi#her price$

Theoretica"* the price of a share an in&estor !oud pa" e'uas thepresent &aue of in&estor/s anticipated future cash fo!s discounted


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at his opportunit" cost$ The opportunit" cost depends on theaternati&es a&aiabe to the in&estor$ The shares of isted 9oint stoc%companies are traded on the stoc% exchan#e and the prices %eepon fuctuatin# !ith the chan#es in the factors mentioned abo&e$Some of the factors are controabe b" companies !hereas othersare not$

In Pa%istan under!ritin# is re'uired for pubic offerin#s !here apremium is bein# char#ed under the pro&isions of rue 23iii4 of theCompanies 3Issue of Capita4 Rues* +225$ A reaxation from there'uirements of the said rue ma" be obtained b" the Offerer fromthe S6CP$:here a compan" issues shares at a premium* !hether incash or other!ise* a sum e'ua to the a##re#ate amount or the&aue of the premiums on those shares sha be transferred to anaccount* to be caed ;the share premium account;$ The sharepremium account ma" be appied b" the compan"

i in !ritin# off the preiminar"* expenses of the compan"ii in !ritin# off the expenses of* or the commission paid or

discount ao!ed on* an" issue of shares or debentures of the

compan"iii in pro&idin# for premium pa"abe on the redemption of an"

redeemabe preference shares or debentures of thecompan" ?#la!n thed!fference (et)een them.

2 @ame sources of share ca!tal. ;ould !t suff!ce to ma!nta!n one account called share ca!tal for allsources of share ca!tal> ;hy or )hy not>

3 Ident!fy the character!st!cs of a r!vate and a u(l!c l!m!ted comany.

4 ;hat are the r!$hts of ord!nary shareholders>

5 ;hat !s the d!fference (et)een author!Aed ca!tal and a!d*!n ca!tal>

Bo) !s a u(l!c l!m!ted comany formed>

+ ;hat are the advanta$es and d!sadvanta$es of a u(l!c l!m!ted comany>

;hy do coman!es ay d!v!dends>

;hat !s meant (y calls*!n arrears>

10 :escr!(e d!fferent tyes of reference shares.

11 ?#la!n the d!fference (et)een memorandum of assoc!at!on and art!cles of assoc!at!on.

12 ;hat are the cond!t!ons under Shariah-Islam!c la)/ for trad!n$ on stoc" e#chan$e>

(rue and )alse1 'he u(l!c l!m!ted coman!es are al)ays o)ned (y the $overnment.

2 'he ord!nary shareholders have the r!$ht to vote !n the annual $eneral (ody meet!n$.

3 'he d!v!dend to (e a!d to the reference shareholders !s redeterm!ned )hereas for ord!nary

shareholders !t !s not.

4 @om!nal value of reference share !s $enerally e=ual to !ts mar"et value.

5 'he ord!nary shares can (e !ssued !n e#chan$e of non*cash cons!derat!ons l!"e serv!ces erformed(y a mana$er.

emorandum of assoc!at!on e#la!ns the (y la)s of the comany.

+ 6ccord!n$ to oman!es Ord!nance, 14, shares cannot (e !ssued at rem!um.

'he share rem!um !s the d!fference (et)een the nom!nal value and the mar"et r!ce of the share.

Islam allo)s !nvest!n$ !n shares of all tyes of (us!ness or$an!Aat!ons rov!ded seculat!on !s not!nvolved.

10 alls*!n*advance !s a current asset.

11 'he oman!es Ord!nance, 4 allo)s to !ssue ord!nary shares and rece!ve ayments !n !nstalments.

12 7hort sell!n$ !s erm!tted under Islam!c la) only !n case of trad!n$ !n shares.

)ill-ins


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1 'he coman!es can roduce at a lo)er cost (ecause of********************.

2 'he t)o ma!n cate$or!es of shares are*************and******************.

3 'he t)o ma!n documents to (e f!led at the t!me of re$!strat!on are**************and**************.

4 'he ord!nary shareholder has a ************* cla!m on the rof!t of the comany.

5 7hare rem!um !s the d!fference (et)een *************** and ****************.

alls*!n*arrears !s a ***************** and resented !n the *******************.

+ Islam for(!ds !nvestment !n a (us!ness )h!ch !s (ased uon ***********,***************and**********.

'he (as!s of a stoc" e#chan$e esta(l!shed under Islam!c la) )!ll (e the a(sence of***********and**************.

'he shares su(scr!(ed may (e ************** !f the su(scr!(er defaults on ************.

10 If the num(er of al!cat!ons rece!ved !s more than the shares !ssued, the !ssue !s *************.

#elf-#tud %uestions

Test your understanding of the chapter by marking the best answer for each of the following questions:

1 ;h!ch of the follo)!n$ !s not an advanta$e of the cororate form of or$an!Aat!on>

a ont!nuous e#!stence of the ent!ty

( !m!ted l!a(!l!ty of shareholders

c Government re$ulat!on

d ?asy transfer of o)nersh!

2 6n amount ass!$ned (y the (oard of d!rectors to each share of a $!ven class of share !sC

a @om!nal value( 7tated value

c &edemt!on valued !=u!dat!on value

3 Preference shares that has d!v!dends !n arrears areC

a @oncumulat!ve( @oncumulat!ve and art!c!at!ve

c @oncumulat!ve and convert!(led umulat!ve

e

4 PaneAa! !nes td. !ssued 10,000 ord!nary shares of &s. 10 ar value at &s. 25 er share. 'heamount that )ould (e cred!ted to share ca!tal !sC

a &s. 100,000( &s. 150,000c &s. 250,000

d &s. 350,000e @one of the a(ove

5 If the (alance !n ord!nary share ca!tal account !s &s. 40,000 -&s. 40 ar/ and !n share rem!umaccount !s &s. 10,000D 6ssum!n$ only one class of shares, the mar"et value er share !sC

a &s 50( &s 140c &s 40

d &s 10e @one of the a(ove

6ccord!n$ to Islam trad!n$ !n shares (ecomes for(!dden, !fa the comany does not declare d!v!dend


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( !t !nvolves seculat!onc the comany !s not re$!stered on the

stoc" e#chan$e

d @one of the a(ovee 6ll of the a(ove

+ 6n ord!nary shareholder hasa &!$ht to vote

( &es!dual cla!m on rof!tc &es!dual cla!m of assets !n the event

of l!=u!dat!on

d @one of the a(ovee 6ll of the a(ove

emorandum of assoc!at!on !ncludes clauses to descr!(ea 'he (y la)s of the comany

( Po)ers of the d!rectorsc Procedure to call the annual $eneral

(ody meet!n$

d 'he o(Eect!ve clause !dent!fy!n$ theo(Eect!ves of the comany

e 'he rocedure to ao!nt the aud!tor

'he ta(le F6< of coman!es ord!nance 4 rov!desa alance sheet format

( Prof!t 9 loss formatc odel F6rt!cles of 6ssoc!at!on

Documents

Accounting for Raising Capital.doc