Welcome to Your Guide on Payroll and Share Issues!

In this section of your BA3 studies, we are looking at two very important ways businesses record transactions. First, we look at Payroll (how we pay our hard-working employees) and then the Issue of Shares (how a company raises equity finance from investors). These topics might seem a bit technical at first, but don't worry! We will break them down into simple steps that make perfect sense.

Understanding these records is vital because they show how money flows out of the business to staff and how capital flows in from owners. Let's dive in!


1. Payroll: More Than Just a Monthly Salary

When you work, your employer doesn't just hand you a bag of cash. There are taxes to pay and records to keep. For an accountant, payroll is about recording the total cost of employment, not just the amount that hits the employee's bank account.

Key Terms to Know

  • Gross Pay: This is the "headline" salary or wage earned by the employee. If you are hired for \( \$3,000 \) a month, that is your Gross Pay.
  • Deductions: These are amounts taken away from Gross Pay before payment (such as income tax and employee social security or pension contributions).
  • Net Pay: This is "take-home" pay—what is left after statutory and voluntary deductions are subtracted from Gross Pay.
  • Employer's Costs: In addition to Gross Pay, employers must pay secondary contributions (such as employer social security or pension contributions). This increases the business's total employment expense.
The "Pizza Analogy"

Imagine your Gross Pay is a whole pizza. Before you can eat it, the government takes two slices (Tax), and your pension fund takes one slice (Deductions). The remaining slices you actually get to eat are your Net Pay. The business, however, accounts for the whole pizza plus the extra delivery charge it pays on top (Employer's costs)!

The Accounting Entry for Payroll

When we record payroll, our debits and credits must reflect the total expense incurred by the business and the liabilities created until cash is paid over to employees and tax authorities.

Step 1: Recording the Expense and Liabilities

We debit the Wages and Salaries Expense with the total cost to the company (Total Gross Pay plus Employer's payroll taxes/contributions). We credit current liability accounts for the amounts owed to employees (Net Pay) and to tax authorities or benefit funds.

Example Journal Entry:
Debit: Wages and Salaries Expense (Gross pay \( + \) employer's contributions)
Credit: Wages / Payroll Payable or Bank (Net pay due to employees)
Credit: Income Tax / PAYE Liability (Income tax withheld from gross pay)
Credit: Social Security / Payroll Tax Liability (Both employee and employer contributions)

Quick Review: Common Mistake Alert!

Don't forget: Total employment cost is an expense (Debit), while the amounts held back to pay the tax authorities and staff are liabilities (Credit) until settlement.


2. The Issue of Shares

When a limited company needs to raise finance to grow, it can issue (sell) shares. A share represents a unit of ownership in the company. In financial accounting, we must distinguish between the nominal value (or par value) of the share and any premium received above that nominal value. The syllabus requires you to understand three specific types of share issue: an issue at full market price, a rights issue, and a bonus issue.

Nominal Value vs. Market Value

  • Nominal Value (or Par Value): This is the legal face value assigned to each share (for example, \( \$1.00 \) or \( \$0.50 \)). Under IAS 1 presentation rules, the Ordinary Share Capital account can only ever record shares at their nominal value.
  • Issue Price: The actual price paid by the investor per share.
  • Share Premium: Any excess cash received over nominal value must be credited to a separate equity reserve: the Share Premium Account.
    \( \text{Share Premium per share} = \text{Issue Price} - \text{Nominal Value} \)

Type 1: Issue at Full Market Price

New shares are offered to new or existing investors at the prevailing market price.

Example: A company issues 1,000 ordinary shares of nominal value \( \$1 \) each at a full market price of \( \$3 \) per share.

Total cash received: \( 1,000 \text{ shares} \times \$3 = \$3,000 \)
Nominal value: \( 1,000 \text{ shares} \times \$1 = \$1,000 \)
Share premium: \( 1,000 \text{ shares} \times (\$3 - \$1) = \$2,000 \)

Journal Entry:
Debit: Bank \( \$3,000 \)
Credit: Ordinary Share Capital \( \$1,000 \)
Credit: Share Premium \( \$2,000 \)

Type 2: Rights Issue

A rights issue is an offer of new shares to existing shareholders in proportion to their existing holding, typically offered at a discount to the current market price to encourage take-up (but at or above nominal value).

  • Cash flows into the company (Bank is debited).
  • Share capital increases by the nominal value of new shares issued.
  • Share premium increases by the difference between the issue price and the nominal value.

Example: An investor holds 4,000 shares of \( \$1 \) nominal value. The company announces a "1-for-4 rights issue" at \( \$2.50 \) per share.

New shares issued: \( 4,000 / 4 \times 1 = 1,000 \text{ shares} \)
Total cash received: \( 1,000 \text{ shares} \times \$2.50 = \$2,500 \)
Nominal value: \( 1,000 \text{ shares} \times \$1 = \$1,000 \)
Share premium: \( 1,000 \text{ shares} \times (\$2.50 - \$1.00) = \$1,500 \)

Journal Entry:
Debit: Bank \( \$2,500 \)
Credit: Ordinary Share Capital \( \$1,000 \)
Credit: Share Premium \( \$1,500 \)

Type 3: Bonus Issue (Capitalisation Issue)

A bonus issue (also called a scrip issue or capitalisation of reserves) is an issue of fully paid new shares to existing shareholders in proportion to their current holdings for free. No cash is received from shareholders.

Instead, the company converts existing equity reserves (such as Share Premium or Retained Earnings) into share capital:

  • No cash is received: the Bank account is unaffected.
  • Total equity remains unchanged; it is simply a reorganisation among equity reserves.
  • The new shares are capitalised strictly at their nominal value.

Example: A company with 10,000 ordinary shares of \( \$1 \) nominal value makes a "1-for-5 bonus issue" using its Share Premium account.

New shares created: \( 10,000 / 5 \times 1 = 2,000 \text{ shares} \)
Nominal value capitalised: \( 2,000 \text{ shares} \times \$1 = \$2,000 \)

Journal Entry:
Debit: Share Premium (or Retained Earnings) \( \$2,000 \)
Credit: Ordinary Share Capital \( \$2,000 \)


3. Summary and Key Takeaways

Payroll Summary:
  • Gross Pay is the total remuneration earned by the employee.
  • Net Pay is the take-home cash paid to the employee after deductions.
  • Total Employment Cost = Gross Pay \( + \) Employer's payroll taxes/contributions.
  • The Wages and Salaries Expense is debited with the total employment cost, while statutory deductions and net pay create credits to current liabilities or cash.
Share Issue Summary:
  • Ordinary Share Capital always records the Nominal Value of shares issued.
  • Issue at Market Price: Debit Bank for cash received; credit Share Capital for nominal value; credit Share Premium for the excess.
  • Rights Issue: Cash is received from existing shareholders at the offer price; debit Bank, credit Share Capital (nominal value), credit Share Premium (excess).
  • Bonus Issue: No cash is received; debit Share Premium (or Retained Earnings) and credit Share Capital at nominal value. Total equity is unchanged.

Pro-Tip: When reading a share issue question in BA3, first ask yourself: "Did the company receive cash?" If yes, debit Bank and split between Share Capital and Share Premium. If it's a bonus issue, no cash changes hands—simply transfer from reserves to Share Capital!