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In this section I’ll tell you about:

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O authorised and issued share capital;

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O treasury shares;

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O share issues;

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O the different types of shares found in company accounts.

Authorised and issued share capital

Companies usually show two share capital numbers in the notes to the accounts:

the authorised share capital, and the issued share capital. The authorised share capital is the amount that the company can issue at the moment. If the direc-tors of the company want to issue more shares they have to seek approval from their shareholders. This normally just requires the passing of a resolution by a majority of the shareholders. (From October 2008, the Companies Act 2006 no longer requires UK companies to have an authorised share capital.)

The issued share capital on the balance sheet is the total number of shares currently in issue at their original value (this is called the nominal or the par value). All UK shares must have a par value that is determined when the com-pany is started. Shares have to be issued for at least this amount, as they can’t be issued below their par value. (This is not always true overseas – for example, in some American states you’ll find shares with no par value and shares can be issued for any price.) The notes to the accounts usually describe the issued shares as allotted (the company has decided who is going to hold the shares), called up (they have asked for the money) and fully paid (they’ve received it).

Treasury shares

Since December 2003 the Companies Act has allowed most listed companies buying back their own shares out of distributable profits the option of hold-ing these shares ‘in treasury’. This means that they don’t have to be cancelled and can be held for sale for cash at a later date or transferred into an employee share save scheme. They can subsequently be cancelled. The shares held in treasury can’t exceed 10% of the issued shares, and the company can’t exercise the treasury shares’ voting rights and doesn’t receive any dividend. In a few pages you’ll see that at the end of 2008 IMI had 20.6 million treasury shares.

Share issues

Two things have affected a company’s ability to issue more shares:

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O Their authorised share capital.

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O The Companies Act 2006 – This prevents companies from issuing shares to new investors without the existing shareholders’ prior consent. S571 effectively ’disapplies’ the other relevant sections of the Act by allowing companies to offer some shares to anyone, as long as 75% of their shareholders have agreed they can do this. However most major new issues are in the form of a rights issue.

In a rights issue, a company offers its existing shareholders the opportunity to buy new shares, in proportion to its existing holding, at a discounted price. The shareholders then have three alternatives:

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O They can exercise their right to buy the share.

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O The can sell their rights to buy the share (in practice this option is only available to large shareholders in listed companies, the smaller shareholders’ profit will be wiped out by dealing fees).

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O They can do nothing. The company usually sells the warrants to buy the shares on their behalf and sends them the proceeds.

Most share issues are underwritten. Underwriting is a form of insurance, pro-vided by banks and financial institutions, where the underwriters agree to buy the shares if no one else wants them. This ensures that the company receives some cash from the rights issue.

Not all share issues raise cash. Companies can have scrip, bonus or capitali-sation issues – they all mean the same thing! In these issues the company converts some of its reserves into share capital. The share price falls after the issue, as the company’s market value hasn’t changed and it is now spread over an increased number of shares. Companies usually do this when they believe their share price is too high.

Another way of reducing the share price, without capitalising reserves, is to have a share split. This reduces the nominal value of each share in issue.

For example on 27 June 2002 the French building products company, Saint Gobain, changing the nominal value its shares from €16 to €4. This reduced the closing price of its shares from €161.259 to €40.065.

Both bonus issues and share splits reduce share prices. In a bonus issue, shareholders receive additional shares. In a share split, shareholders receive new shares in place of the old share.

Classes of share

You’ll find different types of shares in company accounts including:

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O deferred shares;

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O ordinary shares;

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O American depository receipts.

Companies may also issue warrants to allow people to subscribe for shares at some future date.

Deferred shares

These are often the founders’ shares and are rarely seen now in company accounts. They either:

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O do not receive a dividend until some future date, usually several years after issue;

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O only receive a dividend after ordinary shareholders’ dividends have reached a pre-determined level.

The shipping company P&O had deferred shares rather than ordinary shares, these dated from the time it became a limited company following the grant-ing of a royal charter in 1840.

More recently they have been used in capital reconstructions, where there is a need to make the shares virtually valueless. In this case they rank behind the ordinary shares if the business fails.

Ordinary shares

These are the commonest form of shares, but they’re not necessarily all the same. Companies can have more than one type of ordinary shares with dif-ferences in:

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O voting rights;

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O entitlement to dividend;

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O ranking if the company is liquidated.

American depository receipts

You may find reference in some accounts to American depository receipts (ADRs), and although they aren’t another type of share I’m discussing them here. An ADR is a mechanism used in the USA to simplify the procedures for holding shares in foreign companies. The shares are bought, on behalf of the American investor, and deposited in a bank outside of the USA. An American bank then issues ADR certificates to the American shareholder. The custodian bank then processes the payment of dividends, rights issues, etc.

ADRs may be traded on American stock exchanges if the company is reg-istered with the Securities Exchange Commission and complies with their requirements (they are then called sponsored ADRs).

Reserves

You’ll find that there is a number of reserves in company accounts. They can be classified into those that are distributable (this means that they can be used to pay dividends), and those that are undistributable. The only distrib-utable reserve is the retained earnings, and not all retained earnings may be distributable.

You’ll usually find the following reserves on a balance sheet.

The retained earnings, or the profit and loss account

This is the accumulated profits and losses made since the company started adjusted by two factors: goodwill written off before 23 December 1998, and any cancelled, or redeemed, shares.

As it contains the retained profits it is the only distributable reserve.

However, not all of the reserve is ‘distributable’, as not all of the profits have been realised. (To be realised, the company must have received it either in cash or other realisable assets. Realisable assets include receivables and other assets that can easily be converted into cash.) This means that not all of the retained earnings are realised. A good example is when a company has made a ‘bargain purchase’ and has acquired a company for less than its net asset value (negative goodwill). The accounting rules require this to be shown as a profit, but it isn’t a realised profit.

The revaluation surplus, or reserve

This represents the accumulated revaluations of assets. When previously revalued assets are sold, and the revaluation is realised, the revaluation is transferred from the revaluation reserve to the profit and loss account.

Whilst the revaluation reserve is not a distributable reserve, it can be used for a bonus issue.

The share premium account

Shares are usually issued at a premium to their nominal value, and this pre-mium is shown in the share prepre-mium account. The only exception to this rule applies to companies using UK GAAP where shares are issued for an acquisition. (The company may then qualify for statutory share premium relief under Section 131 of the Companies Act. This allows companies, meeting certain criteria, to write off any goodwill arising on consolidation through the share premium account, via a merger reserve.)

Once a share premium has been created it is legally treated as part of the company’s share capital, and is not a distributable reserve. It may however be used for:

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O writing off any expenses, commissions or discounts relating to share or debenture issues;

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O writing off the company’s preliminary expenses;

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O providing for any premium repayable on the redemption of debentures;

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O a bonus issue.

The capital redemption reserve

Shares can generally only be bought out of distributable profits, or from the proceeds of a new share issue. A company creates a capital redemption reserve if it buys back, or redeems, its shares. These shares are then cancelled, and the issued share capital reduced accordingly. The authorised share capi-tal is unaffected by the buy back.

The accounting for share cancellations and redemptions is as follows:

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O Share capital This is reduced by the nominal value of the shares purchased, or redeemed, and the amount is then transferred to a capital redemption reserve. This is a non distributable reserve of the company, which is separately disclosed on the balance sheet. (The principle underlying the Companies Act’s requirements is that the total of the share capital and the undistributable reserves should remain unchanged following the repayment of share capital. This is achieved by transferring the nominal value of the shares bought, or redeemed, from issued share capital to the capital redemption reserve.)

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O Retained earnings When shares are purchased from distributable profits, rather than a share issue, this is reduced by the total cost of the purchase. If the shares are purchased through another share issue, the retained earnings are only reduced if the buy back cost more than the cash the company received when the shares were issued. The retained earnings are then reduced by the difference between the cash received when the shares were issued and the cash paid to buy the shares.

When shares are held in treasury the nominal value remains in share capi-tal until they are sold for cash, or transferred into an employee share save scheme. If they are subsequently cancelled their nominal value will transfer to the capital redemption reserve.

You’ll see this when you look at IMI’s note on share capital and reserves.

The merger reserve

You’ll only find this when companies have merged and it reflects any:

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O differences between the nominal value of the shares that have been issued and the nominal value of the shares received;

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O existing balances on the new ‘subsidiary’s’ share premium account and capital redemption reserve.