McGraw-Hill/Irwin Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved. Shareholders’ Equity: Capital Chapter 11

11-2 Existence is separate from owners. An entity created by law. Has rights and privileges. Privately, or Closely Held Publicly Held Ownership can be Corporations

11-3 Limited personal liability for shareholders Transferability of ownership Professional management Continuity of existence Advantages of Incorporation

11-4 Heavy taxation Greater regulation Cost of formation Separation of ownership and management Disadvantages of Incorporation

11-5 The costs associated with incorporation are usually expensed immediately. Formation of a Corporation Each corporation is formed according to the laws of the place or country where it is located. The application for corporate status is supported by the Memorandum and Articles of Incorporation.

11-6 Shareholders Rights Voting (in person or by proxy). Proportionate distribution of dividends. Proportionate distribution of assets in a liquidation. Rights of Shareholders

11-7 Ultimate control Rights of Shareholders Shareholders usually meet once a year.

11-8 Chief Accountant Contractual and legal representation Custodian of funds Functions of the Corporate Officers

11-9 Publicly Owned Corporations Face Different Rules By law, publicly owned corporations must:  Prepare financial statements in accordance with relevant accounting standards, e.g. IFRS.  Have their financial statement audited by an independent CPA.  Comply with relevant rules and regulations.  Submit financial information for relevant authority for review.

11-10 Shareholders usually meet once a year. Shareholder ledgers are often maintained by a share transfer agent or share registrar. Shareholder Records in a Corporation Each unit of ownership is called a share. Share certificates serve as proof that a shareholder has purchased shares. Each unit of ownership is called a share. Share certificates serve as proof that a shareholder has purchased shares. When the share is sold, the shareholder signs a transfer endorsement on the back of the share certificate.

11-11 Shareholders’ Equity of a Corporation

11-12 The maximum number of shares that can be sold to the public. Authorized Shares Authorized Shares Authorization and Issuance of Share Capital

11-13 Issued shares are authorized shares that have been sold. Unissued shares are authorized shares that never have been sold. Usually shares are sold through an underwriter. Authorized Shares Authorized Shares Authorization and Issuance of Share Capital

11-14 Unissued Shares Unissued Shares Treasury Shares Outstanding Shares Treasury shares are issued shares that have been reacquired by the corporation. Issued Shares Issued Shares Outstanding shares are issued shares that are owned by shareholders. Authorized Shares Authorized Shares Authorization and Issuance of Share Capital

11-15 Par value is an arbitrary amount assigned to each share when it is authorized. Market price is the amount that each share will sell for in the market. Par value is an arbitrary amount assigned to each share when it is authorized. Market price is the amount that each share will sell for in the market. Shareholders’ Equity

11-16 Ordinary share can be issued in three forms: No-Par Ordinary Share Par Value Ordinary Share Stated Value Ordinary Share All proceeds credited to Ordinary Share Capital Treated like par value ordinary share Shareholders’ Equity Let’s examine this form of share.

11-17 Assume a corporation issues 10,000 shares of its $2 par value share for $25 per share. Record: 1.The cash received. 2.The number of shares issued × the par value per share in the Ordinary Share account. 3.The remainder is assigned to Share Premium (or Additional Paid-in Capital). Record: 1.The cash received. 2.The number of shares issued × the par value per share in the Ordinary Share account. 3.The remainder is assigned to Share Premium (or Additional Paid-in Capital). Issuance of Par Value Share

11-18 Issuance of Par Value Share Assume a corporation issues 10,000 shares of its $2 par value share for $25 per share. DescriptionDebitCredit Cash 250,000 Ordinary Share 20,000 Share Premium 230,000 10,000 × $2 = $20,000

11-19 Issuance of Par Value Share Shareholders' Equity with Ordinary Share Shareholders' Equity Contributed capital: Ordinary share - $2 par value; 50,000 shares authorized; 10,000 shares issued and outstanding $ 20,000 Share premium 230,000 Retained earnings 65,000 Total shareholders' equity $ 315,000

11-20 Preference Share A separate class of share, typically having priority over ordinary shares in...  Dividend distributions (rate is usually stated).  Distribution of assets in case of liquidation.  Specific characteristics (say redeemable) can affect its presentation in the balance sheet as liabilities (IAS 32). Cumulative dividend rights. Normally has no voting rights. Usually callable by the company. Other Features Include:

11-21 Vs.NoncumulativeCumulative Dividends in arrears must be paid before dividends may be paid on ordinary share. Undeclared dividends from current and prior years do not have to be paid in future years. Cumulative Preference Share

11-22 Example: Consider the following partial Statement of Shareholders’ Equity. During 2008, the directors declare cash dividends of $5,000. In 2009, the directors declare cash dividends of $42,000. Share Preferred as to Dividends

11-23 Share Preferred as to Dividends

11-24 I just converted 100 shares of preference share into 1,000 ordinary shares and ended up with a higher dividend yield! Some preference share is convertible into ordinary shares. Other Features of Preference Share

11-25 Preference Share

11-26 Accounting by the issuer. Accounting by the investor. Ordinary share is carried at original issue price. Investments in marketable securities are carried at market value. Market Value

11-27 Market Price of Preference Share Factors affecting market price of preference share: Factors affecting market price of preference share: Dividend rateDividend rate RiskRisk Level of interest ratesLevel of interest rates The return based on the market value is called the “dividend yield.”

11-28 Factors affecting market price of ordinary share: Investors’ expectations of future profitability. Risk that this level of profitability will not be achieved. Factors affecting market price of ordinary share: Investors’ expectations of future profitability. Risk that this level of profitability will not be achieved. Changes in market value have no impact on the books of the issuer. Market Price of Ordinary Share

11-29 Book Value per Share of Ordinary Share Total Shareholders’ Equity Number of Ordinary Shares Outstanding Preference share and preference dividends in arrears are deducted from total shareholders’ equity. Book Value Market Value ≠

11-30 Ice Cream Parlor Share Splits Now Available Share Splits  Companies use share splits to reduce market price.  Outstanding shares increase, but par value is decreased proportionately.  Companies use share splits to reduce market price.  Outstanding shares increase, but par value is decreased proportionately.

11-31 Assume a corporation has 5,000 shares of $1 par value ordinary share outstanding before a 2–for–1 share split. Increase Decrease No Change Share Split

11-32 When share is reacquired, the corporation records the treasury share at cost. Treasury shares are issued shares that have been reacquired by the corporation. Treasury Share

11-33 Riley Corporation reacquires 3,000 shares of its ordinary share at $55 per share. Prepare the journal entry to record the purchase of treasury share. Recording Purchases of Treasury Share

11-34 Riley Corporation reissued 1,000 shares of the treasury share originally purchased for $55 per share. The shares were reissued at $75 per share. Recording Purchases of Treasury Share 1,000 shares × $55 cost = $55,000 1,000 shares × $75 = $75,000

11-35 Shareholders’ Equity Presentation

11-36 Share Buyback Programs Some corporations have buyback programs, in which they repurchase large amounts of their own ordinary share. As a result of these programs, treasury share has become a material item in the balance sheet of many corporations. Share option plans are an important part of employee compensation for many companies. Treasury share purchases are an effective means by which the company can have available the shares needed to satisfy the requirement of share option plans to issue the shares to employees. Some corporations have buyback programs, in which they repurchase large amounts of their own ordinary share. As a result of these programs, treasury share has become a material item in the balance sheet of many corporations. Share option plans are an important part of employee compensation for many companies. Treasury share purchases are an effective means by which the company can have available the shares needed to satisfy the requirement of share option plans to issue the shares to employees.

11-37 Financial Analysis and Decision Making Return on Ordinary Shareholders’ Equity Profit – Preference Dividends Average Ordinary Shareholders’ Equity =

11-38 End of Chapter 11