Organization and Operation of Corporations CHAPTER 10 Electronic Presentations in Microsoft® PowerPoint®

1. 1. Identify characteristics of corporations and their organization Describe and contrast the specialized components of corporate financial statements Record the issuance of common and preferred shares and describe their presentation in shareholders’ equity on the balance sheet. Learning Objectives

4. 4. Describe and account for cash dividends Distribute dividends between common and preferred shares Record closing entries for a corporation Compute book value and explain its use in analysis (Appendix 15A). Learning Objectives

 Separate legal entity  Limited liability of shareholders  Ownership rights are transferable  Continuous life  Shareholders are not corporate agents  Ease of capital accumulation  Government regulation  Corporate taxation Characteristics of Corporations

The company:  obtains a certificate of incorporation from the federal or provincial government,  sells shares to its subscribers,  elects a board of directors, and  establishes a set of bylaws regarding the internal activities of the corporation. Organizing a Corporation

 Costs include legal fees, promoters’ fees and amounts paid to obtain a charter.  These costs are treated as an intangible asset and are amortized.  The amortization period is often short since these fees are small in amount. Organization Costs

Example: A corporation pays $15,000 in organization costs. Example: A corporation pays $15,000 in organization costs. The entry to record this would be: The entry to record this would be: Organization Costs 15,000 Organization Costs 15,000 Cash 15,000 Cash 15,000 Organization Costs

Shareholders Board of Directors President, Vice-President, and Other Officers Employees of the Corporation Corporate Organization Structure

According to the Canada Business Corporations Act, shareholders have the right to:  Vote.  Receive dividends that have been declared.  Receive property of the corporation after its closure. Rights of Shareholders

Corporate Financial Statements

The statements are identical except for the $12 of income tax expense. Corporation Single Proprietorship

ABC Corporation Statement of Retained Earnings For Year Ended December 31, 2011 Retained Earnings, January 1 $0 Add: Net Income 48 Total $48 Less: Dividends 40 Retained Earnings, December 31 $8 Dell’s Servicing Statement of Owner’s Equity For Year Ended December 31, 2011 I. Dell, Capital, January 1 $0 Add: Owner Investment 500 Net Income 60 Net Income 60 Total $560 Less: Withdrawals 40 I. Dell, Capital, December 31 $520 Retained earnings represents the earnings that have been kept (retained) by the corporation for the purpose of reinvestment.

ABC Corporation Partial Balance Sheet December 31, 2011 Shareholders’ Equity Share Capital$500 Share Capital$500 Retained Earnings 8 Retained Earnings 8 Total Shareholders’ Equity$508 Dell’s Servicing Partial Balance Sheet December 31, 2011 Owner’s Equity I. Dell, Capital $520 The balance sheets for corporations and single proprietorships are identical except for the equity section.

ABC Corporation Partial Balance Sheet December 31, 2011 Shareholders’ Equity Share Capital$500 Share Capital$500 Retained Earnings 8 Retained Earnings 8 Total Shareholders’ Equity$508 Dell’s Servicing Partial Balance Sheet December 31, 2011 Owner’s Equity I. Dell, Capital $520 Shareholders’ equity and Owner’s equity include the same transactions in total: net income (losses), distributions of income, and owner’s investments.

 Companies obtain capital, or money, by issuing shares.  This is referred to as equity financing.  Shares may be sold directly to investors or may be sold through a brokerage house.  If a company only has one class of shares, they are known as common shares.  The CBCA requires all shares to be no par value. Issuing Share Capital

Example: Dillon Snowboards Ltd. issued 30,000 common shares for $300,000 cash. Example: Dillon Snowboards Ltd. issued 30,000 common shares for $300,000 cash. The entry to record this would be: The entry to record this would be: Cash 300,000 Cash 300,000 Common Shares 300,000 Common Shares 300,000 Issuing Share Capital

Example: Shareholders’ equity of Dillon Snowboards Ltd. after the first year of operating. Assume net income of $65,000 and no dividend payments. Example: Shareholders’ equity of Dillon Snowboards Ltd. after the first year of operating. Assume net income of $65,000 and no dividend payments. Shareholders’ Equity Common Shares, unlimited shares authorized, 30,000 shares issued and outstanding $300,000 Retained earnings 65,000 Total shareholders’ equity $365,000 Shareholders’ Equity

Identifies how many shares the corporation is allowed to sell. Shareholders’ Equity Common Shares, unlimited shares authorized, 30,000 shares issued and outstanding $300,000 Retained earnings 65,000 Total shareholders’ equity $365,000 Shareholders’ Equity

Identifies how many shares have been sold or given out. Shareholders’ Equity Common Shares, unlimited shares authorized, 30,000 shares issued and outstanding $300,000 Retained earnings 65,000 Total shareholders’ equity $365,000 Shareholders’ Equity

Defines how many shares are held by shareholders. Shareholders’ Equity Common Shares, unlimited shares authorized, 30,000 shares issued and outstanding $300,000 Retained earnings 65,000 Total shareholders’ equity $365,000 Shareholders’ Equity

Discloses dollars invested by shareholders in exchange for shares. Shareholders’ Equity Common Shares, unlimited shares authorized, 30,000 shares issued and outstanding $300,000 Retained earnings 65,000 Total shareholders’ equity $365,000 Shareholders’ Equity

This reflects accumulated profits/losses less dividends. Shareholders’ Equity Common Shares, unlimited shares authorized, 30,000 shares issued and outstanding $300,000 Retained earnings 65,000 Total shareholders’ equity $365,000 Shareholders’ Equity

Mini-Quiz The category of shareholders' equity created by a corporation's profitable activities is called: The category of shareholders' equity created by a corporation's profitable activities is called: A. Contributed capital. B. Intangibles. B. Intangibles. C. Retained earnings. C. Retained earnings. D. Paid-in capital. D. Paid-in capital. E. P & L.

Mini-Quiz The category of shareholders' equity created by a corporation's profitable activities is called: The category of shareholders' equity created by a corporation's profitable activities is called: A. Contributed capital. B. Intangibles. B. Intangibles. C. Retained earnings. C. Retained earnings. D. Paid-in capital. D. Paid-in capital. E. P & L.

 Shares that give their owners a priority status over common shareholders including:  Payment of dividends, and  Distribution of assets on liquidation.  Do not usually have the right to vote.  Are listed before common shares in the shareholders’ equity section. Preferred Shares

Example: Dillon Snowboards Ltd. issued 5,000 preferred shares with a dividend preference of $3 per share for a total of $125,000 cash. Example: Dillon Snowboards Ltd. issued 5,000 preferred shares with a dividend preference of $3 per share for a total of $125,000 cash. The entry to record this would be: The entry to record this would be: Cash 125,000 Cash 125,000 Preferred Shares 125,000 Preferred Shares 125,000 Issuing Preferred Shares for Cash

$530,000 Total contributed capital $125,000 Preferred shares, $3, unlimited shares authorized, 5,000 shares issued and outstanding Shareholders’ Equity Contributed Capital: $365,000 Total shareholders’ equity 303,000 Retained earnings $405,000 Common Shares, unlimited shares authorized, 30,000 shares issued and outstanding Represents the dividend preference. Preferred shareholders are entitled to dividends at the rate of $3 per preferred share when declared. Shareholders’ Equity After Issue of Preferred Shares

Reasons for issuing preferred shares include: Reasons for issuing preferred shares include:  No sacrifice of control,  Potential to increase return to common shareholders,  Appeal to potential investors, and  Market price of common shares may be too low. Preferred Shares

 Are a distribution of earnings to shareholders  Reduce retained earnings  Are decided by the board of directors  May be in cash or shares Dividends

Important dates: 1. Date of declaration 2. Date of record 3. Date of payment The date the directors vote to pay a dividend. This creates a legal liability for the corporation. Dividends

Important dates: 1. Date of declaration 2. Date of record 3. Date of payment The future date specified by the directors for identifying those shareholders listed in the corporation’s records to receive dividends. Dividends

Important dates: 1. Date of declaration 2. Date of record 3. Date of payment The date the shareholders receive payment. Dividends

Example: On November 9, the board of directors of a company with 5,000 common shares outstanding declared a $1 per share dividend payable December 1 to the shareholders of record on November 22. Example: On November 9, the board of directors of a company with 5,000 common shares outstanding declared a $1 per share dividend payable December 1 to the shareholders of record on November 22. On November 9, the date of declaration, the entry would be either: On November 9, the date of declaration, the entry would be either: Cash Dividends 5,000 Cash Dividends 5,000 Common Dividends Payable 5,000 Common Dividends Payable 5,000or Retained Earnings 5,000 Retained Earnings 5,000 Common Dividends Payable 5,000 Common Dividends Payable 5,000 Cash Dividends

No entry is required on November 22, the date of record. No entry is required on November 22, the date of record. Cash Dividends

On December 1, the date of payment, the entry would be: On December 1, the date of payment, the entry would be: Common Dividends Payable 5,000 Common Dividends Payable 5,000 Cash 5,000 Cash 5,000 Cash Dividends

On December 31, the corporation’s year end, the closing entry would be: On December 31, the corporation’s year end, the closing entry would be: Retained Earnings 5,000 Retained Earnings 5,000 Cash Dividends 5,000 Cash Dividends 5,000 No closing entry would be necessary if the retained earnings account was debited on the date of declaration. No closing entry would be necessary if the retained earnings account was debited on the date of declaration. Cash Dividends

 A corporation with a debit balance in retained earnings is said to have a deficit.  Deficits reduce total shareholders’ equity.  Corporations are not allowed to pay cash dividends when there is a deficit. Deficits and Cash Dividends

Mini-Quiz The payment of a dividend will reduce the following two accounts: A) Common shares and cash B) Cash and retained earnings C) Shareholders' equity and retained earnings D) Retained earnings and accounts payable E) Shareholders' equity and cash

Mini-Quiz The payment of a dividend will reduce the following two accounts: A) Common shares and cash B) Cash and retained earnings C) Shareholders' equity and retained earnings D) Retained earnings and accounts payable E) Shareholders' equity and cash

 Common shares cannot receive dividends unless preferred share dividends are paid first.  Preferred dividends are not guaranteed.  The board of directors must declare a dividend before shareholders are entitled to a dividend.  Preferred shares may be either cumulative or non-cumulative. Preferred Shares

Cumulative  Undeclared dividends accumulate until they are paid.  Common shareholders cannot receive dividends until all cumulative dividends are paid. Non-Cumulative  Have no right to prior periods’ unpaid dividends if they were not declared. Preferred Shares

 A liability for a dividend does not exist until the directors declare a dividend.  Dividends in arrears on cumulative preferred shares must be disclosed in the corporation’s financial statements. Financial Disclosure of Dividends

Non-participating  Have dividends limited to a maximum amount each year. Non-Participating  Have a feature that allows preferred shareholders to share with common shareholders in any dividends paid in excess of the percent stated on the preferred shares. Preferred Shares

Convertible  Gives holders the option of exchanging their preferred shares into common shares at a specified rate. Callable  The issuing corporation, at its option, may retire by paying a specified amount (the call price) to the preferred shareholders plus any dividends in arrears. Preferred Shares

 Income summary is closed to retained earnings.  The cash dividends declared account is closed to retained earnings (assuming dividends were not debited to retained earnings when declared). Closing Entries

Review Discuss the characteristics of corporations. Corporations are legal entities separate and distinct from their owners. Ownership of corporations is represented by shares. Owners of the shares are called shareholders or stockholders. Shares issued by corporations are easily transferable and shareholders are not personally liable for acts of the corporation. Corporations are regulated by provincial and federal governments and are subject to income tax.

Review Describe the components of shareholders' equity. Shareholders' equity is composed of two parts, contributed capital and retained earnings. Contributed capital consists of funds raised by the issuance of shares, either common or preferred. Retained earnings consists of current and prior periods' earnings not distributed to shareholders.

 Often used in the financial analysis of a company.  Other uses include share valuations, merger negotiations, and loan contracts  Uses the book value of assets and liabilities, not the market value. Book Value Per Share Appendix 15A

Book Value Per Common Share Shareholders’ Equity Applicable to Common Shares Number of Common Shares Outstanding = When only common shares are outstanding: Book Value Per Share Appendix 15A

Book Value Per Preferred Share Shareholders’ Equity Applicable to Preferred Shares* Number of Preferred Shares Outstanding = Book Value Per Share Appendix 15A *Preferred share’s call price plus any cumulative dividends in arrears or paid in capital from preferred shares plus dividends in arrears.

= When both common and preferred shares are outstanding: Number of Common Shares Outstanding Total Shareholders’ Equity Equity Applicable to Preferred Shares* _ Book Value Per Common Share Book Value Per Share Appendix 15A *Preferred share’s call price plus any cumulative dividends in arrears or paid-in capital from preferred shares plus dividends in arrears.

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