What is a rights issue and how is it recorded?

What is a rights issue and how is it recorded?

• A. It offers existing shareholders the option to sell additional shares; Dr Bank; Cr Share Capital
• B. It is a bonus issue; Dr Reserves; Cr Share Capital
• C. It offers existing shareholders the option to buy additional shares; Dr Bank; Cr Share Capital and Share Premium
• D. It is issue of shares to new investors at market price; Dr Bank; Cr Share Capital

Answer: (C)

A rights issue is when a company offers its existing shareholders the option to buy additional shares, usually at a price set for the issue and often below market value. When shareholders exercise this option, the company receives cash (bank). The shares are issued with a nominal value, so the accounting entry credits Share Capital for the par value of the new shares, and any amount received above par is credited to Share Premium. If the issue price equals the nominal value, only Share Capital is credited. So the correct approach is to record the cash received as Dr Bank, and credit both Share Capital and Share Premium for the amount received. This reflects both the increase in share capital at par and any premium earned on the new shares. If there’s no premium, only Share Capital would be credited. The other descriptions don’t fit: a rights issue is not an option to sell existing shares, and a bonus issue transfers reserves to share capital rather than raising new funds; issuing to new investors at market price describes a different kind of share issue, not a rights offer to existing shareholders.

A rights issue is when a company offers its existing shareholders the option to buy additional shares, usually at a price set for the issue and often below market value. When shareholders exercise this option, the company receives cash (bank). The shares are issued with a nominal value, so the accounting entry credits Share Capital for the par value of the new shares, and any amount received above par is credited to Share Premium. If the issue price equals the nominal value, only Share Capital is credited.

So the correct approach is to record the cash received as Dr Bank, and credit both Share Capital and Share Premium for the amount received. This reflects both the increase in share capital at par and any premium earned on the new shares. If there’s no premium, only Share Capital would be credited.

The other descriptions don’t fit: a rights issue is not an option to sell existing shares, and a bonus issue transfers reserves to share capital rather than raising new funds; issuing to new investors at market price describes a different kind of share issue, not a rights offer to existing shareholders.