Chapter 12 Issue of shares and debentures ( 發行股份及債券 )

Name : Serial No: Chapter 12 Issue of shares and debentures ( 發行股份及債券 ) 12.2 Classification of share capital ( 股份的分類 ) 12.2.1 Preference shares vs. ordinary shares ( 優先股與普通股 ) Shares are usually called stock. Preference shares ( 優先股 ) are known as preferred stock while ordinary shares ( 普通股 ) are known as common stock. Preference shares are seldom issued to the public ( 甚少會向公眾發行 ). They are usually sold privately ( 私人途徑出售 ) to financial institutions or other companies. Most of the shares traded on ( 買賣 ) the Stock Exchange of Hong Kong ( 香港交易所 ) are ordinary shares ( 普通股 ). Receipt of dividends ( 收取股息 ) A company may distribute some of the profits earned as dividends ( 股息 ) to its shareholders. The profits that are not distributed will be held as reserves ( 儲備 ). Preference shareholders ( 優先股股東 ) must receive a certain amount ( 一定金額 ) of dividends before ( 前 ) ordinary shareholders ( 普通股股東 ). Moreover, the dividend amount ( 股息金額 ) that preference shareholders are entitled to ( 收取 ) is usually stated as ( 按 ) a fixed percentage ( 固定百分比 ) of the nominal value ( 票面值 ) (par value, face value) of the preference shares held ( 所持的優先股 ). However, the rate of dividend payable to ordinary shareholders may be higher or lower, depending on the amount of profit made and distributed as dividend during the year. Example 1 A company has issued 1,000,000 5% preference shares of $1 each and 1,000,000 ordinary shares of $1 each. The dividends paid to the preference shareholders and ordinary shareholders in the years 2008 to 2010 are shown below: Year 2008 2009 2010 $ $ $ Profit distributable as dividends 130,000 90,000 50,000 Preference dividends (5%) 50,000 50,000 50,000 Ordinary dividends 80,000 40,000 ($ 1,000,000 5%) (Total dividents Preference dividens) The preference shareholders obtain a fixed rate of return and from their investment in the company, while ordinary shareholders might receive a higher or lower return. Voting rights ( 投票權 ) Ordinary shares carry voting rights ( 附有投票權 ) at shareholders general meetings ( 股東大會 ) while preference shares do not. Only ordinary shareholders can exercise controlling power ( 行使控制權 ) over the company by voting on important matters ( 重要事項 ) tabled ( 提交 ) at shareholders general meetings. Claims to the company s net assets in liquidation ( 公司清盤時的淨資產索償權 ) When a limited company goes into liquidation ( 清盤 ), the preference shareholders have priority ( 優先權 ) over the ordinary shareholders in getting back ( 取回 ) the nominal value ( 面值 ) of their share capital ( 股本 ) after the company has paid off ( 清還 ) all its liabilities ( 所有債務 ). 12.2.2 Authorised share capital vs. issued share capital ( 法定股本與已發行股本 ) Limited companies must disclose ( 註明 ) both authorized and issued share capital in their annual reports. Authorised share capital ( 法定股本 ) Authorised share capital (registered share capital) is the maximum amount ( 上限 ) of share capital ( 股份 ) that a company is allowed to issue ( 可發行 ) and is calculated as follows: Authorised share capital = Maximum number of shares x nominal value per share ( 每股面值 ) Issued share capital ( 已發行股本 ) Issued share capital is the amount of share capital ( 股本額 ) that a company has issued ( 已發行 ). The amount cannot exceed ( 不能超出 ) the amount of authorized share capital ( 法定股本 ) and is calculated as follows: The amount of issued share capital = Number of shares issued x Nominal value per share The number of shares authorized, less ( 減去 ) the number issued, is known as unissued shares ( 未發行股份 ). When a company plans to expand ( 擴充 ) in future, it can sell the unissued shares. It cannot issue more than ( 不能發行超出 ) the unissued number of shares ( 未發行股份 ) unless it applies for an increase ( 增加 ) in authorized share capital ( 法定股本 ). 1

12.3 Issue of shares ( 發行股份 ) Limited companies ( 有限公司 ) are allowed to issue shares to raise funds but only the public companies ( 公眾有限公司 ) are allowed to issue shares to the public ( 可向公眾發行股份 ). 12.3.1 Procedures for issuing shares ( 發行股份的程序 ) Step 1 The public are invited to subscribe for the shares ( 邀請公眾認購股份 ). Step 2 Applications are received ( 收集認購申請表格和認購股款 ). Step 3 Shares are allotted to applicants ( 向申請人分配股份 ). Step 4 If shares are over-subscribed ( 超額認購 ) on application, the excess application monies ( 多收的款項 ) will be refunded ( 退還 ) to applicants ( 申請人 ). Shares can be issued in any of the following ways: 1 Issued at par ( 按面值發行 ): Shares are issued at ( 等於 ) nominal value ( 面值 ) (par value). 2 Issued at a premium ( 溢價發行 ): Shares are issued at a price higher than ( 高於 ) the nominal value. 3 Issued at a discount ( 折價發行 ): Shares are issued at a price lower than ( 低於 ) the nominal value. 12.3.2 Accounting entries for the issue of shares ( 發行股份的會計分錄 ) 1 Shares issued at par ( 股份按面值發行 ) On 1 December 2010, JJ Ltd announced a public offering of 100,000 ordinary shares of $4 each at par. On 10 December 2010, applications together with application monies were received for exactly 100,000 shares. The shares were allotted to the applicants two days later. 1 Receipt of application monies: Dr account $400,000 (100,000 x $4) Cr Ordinary share applicants account $400,000 2 Allotment of shares to share applicants: Dr Ordinary share applicants account $400,000 Cr Ordinary share capital account $400,000 (100,000 x $4) 2010 $ Dec 10 Ordinary share applicants (1) 400,000 Ordinary share Applicants Dec 12 Ordinary share capital (2) 400,000 Dec 10 (1) 400,000 Ordinary share Capital 2010 $ Dec 12 Ordinary share applicants (2) 400,000 Class work 1 A limited company has an authorized share capital of $100,000, divided into 100,000 ordinary shares of $1 each. On 1 January 2010, the company announced that all of its share capital would be issued at par, payable in full on application. Applications were received for exactly 100,000 shares on 15 January 2010. Shares were allotted on 31 January 2010. Prepare journal entries to record the issue of shares. Date Details Dr Cr 2010 $ $ Jan 15 100,000 Ordinary share applicants 100,000 31 Ordinary share applicants 100,000 Ordinary share capital 100,000 2

2 Over-subscription of shares ( 股份超額認購 ) Suppose on 1 December 2010, applications were received for 150,000 shares. The shares were then said to be over-subscribed ( 超額認購 ). Usually, the shares will be allotted on a pro-rata basis ( 按比例 ) in the event of an over-subscription. The excess application monies were refunded on the date of allotment. 1 Receipt of application monies: Dr account $600,000 (150,000 x $4) Cr Ordinary share applicants account $600,000 2 Allotment of shares to share applicants: Dr Ordinary share applicants account $400,000 Cr Ordinary share capital account $400,000 (100,000 x $4) 3 Refund of excess application monies: Dr Ordinary share applicants account $200,000 (50,000 x $4) Cr account $200,000 2010 $ Dec 10 Ordinary share applicants (1) 600,000 Dec 10 Ordinary share applicants Refund (3) 200,000 Ordinary share Applicants Dec 12 Ordinary share capital (2) 400,000 Dec 10 (1) 600,000 12 Refund (3) 200,000 600,000 600,000 Ordinary share Capital 2010 $ Dec 12 Ordinary share applicants (2) 400,000 Class work 2 A limited company had a registered share capital of $120,000 in ordinary shares of $1 each. The company announced on 1 April 2010 that a quarter of its share capital would be issued at par, payable in full on application. Applications were received for 40,000 shares on 10 April 2010. The shares were allotted on 30 April 2010, and the excess application monies were refunded on the same day. Show the necessary journal and ledger entries to record the issue of shares. Date Details Dr Cr 2010 $ $ Apr 10 (40,000 x $1) 40,000 Ordinary share applicants 40,000 30 Ordinary share applicants 30,000 Ordinary share capital 30,000 30 Ordinary share applicants 10,000 Refund (10,000 x $1) 10,000 Apr 10 Ordinary share applicants 40,000 Apr 30 Ordinary share applicants Refund 10,000 Ordinary share Applicants Apr 30 Ordinary share capital 30,000 Apr 10 40,000 30 Refund 10,000 40,000 40,000 Ordinary share Capital Apr 30 Ordinary share applicants 30,000 3

3 Shares issued at a premium ( 股份按溢價發行 ) On 1 January 2011, KK Ltd announced a public offering of 100,000 ordinary shares of $2 each at a price of $3 per share. On 10 January 2011, applications together with application monies were received for exactly 100,000 shares. The shares were allotted to the applicants three days later. 1 Receipt of application monies: Dr account $300,000 (100,000 x 3) Cr Ordinary share applicants account $300,000 2 Allotment of shares to share applicants: Dr Ordinary share applicants account $300,000 Cr Ordinary share capital account $200,000 (100,000 x $2) Cr Share premium account $100,000 (100,000 x $1) Jan 10 Ordinary share applicants (1) 300,000 Ordinary share Applicants Jan 13 Ordinary share capital (2) 200,000 Jan 10 (1) 300,000 13 Share premium (2) 100,000 300,000 300,000 Ordinary share Capital Jan 13 Ordinary share applicants (2) 200,000 Share Premium Jan 13 Ordinary share applicants (2) 100,000 1 The Companies Ordinance ( 公司條例 ) requires that the share capital account ( 股本帳戶 ) be used to record only the nominal value of share issued ( 發行股份的面值 ). The amount of share premium ( 股份溢價 ) should be recorded in a separate account ( 獨立帳戶 ). 2 The amount entered in the share premium account ( 股份溢價帳戶 ) is the actual number of shares allotted ( 實際配發股數 ) multiplied by the premium per share ( 每股溢價 ). The balance of the share premium account ( 股份溢價帳戶結餘 ) would be shown as a reserve ( 儲備 ) in the balance sheet at the end of an accounting period. Class work 3 Cheung King Ltd has an authorized share capital of 200,000 ordinary shares of $1 each, of which 150,000 had been issued and fully paid. To finance expansion, Cheung King Ltd decided to issue all the remaining authorized ordinary shares at $1.5 each, payable in full on application. On 10 June 2009, applications for 60,000 ordinary shares were received. The shares were allotted on 20 June 2009, and the excess application monies were refunded on the same day. Show the necessary ledger accounts to record the issue of shares. 2009 $ 2009 $ Jun 10 Ordinary share applicants (60,000 x $1.5) 90,000 Jun 20 Ordinary share applicants Refund 15,000 Ordinary share Applicants 2009 $ 2009 $ Jun 20 Ordinary share capital (50,000 x $1) 50,000 Jun 10 90,000 20 Share premium (50,000 x $0.5) 25,000 20 Refund (10,000 x $1.5) 15,000 90,000 90,000 Ordinary share Capital 2009 $ 2009 $ Jun 20 Ordinary share applicants 50,000 Share Premium 2009 $ 2009 $ Jun 20 Ordinary share applicants 25,000 4

4 Under-subscription of shares ( 股份認購不足 ) Suppose on 10 January 2011, applications were received for 80,000 shares. The shares were then said to be under-subscribed ( 認購不足 ). 1 Receipt of application monies: Dr account $240,000 (80,000 x $3) Cr Ordinary share applicants account $240,000 2 Allotment of shares to share applicants: Dr Ordinary share applicants account $240,000 Cr Ordinary share capital account $160,000 (80,000 x $2) Cr Share premium account $80,000 (80,000 x $1) Jan 10 Ordinary share applicants (1) 240,000 Ordinary share Applicants Jan 13 Ordinary share capital (2) 160,000 Jan 10 (1) 240,000 13 Share premium (2) 80,000 240,000 240,000 Ordinary share Capital Jan 13 Ordinary share applicants (2) 160,000 Share Premium Jan 13 Ordinary share applicants (2) 80,000 5 Share issued at a discount ( 股份按折價發行 ) On 1 February 2011, M&M Ltd announced a public offering of 200,000 ordinary shares of $3 each at a price of $2 per share. On 10 February 2011, applications together with application monies were received for exactly 200,000 shares. The shares were allotted to the applicants three days later. 1 Receipt of application monies: Dr account $400,000 (200,000 x 2) Cr Ordinary share applicants account $400,000 2 Allotment of shares to share applicants: Dr Ordinary share applicants account $400,000 Dr Share discount account $200,000 (200,000 x $1) Cr Ordinary share capital account $600,000 (200,000 x $3) Feb 10 Ordinary share applicants (1) 400,000 Ordinary share Applicants Feb 13 Ordinary share capital (2) 400,000 Feb 10 (1) 400,000 Share Discount Feb 13 Ordinary share capital (2) 200,000 Ordinary share Capital Feb 13 Ordinary share applicants (2) 400,000 13 Share Discount (2) 200,000 The issue of shares at a discount rarely occurs ( 很少發生 ) because this is prohibited ( 禁止 ) in many places. In Hong Kong, a company is allowed issue shares at a discount only if the issue has already been authorized ( 已被授權 ) by a resolution passed ( 通過一項決議 ) at a general meeting ( 在股東大會上 ) and sanctioned by the court ( 法院判決 ). 5

Class work 4 1. Hickson Ltd had an authorized share capital of $1,000,000, divided into 600,000 ordinary shares of $1 each and 400,000 5% preference shares of $1 each. Half of the ordinary and preferences shares have been issued and fully paid. To finance expansion, Hickson Ltd decided to issue half of the remaining authorized ordinary shares at $1.2 each and half of the remaining authorized preference shares at $1.1 each. All monies had to be fully paid on application. On 1 September 2010, applications for 200,000 ordinary shares and 60,000 preference shares were received. Shares were allotted on 15 September 2010, and the excess application monies were refunded on the same day. (a) Prepare journal entries to record the above transactions. (b) Briefly explain the differences between ordinary shares and preference shares from the perspective of the issuing company. (a) Date Details Dr Cr 2010 $ $ Sept 1 (200,000 x $1.2 + 60,000 x $1.1) 306,000 Ordinary share applicants (200,000 x $1.2) 240,000 Preference share applicants (60,000 x $1.1) 66,000 15 Ordinary share applicants 180,000 Ordinary share capital (150,000 x $1) 150,000 Share premium (150,000 x $0.2) 30,000 15 Ordinary share applicants (50,000 x $1.2) 60,000 Refund 60,000 15 Preference share applicants 66,000 Preference share capital (60,000 x $1) 60,000 Share premium (60,000 x $0.1) 6,000 (b) Payment of dividends The company has to pay a fixed rate of dividend to preference shareholders. However, the rate of dividend payable to ordinary shareholders may be higher or lower, depending on the amount of profit mad and distributed as dividend during the year. Voting rights Ordinary shares carry voting rights while preference shares do not. Only ordinary shareholders can exercise controlling power over the company by voting on important matters tabled at shareholders general meetings. Claims to the company s net assets on liquidation When a company goes into liquidation, the preference shareholders have priority over ordinary shareholders in getting back the nominal value of their share capital after the company has paid off all its liabilities. HKCEE (2006, 4) Ball Limited had an issued share capital consisting of 650,000 ordinary shares of $1 each as at 1 January 2005. On 1 July 2005, the company made an additional issue of 250,000 ordinary shares at $1.50 per share, payable in full on application. Applications were received for 260,000 shares on 8 July 2005. The shares were allotted to the successful applicants on 15 July 2005. Cash was returned to the unsuccessful applications on the same day. You are required to: Prepare journal entries for Ball Limited to record the share issue in July 2005. (Narrations are not required) Date Details Dr Cr 2005 $ $ Jul 8 (260,000 x $1.50) 390,000 Share application ordinary shares 390,000 15 Share application ordinary shares 375,000 Ordinary share capital (250,000 x $1) 250,000 Share premium (250,000 x $0.50) 125,000 15 Share application ordinary shares 15,000 Refund (10,000 x $1.50) 15,000 6

HKCEE (2007, 7) Bamboo Limited is engaged in the trading business. After preparing the adjusting entries, the bookkeeper extracted an adjusted trial balance as at 31 March 2007. However, he found that the debit and credit totals did not agree: Debit Credit $ $ Ordinary share capital 1 April 2006 180,000 Retained profits, 1 April 2006 20,000 Plant and equipment, at cost 692,460 loan, repayable in 2010 120,000 (i) Sales Required entries: Wrong entries: 985,000 Debtors Dr $800 Dr $800 105,690 Cost of goods Cr interest sold income $800 Dr prepaid selling expenses $800 538,600 Administrative expenses Suspense entries: 123,700 Cr Suspense $1,600 Selling expenses 187,500 Correct entries Interest on bank loan 5,000 Dr Suspense $1,600 Deposits received Cr interest from income debtors $800 16,000 Share application Cr prepaid money selling received expenses $800 70,000 Cash at bank 47,400 Creditors 96,710 Stock, 31 March 2007 22,100 Prepaid selling expenses, 31 (ii) March Required 2007 entries: Wrong entries: 8,000 Accumulated depreciation plant Dr and equipment, (cash) 31 $4,884 March 2007 Dr (cash) 246,540 $4,844 (iii) Cr Required entries: Sales $4,884 Cr Wrong entries: 1,793,400 Debtors $4,844 1,671,300 Dr administrative Correct entries expenses $300 Dr Creditors $300 You are required to: Cr Dr $300 (cash) $40 Cr $300 (a) Based on the items listed above, rewrite the adjusted trial balance as at 31 March 2007 for Bamboo Limited. Dr Debtors $4,844 Correct entries Cr Sales $4,884 (iv) Required entries: Dr administrative expenses $300 Wrong entries: Subsequent checking Dr administrative for records Cr revealed expenses Creditors the $16,000 $300 following errors and Dr omissions: Plant and equipment $10,600 (i) Interest income Cr of $800 had $16,000 been debited to the cash at bank account Cr and $16,000 the prepaid selling expenses account Dr administrative expenses ($10,600 x 20%) $2,120 only. Cr accumulated depreciation $2,120 (ii) Cash sales of (v) $4884 Required had been entries: recorded as a cash settlement Suspense of $4844 entries: from Wrong debtors. entries: (iii) A payment of administrative Dr Cash expenses $12,000 of $300 was recorded Dr as Suspense a settlement Dr $5,400 of omitted credit purchases. Cr Deposits received from debtors $12,000 Cr omitted (iv) Equipment Correct repairs entries Dr of Interim $16,000, dividend an administrative $12,000 expense, had been recorded as $10,600 in the plant and equipment Dr account. administrative A Cr full Cash year s expenses $12,000 depreciation $16,000 had been calculated at 20% on this amount and was included in administrative expenses. Cr Plant and equipment $10,600 Cr Suspense $5,400 (v) The closing Dr stock accumulated had Correct been entries undercast depreciation by $6000. $2,120 (vi) $12,000 cash was Cr Dr received administrative Interim from dividend a expenses customer $12,000 $2,120 as the deposit for placing a purchase order. The cash had been used Cr Deposits received from debtors $12,000 to pay an interim dividend to the shareholders. Both transactions were entirely omitted from the books. (vii) In March 2007, 40,000 ordinary shares of the par value of $1 each were issued to the public at $1.40 each, payable (vi) Required in full on entries: application. There was an over-subscription Wrong entries: and the application money received had been correctly Dr recorded. Stock (vii) On $6,000 The 31 March correct processes 2007, the for shares the were allotment Dr allotted omitted of and share at and the the same refund: time, the excess application Cr Cost Dr of goods Share sold application $6,000 ordinary shares (40,000 Cr omitted x $1) $40,000 money was refunded to the unsuccessful applications. No entries had been made for the allotment of share and Cr Ordinary share capital (40,000 x $1) $40,000 the refund. Correct entries Dr Stock Dr $6,000 Share application ordinary shares (40,000 x $0.40) $16,000 Cr Cost of Cr goods Share sold premium $6,000 (40,000 x $0.40) $16,000 You are required to: Dr Share application ordinary shares (70,000 40,000 x $1.4) $14,000 (b) Prepare the necessary journal Cr entries Refund to correct (70,000 the errors 40,000 and x $1.4) omissions in (i) to (vii) $14,000 above. (Narrations are not required.) 7

(a) Bamboo Limited Adjusted trial balance as at 31 March 2007 Debit Credit $ $ Ordinary share capital 1 April 2006 180,000 Retained profits, 1 April 2006 20,000 Plant and equipment, at cost 692,460 loan, repayable in 2010 120,000 Sales 985,000 Debtors 105,690 Cost of goods sold 538,600 Administrative expenses 123,700 Selling expenses 187,500 Interest on bank loan 5,000 Deposits received from debtors 16,000 Share application money received 70,000 Cash at bank 47,400 Creditors 96,710 Stock, 31 March 2007 22,100 Prepaid selling expenses, 31 March 2007 8,000 Accumulated depreciation plant and equipment, 31 March 2007 246,540 Suspense 3,800 1,734,250 1,734,250 (b) Details Debit Credit $ $ (i) Suspense 1,600 Interest income 800 Prepaid selling expenses 800 (ii) (Cash) 40 Debtors 4,844 Sales 4,884 (iii) Administrative expenses 300 Creditors 300 (iv) Administrative expenses 16,000 Plant and equipment 10,600 Suspense 5,400 Accumulated depreciation plant and equipment 2,120 Administrative expenses ($10,600 x 20%) 2,120 (v) Stock 6,000 Cost of goods sold 6,000 (vi) Interim dividend The correct processes: 12,000 Deposits received from debtors Dr interim dividend $12,000 12,000 Cr Debtor $12,000 (vii) Share application money 70,000 Ordinary share capital 40,000 Share premium ($0.4 x 40,000) 16,000 ($1.4 x 10,000) 14,000 8

12.4 Issue of debentures ( 發行債券 ) Public limited companies are also allowed to issue debentures (bonds) to the public in order to raise funds. The procedures for issuing debentures are similar to those for the issue of shares. 12.4.1 Differences between debentures and shares ( 債券與股份不同之處 ) 1 A debenture represents a loan ( 貸款 ) made to a company, while a share represents a part of the ownership ( 擁有權的一部分 ) of a company. 2 Debenture holders are entitled to a fixed rate of return ( 固定的回報率 ) (interest, coupon rate) while ordinary shareholders are not guaranteed ( 不一定 ) any dividend. Debenture interest is payable whether or not a company makes profits. 3 Debenture interest ( 債券利息 ) must be paid before ( 先派 ) share dividends ( 股息 ). 4 When a company goes into liquidation ( 清盤 ), the debenture holders have priority ( 優先權 ) over the shareholders in their claim ( 索償 ) on the company s residual assets ( 公司餘下的資產 ). 5 Debentures are usually redeemable ( 可贖回 ) but shares are usually irredeemable ( 不可贖回 ). 6 In the balance sheet, the debentures issued are shown as a liability ( 負債 ), while the shares issued are shown as share capital or owners' equity ( 股本或股東權益 ). 7 Debenture holders do not have any voting rights ( 投票權 ) but ordinary shareholders have such rights. 12.4.2 Accounting entries for the issue of debentures ( 發行債券的會計分錄 ) The balance of the debentures account will be shown as a non-current liability at nominal value in the balance sheet at the end of an accounting period. 1 Debentures issued at par ( 債券按面值發行 ) On 1 November 2010, NP Ltd announced a public offering of $100,000 5% debentures redeemable on 30 November 2015 at par. On 20 November 2010, applications together with application monies were received for $150,000 debentures. The debentures were allotted to the applicants and the excess application monies were refunded on 1 December 2010. 1 Receipt of application monies: Dr account $150,000 Cr Debenture applicants account $150,000 2 Allotment of debentures to debenture applicants: Dr Debenture applicants account $100,000 Cr 5% debentures account $100,000 3 Refund of excess application monies: Dr Debenture applicants account $50,000 Cr account $50,000 2010 $ Nov 20 Debenture applicants (1) 150,000 Dec 1 Debenture applicants Refund (3) 50,000 Debenture Applicants Dec 1 5% debentures (2) 100,000 Nov 20 (1) 150,000 1 Refund (3) 50,000 150,000 150,000 5% Debentures 2010 $ Dec 1 Debenture applicants (2) 100,000 9

Class work 5 1. BAFS Ltd announced on 1 March 2011 that it would issue $200,000 6% debentures at par. On 20 March 2011, applications were received for $250,000 debentures. Allotments were made on 1 Apr 2011, and the excess application monies were refunded on the same day. (a) Show the necessary journal entries to record the issue of debentures. (b) If the interest on debenture was to be paid every 6 months, show the necessary journal entries to record the interest payment after six months. Details Dr Cr $ (a) Mar 20 250,000 Debenture applicants 250,000 Apr 1 Debenture applicants 200,000 6% debentures 200,000 1 Debenture applicants 50,000 Refund 50,000 (b) Sept 30 Debenture interest ($200,000 x 6% x 6/12) 6,000 6,000 2. Cyber Ltd announced on 1 March 2011 that it would issue $200,000 5% debentures at par. Applications were received for $250,000 debentures on 15 March 2011. Allotments were made on 1 April 2011, and the excess application monies were refunded on the same day. (a) Show the necessary ledger accounts to record the issue of debentures. (b) Suppose the financial year ends on 31 December. Calculate the debenture interest for the year ended 31 December 2011. (c) If the interest on debenture was to be paid every 6 months, show the necessary journal entries to record the interest payment after preparing the financial statement. (a) Mar 15 Debenture applicants 250,000 Apr 1 Debenture applicants Refund 50,000 Debenture Applicants Apr 1 5% debentures 200,000 Mar 15 250,000 1 Refund 50,000 250,000 250,000 5% Debentures Apr 1 Debenture applicants 200,000 (b) Debenture interest = $200,000 x 5% x 9/12 = $7,500 (c) Date Details Dr Cr $ Dec 31 Debenture interest (Profit and loss) 2,500 Accrued debenture interest ($200,000 x 5% x 3/12) 2,500 10

2 Debentures issued at a premium ( 債券按溢價發行 ) Differences between market interest rate ( 市場利率 ) and nominal interest rate ( 名義利率 ) Nominal interest rate is the rate of interest ( 利率 ) stated on the debenture certificate ( 債券 ). Market interest rate (effective interest rate) is the rate of interest paid in the market ( 市場上 ) on debentures of similar risk ( 同等風險 ). It fluctuates ( 波動 ) all the time and the debentures issuers ( 債券發行人 ) have no control over it ( 不能控制 ). Hence, there is often a difference between the market interest rate and the nominal interest rate on the issue date. Market interest rate < Nominal interest rate If the market interest rate is lower than the nominal interest rate, the issue price of the debentures ( 債券發行價 ) will be higher than ( 高於 ) the nominal value ( 面值 ) and the debentures are said to be issued at a premium ( 債券按溢價發行 ). The premium ( 溢價 ) equals ( 等於 ) the excess of the issue price over the nominal value ( 發行價超過面值的價值 ). Example 2 On 1 January 2011, QQ Ltd announced a public offering of $100,000 5% debentures redeemable on 31 January 2021 at 105 (The term 105 represents a premium of 5% over the debenture s nominal value). Interest is payable half-yearly. On 15 January 2011, applications together with application monies were received for exactly the same amount of debentures. The debentures were allotted to the applicants on 1 February 2011. 1 Receipt of application monies: Dr account $105,000 ($100,000 x 105%) Cr Debenture applicants account $105,000 2 Allotment of debentures to debenture applicants: Dr Debenture applicants account $105,000 Cr 5% debentures account $100,000 Cr Debenture premium account $5,000 ($100,000 x 5%) Jan 15 Debenture applicants (1) 105,000 Debenture Applicants Feb 1 5% debentures (2) 100,000 Jan 15 (1) 105,000 1 Debenture premium (2) 5,000 5% Debentures Feb 1 Debenture applicants (2) 100,000 Debenture Premium Feb 1 Debenture applicants (2) 5,000 Amortization of debenture premium ( 攤銷債券溢價 ) The debenture premium should be amortised ( 攤銷 ) over the life of the debentures ( 債券的期限 ), 10 years. The debenture interest expense for each period ( 每期債券利息支出 ) would be reduced ( 減少 ) by the amount of premium amortised ( 可攤銷溢價 ). The accounting entries on the date of semi-annual payment of debenture interest (1 February and 1 August) would be: 3 Payment of debenture interest on 1 August 2011: Dr Debenture premium account $250 [($5,000 10) x 6/12] Dr Debenture interest account $2,250 ($100,000 x 5% x 6/12 $250) Cr account $2,500 ($100,000 x 5% x 6/12) The nominal value of the debentures, inclusive ( 包括 ) of the unamortized debenture premium ( 未攤銷債券溢價 ), should be shown as a non-current liability ( 非流動負債 ) in the balance sheet at the end of the accounting period. QQ Ltd Balance Sheets as at 31 December 2011 (extract) $ Non-Current liabilities 5% debentures {$100,000 + [$5,000 ($5,000 10 x 11/12)]} Unamortised debenture premium 104,542 Amortised debenture premium(1feb 2011-31Dec 2011) 11

If the company needs to prepare the final account at 31 December 2011, the required entries for the debenture interest accrued for 1 August 2011 to 31 December 2011 (5 months, to be paid on 1 February 2012) are: Dr Debenture premium account $208 [($5,000 10) x 5/12] Dr Debenture interest account $1,875 ($100,000 x 5% x 5/12 $208) Cr Accrued debenture interest account $2,083 ($100,000 x 5% x 5/12) Class work 6 On 1 January 2010, BAFS Ltd announced a public offering of $100,000 8% debentures redeemable on 31 January 2020 at 110. Interest is payable half-yearly. On 15 January 2010, applications together with application monies were received for exactly the same amount of debentures. The debentures were allotted to the applicants on 1 February 2010. (a) Prepare journal entries to record the issue of debentures. (b) Show the journal entries for the debenture interest charged after half-year. (c) Show the journal entries for the debenture interest to prepare the final account at 31 December 2011. (d) Post all the journal entries to the ledger account. Details Dr Cr 2010 $ $ (a) Jan 15 ($100,000 x 110%) 110,000 Debenture applicants 110,000 Feb 1 Debenture applicants 100,000 8% Debentures 100,000 1 Debenture applicants 10,000 Debenture Premium ($100,000 x 10%) 10,000 (b) Jul 31 Debenture Premium ($10,000 10 x 6/12) 500 Debenture interest ($4,000 $500) 3,500 ($100,000 x 8% x 6/12) 4,000 (c) Dec 31 Debenture Premium ($10,000 10 x 5/12) 417 Debenture interest ($3,333 $417) 2,916 Accrued debenture interest ($100,000 x 8% x 5/12) 3,333 (d) Jan 15 Debenture applicants 110,000 Jul 31 Debenture premium 500 31 Debenture interest 3,500 Debenture Applicants Feb 1 8% Debentures 100,000 Jan 15 110,000 1 Debenture premium 10,000 Debenture Premium Jul 31 500 Feb 1 Debenture applicants 10,000 Dec 31 Accrued debenture interest 417 8% Debentures Feb 1 Debenture applicants 100,000 Debenture interest Jul 31 3,500 Dec 31 Accrued debenture interest 2,916 Accrued debenture interest Dec 31 Debenture premium 417 31 Debenture interest 2,916 12

3 Debentures issued at a discount ( 債券按折價發行 ) Market interest rate > Nominal interest rate If the market interest rate ( 市場利率 ) is higher than the nominal interest rate ( 名義利率 ), the issue price ( 發行價 ) of the debentures will be lower than ( 低於 ) the nominal value and the debentures are said to be issued at a discount ( 債券按折價發行 ). The discount ( 折價 ) equals the excess of the nominal value over the issue price. On 1 March 2011, A&T Ltd announced a public offering of $100,000 5% debentures redeemable on 31 January 2021 at 98 (The term 98 represents a discount of 2% on the debenture s nominal value). Interest is payable half-yearly. On 25 March 2011, applications together with application monies were received for exactly the same amount of debentures. The debentures were allotted to the applicants on 1 April 2011. 1 Receipt of application monies: Dr account $98,000 ($100,000 x 98%) Cr Debenture applicants account $98,000 2 Allotment of debentures to debenture applicants: Dr Debenture applicants account $98,000 Dr Debenture discount account $2,000 ($100,000 x 2%) Cr 5% debentures account $100,000 Mar 25 Debenture applicants (1) 98,000 Debenture Applicants Apr 1 5% debentures (2) 98,000 Mar 25 (1) 98,000 Debenture Discount Apr 1 5% debentures (2) 2,000 5% Debentures Apr 1 Debenture applicants (2) 98,000 1 Debenture discount (2) 2,000 Amortization of debenture discount ( 攤銷債券折價 ) The debenture discount should be amortised ( 攤銷 ) over the life of the debentures ( 債券的期限 ), 10 years. The debenture interest expense for each period ( 每期債券利息支出 ) would be increased ( 增加 ) by the amount of discount amortised ( 可攤銷折價 ). The accounting entries on the date of semi-annual payment of debenture interest (1 Apr and 1 Oct) would be: 3 Payment of debenture interest on 1 Oct 2011: Dr Debenture interest account $2,600 ($100,000 x 5% x 6/12 $100) Cr account $2,500 ($100,000 x 5% x 6/12) Cr Debenture discount account $100 [($2,000 10) x 6/12] The nominal value of the debentures, less the unamortized debenture discount ( 未攤銷債券折價 ), should be shown as a non-current liability in the balance sheet at the end of the accounting period. A&T Ltd Balance Sheets as at 31 Deccember 2011 (extract) $ Non-Current liabilities 5% debentures {$100,000 [$2,000 ($2,000 10 x 9/12)]} Unamortised debenture discount 98,150 Amortised debenture discount (1Apr 2011-31Dec 2011) If the company needs to prepare the final account at 31 December 2011, the required entries for the debenture interest accrued for 1 Oct 2011 to 31 December 2011 (3 months, to be paid on 1 Apr 2012) are: Dr Debenture interest account $1,300 ($100,000 x 5% x 3/12 $50) Cr Accrued debenture interest account $1,250 ($100,000 x 5% x 3/12) Cr Debenture discount account $50 [($2,000 10) x 3/12] 13

Class work 7 1. On 1 January 2010, Jolly Ltd announced the issue of $100,000 6% debentures at 95, payable in full on application and repayable 10 years later (i.e., on 31 January 2020) at par. Applications were received for exactly $100,000 debentures on 20 January 2010. (a) Allotments were made on 31 January 2010. (a) Prepare journal entries to record the issue of debentures. (b) Explain how the debenture discount should be treated in the accounts of Jolly Ltd. Date Details Dr Cr 2010 $ $ Jan 20 95,000 Debenture applicants 95,000 31 Debenture applicants 95,000 Debenture Discount 5,000 6% Debentures 100,000 (b) The debenture discount should be amortised over the life of the debentures, which is 10 years. The debenture interest expense for each period would be increased by the amount of discount amortised. The nominal value of the debentures, less the unamortized debenture discount, should be shown as a non-current liability in the balance sheet at the end of the accounting period. 2. On 1 March 2010, Glory Ltd announced the issue of $150,000 10% debentures at 97 payable in full on application and repayable 25 years later (i.e., on 31 March 2035) at par. Interest on the debentures was payable on the nominal amount as from 1 April 2010. Applications were received for $250,000 debentures on 20 March 2010. Both the allotment of debentures and the refund of excess application monies were made on 1 April 2010. The discount on debentures is to be written off evenly over the period of 25 years. The financial year ends on 31 December. (a) The necessary ledger accounts to record the issue of debentures. (b) The debenture interest charged to the income statements for the two years ended 31 December 2010 and 2011. (a) Mar 20 Debenture applicants ($250,000 x 97%) 242,500 Apr 1 Debenture applicants Refund 97,000 Debenture Applicants Apr 1 10% debentures ($150,000 x 97%) 145,500 Mar 20 242,500 1 Refund 97,000 242,500 242,500 Debenture Discount Apr 1 Debenture applicants ($150,000 x 3%) 4,500 10% Debentures Apr 1 Debenture applicants 145,500 1 Debenture discount 4,500 (b) Less Glory Ltd Income Statement for the year ended 31 December 2010 $ Expenses: Debenture interest [(150,000 x 10% x 9/12) + ($4,500 25 x 9/12)] 11,385 Less Glory Ltd Income Statement for the year ended 31 December 2011 $ Expenses: Debenture interest [(150,000 x 10%) + ($4,500 25)] 15,180 14

3. China Trading Ltd was expanding and required extra funds of $600,000. It board of directors was considering choosing either one of the following options: (i) 600,000 5% preference shares of $1 each to be issued at par. (ii) $625,000 4% debentures to be issued at 96, the debentures will be repayable four years later. (a) (b) Which of the above options should be chosen if China Trading Ltd intended to minimize the cost of financing? Consider one more option of financing: the issue of 600,000 $1 ordinary shares at par. State one advantage and one disadvantage of this option compared to Option (i). (a) (b) The cost of issuing preference shares = $600,000 x 5% = $30,000 in dividends each year. The cost of issuing 4% debenture = $625,000 x 4% + $625,000 x 4% 4 = $31,250 in interest each year. Option (i) should be chosen because the annual debenture interest inclusive of the amortised debenture discount is higher than the annual preference dividend. Advantage: The company has no obligation to pay a fixed rate of dividend each year. Disadvantage: The granting of voting rights to ordinary shareholders may hinder the decision-making process of The company. 4. Bong Ltd had an authorised share capital of $200,000, divided into 150,000 ordinary shares of $1 each and 50,000 8% preference shares of $1 each. On 1 May 2011, it announced the following issues. All the authorized ordinary shares were issued at $1.6. Of the preference shares, only 20,000 were issued and each share was sold for $1.4. In addition, $100,000 6% debentures (redeemable at par on 1 July 2021) were issued at 96. Subscription rates of 200%, 160% and 150% were reported for ordinary shares, preference shares and debentures, respectively. All monies were fully paid on application dated 20 June 2011. Shares and debentures were allotted on 1 July 2011 and the excess application monies were refunded on the same day. The financial year ends on 31 December. (a) How much money was raised from the issue of shares and debentures? (b) How much discount was given on the debentures issued? How would it be treated in the accounts of Bong Ltd? (c) Assuming there were sufficient profits, how much would be paid in preference share dividend for the year ended 31 December 2011? (d) How much would be paid in debenture interest (excluding the amortised debenture discount) for the year ended 31 December 2011? Would your answer differ if the profit were insufficient to meet debenture interest payments? (e) If net profit before charging debenture interest (including the amortised debenture discount) for the year ended 31 December 2011 was $3,200 and it was to be distributed in full, how much would be paid in preference and ordinary share dividends? (f) If net profit before charging debenture interest (including the amortised debenture discount) for the year ended 31 December 2011 was $6,000 and it was to be distributed in full, how much would be paid in preference and ordinary share dividends? (a) Ordinary shares : 150,000 x $1.6 = $240,000 Preference shares : 20,000 x $1.4 = $28,000 Debentures : 100,000 x 96% = $96,000 Total = $240,000 + $28,000 + $96,000 = $364,000 (b) Debenture discount = 100,000 x 4% = $4,000 The debenture discount should be amortised over the life of the debentures, which is 10 years. The debenture interest expense for each period would be increased by the amount of discount amortised. The nominal value of debentures, less the unamortized debenture discount, should be shown as a non-current liability in the balance sheet at the end of an accounting period. (c) Preference dividend = 20,000 x $1 x 8% x 6/12 = $800 (d) Debenture interest for the year = $100,000 x 6% x 6/12 = $3,000 Even if the profit were insufficient, the answer would be the same, as debenture interest must be paid whether profits are sufficient or not. (e) Total debenture interest for the year = ($100,000 x 6% x 6/12) + ($4,000 10 x 6/12) = $3,200 Net profit after charging debenture interest = $0 No preference dividend nor ordinary dividend would be paid for the year. (f) Net profit after charging debenture interest = $6,000 $3,200 = $2,800 Preference dividend = $800 Ordinary dividend = $2,000 15

(HKCEE 2006 5) The trial balance of Ho Limited as at 31 March 2006 failed to agree and the difference was entered in a suspense account. The draft net profit for the year amounted to $80,260. Additional information: (i) The last month s bank statement balance at 28 February 2006 showed a credit balance of $19,900, which was the same as that in the cash book on that date. The balance had been wrongly included as the bank balance in the trial balance as at 31 March 2006. Deposits and cheque payments, totaling $315,000 and $300,700 respectively, had been recorded in the cash book during March 2006. (ii) The following items were shown on the March bank statement but not in the cash book: 1 charges of $80; 2 deposit interest of $650; 3 A dishonoured cheque of $10,250 from Star Ray Limited; and 4 A direct deposit of $2,400 logged by Kettler Limited. (iii) Cheques, issued in March, amounting to $16,500 had not been presented to the bank for payment. (iv) Lodgements, totaling $6,630 for March, were not recorded by the bank until 2 April 2006. You are required to: (a) Show the necessary adjustments to be made in the cash book on 31 March 2006. (b) Prepare a bank reconciliation statement as at 31 March 2006, commencing with the adjusted cash book balance in (a) above. Subsequent checking of the records revealed the following: (v) The salaries account had been undercast by $500. (vi) A credit purchase of $2,000 had been completely omitted. (vii) Returns from Jane Limited, amounting to $780, had been recorded in the accounts as $870. (viii) An electricity bill of $1,240 for March 2006 had been paid twice. Both payments had been posted to the ledger. The excess amount paid was to be used to settle future bills. (ix) A trade discount of 10% was granted to a customer, Mr Wu, on a bulk purchase of $10,000. The sale had been properly recorded in the books. A cash discount of 5% was also allowed to him on his settlement of account in March. However, only the amount received was debited in the cash book and no other entries were made. (x) $200,000 6% debentures were issued at par on 1 March 2006 to settle a bank loan. Interest on debenture was to be paid every 6 months. No entries relating to these had been made. You are required to: (c) Prepare the necessary journal entries to correct items (v) to (x) above. (Narrations are not required.) (d) Prepare a statement to correct the draft net profit for the year ended 31 March 2006. (a) Cash Book (bank column only) $ $ Balance b/d (19,900 + 315,000 300,700) 34,200 charges 80 deposit interest 650 Star Ray Limited dishonoured cheque 10,250 Kettler Limited 2,400 Balance c/d 26,920 37,250 37,250 (b) Reconciliation Statement as at March 2006 $ Adjusted balances as per cash book 26,920 Add Uncredited cheque 16,500 43,420 Less Lodgements not yet recorded by bank 6,630 Adjusted balances as per bank statement 36,790 16

(c) Details Dr Cr $ $ (v) Salaries (Profit and loss) 500 Suspense 500 (vi) Purchases (Trading) 2,000 Creditors 2,000 (vii) Jane Limited ($870 $780) 90 Returns inwards (Trading) 90 (viii) Prepaid electricity 1,240 Electricity (Profit and loss) 1,240 (ix) Discount allowed (Profit and loss) 450 Suspense 8,550 Mr Wu 9,000 (x) loan 200,000 6% debentures 200,000 Debenture interest (Profit and loss) 1,000 Interest payable (200,000 x 6% x 1/12) 1,000 (d) Statement of adjusted profit for the year ended 31 March 2006 $ $ Net profit per draft accounts 80,260 Add deposit interest not recorded 650 Electricity prepaid 1,240 Returns inwards overstated 90 1,980 82,240 Less charges not recorded 80 Salaries undercast 500 Purchases omitted 2,000 Discount allowed not recorded 450 Debenture interest accrued 1,000 4,030 Adjusted net profit 78,210 17