Chapter 12
Companies
Learning Objectives
• Know what we mean by the term company
• Understand new terminology that is specific to companies
• Know a bit about the 2008 Companies Act
• Know the different types of companies allowed by the 2008
Companies Act
• Understand the basic principles and procedures for forming a
company
• Discuss how a company obtains capital
• Understand what is meant by the term shareholders and the rights of
the shareholders
• Record the transactions, which are specific to companies
• Describe how a company issues share capital
• Know what happens when a company declares a dividend
• Recognise income tax and capital gains tax
• Discuss dividend tax
• Understand when retained income and other reserves arise
• Know how to prepare a statement of changes in equity
• Present the annual financial statements of a simple company in terms
of generally accepted accounting practice
What is a company?
• A company is a legal (or “artificial”) person.
•The company is an entity with rights and duties
separate from its shareholders.
•The assets of a company belong to the company
itself and not to its shareholders.
• The powers of a company and what acts a
company can perform as a legal person are
indicated in the Companies Act 71 of 2008.
What is a company?
• The Companies Act of 2008 provides for two types of
companies, namely profit companies, and non-profit
companies.
• In terms of the 2008 Act, a single document, the
Memorandum of Incorporation (MOI), will describe
how the company must operate (replaces the
Memorandum and Articles of Association of the 1973
Act).
Different types of companies
Two types
Profit Non profit
(For financial gain) (For public benefit)
Private company
Public company
Personal liability
State-owned
Separate legal person
• Limited liability
• Perpetual succession
Company and the Law
• 2008 Companies Act
• CIPC administers the Act
• Formation of company
o 2 forms lodged
Notice of incorporation
Memorandum of Incorporation (MOI)
Private/Public companies
Unique restrictions that apply to a private
company:
• A restriction on how to attract new
shareholders
• A restriction on the sale of shares.
Unique qualities that that apply to a public
company:
• Can raise capital from the general public
• Shares of a public company are freely
transferable.
Stock/securities exchange
Issues Shares Company
DR Bank (A)
Cash
CR Equity
Shareholders
PRIMARY MARKET
Sell/Trade Shares
SECONDARY MARKET
Cash
For profit companies
Type Name
Private company (Pty) Ltd
Public company Ltd
Personal liability Inc Used by Professionals
such as accountants
State-owned SOC Owned by the
government
Learn Accounting video
www.learnaccounting.uct.ac.za
Go and watch What is a share. This video explains some of
the common questions relating to shares.
Formation of a company
• Setting up a company
• Company name
• Company goals and objectives
o Memorandum of incorporation
o Registration certificate
• Legal rights of a company
Steps to forming a company
1. One or more persons may incorporate a profit
company.
2. Each person completes and signs the
Memorandum of Incorporation (MOI).
3. A Notice of Incorporation filed with the
Commission.
4. The MOI of the company must accompany the
Notice together with the prescribed fee.
5. A MOI can be unique to the company, or company
can use the MOI provided in the Act.
Legal rights of a company
• 2008 Companies Act provides that a company has
the legal capacity and powers of an individual.
• So would a company be able to enter into a contract
of marriage??
• Restrictions in a company’s MOI only legally relevant
if third parties actually aware of them
• The restrictions, in terms of the MOI are binding
between the company, its shareholders and/or its
directors
Ownership of companies
• What are the owners of a company called?
• What is a share?
• Is a share a physical thing?
• Can an owner of a company sell their shares to
someone else?
Shareholder rights
• Right to share in the net assets of company on
liquidation
• Right to receive a distribution
o Fixed, cumulative
o Dividend policy
• Right to vote
o Right to choose a board of directors
• Right to sell shares
Control of companies
• Do shareholders manage companies?
• What is the title given to the most senior managers
of companies?
• Shareholders, however, maintain control, by:
o Appointing directors
o Approving dividends (proposed by directors)
o Approving future share issues
o Approving appointment of auditors, and AFS
Control of companies
• Most shareholder decisions are made at the AGM
by general resolution; others are by special
resolution:
o General resolution: 50% + 1 share (MOI may
change this)
o Special resolution: 75%
Share capital of a company
Authorised share capital - maximum number of shares
a company can issue.
Issued share capital - number of shares actually
issued to shareholders.
Share capital - amount of funding contributed by
shareholders (owners).
A share - a collection or bundle of rights
Distinguishing designation - specific bundle of rights
and/or limitations linked to each type (class) of share.
E.g. of changes to share capital
terminology
Companies Act, No 71 of 2008: Companies Act, No 61 of
1973:
Class A shares – voting rights and entitled
to distributions and to net assets on Ordinary shares
liquidation of company
Class B shares – no voting rights, entitled to
fixed distribution of 10% of issue price, 10% Preference shares
prior to distributions to Class A shares.
Class C shares – no voting rights, entitled
to fixed distribution of 12% on issue price, 12% Redeemable
prior to distributions to Class A shares. preference shares
Shares redeemable at option of company.
Share capital of a company
Each class of share issued with “distinguishing
designation”
o Right to vote
o Right to share in NAV on liquidation
o Right to receive a distribution (could be
fixed/cumulative)
•At least ONE class must have voting rights and
right to share in net assets on liquidation
Prospectus
• Prospectus an invitation to the public to apply
for (subscribe) shares in the company.
• Protect the public - rules in Companies Act
govern information included in prospectus.
• Rules ensure that prospectus is not
misleading and does not contain false
information.
• Private company will never issue a
prospectus - not allowed to offer shares to
the public.
Issue of shares to the public
public apply New Act: Directors
for shares, and can issue over
pay in cash subscribed shares
Closing date for Issue shares to
Shares
share successful applicants,
offered to
applications unsuccessful applicants
public
(if company chooses)
What type of are refunded
account is A&A? What would the
Journal entry Why? journal entry look
DR Bank like if there is a
refund Journal entry
CR Application and Allotment
DR A&A
CR Share Capital
Par value shares
• Par value - arbitrary nominal value
• Par value not price at which shares issued / worth
after issued.
• If issue price more than par value - difference is
share premium. Both the Share Capital account and
the Share Premium account record the capital of a
company.
Par value amount shares issued
CR Share Capital account
Amount in excess of par value
CR Share Premium account.
Par value shares
Company issues a share at R10.
Par value is R1.
Journal entry
DR Bank 10
CR Share Capital 1
CR Share premium 9
No par value shares
NO nominal (par) value allocated to each share.
Full proceeds are taken to the Share Capital account.
Company issues a share at R10.
Journal entry
DR Bank 10
CR Share Capital 10
Recording a share issue
• Over-subscription
• Under-subscription and underwriting
• Other share issue costs
• Closing off share issue costs
• Statement of financial position and notes
Over subscription
Prepare journal entries to record issue of 490 000
Class A shares (issue price of R22) - received
applications for 600 000 shares. Gave refund
Dr Bank 13 200 000
Cr Application and allotment 13 200 000
Cash received on receipt of applications for shares
Dr Application and allotment 13 200 000
Cr Bank (110 000 x R22) 2 420 000
Cr Share capital 10 780 000
Shares allotted and refunded unsuccessful investors
Under-subscription
• Minimum subscription: minimum amount of money
required by share issue
• Stated in the prospectus
• If insufficient shares are sold (below the minimum
subscription), no shares can be issue any shares – all
cash received refunded
• Underwriter: Guarantee that sufficient equity raised in
share issue. Underwriter purchases sufficient
unissued shares to ensure required equity raised.
Under-subscription
Share issue underwritten. Commission of 5%. 490 000
Class A shares offered at R22 each. 400 000 applied
for by the public.
Dr Bank (400 000 x R22) 8 800 000
Cr Application and allotment 8 800 000
Public applied and paid for 400 000 shares
Dr Bank (90 000 x R22) 1 980 000
Cr Application and allotment 1 980 000
Underwriter purchases 90 000 shares
Under-subscription
Dr Application and allotment 10 780 000
Cr Share capital: Class A 10 780 000
Shares issued to public and underwriter
Dr Underwriter’s commission 539 000
Cr Bank/trade payables 539 000
(10 780 000 x 5%)
Commission for underwriters recorded
Commission charged on entire share issue regardless
of whether issue under subscribed or not.
Commission compensates for RISK
Closing off share issue costs
Dr Share capital 539 000
Cr Underwriter’s commission 539 000
Transfer commission to share capital
Why is the Share Capital account debited??
Think about the definition of expenses in the framework -
the definition excludes all amounts relating to transactions
with the owners (shareholders).
The share issue costs are incurred in a transaction with the
owner – closed off directly to equity and not P + L
Rights issue
• Share offer made to existing shareholders (in
proportion to existing holdings)
• Accounting for a rights issue is the same as for a
public issue - only difference is who the shares are
issued to
Capitalisation issue
• Issue shares to current shareholders (No cash
received)
• Issued in same ratio as existing shareholding.
• How: Capitalisation of profits.
• Retained Earnings transferred to share capital
account. Total equity (Share capital + retained
earnings) unchanged
• Retained Earnings reduced DR and share capital
increases CR.
• Directors decide on the price of the shares -
market value or other value
• This is the amount that will be transferred out of
Retained Earnings.
Dividends
• Share of profits distributed to owner
• No legal right to dividend until dividend is declared
• Declaration date – a legal obligation to pay dividend
• Interim and final dividend
Dividends
• Distributions only authorised if company will
satisfy the solvency and liquidity test
immediately after distribution paid
• Solvency and liquidity test
o Assets, if fairly valued, equal to or greater than liabilities of
the company
o Company will be able to pay debts – as they come due for
12 months after test
Class A and B shares
Class A shares (Ordinary shares) Class B, C etc (Preference shares)
Voting rights Generally no voting rights
Dividend paid per share. Fixed dividend amount stated as
percentage of issue price
Typically, interim and final Dividend calculated like interest on
dividends are declared. loans: time-based.
Have right to profits if a dividend Have right to profits if dividend
is declared declared. These dividends “fully paid
up” before class A dividend
declared.
Dividend Timeline
Shares trade Shares trade
“cum dividend” “ex dividend”
Dividend Last day to Dividend payment to
declared register (LDR) shareholders
registered on LDR
Journal entry on declaration: Journal entry on payment:
DR Dividends DR Shareholders for
CR Shareholders for dividend dividend
CR Bank
Closing journal entry :
DR Retained earnings
CR Dividends
Recording: Dividends
Journal entry when dividend DECLARED
Dr Dividends x
Shareholders for dividend
Cr (liability) x
Dividend declared
Closing entry for dividends
Dr Retained earnings x
Cr Dividends x
Dividend closed off directly to retained earnings – not P + L
Recording dividends
Journal entry when dividend PAID
Shareholders for dividend x
Dr (liability)
Cr Bank x
Dividend paid
Share issue as a dividend
Journal entry when dividend DECLARED
Dr Dividends x
Cr Share capital x
Issue of capitalisation shares as payment of the dividend
Closing entry for dividends
Dr Retained earnings x
Cr Dividends x
Dividend closed off directly to retained earnings – not P + L
Issue of shares with right to fixed
distribution (preference shares)
Par Value preference shares
DR Application & allotment
CR Preference Share capital
CR Share premium
No par value shares with the right to a fixed
distribution
DR Application & allotment
CR Share capital: Class B
Dividend calculations: Class B
Company issues 10 000 12% shares with a face value
of R1. Declares a dividend.
Journal entries
Dr Dividends 1 200
Shareholders for dividend
Cr (liability) 1 200
Dividend declared
Total dividend = R1 200 (10 000 x R1 = R10 000 x
12%).
Class B: Time based
Company issues 10 000 12% shares with a face value
of R1 on 30 June X1. Declares a dividend at year end
– 31 December X1
Journal entries
Dr Dividends 600
Shareholders for dividend
Cr (liability) 600
Dividend declared (R1 200 x 6/12)
Cumulative
Company issues 10 000 12% shares with a face value of R1.
Declares a dividend end of yr 2, no dividend declared in yr1.
Journal entries
Dr Dividends 2 400
Shareholders for dividend
Cr (liability) 2 400
Dividend declared (R1 200 x 2)
Cumulative: Right to arrear dividends when
dividend declared
Company Tax
Accounting profit and taxable income
• 28% flat rate charged on taxable income company
earns in a year
• Taxable income determined by the Income Tax Act
and not GAAP
• Taxable income not necessarily the same as profit for
the period
Taxable income
A business has profit before tax of R200 000. This
includes dividend income of R80 000, and traffic fines
expense of R6 000. All other income is taxable, and
all other expenses are deductible for tax purposes.
Profit before tax R200 000
Add back: Traffic fines R 6 000
Less: Dividend income R (80 000)
Taxable income R126 000
Income tax: = 28% x R126 000 = R35 280
Recording current income tax
When financial statements prepared at year-end
calculate an estimation of company’s income tax
Journal entry
Dr Taxation expense x
Cr SARS (liability) x
Current year’s income tax recognised as a liability
Recognise tax Company Tax
expense as
estimated by
business
DR Tax expense
CR SARS
Year 1 Year 2
Possible under-
provision
1st Provisional 2nd Provisional Business
tax payment tax payment estimate of tax
DR SARS DR SARS DR Tax expense
forY1 less than CR SARS
CR Bank CR Bank assessment by Process additional
SARS tax expense in Y2
Payment to SARS
• The total income tax is not paid when the assessment
is received.
• Companies pay income tax in installments during the
year: provisional tax payments.
• A payment is made every six months of the company’s
financial year.
Dr SARS (liability) x
Cr Bank x
Recognition of payment to SARS
Income tax return & provisional
tax
A company will make 2 provisional tax payments during
the year (based on their estimates).
The company submits form (IT14) with a copy of its
financial statements to SARS.
SARS calculates the taxable income and sends a bill for
tax owing (IT34).
If SARS calculation is higher – company will make a 3rd
payment.
Dividends tax
• A withholding tax (similar in concept to VAT)
• A tax on shareholders, not the company
• Tax paid by company to SARS on behalf of the
shareholders
• Calculated as 20% of dividend declared
• No dividends tax is charged where dividends paid to
SA-resident companies
Dividends tax
On 31 /12/11, a Class A dividend of R15 000 is declared.
60% of the company’s shareholders are SA-resident
companies.
Shareholders who are SA-resident companies will receive:
R15 000 x 60% = R9 000 cash
Shareholders who are not will receive: R15 000 x 40% x
80% = R4 800 cash
Dr Dividends: Class A 15 000
Cr Shareholders for dividends 13 800
Cr SARS (dividends tax) 1 200
Dividends declared (dividends tax = R15 000 x 40% x 20%)
Capital Gains tax
• Capital asset: Use over time to generate income
• Revenue asset: End product that is sold
• Capital Gains Tax charged on capital assets when
sold
Reserves
• Equity accounts in the statement of financial
position which do not arise from transactions with
owner
• Therefore excludes share capital
• e.g. retained earnings and revaluation surplus
Statement of changes in
equity
Informs shareholders why the equity of the company
changes from year to year
Statement shows how each type of equity (share
capital, retained earnings, revaluation surplus) on the
statement of financial position has changed over the
year.
Statement of changes in equity
Share Retained Revaluation Total
capital: earnings surplus
Class A
Balance 1/1/2012
Profit or loss
Other comprehensive income
Total comprehensive income
Issue of shares
Share issue costs
Dividends
Transactions with shareholders
Balance 31/12/2012
Debt and gearing
High level of borrowing (debt) in relation to funding of
equity - company is highly “geared”.
Types of debt :
• Loan from a bank
• Credit terms with trade
• Mortgage bond - loan where property acts as security
• Lease agreements and hire purchase agreements
• Debentures
Debentures
Contract between the company and third parties, to
lend money for specified time period at a specified
interest rate.
Differs from a loan in that debentures are offered to the
public who can finance part of the loan.
Total loan divided into parts – debentures
These are issued/traded separately.
The debenture is transferable – bought and sold in the
market like a share.
Debentures
Dr Bank x
Cr Debentures (liability) x
Proceeds received from the issue of debentures
Debentures recognised as interest-bearing
liabilities
Annual financial statements
(AFS)
• Objective:
o For financial statements: “to provide financial
information ... that is useful to existing and potential
investors, lenders and other creditors in making
decisions” (Framework)
o For integrated reporting: “to report to stakeholders on
the strategy, performance and activities of the
organisation in a manner that enables stakeholders to
assess the ability ... To create and sustain value of
the short-, medium- and long-term.”
• Companies accountable to the public:
o Audited
• Other companies:
o Subjected to independent review
Types of reporting frameworks
IFRS/SA GAAP
GAAP for
SME’s Basic
Companies accounting
that are Enterprises concepts
accountable not
accountable Micro
to the general to the general entities
public public
Preparation and audit of
financial statements
Companies accountable to the general public:
• Must produce financial statements, in accordance
with IFRS and comply with Companies Act
• Financial statements must be audited
• An independent review is required for other
companies
The Companies Act
Entity Reporting Audit/independent review
Standard
Listed public company IFRS Audit
Unlisted public company IFRS Audit
Private company with a IFRS for SMEs
public interest score of 350
or higher
Private company with a IFRS Independent review
public interest score of IFRS for SMEs An audit is required if the
between 100 and 349, or, if financial reports have been
the public interest score is internally compiled (have
less than 100, their financial been prepared by the
reports were independently company’s own staff)
compiled
Private company with a Not specified Independent review
public interest score of less
than 100 and their financial
reports were internally
compiled
The Companies Act
Section 29 of the Companies Act, 2008
Financial statements must:
• Satisfy financial reporting standards,
• Present fairly the state of affairs and business of
company,
• Explain the transactions and financial position of the
company,
• Show company’s assets, liabilities and equity, and
income and expenses, and any other prescribed
information,
• Set out the date when statements are produced, and
the accounting period to which the statements apply,
• Clearly identify whether the statements have been
audited or not.
An audit
• What is the main purpose of this document?
– To express the auditor’s opinion as to whether the
financial statements fairly present in all material
respects the financial information of the company, in
accordance with IFRS and the Companies Act
• What must be true of the financial information of a
business in order for the auditor to express a favourable
opinion?
– Valid: all information pertains to the business’s
transactions
– Accurate: the recorded amount and account are correct
– Complete: there are no unrecorded transactions in the
period
Public interest score
How to calculate the PI score:
According to CIPC the Public Interest Score is calculated
as follows
•a number of points equal to the average number of
employees
•one point for every R1 million (or portion thereof) in third
party liability
•one point for every R1 million (or portion thereof) in
turnover
•one point for every individual who, at the end of the
financial year, is known to directly or indirectly have a
beneficial interest in any of the company’s issued
securities
Protecting the public interest
• What does an audit involve?
• What does an independent review involve?
• How does an auditor protect the public interest?
• How do accountants generally protect the public
interest?
• Why is it important that accountants and auditors are
ethical?
Corporate governance
Concept of corporate governance first introduced into
South Africa in 1994 with the publication of the King
Report on Corporate Governance.
King I: 1994
Recommended standards of conduct for directors
Emphasised the need for responsible corporate
activities.
Corporate governance
King II: 2002
Introduced a Code of Corporate Practices and Conduct
King III: 2009
Greater emphasis on risk management and good
strategic planning.
King IV: 2016
Coherence with international governance codes and
best practice. Includes aligning King report towards
integrated thinking across the six capitals.
Corporate governance
The six capitals include financial capital; manufacturing
capital; human capital; social and relationship capital;
intellectual capital and, natural capital.
Focuses on new reporting and disclosure requirements
for example, Integrated Reporting.
King IV effective for financial year-ends starting on 1
April 2017.
Integrated Reporting
• Investors complain they do not get all information
needed to make decisions.
• A lot is provided on financial performance – possibly
so much it is difficult to decide what is important
• Insufficient information on broader risks of the
business and its impact on society and the
environment.
• Resulted in integrated reporting
What is integrated thinking?
• A basis of making decisions that takes all relevant
information into account
• A basis for making decisions based on a broad set of
information that is inter-connected and more
forward-looking than traditional financial analysis.
What is integrated thinking?
Applying integrated thinking
• what drives value creation in the organization
• understanding the business model
• inputs into the business
• outcomes of the business activities
• external environment that the business operates
in
What is integrated thinking?
• Considering all with the potential to impact value
creation in short, medium or long term.
• Need to know inputs into your business model, and
careful consideration of how business depends on
each of the six capitals.
• Six capitals include financial; manufacturing; human;
social and relationship; intellectual and, natural
capital.
Sources of Corporate governance
in SA
1. The provisions of the Companies Act and
promulgated regulations
2. The common law (South African decided case law,
and in some circumstances relevant English law
decisions)
3. All other relevant statutes (for example, the Basic
Conditions of Employment Act 75 of 1997, the
Employment Equity Act 55 of 1998, and the
Promotion of Access to Information Act 2 of 2000)
4. The King Code of Corporate Practices and Conduct
(the King Code), and
5. The JSE Securities Exchange Rules for listed
companies.
