2. Reporting and Analyzing Shareholders’ Equity
Chapter 11
Reporting and Analyzing Shareholders’ Equity

3. Corporation Separate legal entity
Has most of the rights and privileges of a person
Classified by purpose and ownership
Purpose: profit or not-for-profit
Ownership: public or private
Other (e.g., income trust)
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4. Characteristics of Corporation
Separate legal existence
Limited liability of shareholders
Transferable ownership rights
Ability to acquire capital
Continuous life
Corporation management
Government regulations
Income taxes
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5. Advantages and Disadvantages of a Corporation
Corporate management
Separate legal existence
Limited liability of shareholders
Deferred or reduced taxes
Transferable ownership rights
Ability to acquire capital
Continuous life
Disadvantages
Increased costs and complexity in order to adhere to government regulation
Additional taxes
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6. Shareholder Rights
To raise capital, the corporation sells shares (other way is to issue debt)
If there is only one class of shares, these are referred to as common shares
Ownership rights are specified in articles of incorporation or in by-laws
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7. Share Terminology Authorized shares Issued shares Fair value
Maximum amount of shares corporation allowed to sell
May be limited or unlimited
Disclosed only, not recorded
Issued shares
Number of shares sold
Fair value
Legal capital
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8. Issuing Shares
First issue normally through initial public offering (IPO). Share price set by company
Once issued, shares of publicly held companies trade on organized exchanges at dollar prices per share established between buyers and sellers (no direct impact on company)
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9. Issuing Shares Shares are usually issued for cash:
Dr. Cash Cr. Common Shares
Shares can be issued in exchange for services or noncash assets
Record at cash equivalent price (ideally market value of shares given up)
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10. Reacquisition of Shares
Reacquired shares are a corporation’s own shares (either common or preferred) that have been issued and reacquired by the corporation
Reacquired shares are normally retired and cancelled
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11. Reacquisition of Shares
Reasons to reacquire shares:
Increase trading on securities markets
Reduce number of shares issued (increases earnings per share and return on common shareholders’ equity)
Buyout hostile shareholders
Have shares available for compensation or other uses
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12. Reacquisition of Shares
Steps to record a reacquisition:
Remove cost of shares from share capital account, based on average cost per share (must be calculated)
Record cash paid for the shares
Record the “gain or loss” on reacquisition
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13. Reacquisition of Shares: Below Average Cost
Average cost of shares:
Balance in Common Shares Account Number of Common Shares Issued
If shares reacquired at a price < average cost:
Difference credited to a new shareholders’ equity account for contributed capital from reacquisition:
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14. Reacquisition of Shares: Above Average Cost
If shares reacquired at a price > average cost:
Additional cost of shares first debited to contributed capital from previous re-acquisitions (if any)
Remaining difference debited to retained earnings
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15. Preferred Shares
Share capital can consist of preferred and common shares
Preferred shares listed first in share capital section
Preferred usually do not have voting rights
Accounting for preferred shares similar to common shares
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16. Preferred Share Preferences
Dividend preference
Cumulative (dividends in arrears)
Liquidation preference
Other preferences
Convertible
Redeemable/callable (company option)
Retractable (shareholder option)
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17. Dividends Dividends are distributed by a
corporation to its shareholders on a pro rata (equal) basis
They are normally in the form of:
Cash
Stock (common shares)
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18. Cash Dividends For a cash dividend to occur, a corporation must have:
1. Retained earnings
2. Adequate cash
3. Dividends declared by board of directors
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19. Entries for Cash Dividends
Three dates are important in connection with dividends:
1. Declaration date
2. Record date
3. Payment date
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20. Declaration Date Date the Board of Directors declares cash dividend
Commits the corporation to a binding legal obligation that cannot be rescinded
On December 1, 2009 the directors of Media General declare a $0.50 per share cash dividend on 100,000 common shares (100,000 x $0.50 = $50,000)
Dec. 1 Cash Dividends 50,000
Dividends Payable ,000
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21. Record Date
Date ownership of shares is determined for dividend purposes
Dec No entry necessary
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22. Payment Date Date dividend cheques are mailed
Payment date for Media General is January 20
Jan. 20 Dividends Payable 50,000
Cash 50,000
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23. Stock Dividends Cash dividend: paid in cash
Stock dividend: Distributed (paid) in shares
Fair value is assigned to the stock dividend shares
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24. Purpose and Benefits of Stock Dividends
For company
Satisfy shareholders' dividend expectations without spending cash
Increase marketability of its shares by increasing number of shares and decreasing market price per share
Reinvest and restrict a portion of shareholders' equity
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25. Purpose and Benefits of Stock Dividends
For shareholder
More shares with which to earn additional dividend income
More shares for future profitable resale, as share price increases
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26. Stock Dividends
Assume 2% ownership interest in Cetus Inc., owning 200 of its 10,000 common shares
In a 10% stock dividend, 1,000 common shares (10,000 x 10%) would be issued
You would receive 20 shares (2% x 1,000), but your ownership interest would remain at 2% (220 ÷ 11,000)
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27. Common Stock Dividends Distributable
Cetus Inc. would record the stock dividend as follows, assuming $25 fair value (1,000 x $25 = $25,000):
Declaration Date
Stock Dividends
Common Stock Dividends Distributable
25,000
Record Date No entry
Distribution Date
Common Shares
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28. Stock Dividends
Decreases retained earnings, increases common shares, total shareholder’s equity remains the same
Before Stock Dividend
After Stock Dividend
Common shares
$500,000
$575,000
Retained earnings
300,000
225,000
Total shareholders’ equity
$800,000
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29. Discussion Question
How is a stock dividend reflected on the cash flow statement?
Discussion points:
As cash is not involved a stock dividend does not get reported on the Cash Flow Statement
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30. Stock Splits
A stock split involves the issue of additional shares to shareholders according to their percentage ownership
Number of shares is increased
No change to dollar amount in share capital account
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31. Stock Splits
A stock split has no effect on total share capital, retained earnings, or total shareholders’ equity
Market value of the shares will decrease roughly proportionately to the split
It is not necessary to formally journalize a stock split
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32. Comparison of Dividends and Stock Splits for Corporation
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33. Discussion Question
Identify the effects of a (a) cash dividend, (b) stock dividend, and (c) stock split for an individual, rather than for a corporation.
Discussion points:
Cash dividend: An individual receives cash
Stock dividend: An individual receives shares, however, the fair value will likely drop proportionately so there is no change to the total fair value of the holdings. There are, however, more shares on which to earn dividend income in future and benefit from possible increases in the share price
Stock split: An individual receives shares, however, the fair value will likely drop proportionately so there is no change to the total fair value of the holdings. There are, however, more shares on which to earn dividend income in future and benefit from possible increases in the share price
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34. Retained Earnings
Retained earnings is the cumulative net earnings (less losses) that is retained in the business (i.e., not distributed to shareholders)
Retained earnings, opening balance
+ Net earnings (or – net loss)
– Dividends
= Retained earnings, ending balance
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35. Retained Earning Restrictions
Restrictions make a portion of the balance currently unavailable for dividends for contractual or voluntary reasons
No journal entry; disclosed in notes
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36. Accumulated Other Comprehensive Income
Accumulated other comprehensive income is similar to retained earnings. It starts with the opening balance and is increased by other comprehensive income (decreased by other comprehensive losses) each period
Other comprehensive income (OCI) includes unrealized gains and losses from revaluing available-for-sale securities (which we will learn about in Ch. 12), amongst other examples
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37. Shareholders’ Equity on the Balance Sheet
Contributed Capital
Share capital: preferred and common shares
Additional contributed capital: amounts contributed from acquiring and retiring shares
Retained Earnings
Cumulative net income (loss) since incorporation
Annual net earnings is added; dividends are deducted
Accumulated Other Comprehensive Income
Certain gains and losses that bypass net earnings
Recorded directly to shareholders’ equity
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38. Statement of Shareholders’ Equity
The statement expands and replaces the statement of retained earnings
It discloses the changes in each shareholders’ equity account during the period
Covers same period of time as statement of earnings and statement of comprehensive income
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39. Measuring Corporate Performance
Dividend record
Payout ratio
Dividend yield
Earnings performance
Earnings per share
Return on common shareholders’ equity
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40. Higher is better if investor looking for income
Payout Ratio
Measures the percentage of earnings distributed in the form of cash dividends to common shareholders
Payout Ratio =
Cash Dividends
Net Earnings
Higher is better if investor looking for income
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41. Higher is better if investor looking for income
Dividend Yield
Measures the earnings generated by each share, based on the market price of the shares
Dividend Yield =
Dividend per Share
Market Price per Share
Higher is better if investor looking for income
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42. Earnings per Share Measures the income earned by each common share
Net Earnings Available to Common Shareholders
Weighted Average Number of Common Shares
Not comparable between companies
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43. Earnings per Share Net earnings available to common shareholders
Net earnings – preferred dividends
Weighted average number of common shares
Shares issued during the year x the fraction of the year they are outstanding
Example: April 1 = 3/12 months if calendar year used
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44. Earnings per Share: Complex Capital Structure
When a company has securities that can be converted into common shares, the additional common shares will result in a reduced (diluted) EPS figure
Two EPS amounts are calculated:
Basic EPS: calculation on preceding page
Fully diluted EPS: calculated as if all securities were converted into common shares
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45. Returns on Common Shareholders’ Equity
Measures the company’s profitability from the shareholders’ point of view
Return on Common Shareholders’ Equity =
Net Earnings Available to Common Shareholders
Average Common Shareholders’ Equity
Higher is better
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46. Return on Common Shareholders’ Equity
Net earnings available to common shareholders
Net earnings – preferred dividends
Common shareholders’ equity
Total shareholders’ equity – preferred shares (legal capital)
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47. Copyright Notice
Copyright © 2009 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 programs or from the use of the information contained herein.