Ordinary Shares & Debentures (Cambridge (CIE) AS Accounting): Revision Note

Issue of ordinary shares

What are the advantages of issuing ordinary shares?

• Issuing ordinary shares is a permanent source of finance

  • They never need to be repaid

• The payment of dividends to shareholders is not compulsory

  • The directors can choose when and how much to pay

• Dividends do not reduce the profit for the year

  • They are an appropriation of the profit

• No security is needed when issuing shares

• They are perceived as less risky than loans

What are the disadvantages of issuing ordinary shares?

• Dilution of control

  • Shareholders have voting rights

• No guarantee that they will be fully subscribed

  • The company might not be able to sell all the shares to raise the required finance

• Legal costs of issuing shares

  • It can be expensive to organise a new issue of shares

• Potential reduction in earnings per share

  • The more shares issued, the less earnings per share

How are shares issued?

• The limited company sells ordinary shares at an issue price

  • The nominal (or par) value is the value of the share

  • The share premium is the difference between the issue price and the nominal value

    • E.g. if a share is sold at $1.50 and its nominal value is $1, then the share premium is $0.50

• The amount of share capital that is issued to shareholders is known as the issued share capital 

  • The nominal value is used when calculating the share capital

• The company might not ask for payment of the shares upfront

  • The amount that has been asked to be paid is known as the called-up capital

  • The amount that has been paid is known as the paid-up capital

How do I make the journal entries for an issue of shares?

• STEP 1
  Calculate the total amount received

  • issue price × number of shares issued

• STEP 2
  Calculate the increase in the share capital and share premium

  • increase in share capital = nominal value × number of shares issued

  • increase in share premium can be calculated in two different ways

    • share premium per share × number of shares issued

    • total amount received - increase in share capital

• STEP 3
  Make the journal entries

  • Debit the bank account with the total amount received

  • Credit the share capital account

  • Credit the share premium account if the issue is at a premium

Issue of debentures

What are debentures?

• A debenture is a source of finance for a limited company

  • It is repaid in full at a specific date in the future

• A debenture is a document issued by a company to a lender or investor when the money is borrowed

  • The investor or lender is known as the debenture holder

• The debenture states the terms of the borrowing such as:

  • the fixed interest rate

  • the repayment date

  • any security that must be provided

• The debenture interest is charged to the statement of profit or loss as a finance cost

What are the advantages of issuing debentures?

• No dilution of control

  • Debenture holders do not have voting rights

• No dilution of dividends

  • Debenture holders do not receive payments of dividends

• Access to temporary finance

  • Debentures are not permanent and are used for funding a specific, time-limited project

What are the disadvantages of issuing debentures?

• Interest must be paid

  • The company must pay a fixed rate of interest each year

  • This reduces the profit for the year

• They must be repaid

  • The company needs to generate sufficient cash flow to repay the debentures at the agreed date

• Security is usually required

  • The company might have to provide security against its assets

• Investors or lenders might perceive investment in that the company as being risky if they have debentures