Can someone resolve an argument

Barry

We are having a debate on the accounting treatment and wonder if someone can offer some advice?

Client issues shares with a nominal value of £100 for £1000 so I understand there is a share premium of £900. There is a non discretionary dividend for the first 5 years with discretionary divis after that period. The partner says that the 5 year bit is the debt part which is worth £200 and my colleague has put £200to liabilities which I don't agree with.

The client has said they will potentially allow the company to repurchase the shares out of distributable profit in the future so how would that work as well? My senior thinks its just debit capital and credit income but I also don't agree.

Thanks in advance.

Steve Collings

Hmmm - interesting! I assume you are reporting under UK GAAP but I'll put the international counterpart references in brackets just in case you're not.

The partner has classified the debt/equity component of the shares with reference to FRS 25 'Financial Instruments: Presentation' (IAS 32). So the fair value of the debt equity (as per the partner) is £200 whilst the equity will be the balance of £800, so I agree with your colleague's treatment who has presumably:

DR cash £1,000
CR equity £800
CR liability £200

The liability portion will be the £20 par value of the share PLUS the £180 premium on issue and the remaining £80 par value of the shares will be included within equity PLUS the remaining £720 share premium.

I am not sure how much the client is proposing to repurchase the shares out of distributable profit for, but assuming it's £1,000 then the company will:

DR equity (share capital) £80
DR liability £200
DR equity - retained earnings £1,000
CR equity - share premium £180
CR cash £1,000
CR capital redemption reserve £100

Regards
Steve

Barry

Thank you Steve but I don't understand where you get £80 in the debit share capital part.

Also would it make a difference if the profit and loss account immediately before the client repurchased the shares had a balance on it?

Steve Collings

Re the £80 DR: the share issue was £1,000 of which £200 is recognised as a liability because this is the debt element, the remaining £800 is made up of £720 share premium (ie 9/10ths of the equity element) with the remaining £80 (the remaining 1/10th) going to share premium, hence a DR on repurchase of the shares.

If the retained earnings had a balance immediately before repurchase the client's P&L reserves would be affected. If we assume the reserves were £11k, then the balance sheets would look like this:

..............................................................................................Before repurchase...............After repurchase

Liability element of share issue........................................................(200).....................................£nil
Cash/assets...............................................................................12,000..................................11,000
Net assets..................................................................................11,800.................................11,000

Share capital....................................................................................80......................................£nil
Share premium...............................................................................720......................................900
Capital redemption reserve...............................................................£nil......................................100
Retained earnings.......................................................................11,000.................................10,000
Total equity...............................................................................11,800..................................11,000

Hope that helps

Steve