Lesson 3 — Limited Companies: Share Capital and Financing
Types of Shares · Debentures · Share Issues · Rights Issues ·
Bonus Issues · Equity in the SFP |
Cambridge A Level Accounting 9706
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📌 Prerequisites: You should understand the basic concept of
capital from O Level — the idea that businesses need funding to operate.
This lesson introduces the unique financing structure of limited companies,
which is fundamentally different from sole traders and partnerships.
No prior knowledge of company accounting is assumed.
1. What is a Limited Company?
9706 / 3.1
A limited company is a business that has a legal identity
separate from its owners (shareholders). The company can own assets, incur
liabilities, enter contracts and sue or be sued — entirely in its own name.
The owners' personal assets are protected — their liability is
limited to the amount they invested.
Limited Liability: If the company fails and cannot pay its
debts, shareholders lose only what they paid for their shares. Their personal
savings, homes and other assets cannot be seized to pay company debts. This
makes companies attractive to investors and enables large-scale capital raising.
Two Types of Limited Company
Private Limited Company (Ltd)
Shares cannot be offered to the general public
Shares transferred only with agreement of other shareholders
Smaller — often family businesses
Less regulatory burden
Example: most small/medium businesses in Pakistan
Public Limited Company (Plc)
Shares can be bought and sold on a stock exchange
Can raise very large amounts of capital from the public
More regulatory requirements and disclosure obligations
Subject to greater public scrutiny
Example: listed companies on Pakistan Stock Exchange
📌 Cambridge Exam Focus: Questions refer to companies
generically — you do not need to distinguish between Ltd and Plc unless
the question specifically asks. Focus on the accounting treatment which
is the same for both types.
2. Share Capital — Key Terminology
Must Know
Understanding the terminology of share capital is essential — Cambridge
questions use these terms precisely and expect precise answers.
Term
Definition
Example
Nominal Value (Par Value / Face Value)
The fixed face value printed on the share certificate. Does not change regardless of market price.
$1 ordinary share — nominal value = $1
Authorised Share Capital
The maximum number of shares the company is legally permitted to issue, as stated in its constitution. Not recorded in the double entry system.
Authorised: 1,000,000 ordinary shares of $1 each = $1,000,000
Issued Share Capital
The number of shares actually issued to shareholders. Always ≤ Authorised. This IS recorded in the accounts.
Issued: 600,000 ordinary shares of $1 each = $600,000
Called-up Share Capital
The amount of the issue price that has been demanded from shareholders. May equal or be less than issued capital.
600,000 shares, $0.75 called up = $450,000
Paid-up Share Capital
The amount actually received from shareholders. May be less than called-up if some shareholders have not paid.
$450,000 called up − $5,000 calls in arrears = $445,000
Issue Price
The price at which shares are offered. Usually above nominal value — the excess is the share premium.
$1 nominal share issued at $1.50 — premium = $0.50
Share Premium
The excess received above nominal value on share issue. Shown as a separate reserve in equity — NOT distributable as dividend.
The current price at which shares trade on the stock market. Changes daily. Not recorded in the company's accounts.
$1 nominal share may trade at $3.20 on the stock exchange
3. Types of Shares
9706 / 3.1
Companies issue different types of shares to attract different categories
of investor. The two main types examined at A Level are ordinary shares
and preference shares.
Ordinary Shares (Equity Shares)
The most common type — the owners of the company
Dividend is not fixed — paid at directors' discretion
Receive dividends after preference shareholders
Receive assets on liquidation last (residual claim)
Carry voting rights — elect directors
Benefit most when company is profitable
Bear the most risk
Preference Shares
Receive a fixed percentage dividend before ordinary shareholders
Priority over ordinary shares in dividend payment
Priority over ordinary shares in liquidation
Usually no voting rights
Less risk than ordinary shares — but less upside
Cumulative: unpaid dividends accumulate and must be paid before ordinary dividends
Non-cumulative: unpaid dividends are lost
Important: Preference shares are part of equity
in the Statement of Financial Position — not a liability — unless they are
redeemable preference shares (which create an obligation to repay, making
them more like debt). Standard preference shares sit in the equity section.
Cumulative vs Non-Cumulative Preference Shares
📋 Example 1: Cumulative Preference Dividends
A company has 200,000 8% cumulative preference shares of $1 each.
No dividend was paid in 2024 or 2025. In 2026, the company pays all
arrears and the current year dividend.
Only after paying all $48,000 to preference shareholders can any dividend
be paid to ordinary shareholders.
💡 In the SFP: Cumulative preference dividends in arrears
must be disclosed as a note — they are not a liability until declared,
but users need to know about them. They are deducted from retained
earnings when calculating distributable profits.
4. Debentures and Loan Capital
9706 / 3.1
As well as issuing shares, companies can raise long-term finance by
borrowing. Debentures are the main form of long-term
borrowing for limited companies.
Debenture: A long-term loan made to a company, evidenced
by a certificate, carrying a fixed rate of interest that
must be paid regardless of profit. Debenture holders are creditors
— not owners — and have priority over all shareholders in liquidation.
Shares vs Debentures — Key Differences
Feature
Ordinary Shares
Preference Shares
Debentures
Nature
Equity (ownership)
Equity (ownership)
Liability (debt)
Return
Variable dividend
Fixed % dividend
Fixed % interest
Return charged to
Appropriation of profit
Appropriation of profit
Income Statement (expense)
Tax treatment
Not tax deductible
Not tax deductible
Tax deductible expense
Voting rights
Yes
Usually no
No
Priority in liquidation
Last
Before ordinary
Before all shareholders
SFP position
Equity section
Equity section
Non-current liability
Repayment
Not repaid (permanent)
May be redeemable
Repaid on maturity date
📌 Critical Exam Point: Debenture interest is an
expense — it appears in the Income Statement before tax and
reduces profit. Share dividends are an appropriation of
profit — they appear after profit has been calculated, never as
an expense. Confusing these two is a very common exam mistake.
5. Issuing Shares at a Premium
Core Topic
When a company issues shares above their nominal value, the excess is
called the share premium. This is the most commonly examined
share issue in Cambridge Paper 3.
Share Issue — Double Entry
DR Bank (or Application and Allotment A/c) — with total receivedCR Share Capital — with nominal value × shares issuedCR Share Premium — with excess above nominal value × shares issued
📋 Example 2: Issue of Shares at a Premium
Karachi Industries Ltd issues 500,000 ordinary shares
of $1 nominal value at $1.60 per share.
All shares are fully subscribed and paid immediately.
Being issue of 500,000 ordinary shares of $1 at $1.60 per share,
fully paid.
Equity section of SFP after the issue:
Extract — Equity Section
Share Capital and Reserves$
Ordinary share capital (500,000 shares × $1)500,000
Share premium account300,000
Total equity800,000
Share premium cannot be used to pay dividends.
It can only be used for: (1) issuing bonus shares; (2) writing off
preliminary expenses; (3) writing off share issue costs. Cambridge
frequently tests this restriction.
6. Rights Issue
9706 / 3.1
A rights issue offers existing shareholders the right to
buy additional new shares, usually at a discount to the current
market price, in proportion to their existing holdings.
Why a Rights Issue? It raises new cash for the company
while giving existing shareholders the opportunity to maintain their
proportional ownership. It is cheaper than a full public offer because
underwriting costs are lower and marketing is minimal.
Rights Issue — Key Terms
Ratio: e.g. "1 for 4" means 1 new share for every 4 already heldIssue Price: below current market price — attractive to shareholdersTheoretical Ex-Rights Price (TERP) = (Market value of old shares + Rights issue proceeds) ÷ Total shares after issue
📋 Example 3: Rights Issue
Lahore Steel Plc has 4,000,000 ordinary shares of
$0.50 nominal value in issue, currently trading at $2.40
per share. The company makes a 1 for 4 rights issue
at $1.80 per share.
New shares issued: 4,000,000 ÷ 4 = 1,000,000 shares
Cash raised: 1,000,000 × $1.80 = $1,800,000
Share capital increase: 1,000,000 × $0.50 = $500,000
Ordinary Share Capital (1,000,000 × $0.50)$500,000
Share Premium (1,000,000 × $1.30)$1,300,000
Being 1 for 4 rights issue of 1,000,000 ordinary shares of $0.50
at $1.80 per share, fully paid.
Theoretical Ex-Rights Price (TERP):
Value of 4 existing shares: 4 × $2.40 = $9.60
Plus rights issue price: $1.80
Total value of 5 shares: $11.40
TERP = $11.40 ÷ 5 = $2.28 per share
💡 TERP in the exam: The TERP is the theoretical price
after the rights issue. It falls below the pre-issue market price because
new shares were issued at a discount. Shareholders who take up their rights
are no worse off overall — they gain shares below market price. Those who
do not take up rights suffer dilution.
A bonus issue gives existing shareholders additional
free shares in proportion to their current holdings. No cash is
raised — instead, reserves (typically share premium or retained
earnings) are converted into permanent share capital.
Why a Bonus Issue? (1) Reduces the market price per share
— making shares more affordable and increasing trading liquidity. (2)
Converts distributable reserves into non-distributable share capital —
signalling that the company intends to retain these funds permanently.
(3) Rewards shareholders without cash outflow.
Bonus Issue — Double Entry
DR Share Premium Account (preferred source) — with total bonusDR Retained Earnings (if share premium insufficient) — with remainderCR Ordinary Share Capital — with nominal value × bonus shares issuedNote: NO cash movement. NO change in total equity.
📋 Example 4: Bonus Issue
Islamabad Holdings Ltd has the following equity before a bonus issue:
Equity Before Bonus Issue
Ordinary share capital (2,000,000 × $1)2,000,000
Share premium account800,000
Retained earnings1,200,000
Total equity4,000,000
The company makes a 1 for 4 bonus issue using the
share premium account first, then retained earnings if needed.
From share premium: $500,000 (share premium has $800,000 — sufficient)
Journal Entry — Bonus Issue
Share Premium Account$500,000
Ordinary Share Capital (500,000 × $1)$500,000
Being 1 for 4 bonus issue of 500,000 ordinary shares of $1 each,
funded from share premium account.
Equity After Bonus Issue
Ordinary share capital (2,500,000 × $1)2,500,000
Share premium account (800,000 − 500,000)300,000
Retained earnings (unchanged)1,200,000
Total equity (unchanged at $4,000,000)4,000,000
Critical observation: Total equity is exactly
the same before and after the bonus issue — $4,000,000. The
bonus issue simply reclassifies reserves into share capital. No value
is created or destroyed. Each shareholder has more shares but each
share is worth proportionally less.
8. The Equity Section of the Statement of Financial Position
The equity section of a company's SFP looks very different from a sole
trader's capital section. It has multiple components and a specific order
of presentation.
Proforma — Equity Section of Company SFP
Equity$
Ordinary share capital (X shares × $Y nominal)X
8% Preference share capital (X shares × $Y nominal)X
Total share capitalX
Share premium accountX
General reserveX
Retained earningsX
Total equityX
📌 Order matters in the exam:
Share capital always appears first, then share premium, then other
reserves, then retained earnings last. Debentures appear in
Non-Current Liabilities — never in the equity section.
📋 Example 5: Full Equity Section
Prepare the equity section of the SFP for Punjab Manufacturing Ltd
from the following information:
Authorised: 5,000,000 ordinary shares of $0.50 each
Issued and fully paid: 3,000,000 ordinary shares of $0.50 each
500,000 6% preference shares of $1 each, fully paid
Share premium: $420,000
General reserve: $150,000
Retained earnings: $380,000
8% Debentures $200,000 (repayable 2030)
Punjab Manufacturing Ltd — Equity Section
Equity$
Ordinary share capital (3,000,000 × $0.50)1,500,000
6% Preference share capital (500,000 × $1)500,000
Total share capital2,000,000
Share premium account420,000
General reserve150,000
Retained earnings380,000
Total equity2,950,000
Non-Current Liabilities$
8% Debentures (repayable 2030)200,000
💡 Note: The authorised share capital
(5,000,000 × $0.50 = $2,500,000) does not appear
in the SFP. Only the issued share capital is recorded in the accounts.
Authorised capital may be disclosed as a note to the accounts.
9. Memory Aids & Common Mistakes
🧠 Memory Aid — Share Issue Double Entry
Always split the proceeds:
Total cash received → DR Bank
Nominal value portion → CR Share Capital
Excess (premium) portion → CR Share Premium
Check: CR Share Capital + CR Share Premium = DR Bank ✓
🧠 Memory Aid — Bonus Issue
"Free shares — no cash"
DR a reserve (Share Premium first, then Retained Earnings)
CR Share Capital
Total equity stays the same — only the split changes.
⚠️ Mistake 1 — Debiting debenture interest to appropriation:
Debenture interest is an expense in the Income Statement —
it reduces profit before tax. Dividends are appropriations of profit after
tax. Never put debenture interest below the profit line.
⚠️ Mistake 2 — Including authorised share capital in SFP:
Only issued share capital appears in the SFP and the
double entry system. Authorised share capital is a legal maximum — it
is disclosed in the notes only, never in the main statements.
⚠️ Mistake 3 — Using share premium to pay dividends:
Share premium is a non-distributable reserve. It can
only be used for a bonus issue, writing off formation expenses, or
share issue costs. It can never be used to pay dividends to shareholders.
⚠️ Mistake 4 — Bonus issue increases total equity:
A bonus issue does not increase total equity — it only
reclassifies reserves into share capital. Total equity before and after
a bonus issue is identical. If your totals change, an error has been made.
⚠️ Mistake 5 — Placing debentures in equity:
Debentures are liabilities — they appear in
Non-Current Liabilities in the SFP, not in the equity section.
Only shares (ordinary and preference) form part of equity.
📝 Exam Practice Questions
Question 1Knowledge — 3 marksPaper 1
State three differences between ordinary shares
and debentures.
Any three of the following (1 mark each):
Ordinary shareholders are owners of the company;
debenture holders are creditors (lenders).
Ordinary shares receive a variable dividend at
directors' discretion; debentures receive a fixed rate of
interest which must be paid regardless of profit.
Ordinary dividends are an appropriation of profit;
debenture interest is an expense in the Income Statement.
Ordinary shares appear in the equity section of
the SFP; debentures appear as a non-current liability.
In liquidation, debenture holders are repaid before
ordinary shareholders who have a residual claim only.
Ordinary shareholders usually have voting rights;
debenture holders do not vote at company meetings.
Question 2Application — 6 marksPaper 3
Sindh Textiles Ltd has 2,000,000 ordinary shares of $0.50 nominal
value in issue. The company makes a 1 for 5 rights issue
at $1.20 per share. All rights are taken up.
(a) Calculate the number of new shares issued and the cash raised.
(b) Prepare the journal entry to record the rights issue.
(c) Show the equity section of the SFP after the rights issue, given
that before the issue: share premium was $180,000 and retained
earnings were $350,000.
DR Share Premium $250,000
CR Ordinary Share Capital $250,000 Being 1 for 4 bonus issue of 1,000,000 shares of $0.25 funded from share premium
(1 mark)
Equity after bonus issue:
Ordinary share capital (5,000,000 × $0.25)
1,250,000
Share premium (600,000 − 250,000)
350,000
Retained earnings (unchanged)
900,000
Total equity (unchanged)
2,500,000
(2 marks — 1 for correct share capital, 1 for confirming total equity unchanged)
Question 4Analysis — 4 marksPaper 1
Explain why a company might choose to make a bonus issue
rather than a rights issue when it wants to restructure
its share capital. Include in your answer the effect on total equity of
each type of issue.
A rights issue raises new cash from shareholders
by selling them additional shares at a discounted price. Total equity
increases by the cash received. (1 mark)
A bonus issue does not raise any new cash — it
simply converts existing reserves (share premium or retained earnings)
into permanent share capital. Total equity is unchanged by a bonus
issue. (1 mark)
A company would choose a bonus issue over a rights issue when it
does not need additional cash — for example when it wishes to reduce
the market price per share to make shares more affordable and improve
trading liquidity, or when it wishes to signal to the market that
certain reserves are being made permanent. (1 mark)
A bonus issue is also more shareholder-friendly in that it does
not require shareholders to spend money — they simply receive
additional shares for free in proportion to their existing holding,
maintaining their proportional ownership without any cash outflow.
(1 mark)
Question 5Analysis — 3 marksPaper 3
A company has 10% cumulative preference shares of $1 each with
a total value of $500,000. No preference dividend has been paid
for the last two years (2024 and 2025). In 2026,
the company makes a profit and the directors wish to pay an ordinary
dividend of $80,000.
Calculate the minimum amount that must be paid
to preference shareholders before any ordinary dividend can be paid,
and state the accounting treatment for dividends in arrears.
Annual preference dividend:
$500,000 × 10% = $50,000 per year (1 mark)
Arrears (2024 + 2025):
$50,000 × 2 = $100,000
Current year (2026): $50,000
Minimum total to preference shareholders:
$100,000 + $50,000 = $150,000 must be paid before
any ordinary dividend. (1 mark)
Accounting treatment of arrears:
Cumulative preference dividends in arrears are not recorded
as a liability until they are formally declared by the
directors. However, they must be disclosed in a note
to the financial statements so that users are aware of the obligation.
(1 mark)