Question

Berry Ltd is a public retail company that is currently expanding their operations. In order to do this, the directors need a substantial injection of cash to finance the new development.

Required:

You have been asked as the graduate accountant, to prepare a report to the board of directors summarising the major differences between the company raising funds by a share issue versus the issue of debentures.

Include in your report the different effects each choice would have on the financial statements, what advantages (if any) each choice would provide the company and what financial commitments the company would be liable for under each option.

Answer 1

Shares and debentures both are ways to raise capital however debentures are borrowed capital whereas shares are a portion of the company’s capital itself. Covered ahead are their key differences between shares and debentures for your understanding.

Shares are small divisions of a company’s capital. When a company goes public for the first time and gets listed on the stock exchanges to raise capital from the market, investors buy a share or number of shares in the company.

Purchasing the shares gives shareholders entitlement to the ownership of the company. In other words, you become owners of the company in proportion to the percentage of shares you own. Shareholding of 50% or more makes the shareholders the biggest owners of the company whereas other shareholders get an entitlement to the ownership.

As shareholders of the company, you are entitled to dividend payouts given in a certain regular fashion. The dividend payouts can come only if the company is recording profits. Otherwise, shareholders can participate in trading in the stock market to get some value out of their investment.

Shareholders are part owners of the company. They got voting rights in the company, a share of the profits in the form of dividends however being the owners in the company they do stand to lose if the company is in debt or has to go for liquidation as the owners of the company, no matter their contribution is paid out last.

Debentures are long term debt instruments that a company issues under its seal. One difference between share and debentures is that debentures become borrowed capital for the company. It is like a loan that a company has taken from the debenture holders which is supposed to pay back with interest in due time.

If you have invested in the company’s long term debt instruments and in effect lending money to the company, you get paid in the form of interest in regular intervals. The interest payments come over and above the company’s profit so they won’t get held back if the company is running in losses.

Debenture holders are creditors to the company. The money invested by debenture holders is basically borrowed capital for the company that it has to pay back with regular interest. This makes debenture holders creditors to the company and at a higher status than shareholders.

This means that if the company runs into major debts and is going under liquidations, the creditors of the company including banks, debenture holders, and others will be paid off first. Shareholders are given the last priority. However, unlike shareholders, debenture holders do not get voting rights. This is a major feature that can help you distinguish between shares and debentures.

Shares and debentures are very different in their structure and characteristics. If you distinguish between shares and debentures, both are superior in their own ways. While shares give you a share in the profits, debentures give you priority in the case the company is getting wound up. Both are ways to be invested in a company are at two fags ends of a curve. Understand your own personal investment profile and choose what suits you best.

The issue of debentures is suitable in the situation when the sales and earning are relatively stable.Debentures do not carry voting rights, financing through debentures does not dilute control of equity shareholders on management.