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February 24, 2020 at 11:25 am
why dont we include reserves in equity while using market values
John Moffat says
February 24, 2020 at 2:15 pm
Because the most obvious reason that the market value is higher than the nominal value is because the company has made profits. Effectively the market value includes the retained earnings (and I do say this in my lectures).
July 28, 2020 at 10:04 pm
I have the same question. Even though I watched your lecture and read your comment here, I still don’t understand why we don’t recalculate the Reserves with effect of market value. I don’t understand why market value includes the reserves. The reserves on Financial Position St is $130,000 meanwhile the Share Capital (10c per share) has nominal value of $10,000. (the reserves value > share capital value, does it mean the reserves is the money saved from many years?). Could you please explain in detail with numbers or in another way easier to help me understand why the Equity included reserves already? I guess because I don’t know the basics and don’t understand the financial positions thoroughly. Please help me!!!
July 29, 2020 at 8:49 am
You will know from Paper FA (was F3) that the SOFP does not show the true value of a business – the non-current assets are shown at cost less depreciation which is not the same as the true value, and internally generated goodwill does not appear on the SOFP. The true value of the equity is what investors are willing to pay for the shares in the business i.e. the market value of the shares.
July 29, 2020 at 4:19 pm
Thank you so much John!!!! I’ll watch FA videos too. For this specific example though, the market value is what investors are willing to pay for the shares. Here the number of shares is 100,000 shares and market value is $2.2 per share. So it means this $220,000 equity will partly used for paying dividends and the remaining is retained as Reserves. (Am I correct? is this what you mean from market value includes REs?) So on the SOFP, the Reserves is $130,000 is this accumulated REs or Opening REs…..? what is the role of this number, so we just ignore it?
July 29, 2020 at 5:02 pm
No. You should remember from Paper FA (was Paper F3) or whatever exempted you from it, that the reserves are simply the total profits that have been retained in the company (i.e. not paid out as dividend). However the figures that appear in the SOFP (and in the SOPL when calculating the profit) do not represent the real position of the business.
Let me give you just one example. Suppose the business bought a building 20 years ago for $10,000. It will have been depreciated and suppose that the net book value (which is what appears on the SOFP) is now only $4,000.
It could be that the building is actually worth now $100,000. However this higher value will not appear in the SOFP and this ‘profit’ will not appear in the reserves either. However, if you were buying shares in the company you would regard to the company as being worth more than the figures that appear in the SOFP.
This is only one tiny example. The main reason the market value of shares is what it is, is because it is based on the future dividends that shareholders expect to receive. If they think the company is going to pay higher dividends in the future then they will pay more for the shares. (This is all explained in the later lectures on the valuation of shares).
The main point here is that the figures on the SOFP are not showing the ‘true’ value of the business at all, and never do.
June 1, 2019 at 9:36 am
Why do we take 100000 debentures when calculating the gearing? The second formula says ordinary share capital + reserves? Thnx 🙂
June 1, 2019 at 11:56 am
Debentures are long term debt borrowing, and both formulae for gearing include long-term debt. Gearing is a measure of the proportion of long-term debt!
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