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COMPANY X

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Authorized capital………………………………………$ 500000

Issued and paid up capital:

7% cumulative preference shares of $1 each…… ……$ 50000

Ordinary shares of 50% cents each

converted to stock units…………… ……$ 1020000

---------------

$ 1570000

Reserves:

Share premium account……………………………$ 826000

Capital reserve………………………………………$ 25000

General reserve ……………………………………$ 600000

-----------------

$ 1451000

 

Unappropriated profits………………………… ……$ 123801

Total shareholders’ funds……………………………$ 3144801

Dividends on preference shares.

The shareholders’ funds section of the balance sheet of company X set out above discloses that 50 000 cumulative preference shares of $ 1 each have been issued. Shares preferred as to dividends carry the right to a dividend at specified rate, in this case 7 per cent, before any dividend is paid to ordinary shareholders. As a result, $ 3500 must be paid to the holders of the preference shares before ordinary shareholders become entitled to any dividend.

In the case of company X, however, the payment of $ 3500 as dividend to the preference shareholders does not necessarily exhaust the liability to them. These shares are cumulative preference shares. Should a dividend of seven per cent fail to be paid to the cumulative preference shareholders in any one year, the holders of these shares are entitled to have the arrears of dividend made up out of future profits before payment of any dividend to ordinary shareholders. For instance, if no dividends have been declared last financial year, the holders of the cumulative preference shares would be entitled to $ 7000 as dividend this year before any dividend could be declared on ordinary shares.

Dividends in arrears are never listed among the liabilities of a company, because no liability exists until a dividend is actually declared. Nevertheless, the amount of any dividends in arrears on preference share is an important factor to investors and other users of the company’s financial statements and must always be disclosed. This disclosure is usually made by a footnote to the balance sheet such as the following:

‘As of 30 June 1985, dividends on the 6 per cent $5 cumulative preference shares were in arrears to the extent of $ 0.90 per share, and amounted in total to $ 40000.’

For non-cumulative preference shares, any unpaid or omitted dividend is lost forever. Because of this factor, investors view the non-cumulative features as an unfavourable element, so few non-cumulative preference shares are issued.

Participating preference shares.

After receiving the preference dividend at the fixed rate, preference shareholders are not normally entitled to participate in any further dividends declared by the company in that year. The memorandum or articles may, however, authorize the issue of participating preference shares. These may entitle the holder to participate equally with the holders of ordinary shares in any further profits distributed. More commonly, the right to further participate is restricted.

Redeemable preference shares.

A company may, if authorized by its articles, issue preference shares which are to be redeemed at a certain date or which are at the option of the company liable to be redeemed. Such a redemption does not have the effect of reducing the authorized capital. The redemption must take place either by issuing fresh shares for the purpose of the redemption, or by transferring profits which would otherwise be available for dividend to a reserve called “capital redemption account”.

Par value of shares.

In the case of a company limited by shares, the amount of the registered capital must be stated in the memorandum, together with its division into shares of a fixed amount.

Many people attach an unwarranted significance to nominal or par value and are inclined to believe, for example, that a $1 par value share has an intrinsic worth of $1. Nominal or par value does not mean market value.

Issue of shares at a premium.

It is not uncommon for a company to issue shares at a premium, that is, at a price in excess of the face value of the shares allotted. Premiums must be transferred to a Share Premium Account, a reserve account that may be applied only according to the conditions set out in the companies code. The Share Premium Account forms part of shareholders’ funds.

Market price of ordinary shares.

The price that the company sets on a new issue of shares (i.e. the extent of the premium, if any) is based on several factors including:

1. an appraisal of the company’s expected future earnings,

2. the probable dividend rate per share,

3. the present financial condition of the company,

4. the current state of the investment market, and

5. whether present shareholders are permitted to subscribe for new shares at less than their true market value.

After the stock has been issued, the price at which it will be traded among investors will tend to reflect the progress of the company, with primary emphasis being placed on earnings and dividends per share. Earnings per share, for example, are calculated by dividing the annual net profit by the number of issued shares, and tend to influence the market price which is not related to nominal value.

Shares issued for assets other than cash.

Companies generally issue their capital stock for cash and use the money obtained in this way to buy the various types of assets needed in the business. Sometimes, however, a company may issue shares in direct exchange for land, buildings or other assets. Shares, may also be issued in payment for services rendered by accountants, lawyers and promoters. When a company issue shares in exchange for services, or for assets other than cash, a question arises as to the proper valuation of the property of services received. The direct exchange of shares, say, for land, may be considered as the equivalent of issuing the shares for cash to buy the land.

Issue of shares at a discount.

In certain circumstances, as set out in the companies code, shares may be issued at a discount. Issues at a discount occur rarely. Discount on Shares Account should be debited with the amount of the discount and will be shown as a balance sheet item until written off.

Forfeiture of shares.

It is usual for the articles to give directors power to forfeit and reissue shares on which calls or installment money are outstanding. Articles must be consulted to determine the rights of the former shareholder on forfeiture and reissue. On reissue of forfeited shares, it may appear that the shares are being reissued at a discount.

Share certificates.

Ownership of capital interest in a company is evidenced by share certificates. A large company with shares listed on a stock exchange may have an issued capital totaling millions of dollars, and tens of thousands of shareholders. In many cases considerable numbers of shares are traded daily and share records are computerized.

Even a small company is apt to have a considerable number of share certificates to account for. It is essential, therefore, that detailed records be maintained showing exactly how many shares are issued and the names and addresses of the shareholders. The capital share records are in a process of continual change, reflecting the purchase and sale of shares among the army of public investors.

The certificates are serially numbered, which aids the company in maintaining control over both issued and unissued certificates. At the time of issuance a certificate is signed by officers of the company.

 


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