Share Capital & Capital Reserves: Types, Accounting & Bonus Issues

1. Share Capital: Definitions and Classifications

Share capital is the fundamental source of equity financing for companies, representing the ownership interest of shareholders. It is classified into four key categories:

1.1 Types of Share Capital

1.2 Ordinary vs. Preference Shares

Mermaid Diagram: Shareholder Rights Flowchart

flowchart TD
    A["Shareholders"] --> B["Preference Shareholders"]
    A --> C["Ordinary Shareholders"]
    B --> D["Fixed Dividend\nNo Voting (usually)"]
    C --> E["Variable Dividend\nFull Voting Rights"]
    D --> F["Redeemable\nPriority in Liquidation"]
    E --> G["Non-Redeemable\nResidual Claims"]

2. Capital Reserves vs. Revenue Reserves

Reserves are accumulated profits or gains retained in the business. They are classified into two broad categories:

2.1 Capital Reserves

Source: Non-trading activities (e.g., premium on issue, revaluation surplus, profit on sale of assets). Usage: Cannot be distributed as dividends; used for bonus issues, capital expansion, or writing off losses.

2.2 Revenue Reserves

Source: Trading profits (e.g., general reserve, dividend equalisation reserve). Usage: Can be distributed as dividends (subject to legal limits).

Comparison Table: Capital vs. Revenue Reserves

3. Bonus Issues (Capitalisation of Reserves)

A bonus issue is a free distribution of shares to existing shareholders from capital reserves (e.g., securities premium, revaluation surplus). It increases share capital without raising new funds.

3.1 Accounting Treatment

Step-by-Step Journal Entries:

1. Transfer reserves to share capital account:

   Dr. Securities Premium Reserve A/c (Rs. X)
   Dr. Revaluation Surplus A/c (Rs. Y)
   Cr. Bonus Share Capital A/c (Rs. X + Y)
   

2. Allocate bonus shares to shareholders:
   • Example: 1 bonus share for every 4 held → Total bonus shares = (Bonus Share Capital / Face Value).

Worked Example: Kathmandu Retail Shop Ltd.

• Given:

  • Authorised capital: 100,000 shares of Rs. 100 each.
  • Issued capital: 80,000 shares (Rs. 8,000,000).
  • Securities premium reserve: Rs. 2,000,000.
  • Revaluation surplus: Rs. 1,000,000.
  • Decision: Issue 1 bonus share for every 2 held using reserves.

• Calculations:

  • Total bonus shares = (Rs. 3,000,000 / Rs. 100) = 30,000 shares.
  • New issued capital = 80,000 (existing) + 30,000 (bonus) = 110,000 shares.

• Journal Entries:

  Dr. Securities Premium Reserve A/c       2,000,000
  Dr. Revaluation Surplus A/c             1,000,000
       Cr. Bonus Share Capital A/c         3,000,000
  

• Adjusted Balance Sheet (Extract):

  Liabilities	Amount (Rs.)	Assets	Amount (Rs.)
  Share Capital (110,000 @ Rs. 100)	11,000,000	Fixed Assets	15,000,000
  Securities Premium Reserve	0	Current Assets	5,000,000
  Revaluation Surplus	0
  General Reserve	2,000,000

Mermaid Diagram: Bonus Issue Process

4. Rights Issues

A rights issue is an invitation to existing shareholders to subscribe to new shares at a discounted price. It helps companies raise capital without diluting control excessively.

4.1 Accounting Treatment

Step-by-Step Journal Entries:

1. Record application money (if received):

   Dr. Bank A/c (Rs. X)
   Cr. Share Application A/c (Rs. X)
   

2. Allot shares and transfer to share capital:

   Dr. Share Application A/c (Rs. X)
   Cr. Share Capital A/c (Face Value × Shares Allotted)
   Cr. Securities Premium A/c (Excess over Face Value)
   

3. Call-up remaining amount (if applicable):

   Dr. Share Capital A/c (Called-up Amount)
   Cr. Bank A/c (Amount Received)
   

Worked Example: Pathao’s Expansion (Hypothetical)

• Given:

  • Authorised capital: 500,000 shares of Rs. 100 each.
  • Issued capital: 400,000 shares (Rs. 40,000,000).
  • Rights Issue: 1 new share for every 5 held at Rs. 80 (Rs. 20 discount).
  • Total new shares: 80,000 (Rs. 8,000,000).

• Journal Entries:

  Dr. Bank A/c (Application Money)       6,400,000
       Cr. Share Application A/c         6,400,000
  
  Dr. Share Application A/c             8,000,000
       Cr. Share Capital A/c (80,000 × Rs. 100) 8,000,000
  

Comparison: Bonus Issue vs. Rights Issue

5. Real-World Applications

5.1 E-sewa’s IPO and Share Capital

• Concept Applied: Issued vs. Paid-up Capital
• How?
  • E-sewa’s IPO in 2021 issued 100 million shares at Rs. 100 each (authorised capital).
  • Only 80% (Rs. 800 million) was subscribed (issued capital).
  • Rs. 90 per share was called-up, with Rs. 85 paid (paid-up capital = Rs. 760 million).
  • The Rs. 5 premium per share (Rs. 40 million) went to Securities Premium Reserve.

5.2 Daraz’s Rights Issue for Expansion

• Concept Applied: Rights Issue
• How?
  • Daraz invited existing shareholders to buy 1 new share for every 3 held at Rs. 200 (vs. market price of Rs. 250).
  • Raised Rs. 1.2 billion for warehouse expansion in Nepal.
  • Journal Entry:

    Dr. Bank A/c (Application Money)       960,000,000
         Cr. Share Application A/c         960,000,000
    
    Dr. Share Application A/c             1,200,000,000
         Cr. Share Capital A/c (6,000,000 × Rs. 200) 1,200,000,000
    

5.3 Ncell’s Revaluation Reserve

• Concept Applied: Capital Reserve (Revaluation Surplus)
• How?
  • Ncell revalued its telecom towers from Rs. 5 billion to Rs. 7 billion (fair value).
  • Journal Entry:

    Dr. Fixed Assets A/c (Towers)          2,000,000,000
         Cr. Revaluation Surplus A/c       2,000,000,000
    

  • Used Rs. 1 billion for a bonus issue (1:1 ratio) to shareholders.

6. Exam Tip: How to Score Full Marks

1. Always show T-accounts for share capital and reserve transactions.

   • Example: For a bonus issue, show:

     Securities Premium Reserve A/c
     Dr.       Cr.
     2,000,000 | 2,000,000
     

2. Adjust the balance sheet after each transaction.

   • Show before and after extracts for share capital and reserves.

3. Calculate ratios correctly for rights issues:

   • Market Price × Rights Multiplier = Theoretical Ex-Rights Price.
   • Example: If market price = Rs. 120, rights = 1:1 at Rs. 100 → Ex-rights price = (120 + 100)/2 = Rs. 110.

4. Distinguish between capital and revenue reserves in explanations.

   • Use the source and usage rule:
     • Capital reserves = Non-operating gains → Cannot be distributed as dividends.
     • Revenue reserves = Operating profits → Can be distributed.

5. For numericals:

   • Bonus issue: Focus on reserve transfer and new share capital.
   • Rights issue: Calculate application money, allotment, and premium.
   • Example Question:

     "A company with 50,000 shares of Rs. 100 (Rs. 80 paid-up) has a securities premium of Rs. 1,000,000. It declares a 1:2 bonus issue. Show journal entries and the adjusted balance sheet." Solution:

     • Transfer Rs. 1,000,000 to bonus share capital (50,000 shares).
     • New shares: 25,000 (1:2 ratio).
     • Adjusted share capital: 75,000 shares of Rs. 100.

6. Common Pitfalls:

   • Forgetting to zero out premium/reserve accounts after transfer.
   • Miscounting bonus shares (e.g., 1:4 ratio means bonus shares = existing shares / 4).
   • Ignoring uncalled capital in balance sheet presentations.

7. Practice Questions (Exam-Style)

1. Bonus Issue:

   • XYZ Ltd. has 100,000 shares of Rs. 100 (Rs. 90 paid-up) and a securities premium of Rs. 2,000,000. It issues 1 bonus share for every 5 held. Show journal entries and the adjusted balance sheet.

2. Rights Issue:

   • ABC Co. invites shareholders to buy 1 new share for every 3 held at Rs. 80 (market price: Rs. 100). Applications for 90,000 shares are received. Show entries for:
     • Application money (Rs. 720,000 received).
     • Allotment of 80,000 shares.

3. Reserve Transfer:

   • A company has:
     • Share capital: 200,000 shares of Rs. 100 (Rs. 80 paid-up).
     • General reserve: Rs. 5,000,000.
     • Revaluation surplus: Rs. 3,000,000.
   • It decides to issue 1 bonus share for every 2 held using reserves. Show the journal entry and new share capital.