Degree In Accounting: CH03 -Company Formations Part 2

Oversubscription

What Does Oversubscribed Mean?
A situation in which the demand for an initial public offering of securities exceeds the number of shares issued.

The goal of a public offering usually is to price the security issue at the exact price at which all the issued shares can be sold to investors, so there will be neither a shortage nor a surplus of securities. If there is more demand for a public offering than there is supply (shortage), it means a higher price could have been charged and the issuer could have raised more capital.

The number of shares applied for may exceed the number of shares that the company has available for issue.
In such cases the directors of the company may decide to:

Reduce the number of share to be issued to each applicant (on a pro-rata basis)
To issue shares only to certain applicants (eg on a first-in-first-served basis)

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

Refunding excess application monies to unsuccessful applicants; or
Retaining the excess application money as an —advance on future calls

The calls in advance account is treated as contributed equity even though it is legally a liability

Oversubscription (Example 4)

ABC issued a prospectus for 100,000 $5 shares on 1 January 2008.
The prospectus required payment of $3 on application and $2 in one years time.
The company received applications for a total of 125,000 shares – these applications were received throughout the month of January.
On 31 January 2008 ABC issued 100,000 shares.

Required: Prepare the journal entries to account for the issue of shares assuming the excess money was offset against the call due in one years time.

Solution

Forfeiture of shares

What Does Forfeited Share Mean?
A share in a company that the owner loses (forfeits) by failing to meet the purchase requirements. Requirements may include paying any allotment or call money owed, or avoiding selling or transferring shares during a restricted period. When a share is forfeited, the shareholder no longer owes any remaining balance, surrenders any potential capital gain on the shares and the shares become the property of the issuing company. The issuing company can re-issue forfeited shares at par, a premium or a discount as determined by the board of directors.

In certain cases, companies allow executives and employees to receive a portion of their cash compensation to purchase shares in the company at a discount. This is commonly referred to as an employee stock purchase plan. Typically, there will be restrictions on the purchase (i.e. stock cannot be sold or transferred within a set period of time after the initial purchase). If an employee remains with the company and meets the qualifications, he or she becomes fully vested in those shares on the stated date. If the employee leaves the company and/or violates the terms of the initial purchase he or she will most likely forfeit those shares.

Directors may be given the power under the company’s constitution to forfeit (cancel) shares in respect of which calls are not made. Possible actions that can be taken in such circumstances are:

The balance of paid monies may be retained by the company. –In this case the balance is retained in an equity account(Forfeited Shares Reserve)
The amount paid may be refunded back to the forfeiting shareholder. –In this case the balance is recorded in a liability account (Forfeited Shares Account). –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. –This option is only available if the company’s constitution states this fact. Where the constitution is silent, the company is entitled to keep any excess (option 1 above).

Forfeiture of shares (Example 5)

This example continues on from example 3.
On 1 July 2008 the directors of ABC decided to forfeit the 10,000 shares in respect of which the call of $1.25 was not made.
The shares were cancelled and reissued as fully paid to $5 per share on payment of $4 per share.
Costs of $500 were incurred to reissue the shares.

Required:

Prepare the journal entries to account for the forfeiture and re issue of the 10,000 shares.

Solution;

Share issue and formation costs

Underwriting costs:

Arranging for the issue to be underwritten will avoid having to refund monies due to under-subscription
Underwriter agrees to purchase all excess shares in return for an upfront payment of an underwriting commission
Treated as a reduction against contributed equity

Other share issue costs:

Includes costs such as stamp duty, legal fees etc
Treated as a reduction against contributed equity

Formation costs:

Treated as an expense

Subsequent issues of shares

Issued to raise funds to support expansion

1 RIGHTS ISSUE

Offer of shares to existing shareholders
Rights dependent on the number of shares held
Rights may be renounceable or non-renounceable

2 PRIVATE PLACEMENTS

Offer of shares to one entity only
Usually issued to institutional investors Accounting for these types of issues is similar to public issues but does not use application/cash trust accounts.

Entry required is:

3 Bonus Issue

Shares granted only to existing shareholders
Issued at no cost in lieu of cash dividend
Number based on shareholding at date of declaration
No change in the net equity of the company.

Entry required is:

Subsequent movements in share capital - options (Example 6)

Required:

Prepare the journal entries to account for the issue and exercising of the options assuming:

a) The options are issued for no consideration. On 1 May 2008, when the share price is $3.10, the CEO exercises the options.

b) The options are issued for no consideration. The options are not exercised by the CEO and lapse on 30 June 2008.
c) The options are issued for $1 each. By 30 June 2008, 9,000 of the options have been exercised.

Solution;

Redeemable preference shares

Such shares either:

Give the holder the right to be repaid his/her capital

Give the company the right to repay the capital

Main issue is the classification of such shares

Are they equity or liabilities?

Redeemable preference shares - equity

1.Proceeds of a fresh issue of shares

Or

2. Retained earnings

Additionally, the constitution may specify payment of a redemption premium which is paid from profit
On redemption the shares are cancelled and cannot be reissued

Redeemable preference shares - liabilities

Redeemable preference shares with the following characteristics are more in the nature of liabilities:

Redeemable in cash on a certain date or at the option of the holder
Cumulative as to the payment of dividends
Non-participating in further dividends distributions
Priority capital return rights

Accounting process required when accounting for redeemable preference shares that are classified as liabilities depends on whether the redemption is:

From a fresh issue of shares
From profits at a premium

Conversion of shares

A company may change its issued capital by:

Consolidation

Involves grouping issued shares into larger parcels

Eg; 2 x $1.00 consolidated into 1 x $2.00 share

Split

Involves splitting issued shares into smaller parcels

Eg; 1 x $2.00 share split into 2 x $1.00 shares

Conversion

Involves converting an ordinary share to a preference share or vice versa.
Governed by the Constitution.

Share buy-backs

WHY BUY BACK SHARES?

Change debt/equity ratio

Defence against takeover

Clear odd lots or employee share schemes

LEGAL REQUIREMENTS
Covered by Corporations Act
Allowed only if not prejudicial to creditors
Limited types of buy-backs allowed

ACCOUNTING FOR BUY-BACKS
Shares must be cancelled
Buy-back may generate a premium or a discount
These are adjusted against either reserves, retained profits or both (UIG Abstract 22)
Each company must adopt an accounting policy
in respect of premiums or discount on buy-backs