AYN417

Topic 2: Financing Company Operations

Suggested Solutions
[To gain the maximum learning benefit from this learning activity, it is highly
recommended that you have attempted all of the questions, participate in
the tutorial(s) prior to reviewing the solution]
Tutorial questions
Chapter 2: Q 1, 4, 5, 10, 15, Case Study 1 (Parts A and B), Practice Questions
2.1, 2.3* 2.4, 2.8
Hybrid securities: The case of reset preference shares
1. Explain the nature of a share. Distinguish between an ordinary share and
a preference share.
Basically, a share represents ownership of a portion of the share capital of a company.
Also note the discussion in Chapter 1 of the text concerning the relationship between
limited liability and the amount paid up on a share.
The differences between ordinary and preference shares are determined by the terms
of issue. A company has the right to issue preference shares, but may only do so
either if there is a statement in its constitution setting out the rights of these shares or
if these rights have been approved by a special resolution of the company. Not all
preference shares are the same.
However common differences between ordinary and preference shares are:
Ordinary shares represent ordinary ownership interest and therefore have right
to participate in profits, voting rights and rights to receive return of capital if the
company is wound up and after that of all other claimants (i.e. creditors).
Preference shares are distinguished as normally having a set rate of dividend
(e.g. 5%) that is paid prior to any dividend to ordinary shareholders and have
preference (before ordinary shareholders) to return of capital if the company is
wound up. Also may be:
Cumulative i.e. if dividends are not paid in one period, they accumulate and
are paid in the future when profits and funds are available;
Participating- may receive an extra dividend and participate in surplus
assets or profits;
May have voting rights (often only in specific circumstances; e.g. if dividends
are not paid)
Redeemable may be able to be bought back either at a fixed time or at the
option of either party (shareholder or company)
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4. If a share issue is oversubscribed, what action can be taken in relation to

excess money received on application?
Excess monies received on application for shares will be refunded to the applicant.
However where shares are issued on a partly paid basis, the excess can be used as an
offset in reducing allotment money due and in payment of any future calls, provided
the companys constitution and the terms of the prospectus allow for this treatment.

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Topic 2: Financing Company Operations

5. When can a company forfeit its shares? What happens to money already
paid by the holder of those shares?
A company can forfeit its shares provided the rules for forfeiture are in the companys
constitution. The rules usually specify that shares would be forfeited for non-payment
of calls. Where shares are forfeited, the company can, depending on the constitution,
retain the funds already paid on the forfeited shares in which case the Forfeited Shares
account will be considered a reserve and part of equity. Alternatively, the forfeited
shares can be reissued and the amount received, less the costs of forfeiture and
reissue of shares, may then be refunded to the former shareholders. In this case, the
Forfeited Shares account is a liability.
10. Detail the characteristics of redeemable preference shares recognised as
liabilities rather than equity.
Redeemable preference shares recognised as liabilities rather than equity normally
would be redeemable in cash on a specified date or at the option of the holder, be
cumulative in regard to the payment of dividends, non-participating in further
dividends and have priority rights to return of capital over ordinary shares. The
accounting treatments of such preference shares when they are redeemed are shown
the text in illustrative examples 2.9 and 2.10.
15. What is a debenture? Briefly outline the different types of debentures
permitted under the Corpansti Ac 201 and outline the procedures which must be followed
to issue debentures.
A debenture is a chose in action whereby a company undertakes to repay money
borrowed by it. The chose in action may include a charge over company property to
secure repayment. The different types of debentures under the Corporations Act are a
mortgage debenture where the security is a first mortgage on land; a debenture where
the security is over sufficient tangible property; and an unsecured note or unsecured
deposit note where the first two names cannot apply.

AYN417

Topic 2: Financing Company Operations

Case Study 1 - Public floats

Part A. A company is required to specify in the disclosure document what it intends to
do with the funds expected to be raised. If the minimum subscription specified in the
document is not met, no shares can be issued and all application money must be
refunded. This is to protect investors as, if the minimum subscription is not reached,
the company would not have adequate funds to achieve the objectives as stated in the
disclosure document. This would place any investment at risk.
Part B. The entries required given these assumptions are:
Please note: In the textbook, it indicates that the company received applications for
the minimum subscription. The minimum subscription amount was $3,000,000 which
effectively is 15,000,000 shares at of 20c per share on application. The wording in the
text is therefore incorrect.
Date
To 15 Mar

27 Mar

Account
Cash trust
Application
(Money received on application 15,000,000
x 20c)

DR
3,000,000

Application
Share capital
(Issue of 15,000,000 shares
20c)

3,000,000

CR
3,000,000

3,000,000
fully paid to

Cash
Cash trust
(Transfer on allotment of shares)

3,000,000

Share issue costs / Share Capital

Cash
(Cost of issuing the sales)

376,350

3,000,000

376,350

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Topic 2: Financing Company Operations

Question 2.1
application

Oversubscription

on

share

issue,

payable

in

full

on

MAPLE LTD
General Journal
Date
Account
31
Mar Cash trust
17
Application
(Money received on application - 560,000 x
$2)

DR
1,120,000

Application
Cash trust
(Refund to unsuccessful applicants for 10
000 shares 10,000 x $2)

20,000

1,120,000

20,000

Application
100,000
Cash trust
(Refund of excess application money to successful
applicants
50,000 x $2)
Application
1,000,000
Share capital
(Issue of 500,000 shares fully paid to applicants for
550,000 shares
500,000 x $2)
Cash
Cash trust
(Transfer on allotment of shares 500,000 x
$2)
Share issue costs / Share Capital
Cash
(Cost of issuing the shares)

CR

100,000

1,000,000

1,000,000
1,000,000

12,000
12,000

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Topic 2: Financing Company Operations

MAPLE LTD
GENERAL LEDGER

31/03/1
7

Application

Cash trust
1,120,000 31/03/1
7

Application

20,000

Application
Cash

100,000
1,000,0
00
1,120,0
00

Cash trust

1,120,00
0

1,120,000

31/03/1
7

Cash trust
Share capital
Cash trust

31/03/1
7
31/03/1
7

Cash
Cash trust

Application
20,000 31/03/1
7
1,000,000
100,000
1,120,000
Share capital
31/03/1
7
Share issue costs
12,000
Cash
1,000,000 31/03/1
7
1,000,000

Balance b/d

988,000

1,120,00
0
Application

Share issue
costs
Balance c/d

1,000,00
0

12,000
988,000
1,000,00
0

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Topic 2: Financing Company Operations

Question 2.3*

Share issue, payment by instalments

Please note: In the textbook, it indicates that the company received 620,000
applications with $3 paid. This does not make sense as only $2.50 is payable on
application. This is treated as an error in the text. We will presume that the application
sent in the correct money - $2.50.
PINE LTD
General Journal
Date
2017
To 1 Sept

Account

DR

Cash trust
1,550,000
Application
(Being receipt of applications for 620,000 shares at $2.50
per share)

6 Sept

Application
Allotment
Share capital
(Being issue of 600,000 shares
Application = 600,000 x $2.50
Allotment = 600,000 x $1.50)

To
1
October

2,400,000

50,000

Share capital/Share issue costs

Cash/Payables
(Being payment of share issue costs)

12,400

Cash

50,000

12,400

1,500,000
1,500,000

900,000

Allotment
(Being receipt of allotment money due
600,000 x $1.50)
1
Feb
2018

Call

900,000

1,800,000

Share capital
(Being first and final call for $3 600,000 x
$3)
To
March

Cash
Call
(Being receipt of call money 600,000 x $3)

1,550,000

1,500,000
900,000

Application
Cash trust
(Being refund to unsuccessful applicants
20,000 x $2.50)

Cash
Cash trust
(Transfer of application money 600,000 x
$2.50)

CR

1,800,000

1,800,000
1,800,000

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Topic 2: Financing Company Operations

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Topic 2: Financing Company Operations

Question 2.4
Date
2017
March
31

Calls on different classes of shares, forfeiture and reissue

OAK LTD
General Journal
Account
DR
CR
Call - ordinary

450,000

Call - preference
200,000
Share capital - ordinary
Share capital - preference
(Call of $1.50 on 300,000 ordinary shares and $2 on
100,000 preference shares)
June 30

Cash
640,000
Call - ordinary
450,000
Call - preference
190,000
(Receipt of $1.50 call on 300,000 ordinary shares and $2 call on 95,000
preference shares)
Share capital - preference
20,000
Call - preference
Forfeited shares account (liability)
(Forfeiture of 5,000 preference shares for non-payment of
$2)
(Forfeited shares account = 5,000 shares x $2)
(Call preference = 5,000 shares x $2)
(Share Capital preference = 5,000 x $4 issue price)

Sept 30

Cash
Forfeited shares account (liability)
Share capital - preference
(Reissue of 5,000 preference shares for $3.50,
paid to $4)
Forfeited shares account (liability)
Cash
(Expenses of reissue)

Oct 31

450,000
200,000

Forfeited shares account (liability)

Cash
(Refund to former shareholders 10,000
2,500 720)

10,000
10,000

17,500
2,500
20,000

720
720
6,780
6,780

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Topic 2: Financing Company Operations

Question 2.8

Forfeiture of shares

The main benefit to a company for forfeiting and reissuing shares is to tidy up the
share capital account and the share register. Shares are usually forfeited for nonpayment of calls; hence, by forfeiting and reissuing these shares, the company can
ensure that all shareholders are paid up to the same amount on their shares. This
makes it easier in the future when dividends are declared on a per share basis in that
all shareholders are paid up to the same amount and no proportionate dividends need
to be calculated.
ARGAN NL
General Journal
Date
2017

Account

DR

Share capital
2,000,000
Call
Forfeited shares account (liability)
(Forfeiture of 1,000,000 shares called to $2 for nonpayment of 50c call)
1 Nov

Cash
1,800,000
Forfeited shares account (liability)
200,000
Share capital
(Reissue of forfeited shares at public auction for $1.80, paid
to $2)
Forfeited shares account (liability)
Cash
(Expenses of forfeiture and reissue)
Forfeited shares account (liability)
Cash
(Refund to former shareholders: 1,500,000
200,000 4,000 = 1,296,000)

CR
500,000
1,500,000

2,000,000

4,000
4,000
1,296,000
1,296,000

Hybrid securities case study

Q1. Define liabilities and detail the commonly accepted criteria for the
recognition of liabilities in statements of financial position.

Refer to the Framework for the definition of a liability

It is commonly accepted that a probable and measurable obligation to an
external party must exist before a liability is recognised.
Whether a liability exists with a RPS is debatable.
The current IFRS
interpretation suggests that a hybrid security with any equity risk (i.e.
conversion into shares) would be classified as equity not a liability.

Q2. Outline how it is possible for step-up RPSs not to be treated as

liabilities under AIFRS.

These new securities expose the holder to equity risk, i.e. they may be
converted by the issuer but cannot be converted at the discretion of the holder.

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Topic 2: Financing Company Operations

Thus, they appear to meet the definition of an equity item under the current
IFRS interpretation.
Outlined below is an extract from the 2005 annual report for Santos Ltd. Santos
states the following in the extract: The redeemable convertible preference
shares may, at the sole discretion of the Company, be converted into ordinary
class shares and/or exchanged.

Q3. Amplify the statement made above, that the treatment of RPSs as a
liability may force some companies to exceed their gearing levels.

Debt contracts generally contain covenants to restrict the borrower from

excessive borrowings. Many of these covenants are stated in terms of
accounting-based ratios, e.g. a maximum debt-to-asset ratio.
If an equity item is reclassified to a debt item, the ratio restriction may be
exceeded which would place the borrower in technical breach of the contract
terms. This could lead to a renegotiation of the debt agreement on less
favourable terms or, in the worst case, a requirement for the immediate
repayment of the loan.

Q4. State the implications for financial statement analysis of treating RPSs
as equity rather than debt in statements of financial position.
Liquidity and solvency-based ratios will change and may be misinterpreted if no
adjustments are made to ensure comparability over time and across companies.