- This topic has 8 replies, 2 voices, and was last updated 5 years ago by
.
- Posts
1. What does ‘cancel paid-up capital that is no longer represented by the assets’ mean?
2. The book also talks about writing off a debit balance on the reserves using capital?
What does that mean?Thank you sir.
The BASIC fundamental accounting equation is that assets = capital + liabilities
Or, in another way, capital = net assets
Now, if that capital element of the statement of financial position is made up of shares £400,000 and reserves £(100,000), the net assets are £300,000
So we can say that the capital of £400,000 is no longer represented by net assets
The above figures also illustrate the situation where we have a debit balance in reserves.
To write off that debit balance would need the double entry:
Dr Share Capital Account £100,000
Cr Reserves Account £100,000
Can you see that we have written off a debit balance on reserves using capital?
OK?
1. Why does a negative figure in the reserve account indicate a debit balance?
2. And why is it that the amount in the reserves account are taken out of the capital?
I thought net assets = Total assets (NCA + CA) – current liabilities…
3. So does that mean reserve accounts are a liability account? – how so?
1) Because reserves are part of shareholders’ funds – in the same general category as share capital
They combined represent the amount of financing provided by the shareholders and, put another way, it’s the amount that the company owes the shareholders
Unlike a ‘provision’ that is ALWAYS a credit balance, ‘reserves’ would ideally also be always a credit balance.
But, unfortunately, companies may accumulate losses so that would lead to a debit balance on the reserves account
2) Following on from the above, when capital + reserves = the amount ‘owing’ to shareholders, why say effectively “We owe you $100,000 share capital but we have a negative figure of $25,000 in the reserves figure so we owe you a net $75,000”
3) You can work out the answer to that question from what I have just written!
OK?
So reserves are basically the proportion of shareholders funds that you owe to shareholders but just choose to keep right? How exactly are share capital and reserves different? I thought reserves increased if there’s greater profit?
1. What I understand so far is that shareholders funds, via share capital and reserves ( – I don’t get how this is different to share capital, i thought you can only gain funds from shareholders by issuing shares and the shareholders buying those shares – ) is the amount that the company owes to the shareholders not compulsory, but would be in the good interest to do so, otherwise they would lose interest in the company right? so thats why they issue dividends? to show strength and stability and to keep shareholders happy?
2. you get rid of reserves from shareholder capital because it is accumulated losses not accumulated gains – might sound like a stupid question, but it means that rather than the company having made profits it actually made realised losses, and therefore it effectively doesn’t have a reserve account, it just has a negative balance?
3. SO how is reserve and accumulated losses different to showing it as a negative figure in the retained earnings? i thought it was the retained earnings account that recorded accumulated realised losses and profits?
“So reserves are basically the proportion of shareholders funds that you owe to shareholders but just choose to keep right?” Yes
“How exactly are share capital and reserves different?” They are both amounts due to the shareholders but share capital tends to be a fixed amount and rarely changes whereas the reserves figure(s) vary each year as, for example, profits / losses are accounted for (and revaluations take place)
“I thought reserves increased if there’s greater profit?” And that’s why the amount representing shareholders’ funds increases … because the company has made some profits this year and that retained profit is credited to reserves and thus increases the amounts due to shareholders
“i thought you can only gain funds from shareholders by issuing shares and the shareholders buying those shares” so you thought wrong! The profits that are made and that increase the figure for shareholders’ funds are NOT ‘gaining funds from shareholders’ These are profits that the company has made ON BEHALF OF those shareholders using funds originally provided by those shareholders on the issue of shares by the company
“is the amount that the company owes to the shareholders not compulsory” I’m not sure where that question is leading – ie I’m not sure what you mean by ‘compulsory’
Your point 2 is, in its simple way, correct … except “you get rid of reserves from shareholder capital” would be better expressed as “you deduct accumulated losses in the reserves account from the accumulated figure for shareholders’ funds” – ok, effectively deduct from the figure for share capital
Your point 3 is valid – but where a company is looking to improve the picture shown by its statement of financial position, it certainly doesn’t likely wish to show the World (and potential investors) that it has performed so badly in the past that it has managed to accumulate these losses
So it will look to restructure and a major (if not THE major) objective in a reconstruction exercise is to eliminate that negative accumulated losses figure.
So, in double entry terms, Credit Accumulated Losses and Debit what??? It can only be shareholders’ funds (share capital)
Better?
1. So all of the profits are effectively owed to the members/shareholders of the company?
But if there has been an accumulated loss so that the reserve is a debit figure, this is basically saying we owe you profits but there’s a loss so we have a -ve liability I.e need to cover for the loss as well for you?2. Share holder capital is the issued capital gains which is used to generate profit for the shareholders – so even if not all the profit is given as dividends, all the profits are theoretically owed to shareholders?
3. If there’s net loss then the reserve account is a debit balance, so reduce that from share capital. If there is a net profit then the reserve account is a credit figure and so you add it to share capital to get shareholder funds?
Thank you very much sir for your help and patience
Point one, it means that the shareholders have made a poor investment – their company, managed by the directors that those shareholders have appointed, is not doing as well as they had hoped
Point two, yes. (Beware using expressions like “capital gains” – this is an expression more normally / usually associated with taxation!)
Point three, yes
OK?
- You must be logged in to reply to this topic.