Explain pro rata allotment of shares

Slides prepared by Miranda Dyason

Workshop 4:

Accounting for share capital and reserves

/ 41

Explain and account for subsequent issues of shares and share buy-backs

Account for the formation of a company through an issue of shares

Explain the nature of reserves, and account for movements in reserves

A

B

C

D

Learning Outcomes

1

E Specify the disclosure requirements for equity

Explain the nature of companies, the key features of the corporate structure, and forms of share capital

/ 41 2

Accounting for share issues in a

company’s accounting records

2

/ 41 3

Things to consider...

3

/ 41

▸ Is the share issue payable in full on application or payable in instalments?

▸ Is there an undersubscription? If yes, has the minimum subscription level been reached? Have we employed the services

of an underwriter?

▸ Is there an oversubscription? If yes,

• With share issues payable in full on application, refund money to unsuccessful

applicants.

• With share issues payable in instalments, will we only issue shares to some

applicants, and refund money to unsuccessful applicants? Or will we issue

shares on a pro-rata basis, and keep excess application to go towards the

shareholders next instalment?

Accounting for share issues

4 We will discuss oversubscription more shortly

/ 41

▸ With share issues payable in instalments, what will we do if some shareholders don’t pay one of the instalments due?

• Are we able to forfeit/cancel their shares?

• If yes can forfeit/cancel the shares, are we able to reissue the shares to new

shareholders?

• Are the former shareholders going to get any money back?

Accounting for share issues

5

/ 41

• Application account:

- a liability account

• Bank trust or cash trust account:

- an asset account

• Allotment account:

- a receivable account

• Call account:

- a receivable account

• Share capital account:

- an equity account

Key accounts

6

Discussion Activity:

Why a bank trust or cash trust

account is used, rather than a

bank or cash account when a

company receives application

money from prospective

shareholders?

/ 41 7

Share issues payable in full on application

7

/ 41

▸ To recognise receipt of application money:

Debit Bank trust

Credit Application

▸ To recognise the issue of shares and to close application account:

Debit Application

Credit Share capital

Accounting for share issues – payable in full

on application

8

/ 41

▸ To refund money received from unsuccessful applicants:

Debit Application

Credit Bank Trust

▸ To transfer cash from trust account to general operating bank account or to the company’s general cash (once shares are allotted):

Debit Cash / Cash at bank

Credit Bank trust

Accounting for share issues – payable in full

on application

9

/ 41

▸ Underwriting costs: – Treated as a reduction against contributed equity

▸ Other share issue costs (eg. Stamp duty, legal fees) – Treated as a reduction against contributed equity

▸ Formation costs: – Treated as an expense

Accounting for share issue costs and

formation costs

10

/ 41

Hot Ltd was registered on 1 January 2016. The directors offered 10,000,000

ordinary shares to the public at $2 per share, payable in full on application.

Applications closed on 31 January 2016, and by that date, the company had

received applications for 11,000,000 shares. On 5 February 2016, the

directors sent letters of regret and refunds to applicants for 1,000,000 shares

and allotted 10,000,000 shares to the remaining applicants. Legal costs re

issuing the shares were $6,000, and were paid.

Required:

Prepare journal entries to record the above transactions.

Example - oversubscription

11

/ 41

Answer:

1-31 January 2016: Application money received

DR Bank Trust $22 000 000

CR Application $22 000 000 (Money received on application: 11,000,000 x $2)

5 February 2016: Refund to unsuccessful applicants, and allotment of shares

DR Application $2 000 000

CR Bank Trust $2 000 000 (Refund to unsuccessful applicants – 1,000,000 x $2)

DR Application $20 000 000

CR Share capital $20 000 000 (Issue of 10,000,000 shares at $2 each)

12

/ 41

Answer:

Transfer of money from Cash Trust to Cash/Bank account:

DR Cash $20 000 000

CR Bank Trust $20 000 000 (Once shares have been allotted, the company can then transfer the cash into its usual

operating account)

Payment of share issue costs:

DR Share issue costs/share capital $6 000

CR Cash $6 000 (Costs of issuing the shares)

13

/ 41

Hot Ltd was registered on 1 January 2016. The directors offered 10,000,000

ordinary shares to the public at $2 per share, payable in full on application.

The share issue was underwritten at a commission of $3,000.

Applications closed on 31 January 2016, and by that date, the company had

received applications for 8,000,000 shares. On 5 February 2016, the

10,000,000 shares and allotted, and the underwriter pays the amount money

due for the 2,000,000 shares, less their commission.

Required:

Prepare journal entries to record the above transactions.

Example – undersubscription with underwriter

14

/ 41

Answer: 1-31 January 2016: Application money received

DR Bank Trust $16 000 000

CR Application $16 000 000 (Money received on application: 8,000,000 x $2)

5 February 2016: Allotment of shares, and receipt of money from underwriter

DR Application $20 000 000

CR Share capital $20 000 000 (Issue of 10,000,000 shares at $2 each)

DR Cash $3 997 000

DR Share capital / share issue costs $3 000

CR Application $4 000 000 (Receipt of money from underwriter for 2,000,000 shares, less commission)

15

/ 41

Answer:

Transfer of money from Cash Trust to Cash/Bank account:

DR Cash $16 000 000

CR Bank Trust $16 000 000 (Once shares have been allotted, the company can then transfer the cash into its usual

operating account)

16

/ 41

Review questions:

17

Loftus et al (Chapter 13):

• Application and analysis exercise 13.11.

/ 41 18

Share issues payable in instalments

18

/ 41

• To recognise aggregate applications for shares:

Debit Bank Trust

Credit Application

• To allot shares as partly paid:

Debit Application

Credit Share Capital

• To recognise amount due on allotment

Debit Allotment

Credit Share capital

Accounting for share issues payable in

instalments

19

These two journals

can be combined

as:

DR Application

DR Allotment

CR Share Capital

/ 41

• To transfer funds to operating bank account:

Debit Cash at bank

Credit Cash/Bank trust

• To recognise receipt of amounts due on allotment

Debit Cash at bank

Credit Allotment

• To record call

Debit Call

Credit Share capital

• To record receipt of amounts due on call

Debit Cash at bank

Credit Call

20

/ 41

▸ The treatment of excess application money depends on the terms of a company’s constitution. Options include:

• Refunding excess application money to applicants:

DR Application

CR Cash Trust

• Issuing shares to applicants on a pro-rata basis, and retaining

the excess application money to go towards future instalments.

The journal entry re the money being retained will be:

DR Application

CR Allotment (or ‘Calls in Advance’ if re a call)

Oversubscription

21

/ 41

Example

Share Issue Payable by instalments

• ABC issued a prospectus for the issue of 100,000 $5 shares on 1 January 2016. The prospectus

specified that $2.50 was payable on application, a further $1.25 was payable on allotment and the

final $1.25 was payable at call.

• The company received applications for a total of 120,000 shares throughout the month of January.

On 1 February 2016, ABC issued 100,000 shares and the directors refunded the money in relation

to unsuccessful applications. Allotment money was payable by 28 February 2016, and by this date,

all allotment money was received.

• On 31 May 2016, the company made the call for the outstanding balance of $1.25 per share. The

call was payable by 30 June 2016.

• By 30 June 2016, the call on 10,000 shares remained unpaid.

Required:

Prepare the journal entries up until 30 June 2016 to account for the issue of shares for ABC. 22

/ 41

Answer:

1-31 January 2016

To record receipt of application money prior to issuing the shares:

Dr Cash trust 300,000

Cr Application 300,000

1 February 2016

Issue of shares applied for and recognise allotment money due:

Dr Application 250,000

Dr Allotment 125,000

Cr Share capital 375,000

Refund of application money to unsuccessful applicants:

Dr Application 50,000

Cr Cash trust 50,000 23

/ 41

1 February 2016

Transfer from cash trust on issue of shares:

Dr Cash 250,000

Cr Cash trust 250,000

28 February 2016

Cash received on allotment:

Dr Cash 125,000

Cr Allotment 125,000

31 May 2016

Call of $1.25 per share on 100,000 shares issued:

Dr Call 125,000

Cr Share capital 125,000 24 24

Answer:

/ 41

30 June 2016

Cash received on call:

Dr Cash 112,500

Cr Call 112,500

• The balance in the call account is $12,500, being $1.25 x 10,000 shares.

• Unpaid calls are referred to as calls in arrears and are shown as a

reduction of share capital in the company’s financial statements.

• The balance in the share capital account at 30 June is as follows:

Share capital (100,000 ordinary shares @ $5) 500,000

Less: Calls in arrears (10,000 shares @ $1.25) (12,500)

TOTAL SHARE CAPITAL 487,500

25 25

Answer:

/ 41

▸ Shares may be forfeited where amounts due and payable by shareholders have not been paid.

▸ Possible actions that can be taken in such circumstances are:

• The balance of paid monies may be retained by the company

(retained in an equity account (Forfeited Shares Reserve)).

• The amount paid may be refunded back to the forfeiting shareholder.

▸ Where the constitution is silent, the company is entitled to keep any excess.

Forfeiture of shares

26

/ 41

▸ Prior to refunding the balance the company could reissue the shares as

fully paid shares to new shareholders with the new shareholders paying

less than the fully paid value of the share.

▸ The difference, as well as any costs of reissue are deducted from the

amount to be refunded back to the forfeiting shareholders (if amounts

are going to be refunded to them).

Reissue of forfeited shares

27

/ 41

• To record forfeiture of shares

Dr Share capital (number of shares x amount called up)

Cr Call (number of shares x unpaid call)

Cr Forfeited shares a/c (number of shares x amount paid up)

This entry cancels the remainder of the call and the forfeited shares.

• To recognise amount received on reissue of forfeited shares

Dr Cash at bank (cash received on sale)

Dr Forfeited shares a/c (discount allowed on reissued shares)

Cr Share capital (number of shares x amount called up)

Forfeiture and reissue of shares

28

/ 41

• To recognise payment of costs relating to reissue of shares

Dr Forfeited shares account

Cr Cash at bank

• To recognise return of remaining money to original shareholders (if it is

to be refunded to them)

Dr Forfeited shares account

Cr Cash at bank

Forfeiture and reissue of shares

29

Take note: the accounting treatment for

costs associated with forfeiture and

reissue is different to costs associated

with the original share issue made.

/ 41

On 1 January 2016, Salami Ltd was incorporated and offered 200,000 shares to the public at

an issue price $4.00 per share. The terms of the issue are that $2.00 is to be paid on

application and the remaining $2.00 within one month of allotment. Applications for shares

close on 31 January 2016.

Applications are received for 300,000 shares during January 2016. On 5 February 2016 the

directors decide that all subscribers will receive shares on a pro-rata basis, with any excess

paid on application to be offset against the amount due on allotment. The amounts payable on

allotment are due by 5 March 2016.

By 5 March 2016, the holders of 30,000 shares have failed to pay the amounts due on

allotment. On 10 March 2016, as provided by the company’s constitution, the directors forfeit

these 30,000 shares. On 20 March 2016, the forfeited shares are reissued as fully paid for a

consideration of $3.50 per share. The balance of the Forfeited Shares Account was returned to

the former shareholders on 20 March 2016.

Required:

Provide the journal entries necessary to account for the above.

Activity

30

/ 41

1-31 January 2016:

DR Bank Trust $600 000

CR Application $600 000

(To recognise the aggregate receipt of application monies: 300,000 x $2)

5 February 2016:

DR Application $400 000

CR Share capital $400 000

(To allot 200,000 shares as paid to $2 per share)

DR Allotment $400 000

CR Share capital $400 000

(To recognise the amount of $2 per share which is due following the allotment of shares)

Answer:

31

/ 41

5 February 2016:

DR Application $200 000

CR Allotment $200 000

(Excess application monies used to offset some of the amount that is due on allotment. $200,000

is now due on allotment, or $1.00 per share)

DR Cash at bank $600 000

CR Bank trust $600 000

(Once shares have been allotted, the company can then transfer the cash into its usual operating

account)

5 March 2016:

DR Cash at bank $170 000

CR Allotment $170 000

(To recognise cash received from holders of 170,000 shares at the rate of $1.00 per share)

Answer:

32

/ 41

10 March 2016:

DR Share capital $120 000

CR Allotment $30 000

CR Forfeited share account $90 000

(To record forfeiture of 30,000 shares. Each forfeited share had been paid to $3.00 per share)

20 March 2016:

DR Cash at bank $105 000

DR Forfeited share account $15 000

CR Share capital $120 000

(To recognise the amount received on the sale of the forfeited shares)

DR Forfeited share account $75 000

CR Cash at bank $75 000

(Return the balance of the FSA to the defaulting shareholders)

Answer:

33

/ 41

Review questions:

34

Loftus et al (Chapter 13):

• Application and analysis exercise 13.14 and 13.15.

/ 41

▸ Understand what you are required to do – for example: prepare journal entries, or prepare ledger accounts.

▸ Understand what’s involved in the scenario presented: eg. Share issue with oversubscription? Undersubscription? Forfeiture and Reissue?

▸ Work through the events and transactions systematically.

▸ If you are required to prepare journal entries, you may find it helpful to also prepare ledger / T-Accounts so that you understand how the ledger accounts

are affected with each journal entry and can check the balances in these

ledger accounts once all journal entries are completed.

How to approach activities re

accounting for share capital?

35

/ 41 36

Subsequent movements in share capital

36

• Placements

• Rights issues

• Share purchase plans

• Dividend reinvestment plans

• Options

• Bonus share issues

/ 41

Review questions:

37

Loftus et al (Chapter 13):

• Application and analysis exercise 13.8 and 13.12.

/ 41 38

Movements in reserves and retained

earnings

38

/ 41

Review questions:

39

Loftus et al (Chapter 13):

• Application and analysis exercise 13.9.

/ 41 40

Accounting for share buybacks

40

/ 41

Review questions:

41

Loftus et al (Chapter 13):

• Application and analysis exercise 13.16.