Question

Merliss Company (a specialty bike-accessory manufacturer) is expecting growth in sales of some products targeted to the low-price market. Merliss is contemplating a preference share issue to help finance this expansion in operations. The company is leaning toward preference shares because ownership will not be diluted, but the investors will get an extra dividend if the company does well. The company management wants to be certain that its reporting of this transaction is transparent to its current shareholders and wants you to research the disclosure requirements related to its capital structure.

Instructions If your school has a subscription to the FASB Codification, go to http://aaahq.org/ascLogin.cfm to log in and prepare responses to the following. Provide Codification references for your responses.

(a) Identify the authoritative literature that addresses disclosure of information about shareholders’ equity.

(b) Find definitions of the following:

(1) Securities.

(2) Participation rights.

(3) Preferred stock.

(c) What information about securities must companies disclose? Discuss how Merliss should report the proposed preferred stock issue.

Answer 1

Part a:

The financial statements of an organization comprise of the following statements:

1. Income statement.
2. Statement of financial position, i.e. Balance sheet.
3. Statement of cash flow.
4. Statement of changes in equity.
5. Notes to accounts.

The statement of changes in equity contains all necessary information about the stakeholders’ equity. The statement contains information about the number of equity shares issued and outstanding as on a particular date, the paid up and face value of each equity share, the number of preference shares issued and the face value of these shares, the excess paid up capital and the amount of retained earnings. Each of this information is essential for the users of the financial statements to understand the position of an organization as far as the shareholders’ equity is concerned.

Part b:

Securities: Securities refer to the equity shares which an organization issue to the general public for accumulation of required capital to finance the business and its operations. Each security, i.e. equity share, represents a part of ownership of an organization. Thus, the investors who invest in the securities of an organization are the owners of the organization represented by the number of shares or securities they have acquired.

Participation right: Participation right is the right of the equity and preference shareholders of an organization in the profits of an organization while the organization is in business and at the time of liquidation of the organization the right to receive the capital.   

Preferred stock: The preferred stock is the shares and securities which have preferential right over the common shares at the time of payment of dividend as well as repayment of capital.

A company must disclose the following information about securities:

1. The number of shares authorized to be issued by the organization both common as well as preference shares.
2. The number of shares issued both common and preference shares along with face value and paid up value of the company.

In case of any shares on which there is any amount due from the investor the fact shall also be disclosed.