B301 Unit 10

B301 Unit 10 Issue and redemption of shares, earnings per share

Nature of shares

Issue of shares

Bonus, right, options.

Nature of equity shares

Ordinary shares

Provide a major source of funds
The lowest ranks in the event of liquidation
Carries voting rights
Entitles to the balance of profits after the rights of preference shareholders have been satisfied
Entitles to an annual dividend

Preference shares

Technically not the real owners of the company, similar to lenders
Entitles to a fixed rate of cash dividend specified in their shares
Not entitled to vote in general meetings or to share any profits beyond their preference dividends.

Issue of shares

Issue at a premium or at a discount

A nominal (par or face) value stated on the share certificate.
The issue price is higher than its nominal value, i.e. at a premium; otherwise at discount
Companies Ordinance S.50 (1): a company may issue its shares at a discount if it is authorized by resolution passed in general meeting and sanctioned by the court.
For the issue of shares, an Application and allotment account is created to record the amount of application and allotment monies received and the amount of shares allotted in the share-issuing process.

Forfeiture and reissue of shares

If a shareholder fails to make the required payment at the time it is due, the amount already paid on the shares is not refundable, i.e. forfeited.
A provision concerning forfeited shares is usually found in the company's articles (rules).
Shares forfeited may be reissued at a minimum price equivalent to the unpaid amount.
Any amount received in excess of the unpaid amount will be credited to the share premium account.

Bonus issue, right issues, options or warrants issues

Bonus issue

Issue of shares to existing shareholders without requiring them to pay for them.
A substantial balance of statutory reserves (such as share premium) that is set aside for specific purpose rather than for distribution as dividends to shareholders, but the Companies Ordinance allows it to be distributed to shareholders by means of bonus issues.

Right issue

To protect existing shareholders' right, a company may give them the right to purchase shares in proportion to their shareholdings at a price lower than the current market price.
Rights can be sold to a third party.

Options or warrants issues

Call options: an incentive scheme as a means of improving staff loyalty to the company. Call options give the holders the right to purchase ordinary shares in accordance with an agreement on the payment of a specified amount.
Warrant: gives the holder the right to purchase a specified number of ordinary shares on payment of a specific amount.
Options and warrant would be exercised if the exercise price were lower than the market price at the time of exercise; otherwise, they would not be exercised.

Redemption or repurchase of own shares

Redeemable shares: to attract more investors to subscribe, shares are issued with the right to be redeemed at future.
Companies (Amendment) Ordinance 1991 (CAO 1991): permits a company to issue redeemable shares, not restricted to redeemable preference shares, if:

The creditors' right is protected and the company has adequate cash for redemption of shares.
The company must maintain its capital at least at its original level after the shares are redeemed

Redemption of shares can be financed by:

A fresh issue of share: adequate cash for the redemption of shares and the original amount of capital can be maintained.
Distributable profits: the company set aside the amount equivalent to the nominal value of shares redeemed from its distributable profits or reserves to the Capital Redemption Reserve, which is not distributable.
A combination of both: partly from the proceeds of a fresh issue of shares and partly from internal funds.

Redemption at a premium

Redeemed shares issued before CAO 1991: the entire premium of shares redeemed could be set off against the company's share premium account.
Redeemed shares issued after CAO 1991:

A fresh issue of share: the premium paid for the redemption could be set off against the proceeds of the fresh issue of shares up to the lowest of:

the premium of original issue; and
the balance of the share premium account (including any premium on the fresh issue of shares).

No fresh issue of shares: all related premiums paid for the redemption should be set off against distributable profit.

E.g. the premium payable from redemption of shares is $50,000 (i.e. $250,000-$200,000), and it count be set off against its share premium account of $30,000. The amount to be transferred from retained profits to the capital redemption reserve is:

Nominal value of shares redeemed	$200,000
Gross proceeds of shares newly issued (80,000 x $1.4)	112,000
Amount transferred to Capital Redemption Reserve	$88,000

Repurchase of own shares

Before 1991,only redeemable preference shares could be redeemed in Hong Kong but not the ordinary shares.
With CAO 1991: companies can now also purchase their own ordinary shares.
A public company can repurchase its own issued shares from the stock market at the market price when the companies have surplus funds with no investment opportunities or when the price of shares is falling.
US: held for subsequent retirement or reissuance.
UK/HK: redeemed shares must be cancelled.
Mainland China: not allow a company to purchase its own shares except for the purpose of reducing its capital.

Redemption out of capital

If a company does not have enough retained profits and distributable reserves when they redeem shares,

Public company: either issue more new shares or not redeem the shares. The transfer from distributable reserves is a statutory requirement and must be observed by public companies all times.
Private company: can redeem its own shares even if there are inadequate distributable reserves for the transfer to its capital redemption. The shortfall amount represents a reduction in capital and is known as a permissible capital payment.

Reserves

Means something that is stored for later use.
Statutory reserves

Companies Ordinance: imposes certain restrictions on a company in the actions it takes to reduce or reconstruct capital contributed by shareholders.
Any movement within the statutory reserves is restricted by law.
S79C, statutory (or undistributable) reserves mainly include:

the share premium;
the capital redemption reserve;
the amount of accumulated, unrealized profit in excess of accumulated, unrealized losses, which has not been used previously, e.g. a reserve which arises from revaluation of fixed assets; and
any other reserve which the company is prohibited from distributing by clauses in its memorandum or articles of association, or by specific provision in the Companies Ordinance.

Non-statutory reserves

Other reserves held for general purposes or for distribution to shareholders.
"General reserve", "Profit and loss account", "accumulated retained profits"
S79B: a company can only make distributions from profits available for the purpose where profits refers to realized profits accumulated less accumulated realized losses.

HKSSAP 5 Earnings per share (Revised in May 1998)

Basis for the "price earnings ratio"
Help investor and shareholders judge how much a company shares are worth.
Must have a standardized method for all companies

　Disclosure of EPS

The EPS figure on the face of the P & L a/c;
The basis for calculating EPS, either in the P & L a/c or in a note, i.e. the amount of earnings and the number of equity shares used in the calculation, should be shown;
The diluted EPS on the face of P & L a/c, if any one of the following conditions exists (para. 6-8):

² Debt or equity instruments, including preference shares, that are convertible into ordinary shares;

² Share warrants, options and other contractual arrangements issued by the company or by any of its subsidiaries to subscribe for equity shares; and

² Employee plans that allow employees to receive ordinary shares as part of their remuneration and other share purchase plans.

Basic EPS

Basic EPS = Earnings / Number of ordinary shares in issue ranking for dividend, where

"Earnings" is the profit after tax or the loss for the period attributable to ordinary shareholders (i.e. profit after tax less preference dividends, if any)
"Number of equity shares" is the weighted average number of shares outstanding during the period.

· Weighted average number of shares (para. 13 --20): the number of ordinary shares to be used as the denominator of the basic EPS formula is derived from the weighted average of outstanding shares in the period.

· Bonus issue (para. 21): the number of bonus issue shares is added to the original number of equity shares without any adjustment of the time factor.

· Rights issue (para. 22): a right issue is granted to shareholders to acquire additional shares at a fixed exercise price at some future specified time.

· Theoretical ex-rights price: the market price per share after the Rights issue. It is calculated by:

(a) adding the amount raised by the additional ordinary shares issued with the rights to the original amount of ordinary shares.

(b) dividing the amount obtained in (a) by the number of shares issued, including the additional shares with the rights

· Adjustment factor =

Fair value per share immediately prior to exercise

Theoretical ex-rights fair value

Diluted EPS:

For the purpose of calculating diluted EPS, the net profit attributable to ordinary shareholders and the weighted average number of shares outstanding should be adjusted for the effects of all dilutive potential ordinary shares
It has to be calculated and shown on the face of P & L a/c if a listed company has a separate class of shares, or if it has debentures or loan stocks, or warrants or options, which can be converted into equity shares.
To inform users of financial information of the possibility that the company’s EPS may be diluted in the future.
Convertible preference shares: the number of equity shares would be increased and thus EPS would be diluted.
Convertible debentures (or loan stock): the earnings for the period should be adjusted by adding back the interest expenses (net of tax) to profit after tax, as these interest expenses would no longer be required once the debentures were converted to ordinary shares.
Share options/warrants: similar to right issue that the company allow shareholders to subscribe for equity

IAS33

Example - Determining the Order in Which to Include Dilutive Securities in the Calculation of Weighted Average Number of Shares

Earnings = Net profit attributable to ordinary shareholders ..............….. 10,000,000

Ordinary share outstanding .................................................................... ……2,000,000

Average fair value of one ordinary share during year ..................…...........….... 75.00

Potential Ordinary Shares

Options	100,000 with exercise price of 60
Convertible Preference Shares	800,000 shares entitle to a cumulative dividend of 8 per share. Each preference share is convertible to 2 ordinary shares.
5% Convertible Bond	Nominal amount 100,000,000. Each 1,000 bond is convertible to 20 ordinary shares. There is no amortization of premium or discount affecting the determination of interest expense.
Tax rate	40%

Increase in Earnings Attributable to Ordinary Shareholders on Conversion of Potential Ordinary Shares

		Increase in Earnings	Increase in Number of Ordinary Shares	Earnings per Incremental Share
Option
Increase in earnings		NIL
Incremental shares issued for no consideration	(100,000 x (75-60)/75		20,000	NIL

Convertible Preference Shares
Increase in net profit	8 x 800,000	6,400,000
Incremental shares	2 x 800,000		1,600,000	4.00

5% Convertible Bonds
Increase in net profit	100,000 x 0.05 x (1-0.4)	3,000,000
Incremental shares	100,000 x 20		2,000,000	1.50

Computation of Diluted Earnings Per Share

	Net Profit Attributable	Ordinary Shares	Per Share

As reported	10,000,000	2,000,000	5.00
Options	0	20,000
	10,000,000	2,020,000	4.95	Dilutive

5% Convertible Bonds	3,000,000	2,000,000
	13,000,000	4,020,000	3.23	Dilutive

Convertible Preference Shares	6,400,000	1,600,000
	19,400,000	5,620,000	3.45	Anti-Dilutive

Since diluted earnings per share is increased when taking the convertible preference shares into account (from 3.23 to 3.45), the convertible preference shares are anti-dilutive and are ignored in the calculation of diluted earnings per share. Therefore, diluted earnings per share is 3.23.

This example does not illustrate the classification of convertible financial instruments between liabilities and equity or the classification of related interest and dividends between expenses and equity as required by IAS 32.

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