1. Chapter 13 Corporations: Organization and Share Capital Transactions

2. Agenda Learning goals Vocabulary
Lesson 1: The Corporate form of organization
Characteristics of a corporation
Forming a Corporation
Ownership rights of shareholders
Shares Issue Considerations

3. Learning goals
Identify and discuss the major characteristics of a corporation
Record common shares transactions
Record preferred shares transactions
Prepare the shareholders’ equity of the balance sheet and calculate return on equity.

4. Vocabulary Authorized shares Noncumulative Common shares
Organization costs
Comprehensive income
Preferred shares
Contributed capital
Privately held corporation
Convertible preferred shares
Publicly held corporation
Corporation
Redeemable (callable) preferred shares
Cumulative dividend
Retained earnings
Dividends in arrears
Retractable preferred shares
Financial instrument
Initial public offering (IPO)
Return on equity
Share capital
Issuing shares
Legal capital
No par value shares

5. The Corporate Form of Organization
The corporation: is a legal entity that is separate form its owners, who are known as shareholders.
As a legal entity, a corporation has most of the rights and privileges of a person.
Obligation to respect laws and pay income tax
It can not vote or hold public office.
Corporation can be for profit and not for profit

6. Classification by Ownership
Publicly held corporation: The shares are traded on organized securities markets, such as Toronto Stock Exchange. Available for anyone in the general public to buy or sell.
Privately held corporation: Shares are owned by a few private shareholders. The share are not traded on stock exchanges and are not available to the general public.

7. Characteristics of a Corporation
Separate legal existence from its owners
Limited liability of shareholders to the amount of their investment
Transferable ownership rights by buying and selling shares
Ability to acquire capital by issuing shares
Continuous and indefinite life
Corporation management
Shareholders manage through an elected board of directors
Board of directors selects corporation management
Government regulations
Canada Business Corporation Act regulates what corporation can or can not do
Income tax
Taxed as a separate entity

8. Advantages and Disadvantage of a Corporation
Disadvantages
Corporate management – professional managers
Separate legal existence
Limited liability to shareholders
Potential for deferred or reduced income tax (shareholder do not pay tax on income earned until it is distributed to them)
Transferable ownership rights
Ability to acquire capital
Continuous life
Corporate management – ownership separated from management
Increased cost and complexity to follow government regulations
Potential for additional income tax

9. Forming a Corporation Can incorporate federally or provincially
Done by filing articles of incorporation
Provide information such as :
Name and purpose of company
Amounts and kinds of share capital
Names and addresses of incorporators
Location of corporation’s head office
By-laws: internal rules and policies
Organization costs:
Costs of forming a corporation (legal fees, accounting fees and regulation)
Normally expensed

10. 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 income
To remaining assets in a liquidation

11. Share Issue Considerations
Authorized share capital
Number of shares company is allowed to sell
Many companies have unlimited number of shares
Issued shares
Authorized shares that have been sold
Issued directly to investors or through an investment dealer
First public sale is called an initial public offering (IPO)

12. 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
Is the amounts contributed to the corporations by shareholders in exchange for shares of ownership it is considered legal capital and can not be distributed to shareholders
Retained earnings are earned capital and can be distributed as dividends

13. Practice questions Self study questions: 1+2 Question 3,5,6
BE 13-1 & 2
E13-1
P13-1A

14. Agenda Common Shares Preferred shares Issuing shares for cash
Reacquisition of shares
Preferred shares
What are they
Dividend preference
Convertible preferred
Redeemable and retractable preferred
Liquidation Preference

15. Common Shares: Issuing Shares
Shares are usually issued for cash:
Dr. Cash Cr. Common shares
Shares can be issued in exchange for services (compensation for lawyers or consultants or noncash assets (land, building and equipment)
Recorded at market value of shares given up:
Dr. Service or asset (amount = mkt value of shares) Cr. Common shares
If market value of shares not determinable, use value of services or noncash assets

16. Common Shares: Issuing Shares
Assume that they lawyer who helped Hydroslide incorporated billed the company $5,000 for her services. On January 18, she agreed to accept 4,000 common shares in payment for her bill. At the time of the exchange, the market price for the shares is $1
Jan legal Fees Expense 4,000
Common Shares 4,000
To record issue of 4,000 common shares for legal service

17. Common Shares: Issuing Shares
For noncash transactions the cost is the cash equivalent price.
This means that when there is an issue of shares in exchange for services or noncash assets, the cash equivalent price is the market value of the common shares given up

18. Common Shares: Issuing Shares
When common shares do not have a ready market value (meaning they can not be bought or sold easily) or their market cannot be determined.
In these cases, the market value of the consideration that is received would instead be used to determine the cash equivalent price.

19. Common Shares: Issuing Shares
Newly incorporated company issued 10,000 shares on October 1 to acquire land with an appraised value of $80,000.
At the time of the acquisition the company's shares do not have a reliable market value because they are not actively traded yet.
In this case, the land would be recorded at the market value of the consideration received $80,000
Oct 1 Land 80,000
Common shares 80,000
To record issue of 10,000 common shares for land

20. Common Shares: Reacquisition of Shares
Companies can reacquire their shares to:
Increase trading on securities markets to increase market value
Increase earnings per share by reducing shares
Buyout hostile shareholders
Have shares available for compensation or other uses (employee and managers)
Comply with share ownership restrictions (limits of foreign ownership)
Reacquired shares are retired and cancelled

21. Common Shares: Reacquisition of Shares 2
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
Price paid to acquire the shares – original cost

22. 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: =

23. Reacquisition of Shares: Above Average Cost
If shares reacquired at a price > average cost:
Additional cost of shares is first debited to contributed capital from previous reacquisitions (only when there is a balance the account otherwise:
Remaining difference is debited to retained earnings:

24. Checking for Understanding
Victoria Corporation begins operations on March 1 by issuing 100,000 common shares for cash at $12 per share. On March 15, it issues 5,000 common shares to its lawyers in settlement of their bill for $65,000. The shares continue to trade at $12 per share on march 15. On June 1, Victoria repurchased 10,000 of it’s shares at $10 per share. Record the share transactions. (page 677)

25. Preferred Shares and Dividends
Priority over common shares for dividends and assets in the event of liquidation of the company. Generally do not have voting rights
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

26. 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

27. Dividend Preference
Staudinger Corporation has 10,000 $3-cumulative preferred shares. The $3 is the per share dividend amount, which is usually expressed as an annual amount, similar to interest rates. So, Staudinger’s annual total dividend is $30,000 (10,000 * $3 per share)$90 Dividends in arrears ($30,000 * 2) $60,000 Current year dividends $30,000 Total preferred dividends $90,000

28. 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

29. Convertible Preferred Shares
Ross Industries Inc. issues 1,000 convertible preferred shares at $100 per share. One preferred she is convertible into 10 common shares. The current market price of the common shares is $9 per share. If the market price of the convertible preferred shares is $101 and common shares is $12 on June 10. The convertible preferred shareholder will choose to convert their shares.

30. Redeemable and Retractable Preferred Shares
Corporation (redeemable) give the issuing corporation the right to purchase the shares at specified future dates and prices
shareholder (retractable) gives the shareholder the option to sell the shares back to the corporation at a future date and price

31. Redeemable and Retractable Preferred Shares
Redeemable and retractable preferred shares are similar in some ways to debt.
Considered a financial instrument (contract between two or more parties that establishes financial rights or obligation)
Usually reported in the liabilities section of the balance sheet

32. Checking for understanding
Turin Corporation issued 50,000 preferred shares on February 22 for $20,000 each. Each share was convertible into 10 common shares. ON April 12, another 30,000 preferred shares were issued for $30 each. On June 5, when the price of the common share was $4 and the price of the preferred shares was $35, shareholder converted 20,000 of the preferred share into common. Record the 3 transactions in a journal (page 681)

33. Practice
Self study questions: 3-7
Questions
BE13-39
E13-46

34. Shareholders’ Equity on the Balance Sheet
Contributed Capital
Share capital: preferred and common shares
Preferred shares are listed first
Additional contributed capital: amounts contributed from acquiring and retiring shares

35. Agenda Statement presentation and analysis
Presentation of shareholder’s equity
Analysis of the statement

36. Shareholders’ Equity on the Balance Sheet
Retained Earnings
Cumulative net income (loss) since incorporation
Annual net income is added; dividends are deducted (similar to drawings by the owner in a proprietorship)

37. Shareholders’ Equity on the Balance Sheet
Closing journal entries
Dec. 31
Service Revenue
500,000
Income Summary
To close revenue to income summary
290,000
Operating expenses
To close operating expenses to income summary
210,000
Retained earnings
To close income summary (500, ,000) to retained earnings

38. Shareholders’ Equity on the Balance Sheet
Dec. 31
Retained Earnings
80,000
Dividends
To close dividends to retained earnings.

39. Shareholders’ Equity on the Balance Sheet
Accumulated Other Comprehensive Income
Certain gains and losses that bypass net income but affect shareholder’s equity.
Recorded directly to shareholders’ equity
Things like:
unrealized gain or loss on available for share securities.
Gain/loss of cash flow hedge
Gain/loss from foreign currency translation
Gain/loss on defined benefit pension plan

40. Sample Shareholders’ Equity Section

41. Average Shareholders’ Equity
Return on Equity
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
Average Shareholders’ Equity ÷ =
Net income
Return on Equity

42. Check for understanding
Look on page and the demonstration problem

43. Practice
Self study question 8
BE13-1013
E 13-711