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Using the present value tables, for 3 years the discount rate is 12%. This means 12% will be used
to allocate the finance cost over 3 years. The effective cost of the bond is 12% compared to the
coupon interest rate of 5%. To ensure that the cost of the bond is spread over the term in a
systematic manner, 12% finance charge is used.
At inception Debit Bank (statement of financial position) £9,800,000
Credit Liability (statement of financial position) £9,800,000
Year Open liability Finance cost x 12% Interest payment Closing
(10m x 5%) liability
£ 000 £ 000 £ 000 £ 000
(1) (2) (3) 1 + 2 - 3
1 9,800 1,176 (500) 10,476
2 10,476 1,257 (500) 11,233
3 11,233 (bal)1,531 (500) 12,264
Total 3,964
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The statement of financial position liability has increased to £12.264 million and when the bonds
are redeemed (Cr Cash £12.264m, Dr Liability £12.264m)
Each year the finance cost on the outstanding liability is charged to the income statement. The
outstanding liability is increased with the finance charge and reduced by the interest payments.
For year one the journal entry would be:
£ 000 £ 000
Dr Finance charge income statement 1,176
Cr Bond 676
Cr Cash 500
The above workings would also be used for other items, such as loan stock, debentures and
preference shares.
IAS 39 is being replaced with IFRS 9 as part of the convergence program to bring US GAAP
and IASB in line. The IASB decided at its meeting to set 1 January 2018 as the effective date
for the mandatory application of IFRS 9. Please view IASB website for all the latest
developments www.iasb.org
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Summary of chapter share capital transaction
A limited company issues shares, which investors buy and then these investors become owners of
the company. These shares may be issued privately (ltd) or to the public (plc). Ownership in the
company is through the issue of shares. The shareholders have an equity stake in the business and
have voting rights.
Usually for large organisations the shareholders do not run the business. The directors do this.
The shareholders are entitled to dividends declared by the directors. The dividends are declared
at the discretion of the directors and depend on how much profit the company has made.
Authorised share capital This is the number of shares that the company is allowed to issue
and is stipulated in its memorandum or articles of association.
Issued share capital This is the number of shares that the company actually issues. This
cannot exceed the authorised share capital
Called up share capital This is the issued share capital for which the shareholders are
required to pay to the company.
Paid up share capital This is the amount of share capital paid up by the shareholders
Nominal value This is the value of the each share which the company will
originally issue the shares at, (also known as face or par value)
Market value This is the trading value of the shares, and is the price an
individual pays for the shares
Share premium This is the increase from nominal value to market value of the
share
Procedures for new issue of equity shares
Issue and forfeiture
Application Potential shareholders apply for shares in the company and send
cash to cover the amount applied for.
Allotment The company allocates shares to the successful applicants and
returns cash to unsuccessful applicants.
Call Where purchase price is payable in instalments, the company will
call for instalments on their due dates of payment
Forfeiture If shareholders fail to pay a call, their shares may be forfeited
without the need to return the money they have paid; the forfeited
shares may then be reissued to other shareholders
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Rights issue of ordinary shares
If a company issues ordinary shares for cash it must first offer them to its existing ordinary
shareholders in proportion to their shareholdings. This is called a rights issue because members
may obtain new shares in right of their existing holdings.
Bonus issue of ordinary shares
A bonus issue is when new shares are issued to existing shareholders but no money is received.
Instead the company capitalises its reserves, this is only permitted to the extent that the articles
permit it and the correct procedure must be observed.
Preference shares
Preference shares are issued by companies to raise finance. These shares are different from
ordinary shares. Preference shares do not give voting rights and therefore holders of preference
shares do not have a stake in the business.
Revenue reserves arise when a company makes profits and does not pay out all the profits to the
shareholders. There is no statutory requirement for a company to have any amounts in its revenue
reserve. These non-statutory reserves take various names like retained profits , profit and loss
reserves , un-appropriated profits etc.. A company can make dividend payments out of revenue
reserves i.e. they are distributable to the shareholders
Capital reserves must be established in certain circumstances by law. These statutory reserves
include share premium account (set up when ordinary shares issued) and revaluation reserve (set
up when fixed assets revalued). A company cannot make dividend payments out of capital
reserves, i.e. they are un-distributable
Redemption of shares
A company may decide to buy back some of its issued ordinary shares and then cancel them. For
this to happen, their must be authorisation from articles of association, special resolutions and
sometimes from the court.
Redemption of shares from capital
The accounting treatment for the redemption of shares is strict. A company must set up a capital
redemption reserve to protect the creditors. This is done by utilising the accumulated realised
profits (distributable reserves). The amount taken to the capital redemption reserve is the nominal
value of the shares redeemed.
Redemption of shares out of new issue of shares
If the redemption of share is financed entirely by a new issue of shares, then no capital
redemption reserve is set up as the capital is maintained.
Redemption of share out of partial new issue
If the redemption of shares is financed partly by a new issue of shares, then the amount of offset
against the new issue is also partial. A capital redemption reserve needs to be created but only to
the extent that the nominal value of shares redeemed exceed the total proceeds from the new issue
(nominal plus premium).
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IAS 32 and IAS 39 financial instruments
Financial instruments
Financial instruments are all instruments that are issued by companies as a means of raising
finance (capital) including shares, debentures, loans, debt instruments, options and warrants that
give the holder the right to subscribe for or obtain capital instruments. It also includes derivative
instruments such as options and futures.
The accounting standards that deal with financial instruments are:
(i) IAS 32 financial instruments - presentation
(ii) IAS 39 financial instruments - recognition and measurement
(iii) IFRS 7 financial instruments disclosures
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