Content Standard 14.2

Types of Capital and Issue of Shares

Jenis modal dan terbitan syer

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Explanation

A company limited by shares raises its long-term capital by issuing (selling) shares to the public or to selected shareholders. Share capital is the total sum collected from shareholders, and every share carries a fixed par value (nominal value), for example RM1.00 each. A person who buys shares becomes a shareholder, that is a part-owner of the company, and is entitled to receive dividends when the company declares them. This standard requires you to identify the types of share capital, distinguish ordinary shares from preference shares, calculate issued and fully paid-up capital, and record the issue of shares in the General Journal and the ledger.

Several types of share capital must be distinguished according to stage. Authorised capital (also called registered or nominal capital) is the maximum amount of capital the company is permitted to issue as stated in its constitution. Issued capital is the portion of authorised capital that has been issued and sold to shareholders. Called-up capital is the portion of the share value the company has requested shareholders to pay, while paid-up capital is the amount received from shareholders. When shares are issued and fully paid at once, issued capital equals fully paid-up capital.

The two main types of shares are ordinary shares and preference shares. Ordinary shares carry voting rights at the general meeting and their dividend is not fixed because it depends on the company's profit; ordinary shareholders bear the highest risk but enjoy the larger residual profit when the company does well. Preference shares carry a fixed dividend rate (for example 6%) and their holders receive dividends before ordinary shareholders, as well as priority in the repayment of capital upon winding up. Cumulative preference shares have a special feature: if the company does not declare a dividend in a particular year due to a loss or insufficient profit, the unpaid dividend accumulates (is carried in arrears) and must be paid in the following year before any dividend is paid to ordinary shareholders. This differs from non-cumulative preference shares, whose dividend is lost if not declared in that year.

To calculate issued capital and fully paid-up capital, use the formula: number of share units issued multiplied by the par value per unit. For example, if a company issues 200,000 units of ordinary shares at a par value of RM1.00 each and all are fully paid, the issued and fully paid-up capital is 200,000 x RM1.00 = RM200,000. If there are also 50,000 units of RM1.00 preference shares fully paid, the paid-up capital for preference shares is RM50,000, giving a total fully paid-up capital of RM250,000. This amount is presented in the owners' equity section of the Statement of Financial Position under the heading Share Capital.

When shares are issued for cash and fully paid, the most basic double entry is to debit the Bank account (asset coming in) and credit the relevant Share Capital account (Ordinary Share Capital or Preference Share Capital). This transaction is first recorded in the General Journal as an opening or issue entry, complete with a narrative stating the number of units and par value. It is then posted to the ledger: the Bank account on the debit side and the Ordinary Share Capital or Preference Share Capital account on the credit side. The credit balance in the share capital account shows the paid-up capital that is finally carried to the Statement of Financial Position.

Worked examples

Issue of fully paid ordinary shares for cash

Maju Bestari Berhad has an authorised capital of 500,000 units of ordinary shares at a par value of RM1.00 each. On 1 January, the company issues 200,000 units of RM1.00 ordinary shares to the public, all fully paid in cash.

Issued and fully paid-up capital = 200,000 x RM1.00 = RM200,000.

General Journal entry: Debit Bank RM200,000; Credit Ordinary Share Capital RM200,000. Narrative: Issue of 200,000 units of ordinary shares at par value RM1.00 each, fully paid.

Post to the ledger: in the Bank account, record on the debit side 'Ordinary Share Capital RM200,000'; in the Ordinary Share Capital account, record on the credit side 'Bank RM200,000'. The credit balance of RM200,000 in the Ordinary Share Capital account is carried to the Statement of Financial Position.

Simultaneous issue of ordinary and preference shares

Delima Ceria Berhad issues 300,000 units of RM1.00 ordinary shares and 100,000 units of 6% RM1.00 preference shares, all fully paid in cash on 1 July.

Paid-up ordinary share capital = 300,000 x RM1.00 = RM300,000. Paid-up preference share capital = 100,000 x RM1.00 = RM100,000. Total fully paid-up capital = RM400,000.

General Journal entry: Debit Bank RM400,000; Credit Ordinary Share Capital RM300,000; Credit Preference Share Capital RM100,000. Narrative: Issue of 300,000 ordinary shares and 100,000 6% preference shares at par value RM1.00, fully paid.

In the Statement of Financial Position, the Share Capital section shows Ordinary Share Capital RM300,000 and Preference Share Capital RM100,000, totalling RM400,000.

Effect of arrears on cumulative preference shares

Indah Permata Berhad has 100,000 units of 8% RM1.00 cumulative preference shares. Annual dividend = 8% x RM100,000 = RM8,000. In Year 1 the company makes a loss and declares no dividend.

Because these shares are cumulative, the Year 1 dividend of RM8,000 falls into arrears and accumulates. In Year 2 the company makes a profit and wishes to declare a dividend.

Before any dividend is paid to ordinary shareholders in Year 2, the company must first pay the Year 1 arrears of RM8,000 and the current Year 2 dividend of RM8,000, a total of RM16,000, to the preference shareholders.

This shows the advantage of cumulative preference shares: the right to a dividend is not lost even though no declaration was made in the previous year.

Practice

Explain the difference between ordinary shares and preference shares in terms of voting rights and dividends.

Answer: Ordinary shares carry voting rights at the company's general meeting, while preference shares usually do not carry voting rights. In terms of dividends, ordinary shares receive a variable dividend because it depends on the company's profit and is declared after the preference shares; preference shares receive a dividend at a fixed rate (for example 6%) and are paid before ordinary shareholders. Ordinary shareholders bear higher risk but have the chance of a larger dividend when the company is profitable, whereas preference shareholders enjoy a more stable return and priority in the repayment of capital upon winding up.

Seri Gemilang Berhad issues 250,000 units of RM1.00 ordinary shares and 80,000 units of RM1.00 preference shares, all fully paid in cash. Calculate the fully paid-up capital and show the General Journal entry.

Answer: Paid-up ordinary share capital = 250,000 x RM1.00 = RM250,000. Paid-up preference share capital = 80,000 x RM1.00 = RM80,000. Total fully paid-up capital = RM250,000 + RM80,000 = RM330,000. General Journal entry: Debit Bank RM330,000; Credit Ordinary Share Capital RM250,000; Credit Preference Share Capital RM80,000. Narrative: Issue of 250,000 units of ordinary shares and 80,000 units of preference shares at par value RM1.00 each, fully paid.

Bayu Restu Berhad has 150,000 units of 7% RM1.00 cumulative preference shares. In Year 1 no dividend was declared due to a loss. How much dividend must be paid to the preference shareholders in Year 2 before ordinary shareholders receive any dividend?

Answer: Annual preference dividend = 7% x (150,000 x RM1.00) = 7% x RM150,000 = RM10,500. Because these shares are cumulative, the undeclared Year 1 dividend of RM10,500 becomes arrears and must be paid in Year 2. Therefore, in Year 2 the company must pay the Year 1 arrears of RM10,500 plus the current Year 2 dividend of RM10,500, a total of RM21,000, to the preference shareholders before any dividend is paid to the ordinary shareholders.

State the meaning of authorised capital, issued capital and paid-up capital.

Answer: Authorised capital (registered or nominal capital) is the maximum amount of capital the company is permitted to issue as stated in its constitution. Issued capital is the portion of authorised capital that has been issued and sold to shareholders. Paid-up capital is the amount received from shareholders on the shares issued. When all issued shares have been fully paid, issued capital equals fully paid-up capital.

Exam tips

Key terms

Authorised capital: The maximum amount of capital the company is permitted to issue as stated in its constitution; also known as registered or nominal capital.
Paid-up capital: The amount of capital received from shareholders on the shares that have been issued.
Cumulative preference shares: Preference shares whose unpaid dividends accumulate as arrears and must be paid in a later year before any ordinary share dividend.
Par value: The fixed nominal value assigned to each share, for example RM1.00 each, used to compute share capital.

Source: DSKP KSSM Prinsip Perakaunan Tingkatan 5

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