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Unformatted text preview: School of Accounting ACCT 1511: Accounting and Financial Management 1B Session 2, 2010 Week 5 Completing the Balance Sheet Student Handout Contents: 1.
Learning Objectives (LO) 2.
Tutorial Questions 3.
Additional Readings 4.
Lecture Materials Lecturer: Andrea Tan Website: http://telt.unsw.edu.au Introduction and Learning Objectives Last week’s lecture provided a useful revision of the accrual concept of accounting. Now we turn our attention towards the remaining major component of the balance sheetowners’ equity. Like liabilities, owners’ equity represents another form of financing for a business. At first glance, liabilities (capital provided by creditors) and owners’ equity (capital provided by owners or shareholders) may look very different. As we delve deeper into the topic, however, you will appreciate that debt and equity are at either end of a continuum of financial instruments and that sometimes, financial instruments exhibit both debt‐ and equity‐like qualities. Further, you will note that some financing arrangements do not appear in the balance sheet at all! In our discussion of equity financing, we discuss the option of using equity as a source for resources (assets) of the corporation. Shareholders are a key source of initial finance for a company. While traditionally regarded as the owners of a company’s assets, more recent thought suggests that the shareholder exchanges their investment in a company for a right to the residual cash flows of the firm (dividends). At the end of this topic, you should be able to: LO1. LO2. LO3. LO4. LO5. LO6. Describe the components of owners’ equity Accounting for contributed equity Accounting for retained profits Accounting for reserves Describe bonus issues, share splits, and share buybacks Understand what is meant by debt/equity trade‐off 1 Required readings: Trotman & Gibbins (TG) Chapter 10, pages 467‐468 – Section on hybrid capital Chapter 11, pages 502‐510 Additional readings: Weekes, Peter. Why buybacks have investors salivating. Sydney Morning Herald, 4‐5 October 2003. (See attached) Excerpt from AASB 101 Presentation of Financial Statements, http://www.aasb.com.au/admin/file/content105/c9/AASB101_09-07_COMPjun09_01-10.pdf Other references used in the lecture: Hoggett, J., L. Edwards & J. Medilin. 2006. Accounting. Melton ALD: John Wiley & Sons Australia Ltd Kimmel, P. D., S. Carlon, J. Loftus, R. Mladenovic, D. Kieso & J. Weygandt. 2003. Accounting building business skills. Melton ALD: John Wiley & Sons Australia Ltd Alfredson, K., Leo, K., Picker, R., Pacter, P. & Radford, J. Applying International Accounting Standards. 2005 Milton QLD: John Wiley & Sons Australia Ltd. Jubb, P, Langfield‐Smith, I & Haswell, S. 2002, Company accounting. Southbank VIC: Nelson Thomson Learning. 2 Tutorial Questions for Week 5 (Commencing 16th August) Preparation Questions: Trotman and Gibbins: Chapter 11 Discussion Questions 5 – 7 and Question 9 Problem 11.10 Problem 11.11 Problem 11.12 Problem 11.15 Case 11D Homework Questions: Trotman and Gibbins: 3 Additional Readings Why Buybacks Have Investors Salivating Peter Weekes, 4/10/2003, The Sydney Morning Herald, (c) 2003 John Fairfax Holdings Ltd. Buybacks. It is a word all shareholders love to hear. And with good reason it usually suggests the company, and their investment, must be in reasonable financial shape to carry one out. This week Telstra, National Australia Bank and Foster's gave details of their buybacks, both small and large. While Telstra's is a more formal off‐market scheme, Foster's and NAB are buying shares in the market. Foster's is also contemplating an off‐market buyback. They are merely the latest in a long list, with 13 of Australia's top 100 listed companies doing the same, and at least another two in the wings. Since 1990, there have been about 560 buybacks. Some have benefited shareholders, some have not. "It's purely capital management, with the aim being to reduce the number of shares on issue," says George Platt, Macquarie Equities' director of quantitative research and co‐
author of a recent report on the issue. "The advantage to shareholders is you get this extra price support because the company is going into the market to buy some shares." Simply put, buybacks push up the share price. Bob Officer, professor emeritus with the Melbourne Business School at the University of Melbourne, says companies with a lot of "spare" cash on their books and no compelling investment opportunities may decide to return the funds to shareholders. "It may make the life of management more comfortable having a few drawers of cash that they can draw on when they like, but from the point of view of the shareholder they are not working that capital, and if they are not working it they should return it," he says. Cashed‐up companies have two options: a buyback, either on or off the market, or higher dividends. Platt's report, released in July, examined 150 buybacks of 64 companies between March 1997 and February 2003, looking at the companies' ongoing performance against the rest of the market. It found most companies were performing in line with the rest of the market before the announcement, but within a month they had outperformed by 1.9 per cent and after 12 months had raced ahead by a median of 11.8 per cent. Research by broker JP Morgan found a similar result. It said strongly performing companies continued to outperform the market after buybacks, while buybacks tended to pull underperformers in line with the market. Platt says buybacks also lead to strong price and earnings momentum and above average consensus recommendations from brokers. Officer says buybacks are usually favoured over higher dividends by both the company and shareholders as they are more tax effective. 4 Dividends are taxed at the shareholder's marginal tax rate, but buybacks are effectively taxed at the significantly lower capital gains tax rate. 5 Excerpts from AASB 101: Presentation of Financial Statements Complete Set of Financial Statements
10. A complete set of financial statements comprises: (a) a statement of financial position as at the end of the period; (b) a statement of comprehensive income for the period; (c) a statement of changes in equity for the period; (d) a statement of cash flows for the period; (e) notes, comprising a summary of significant accounting policies and other explanatory information; and (f) a statement of financial position as at the beginning of the earliest comparative period when an entity applies an accounting policy retrospectively or makes a retrospective restatement of items in its financial statements, or when it reclassifies items in its financial statements. An entity may use titles for the statements other than those used in this Standard. Statement of Changes in Equity 106. An entity shall present a statement of changes in equity showing in the statement: (a) total comprehensive income for the period, showing separately the total amounts attributable to owners of the parent and to non‐controlling interests; (b) for each component of equity, the effects of retrospective application or retrospective restatement recognised in accordance with AASB 108; and (c) [Deleted by the IASB] (d) for each component of equity, a reconciliation between the carrying amount at the beginning and the end of the period, separately disclosing changes resulting from: (i) profit or loss; (ii) each item of other comprehensive income; and (iii) transactions with owners in their capacity as owners, showing separately contributions by and distributions to owners and changes in ownership interests in subsidiaries that do not result in a loss of control. 6 107. An entity shall present, either in the statement of changes in equity or in the notes, the amount of dividends recognised as distributions to owners during the period, and the related amount per share. 108. In paragraph 106, the components of equity include, for example, each class of contributed equity, the accumulated balance of each class of other comprehensive income and retained earnings. 109. Changes in an entity’s equity between the beginning and the end of the reporting period reflect the increase or decrease in its net assets during the period. Except for changes resulting from transactions with owners in their capacity as owners (such as equity contributions, reacquisitions of the entity’s own equity instruments and dividends) and transaction costs directly related to such transactions, the overall change in equity during a period represents the total amount of income and expense,
including gains and losses, generated by the entity’s activities during that period. 110. AASB 108 requires retrospective adjustments to effect changes in accounting policies, to the extent practicable, except when the transition provisions in another Australian Accounting Standard require otherwise. AASB 108 also requires restatements to correct errors to be made retrospectively, to the extent practicable. Retrospective adjustments and retrospective restatements are not changes in equity but they are adjustments to the opening balance of retained earnings, except when an Australian Accounting Standard requires retrospective adjustment of another component of equity. Paragraph 106(b) requires disclosure in the statement of changes in equity of the total adjustment to each component of equity resulting, from changes in accounting policies andseparately, from corrections of errors. These adjustments are disclosed for each prior period and the beginning of the period. 7 Week 5 Learning Objectives ACCT1511: AFM1B LO1
LO5 Completing the Balance Sheet LO6
A.Tan@unsw.edu.au Describe the components of owners’ equity
Accounting for contributed equity
Accounting for retained profits
Accounting for reserves
Describe bonus issues, share splits, and share buybacks
Understand what is meant by debt/equity trade‐
off 2 Definition of a corporation? THE EQUATION: Corporation (n). An ingenious device for obtaining individual profit without individual responsibility.
Ambrose Bierce The Devil’s Dictionary ASSETS = LIABILITIES ASSETS
ASSETS 3 LIABILITIES
LIABILITIES + SHAREHOLDERS’ EQUITY SHAREHOLDERS’
RESERVES SHAREHOLDERS’ EQUITY SHAREHOLDERS’
RESERVES A = L + OE
DIVIDENDS CURRENT YEAR PROFITS
REVENUES EXPENSES 4 THE EQUATION: 5 A = L + OE Components of Owners Equity… O1 CURRENT YEAR PROFITS
REVENUES EXPENSES What we put in Final Dividends declared +
Interim dividends paid SHAREHOLDERS’ EQUITY
RESERVES 6 1 Components of Owners Equity… What the company has made (profits) for shareholders O1 SHAREHOLDERS’ EQUITY
RESERVES Components of Owners Equity… Direct adjustment to equity 7 O1 SHAREHOLDERS’ EQUITY
RESERVES 8 Contributed Equity O2 Share Issues Represents contributions by shareholders of Three illustrations:
1. Issue to an institutional investor company 2. Issue to general public, payable in full on application “Share Capital” 3. Issue to general public, payable by instalment “Cash in return for Shares” All Illustrations use: Helen Ltd issues 200,000 ordinary shares for $2.20 each Regulated by Corporations Act 2001 9 10 1. Institutional Investors Initial Public Offering (IPO) Who are institutional investors? Why?
– No need for a costly prospectus Why issue publicly?
– “Float’ to gain the desired capital structure – Outgrowing venture capital – Less need for costly Investment Banking teams – Seeking listing on an exchange – Firm “too young” to gain access to public markets: “the venture capitalist” – Take advantage of investors who have money 3 requirements to float a company:
1. Journal Entry: Dr Cash (A) ______________
Cr Share capital (OE) _____________ 11 2.
3. 12 2 2. Share Issues – payable full on application 2. Share Issues – payable full on application Issue to general public by way of a prospectus, payable in What if application is unsuccessful? full on application: Dr Cr Trust Account _________
Application Dr Cash Dr Cr Cr _________
Trust Account Application
Share Capital (OE) _________ Cash _________ Cr Trust Account _________
Application Dr _________ Dr Cr _________
Trust Account _________ _________ Dr 13 Cr 14 3. Share Issues – installment 3. Share Issues – installment Issue by installment: $1.70 payable on application, 50c called Entries when 50c called at future date: at a future date
(to record cash received on application) Dr.
(call of 50 cents per share) Days later…
(transfer to cash at bank on allotment) Dr.
(call money received) Dr.
(to record issuance of shares)
15 16 Current Year’s Profit Opening Bal + Transfers from
reserves 17 O3 Retained Profits Woolworths 2007 (see TG p.741) Retained profits Dividends = Closing Bal Transfers to
reserves 18 3 Dividends Payment of Interim Dividends Represent distribution of profits to shareholders
– Reduce owners’ equity Interim dividend of $50,000:
– When declared and authorised: – May be interim or final Dr. – Can only be paid out of profits: e.g. Cr.
– When paid :
Cr. 19 20 Declaration of Final Dividends Payment of Final Dividends Final dividend of $80,000:
– When declared and authorised: When paid:
Dr. Dr. Cr. Cr. 21 22 Reserves ‐ Definition O4 How are Reserves Established? “Reserves” are not defined in the Corporations Act or Accounting standard requirements, e.g. revaluation in any accounting standard reserve, foreign currency translation reserve Accepted practice – result of book entries, e.g. general reserve Since reserves simply reflect where certain gains and Applying Corporations Act, e.g. capital redemption losses have originated, think of them as “direct adjustments to equity”. 23 reserve 24 4 Revaluation Reserve – from 1A Foreign Currency Translation Reserve Reserve recognised when an asset is revalued upwards Recall journal entries to revalue a depreciable non‐current Direct adjustments to equity resulting from foreign currency translation of assets and liabilities asset upwards
Dr. Accumulated Depreciation
Cr. Appropriate non‐current asset
(to write back the A/D)
Dr. Appropriate non‐current asset
Cr. Revaluation reserve
(to revalue asset to fair value) 25 26 General Reserve General Reserve Journal entry to create or increase the general What does this achieve?
– Reduces retained profits and, thereby, the amount available for distribution to shareholders reserve
Dr. Retained profits XX Cr. General reserve XX • Unless you reverse the entry – May signal re‐investing and, thereby, future growth
– May signal rainy day contingencies
– Nature and amount of transfers must be disclosed 27 28 Reserves vs. Cash Dividends Woolworths Ltd 2007 (TG p.743) Which reserve(s) can be used to pay cash dividends? 29 5 O6 “Hot” topics Bonus Issues Bonus issues Also known as stock dividends Share buy‐backs What are they?
– Giving away shares to existing shareholders in proportion to existing holdings Debt/equity trade‐off • e.g., 1:4 bonus issue gives one new share for each 4 currently held – No cost to shareholders 31 32 Bonus Issues Bonus Issues Impact on total owners’ equity?
– No change, rather a re‐allocation within the owners’ equity section of BS Why would a company do this?
– To capitalise long‐term reserves of company, e.g., convert RP into share capital – In Australia, typically sourced from revaluation reserve or retained profits – To signal that the company expects good future profitability levels for cash dividends – ‘Value’ of newly issued shares decided by company – To satisfy shareholders’ dividend expectations without spending cash 33 34 Bonus Issues Bonus Issues Increases number of issued shares
– Leads to a fall in the price per share Example: Bonus issue declared and paid out of asset revaluation reserve to support 500,000 $2 fully‐paid shares : – May make the shares accessible to more investors Dr. Revaluation reserve (OE) – Possibly helps with a takeover defense 35 Cr. Share capital (OE) 1,000,000
1,000,000 36 6 Share Splits Share Buy‐backs Increasing the number of shares available Prohibited in Australia until amendments to Corporations Law in 1989 Why? Reverse of share issue
– Repurchased shares must be cancelled Journal Entry – Reduces issued share capital Dr – Must not affect liquidity Cr – Must not be unfair to different classes of shareholders Fixed tender or buy at market
– E.g., NRMA, Woolworths, CSR, NAB, Foster’s, Commonwealth Bank, BHP
37 38 Share Buy‐backs Share Buy‐backs Reasons
– Market signal that company is undervalued Where buy‐back price equals issue price i.e. $300,000 for 30,000 shares issued at $10 each – Capital structure management by reducing equity
Dr. Share capital (OE) – Efficiently manage surplus funds held by company rather than paying dividends or reinvesting in new ventures 39 Cr. Cash (A) 40 Share Buy‐backs Impact on the Accounting Equation Where buy‐back price does not equal issue price A = L + OE i.e. $400,000 for 30,000 shares issued at $10 each Bonus issues Dr
Dr Share Capital Share splits Cr Cash Share buybacks 41 42 7 O7 Debt/Equity Trade‐Off Effect of Financing Decision on EPS Considerations when deciding on financing mix
– Voting rights Need $ 5 million dollars Equity (200,000 shares x $25) or – Temporary versus permanent needs Debt financing ($5m, 12% debenture) – Contractual implications
– Interest versus dividends If company EBIT = $1.5 m – Tax considerations
– Expected cash flows 43 44 Effect of Financing Decision on EPS
EPS Issue Debt $1 500 000
1 500 000
1 050 000
$ 3.50 $1 500 000
$ 6.30 45 8 ...
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This note was uploaded on 09/16/2011 for the course ACCT 1501 taught by Professor Helen during the Three '09 term at University of New South Wales.
- Three '09