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Int. Acc. FA LECT 4: CH 15 part 1: Equity (Equity-IPO (Underwriters assist…
Int. Acc. FA LECT 4: CH 15 part 1: Equity
Equity-IPO
Underwriters assist companies in IPOs
After the IPO, shares trade freely in the open market
To become public, firms issue shares in an IPO (initial
public offering)
A company selling shares is never required to repay the capital to its public investors
Focus is on public companies
Advantages:
raise capital, monetize investments of early private investors, become a traded enterprise
Disadvantage
: costs, disclosure requirements, stronger agency problems
In large corporations, equity generally consists of a large number of units or shares
Identify different share types
“Ordinary shares”
represent the basic ownership interest
Residual corporate interest that:
Bears the risks of
losses
, and;Receives the
benefit
s of success
Some companies offer two or more classes of shares
One class remains “
ordinary
” (often “Class A”)
Different rights/ privileges for “
preference
” shares (often “Class B”)
Within a given class of shares, each share exactly equals every other share.
Each share has rights and privileges
To share proportionately in management (the right to vote)
To share proportionately incorporate assets upon liquidation
To share proportionately in profits and losses
To share proportionately in new issues of shares
Preference shares
Sacrifice certain basic rights in return for other special rights
Preferred dividends: prior claim on earnings
Sacrifice voting rights
Alternatively: more voting rights per share.
NOTE
: Dual class shares are not always allowed (the Hong Kong stock exchange prohibits this, reason why Alibaba is listing in the US).
Identify the key components of equity.
Equity = residual interest in the firm’s assets after deducting all liabilities
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Explain the accounting procedures for issuing shares
.
Share issues
Enron overstated assets and equity by $1 billion in total by improperly accounting for share issues.
Even though accounting is standardized due to IFRS rules, local governmental rules still affect the accounting procedures taken
Par value
Usually very low amount (for example: EUR0.01, US$0.0001)
In many countries no-par shares are also allowed
No relation with fair value of the shares
No par-value, then often a stated value
Issuance of par-value shares – company maintains accounts for:
Preference shares or ordinary shares
Share premium (agio)
: the excess over par value paid
by shareholders in return for the shares issued to them.
Costs of issuing shares:
Direct costs: underwriting costs, accounting/legal fees, printing
costs, taxes, ...
Reduction of the amounts paid in --> debit to Share Premium
Lump-sum sales
issuing two or more classes of securities for a single payment.
Proportional method:
allocate lump sum on a proportional basis of fair values.
Incremental method:
allocate first to securities with known fair value, rest to the class without fair value.
Shares issued in non-cash transactions
: shares are issued in exchange for services or property other than cash.
If FV of goods/services can’t be measured reliably, record
at FV of shares.
If both are unavailable: use alternative valuation method (e.g., market data or discounted cash flow approach). Avoid using book/par/stated values.
Record shares at fair value of goods/services.