ACCOUNTING PRINCIPLES SIXTH CANADIAN EDITION Prepared by: Debbie Musil Kwantlen Polytechnic University Chapter 13 Introduction to Corporations

The corporate form of organization –Characteristics –Operating a corporation Share capital –Issuing shares –Preferred shares Retained earnings –Corporate income statements –Cash dividends –Reporting retained earnings Statement presentation and analysis Copyright John Wiley & Sons Canada, Ltd. 2

STUDY OBJECTIVES: CHAPTER 13: Introduction to Corporations 1.Identify and discuss characteristics of the corporate form of organization. 2.Account for the issuance of common and preferred shares. 3.Prepare a corporate income statement. 4.Account for cash dividends. 5.Prepare a statement of retained earnings and closing entries for a corporation. 6.Prepare the shareholders’ section of the balance sheet and calculate return on equity. Copyright John Wiley & Sons Canada, Ltd. 3

The Corporate Form of Organization A legal entity separate from its owners (known as shareholders) Classified by purpose and ownership: –Purpose: for profit or not-for-profit –Ownership: Public corporation: shares are available for purchase on an organized securities market Private corporation: shares are held by a few individuals and are not traded Copyright John Wiley & Sons Canada, Ltd. 4

Characteristics of a Corporation Separate legal existence from its owners –Acts under its own name –Owners do not bind the corporation Limited liability of shareholders –Limited to the amount of their investment Transferable ownership rights –Shares may be bought and sold –No effect on operating activities of corporation Ability to acquire capital –Can raise capital by issuing shares –May be difficult for closely-held corporations Copyright John Wiley & Sons Canada, Ltd. 5

Characteristics of a Corporation 2 Continuous and unlimited life –Unaffected by change in ownership Government regulations –Specific laws that govern operations of corporations Income tax –Taxed as a separate entity Copyright John Wiley & Sons Canada, Ltd. 6

Forming a Corporation Can incorporate federally or provincially Done by filing articles of incorporation (the company’s “constitution”): –Provide information such as : Name and purpose of company Number of shares and kinds of shares Location of corporation’s head office By-laws: internal rules and policies Organization costs: –Costs of forming a corporation –Must be expensed when incurred Copyright John Wiley & Sons Canada, Ltd. 7

Ownership Rights of Shareholders Ownership rights are in the form of shares –Can be divided into different classes As stated in the articles of incorporation Each class has rights and privileges Usually referred to as common and preferred shares Shareholders have rights: –To vote on certain matters –To dividends: the distribution of profit –To remaining assets in a liquidation Copyright John Wiley & Sons Canada, Ltd. 8

Corporation Management Shareholders manage the corporation through the Board of Directors that they elect The board: –Decides on the corporation’s operating policies –Selects officers (such as the Chief Executive Officer or CEO) to perform daily management functions 9

STUDY OBJECTIVES: CHAPTER 13: Introduction to Corporations 1.Identify and discuss characteristics of the corporate form of organization. 2.Account for the issuance of common and preferred shares. 3.Prepare a corporate income statement. 4.Account for cash dividends. 5.Prepare a statement of retained earnings and closing entries for a corporation. 6.Prepare the shareholders’ section of the balance sheet and calculate return on equity. Copyright John Wiley & Sons Canada, Ltd. 10

Share Issue Considerations Authorized share capital –Number of shares company is allowed to sell –Many companies have unlimited number of shares Issue of shares –Issued directly to investors or through an investment dealer –First public sale is called an initial public offering (IPO) Copyright John Wiley & Sons Canada, Ltd. 11

Share Issue Considerations 2 Market value of shares –Once issued, shares trade on a secondary market –Prices determined by buyers and sellers and other external factors Legal capital –Share capital is legal capital and cannot be distributed to shareholders –Retained earnings are earned capital and can be distributed as dividends Copyright John Wiley & Sons Canada, Ltd. 12

Common Shares: Issuing Shares Shares are usually issued for cash: Dr. Cash Cr. Common shares Shares can be issued in exchange for services or noncash assets –Recorded at fair value of goods/services received: Dr. Service or asset (e.g. Legal Fees Expense) Cr. Common shares –Under IFRS, if fair value of goods/services not measurable, use fair value of shares given up –Under ASPE, can use either of the above valuation methods Copyright John Wiley & Sons Canada, Ltd. 13

Preferred Shares Priority over common shares for dividends and assets in the event of liquidation of the company Entries to record issue and reacquisition of preferred shares similar to entries for common shares Transactions for each class of share is recorded in a separate account Copyright John Wiley & Sons Canada, Ltd. 14

Dividend Preference Preferred shareholders have a right to dividends before common shareholders Cumulative preferred shares have a right to current year’s dividends and any prior years’ dividends owing before dividends are paid on common shares Any unpaid dividends (in arrears) are not considered a liability –No obligation to pay unless dividend is declared Copyright John Wiley & Sons Canada, Ltd. 15

Convertible Preferred Shares Provide option to exchange preferred shares to common shares at a specified ratio Conversion is recorded by transferring cost from Preferred Shares to Common Shares account Copyright John Wiley & Sons Canada, Ltd. 16

Redeemable and Retractable Preferred Shares Corporation (redeemable) or the shareholder (retractable) can redeem the shares at specified future dates and prices Similar to debt: offers a repayment of the principal Considered a financial instrument These preferred shares usually reported in the liabilities section of the balance sheet Copyright John Wiley & Sons Canada, Ltd. 17

STUDY OBJECTIVES: CHAPTER 13: Introduction to Corporations 1.Identify and discuss characteristics of the corporate form of organization. 2.Account for the issuance of common and preferred shares. 3.Prepare a corporate income statement. 4.Account for cash dividends. 5.Prepare a statement of retained earnings and closing entries for a corporation. 6.Prepare the shareholders’ section of the balance sheet and calculate return on equity. Copyright John Wiley & Sons Canada, Ltd. 18

Retained Earnings The cumulative total of profit less losses and less declared dividends since incorporation Represents part of shareholder’s claim on total assets of a corporation –Not a claim on any specific asset (including cash) Two major components: –Profit –Dividends: cash distributions to owners Copyright John Wiley & Sons Canada, Ltd. 19

Corporate Income Statements Income statement for corporations are similar to proprietorship or partnership statements One major difference is income taxes –Since corporation is a separate legal entity –Affects income statement (income tax expense) and balance sheet (income tax payable or receivable) Copyright John Wiley & Sons Canada, Ltd. 20

Corporate Income Statements 2 21 Copyright John Wiley & Sons Canada, Ltd.

STUDY OBJECTIVES: CHAPTER 13: Introduction to Corporations 1.Identify and discuss characteristics of the corporate form of organization. 2.Account for the issuance of common and preferred shares. 3.Prepare a corporate income statement. 4.Account for cash dividends. 5.Prepare a statement of retained earnings and closing entries for a corporation. 6.Prepare the shareholders’ section of the balance sheet and calculate return on equity. Copyright John Wiley & Sons Canada, Ltd. 22

Dividends Pro-rata distribution of a portion of corporation’s retained earnings to shareholders –Pro-rata: based on the proportion of shares owned Common types of dividends Cash dividends Stock dividends (normally common shares) Copyright John Wiley & Sons Canada, Ltd. 23

Cash Dividends To pay dividends, a corporation must: –Have enough retained earnings and cash –Declare a dividend payable Declaration date: –Board of directors formally declares dividend –Commits company to a legal obligation –Declaration is recorded: Copyright John Wiley & Sons Canada, Ltd. 24

Cash Dividends 2 Record date: –Ownership of shares is determined –Shareholders of record on this date will receive dividend –No journal entry required Payment date: –Dividend is paid to shareholders and recorded: Copyright John Wiley & Sons Canada, Ltd. 25

STUDY OBJECTIVES: CHAPTER 13: Introduction to Corporations 1.Identify and discuss characteristics of the corporate form of organization. 2.Account for the issuance of common and preferred shares. 3.Prepare a corporate income statement. 4.Account for cash dividends. 5.Prepare a statement of retained earnings and closing entries for a corporation. 6.Prepare the shareholders’ section of the balance sheet and calculate return on equity. Copyright John Wiley & Sons Canada, Ltd. 26

Statement of Retained Earnings Shows the changes in retained earnings during the year Required under ASPE Transactions that affect retained earnings: –Earning a profit (incurring a loss) –Declaring cash and stock dividends –Other transactions Copyright John Wiley & Sons Canada, Ltd. 27

Sample Statement of Retained Earnings Copyright John Wiley & Sons Canada, Ltd. 28

STUDY OBJECTIVES: CHAPTER 13: Introduction to Corporations 1.Identify and discuss characteristics of the corporate form of organization. 2.Account for the issuance of common and preferred shares. 3.Prepare a corporate income statement. 4.Account for cash dividends. 5.Prepare a statement of retained earnings and closing entries for a corporation. 6.Prepare the shareholders’ section of the balance sheet and calculate return on equity. Copyright John Wiley & Sons Canada, Ltd. 29

Shareholders’ Equity on the Balance Sheet Contributed Capital –Share capital: preferred and common shares –Contributed surplus: amounts contributed from acquiring and retiring shares Retained Earnings –Cumulative profit (loss) since incorporation –Annual profit (loss) is added (deducted); dividends are deducted Accumulated Other Comprehensive Income –Used by companies that follow IFRS (not ASPE) Copyright John Wiley & Sons Canada, Ltd. 30

Sample Shareholders’ Equity Section Copyright John Wiley & Sons Canada, Ltd. 31

Also called return on investment Considered to be the most important measure of a firm’s profitability It evaluates how many dollars are earned for each dollar invested by shareholders Return on Equity Copyright John Wiley & Sons Canada, Ltd. 32

Copyright © 2013 John Wiley & Sons Canada, Ltd. All rights reserved. Reproduction or translation of this work beyond that permitted by Access Copyright (the Canadian copyright licensing agency) is unlawful. Requests for further information should be addressed to the Permissions Department, John Wiley & Sons Canada, Ltd. The purchaser may make back-up copies for his or her own use only and not for distribution or resale. The author and the publisher assume no responsibility for errors, omissions, or damages caused by the use of these files or programs or from the use of the information contained herein. Prepared by: A. Davis, MSc, BComm, CA, CFE Copyright Copyright John Wiley & Sons Canada, Ltd.