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Equity Components and Capital
Increases in Companies
The Basic Composition of Equity
Capital
Capital is a fundamental item in the shareholder's equity category, representing the finance provided by the owners. The 'capital' account can be governed by two criteria: variability and invariability.
Variability means the "capital" account can be modified simply by making an accounting entry, without the need to fulfill any prior formal requirements. This situation occurs in sole proprietorship enterprises.
In contrast, invariability means a series of formal requirements must first be met as established in legal regulations. This is the case of trading companies.
Profit (Loss) and its Application
The other basic component of equity is the profit (loss) that a business makes through its activities, boosting (reducing) the value of its equity. A business' profit can be distributed to shareholders/owners, which is known as the application of the profit (loss). This type of operation is governed by a series of legal provisions if the titleholder of the business is a legal entity.
The application of the profit (loss) is accounted for in the financial year following the one to which the profit (loss) relates. In trading companies, both the capital and the application of the profit (loss) are legally regulated.
Share Capital: Setting-up
The criterion of invariability rules for share capital, meaning certain formal requirements must be met for the capital to be modified:
The approval of increases or reductions at general meetings. A public deed before a notary recording the above agreement. Registration at the Companies Registration Office.
Partner or shareholder contributions to the capital include sums of money and other goods or entitlements (non-monetary contributions). The capital is divided into parts, each representing an aliquot share of the total amount, called shares in the case of public limited companies and membership interests in the case of limited liability companies.
Limited Liability Company
In a limited liability company, the parts into which the capital is divided are known as membership or owner interests. The capital must be fully subscribed and fully paid up both when the company is incorporated and in any subsequent increase to the capital. The minimum capital required for incorporation is 3,000.
Public Limited Company
In a public limited company, the parts into which the capital is divided are known as shares, and the owners of shares are known as shareholders. The capital must be fully subscribed when both the company is incorporated and in any subsequent capital increases. A minimum of 25% of the capital must be paid up when the company is incorporated and in subsequent capital increases.
Share Premium in Capital Increases
When a company's share capital is increased, the new shares can be issued at a price equal to or above the nominal or face value. This premium is known as the share premium.
The theoretical share value, which represents a measure of the value of the shares depending on the value of the company's equity, can be calculated as: Theoretical share value = Equity / number of shares
To avoid the dilution effect that can occur with a capital increase, the issue price can be established by adding a premium to the face value, known as issuing the new shares at a premium.
Accounting for Share Premium
The accounting record of a capital increase with a share premium is as follows: - The share premium must be fully paid up, unlike the face value of shares. - The adjusted share premium must be set by taking the difference between the theoretical share value before the capital increase and the nominal value.
Application of Profit (Loss)
The company administrators make a proposal for the distribution of the profit, which must be approved at an annual general meeting, together with the annual accounts for the financial year.
The order of application of the profit is as follows: 1. Legal reserve 2. Special reserves 3. Offset losses from previous financial years 4. Statutory reserves 5. Voluntary reserves
Dividends can only be distributed if the value of the equity is not lower than that of the share capital or lower once the dividends have been distributed.
