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The Statutory Reserves, and How they Arise - Case Study Example

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This case study "The Statutory Reserves, and How they Arise" discusses shares how are bought back out of profits or the proceeds of a fresh issue of shares, and then the capital redemption reserve is increased by the amount of reduction to the share capital…
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The Statutory Reserves, and How they Arise
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(a) Looking at the above mentioned balance sheet, what are the sta y reserves, how did they arise and for what purposes could they be used' Capital redemption reserve (s. 733 CA 2006) If shares are bought back out of profits or the proceeds of a fresh issue of shares, then the capital redemption reserve is increased by the amount of reduction to the share capital.1 Where company shares are redeemed or purchased wholly out of a company's profits, the amount by which the company's issued share capital is reduced on cancellation of the shares which are redeemed or purchased or on cancellation of shares held as treasury shares must be transferred to the capital redemption reserve (CRR).2 If the shares are redeemed or purchased from the proceeds of a fresh issue and the total amount of those proceeds is less than the total nominal value of the shares redeemed or purchased, the difference in amount must be transferred to the CRR. However, this does not apply if the proceeds derived from the fresh issue are used by the company in making a redemption or purchase of its own shares in addition to a payment made out of its capital. The provisions of the Companies Act 20063 which relate to the reduction of a company's share capital apply as if the CRR were paid up share capital of the company. The exception to this is that the reserve may be applied by the company in paying up its unissued shares which are to be allotted to company members as fully paid bonus shares. Further, if the permissible capital payment exceeds the nominal amount of the shares redeemed or purchased, the amount of any capital redemption reserve, share premium account or fully paid share capital of the company, and any amount representing unrealised profits of the company for the time being standing to the credit of any revaluation reserve, may be reduced by a sum not exceeding, or by sums not in the aggregate exceeding, the amount by which the permissible capital payment exceeds the nominal value of the shares.4 Where, however, the proceeds of a fresh issue are applied by a company in making any redemption or purchase of its own shares in addition to a payment from its capital under these provisions, the references to the permissible capital payment are to be read as referring to the total amount of that payment and those proceeds. The CRR is mainly used to ensure that the company's capital is not reduced by the redemption of its shares. If the company was to redeem its shares, and the CRR was not used, then there would be a reduction in the company's capital in line with the reduction of the amount of shares redeemed. Although the CRR cannot be distributed out to shareholders by way of dividend in the same way that profits would be utilised, they would be available for issuing bonus issues of share capital should such a scenario arise. Accordingly, the CRR plays an important role in maintaining the value of the company, by both keeping shareholders of redeemable preference shares happy in allowing them to redeem their shares, while also keeping the other shareholders content as the value of the share capital in the company is maintained. This means that there shareholding will be in no way diminished as a result of the redemption. Revaluation Reserves Revaluation reserves arise when the value of an asset becomes greater than the value at which it was previously carried on the balance sheet, increasing shareholders funds.5 Not every increase in value is added to the revaluation reserve, and the exact treatment depends on the history of the asset. Revaluations are carried out when there is a material difference between the current market value of an asset and the value at which it is carried on the balance sheet. Revaluation reserves are not distributable, but may be used for scrip issues, where there is an issue of new shares to existing shareholders at no charge, pro rata to their existing shareholdings. A scrip issue is essentially when one shareholder moves their money from one account to another account belonging to the shareholders. The value of the shareholding remains the same, despite the increase in the number of shares that are actually held. Revaluations may also change their nature in the re-organisation of the company, as the movement of capital will obviously be altered due to this. This ensures that for accounting purposes the share capital is maintained after any transfer of capital has taken place. In this regard, the revaluation reserve operates in a similar manner to the capital redemption reserve in that it is not treated as an asset of the company in the same way profits or cash in hand would be treated. Once again, this reserve is used to balance the books and to ensure that shareholders and their capital are not affected by the revaluation. (b)Assume that the directors wish to redeem all the redeemable shares for '65,000 and for the purpose of the redemption they issue '15,000 shares of '1 each for '15,000, calculate the permissible capital payment that the company could lawfully make for the redemption. The company can raise funds to use to pay the seller for these shares out of capital under s.687 (1) and 692(1) of the Companies Act 2006 (CA 2006). This is only available for private companies under s. 709(1) CA 2006, as only they are permitted to fund a purchase of its own shares out of capital, confirmed under s. 692(1) CA 2006. First one must check to see if the company has any distributable profits available to fund the purchase. If it does in fact have distributable profits, those profits (or indeed funds from a fresh issue of shares for the same purpose) must first be used to fund the own share purchase before capital can be used under s. 710(1) CA 2006. If the directors conclude that a payment should be made out of capital, this view should be verified by the accountants. Provided that the above conditions have been fulfilled, the further documentation required to effect the payment out of capital is set out in s.713 CA 2006: - A written statement of solvency made by the directors of the company is needed. By making this statement, the directors of the company are stating that they believe that the company is able to pay its debts as they fall due from immediately after the payment out of capital is made and that it will continue to be able to do so for a period of 12 months (s.714(3)); - An auditors' report, which is annexed to the written statement (s.714 (6)); and - Within seven days of the directors making the written statement, a special resolution to approve payment out of capital is required (s.716 (1), (2). Redemption out of profits or out of funds from a fresh issue of shares6 A company's redeemable shares may be redeemed out of profits or out of funds from a fresh issue of shares for the purpose of the redemption, if the following conditions are met: - The articles of association of a private company must not exclude or restrict the issue of redeemable shares under s.684 (2) CA 2006). Under s.684 (3) CA 2006 only public companies are required to have an express authority in their articles to issue redeemable shares. - The company must also have non-redeemable shares in issue at the time of the redemption under s.684 (4) CA 2006. This is because if it did not, and the redeemable class of shares were redeemed by the company, the company would be left with no issued share capital. - The shares to be redeemed must be fully paid up under s.686 (1) CA 2006. - Section 685 CA 2006 provides that the terms of the redemption must be set out in the articles unless the articles or an ordinary resolution provide that the directors can determine the redemption rights attaching to such shares prior to their allotment. If the directors determine the redemption rights, these must be set out in the statement of capital (s. 685(3) (b), s.689 (3) CA 2006. - The redeemed shares are cancelled (s.688 CA 2006). - Notification must be sent to Companies House within one month of redemption together with a statement of capital (s.689 CA 2006). Again, only private companies are permitted to fund a redemption out of capital under s.687 (1) CA 2006. The terms of the redemption are set out in the company's articles of association or determined by the directors prior to the shares being allotted. With this in mind, the company must now work out what is the permissible capital payment. The Company has a Capital Redemption Reserve of '10,000, and has a Share Premium Account of '10,000. There is also '20,000 in the Profit and Loss Account. The Revaluation Reserve is '30,000. There is '50,000 worth of redeemable shares. Given this, if the directors want to redeem all the shares for 65,000, this then would require a revaluation of those shares upwards by '15,000. In light of this, the permissible capital paymen'50,000 as the company would not be allowed to alter its capital further by adjusting it in order to pay for the redeemable shares. The other '15,000 would then come either out of the cash at hand, or from a fresh issue of shares in order to complete the redemption. This would accordingly be a permitted capital payment under law. c) Prepare the revised balance sheet of Webb Ltd. after it uses its capital to redeem its shares under section 709 CA 2006. (You should show your workings) Balance Sheet of Webb Ltd ' FIXED ASSETS Premises 200,000 Fixtures 20,000 220,000 CURRENT ASSETS Stock 30,000 Debtors 40,000 Cash in hand 85,000 155,000 CURRENT LIABILITIES Creditors 40,000 Net assets 335,000 Financed by CAPITAL Ordinary shares of '1 each 205,000 Share premium account 10,000 Revaluation Reserves 30,000 Capital Redemption Reserves 60,000 Profit & Loss 20,000 Creditors amounts falling due after more than one year: 5% debentures of '1 each 10,000 335,000 To explain the revised balance sheet I undertook the following workings: 1. I took the '50,000 from the redeemed shares and added them to the Capital Redemption Reserves account, increasing the value from '10,000 to '60,000. 2. The issue of '15,000 ordinary shares for the price of '1 was added to the Ordinary Shares total, increasing this from 190,000 to 205,000. 3. This '15,000 was then added to the overall total capital in the company, increasing this from '320,000 to '335,000. 4. In the top half of the Balance Sheet, due to the '15,000 created by the issue of shares, I added this to the Cash in hand of the company, increasing this from '70,000 to '85,000. 5. Accordingly, this increased the Current Assets total from '140,000 to '155,000. 6. In calculating the Net Assets, this increased due to the extra '15,000 in current assets. The final figure in the Net Assets was increased from '320,000 to '335,000. 7. As a result, the top half and the bottom half of the balance sheet are equal to accurately reflect the increased value of the company. 8. Therefore, as a result of the transfer of shares from the directors to the Company, the company has accordingly increased the company's capital due to the fresh issue of shares in order to fund the purchase of those shares. (d) Webb Ltd wishes to redenominated the nominal value of some of its shares from sterling to euro, the steps it must take to effect the change The registrar1 must cause to be published in the Gazette2, or by some other means of giving public notice approved by the registrar3, notice of the receipt by the registrar of any document that, on receipt, is subject to the Directive disclosure requirements4. The notice must state the name and registered number of the company, the description of document and the date of receipt5. The documents subject to the 'Directive disclosure requirements' are as follows: statement of capital accompanying notice by company of redenomination of shares; statement of capital accompanying notice by company of reduction of capital in connection with redenomination of shares; Further, in representing the redenomination of the nominal value of the shares in the company from sterling to euro, the procedure is outlined in the Companies Act 2006. Under s469, which deals with the preparation and filing of accounts in euro, s469(1) gives the authority for the accounts to be translated into euro. Under s469(2), and in accordance with the duty to file accounts and reports, the directors of a company must then deliver to the registrar an additional copy of the company's annual accounts in which the amounts have been translated into euro. Further, under subsection (3), in both scenarios: (a) The amounts must have been translated at the exchange rate prevailing on the date to which the balance sheet is made up, and (b) That rate must be disclosed in the notes to the accounts. (4) For the purposes of sections 434 and 435 (requirements in connection with published accounts) any additional copy of the company's annual accounts delivered to the registrar under subsection (2) above shall be treated as statutory accounts of the company. In the case of such a copy, references in those sections to the auditor's report on the company's annual accounts shall be read as references to the auditor's report on the annual accounts of which it is a copy. Therefore, it is evident that it is imperative for these requirements to be complied with in order to ensure that the accounts are properly reflected in their proper currency when delivering them to the registrar. Further guidance as to what steps must be taken is provided by s766 CA 2006. This section governs the application of shares where they are denominated in a different currency. It states in s766 (1) CA 2006 that where a company: (A) Has shares denominated in more than one currency, (b) redenominates the whole or part of its allotted share capital, or (c) allots new shares. Then regulations may make provision as to the currencies, exchange rates and dates by reference to which it is to be determined whether the nominal value of the company's allotted share capital is less than the authorised minimum share capital of the company. Further under s 766 (3) CA 2006, the regulations provide that where: (a) a company has redenominated the whole or part of its allotted share capital, and (b) the effect of the redenomination is that the nominal value of the company's allotted share capital is less than the authorised minimum; Then the company must re-register as a private company. Therefore whenever a company carries out such a procedure as the one proposed by Webb Limited, it must be careful that in reducing the value of the company, it does not reduce its share capital beneath its authorised minimum, otherwise if it was a public company it would have to re-register as a private company, which would then considerably alter the direction and make-up of the company. Read More
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