Why does a company issue shares?
Imagine a bakery that wants to open a second shop but doesn’t have enough cash. Instead of borrowing money, it sells a slice of ownership to friends. Companies do the same – they raise money by selling pieces of ownership called shares.
💡 In Simple Words: When a company needs cash, it can create and sell shares. Each share is a tiny ownership token that gives the holder a right to a part of the profit.
What is a share?
A share is a unit of ownership in a company. Think of it like a single Lego brick that, when combined with many others, builds the whole structure. Owning a share means you own a small part of the business and may receive a portion of its earnings called dividends.
Types of shares a company can issue
- Equity shares – also called ordinary shares. They give voting rights and a claim on profits.
- Preference shares – these give a fixed dividend before equity shareholders get anything, but usually no voting rights.
- Bonus shares – free shares given to existing shareholders from the company’s reserves.
- Rights shares – offered to existing shareholders at a discount to raise fresh capital.
Steps in issuing shares (the share issue process)
The journey from decision to cash in the bank follows a clear sequence. Below is a simple flowchart that shows the main milestones.
Journal entries for a share issue
When shares are issued, the accountant records the transaction in the books. The basic entry looks like this:
- Debit (increase) Bank – cash received from shareholders.
- Credit (increase) Share Capital – the nominal (face) value of shares issued.
- If shares are issued at a price above nominal value, the excess is credited to Share Premium – an extra reserve.
Example entry for 1,000 equity shares of ₹10 each issued at ₹15:
Bank Dr ₹15,000 To Share Capital ₹10,000 To Share Premium ₹5,000
Worked example: issuing 500 rights shares
Acme Ltd wants to raise ₹2,00,000. It has 10,000 equity shares of ₹10 each. It decides to issue rights shares at a 25% discount (₹7.50 per share). How many shares will be issued and what will be the journal entry?
- Calculate number of shares: ₹2,00,000 ÷ ₹7.50 = 26,667 shares (rounded to nearest whole share).
- Journal entry:
Bank Dr ₹2,00,000 To Share Capital ₹2,66,670 (26,667 × ₹10) To Share Premium -₹66,670 (adjusted to balance)
Because the nominal value is higher than the issue price, the excess is recorded as a discount on share capital, which reduces the Share Capital account.
Comparison of share issues
| Feature | Equity Shares | Preference Shares | Bonus Shares | Rights Shares |
|---|---|---|---|---|
| Voting right | Yes | No (usually) | Yes (as they become equity) | Yes |
| Dividend | Variable | Fixed | None (free) | Variable |
| Source of capital | New money | New money | Company reserves | Existing shareholders |
| Issue price | Any (≥ nominal) | Usually at premium | Nominal value | Discounted to nominal |
Key points to remember
- Share capital is the total nominal value of all issued shares.
- Share premium is the amount received over the nominal value.
- Allotment is the formal allocation of shares to applicants.
- Share certificates are physical proof of ownership (now often electronic).
📝 Likely Exam Questions
- Explain the difference between equity shares and preference shares.
Answer: Equity shares carry voting rights and receive dividends after preference shareholders; preference shares have a fixed dividend, usually no voting rights, and are paid before equity shareholders. - Write the journal entry for issuing 2,000 equity shares of ₹10 each at ₹12 per share.
Answer: Bank Dr ₹24,000; To Share Capital ₹20,000; To Share Premium ₹4,000. - What is a rights issue and why might a company prefer it?
Answer: A rights issue offers existing shareholders the chance to buy new shares at a discount, helping the company raise fresh capital while preserving shareholder control. - List three types of shares that can be issued and give one characteristic of each.
Answer: Equity shares – voting rights; Preference shares – fixed dividend; Bonus shares – issued free from reserves. - Describe the steps a company follows from board approval to recording the share issue in books.
Answer: Board approves, prospectus prepared, application to Registrar, shares allotted, certificates issued, journal entries posted.