2. Companies: Share Capital and the Statement of Financial Position Chapter 14 HORNGREN ♦ HARRISON ♦ BAMBER ♦ BEST ♦ FRASER ♦ WILLETT

3. 14 - 2 Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia Objectives 1.Identify the characteristics of a company. 2.Record the issue of shares 3.Prepare the shareholders’ equity section of a company’s statement of financial position 4.Account for cash dividends 5.Use different share values in decision-making 6.Evaluate a company’s return on assets and return on shareholders’ equity 7.Account for the income tax of a company

4. 14 - 3 Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia Objective 1 Identify the characteristics of a company.

5. 14 - 4 Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia Characteristics – separate legal entity – continuous life and transferability of ownership – no mutual agency – limited liability of shareholders – separation of ownership and management – company taxation – government regulation

6. 14 - 5 Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia Organising a company l The process of creating a company begins when the organisers (promoters) obtain a certificate of registration from ASIC. l The Corporations Act includes a number of basic rules for managing the company. l The company can accept these rules or replace them with their own company constitution.

7. 14 - 6 Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia Organising a company l Shareholders elect the board of directors. l The board sets policy, appoints the officers, and elects a chairperson. l The board also designates the managing director, who is often known as the chief executive officer (CEO).

8. 14 - 7 Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia Authority Structure in a Company Shareholders Board of Directors Chairperson of the Board Chief Executive Officer Various Executives and Company Secretary Controller?Treasurer?

9. 14 - 8 Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia Share Capital l Company ownership is evidenced by a ‘share certificate’ or ‘shareholder holding statement’ which may be for any number of shares. l See Exhibit 14-3 and 14-4 in your textbook l A share that is held by a shareholder is said to be an ‘issued share’.

10. 14 - 9 Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia Shareholders’ Equity Share capital Retained profits Owners’ equity in the company has two components:

11. 14 - 10 Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia Shareholders’ Equity Example On June 1, the Wong’s company issued share valued at $10,000. June 1 Cash10,000 ShareCapital10,000 Issue of share

12. 14 - 11 Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia Shareholders’ Equity Example Wong’s company net profit for the year was $8,000. June 30 Profit and Loss Summary 8,000 Retained Profits 8,000 To close net profit to Retained Profits

13. 14 - 12 Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia Shareholders’ Rights l The ownership of share entitles shareholders to four basic rights, unless specific rights are withheld by agreement. 1 Vote 2 Dividends 3 Liquidation 4 Preemption

14. 14 - 13 Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia Classes of share l Ordinary share is the most basic form of capital share. l Preference share gives its owners certain advantages over ordinary shareholders. l In Australia shares are now issued without a par value (it makes the accounting easier).

15. 14 - 14 Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia Objective 2 Record the issue of shares.

16. 14 - 15 Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia Issuing Shares Example l On January 13, Martin Limited, which manufactures skateboards, issues 10,000 ordinary share for $10 per share.

17. 14 - 16 Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia Issuing Shares Example The 10,000 shares were issued for $10 each. January 13 Cash 100,000 Ordinary Share Capital 100,000 Issue no par value ordinary share

18. 14 - 17 Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia Issuing Shares Example l On February 11, Martin company issued 15,000 shares of its ordinary share for a building worth $100,000. l What is the journal entry?

19. 14 - 18 Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia Issuing Shares Example February 11 Building100,000 Ordinary Share Capital (15,000 shares)100,000 Issued ordinary share in exchange for a building

20. 14 - 19 Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia Issuing Shares Example By Instalment l Shares may sometimes be issued by instalments. l Money may be payable: ä When the investor makes application for the shares. ä When the shares are issued or the allotment made ä Later when more money is asked for or a call is made

21. 14 - 20 Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia Issuing Shares Example By Instalment l Huang Limited issues 10,000 shares ä $5 payable on application ä $3 on allotment and ä $2 call.

22. 14 - 21 Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia Issuing Shares Example Applications received for 10,000shares Cash Trust (10,000 x $5)50,000 Application 50,000 Received application money, to be held in trust

23. 14 - 22 Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia Issuing Shares Example The 10,000 shares were issued (allotted). Application (10,000 x $5) 50,000 Allotment (10,000 x $3)30,000 Ordinary Share Capital 80,000 Issue ordinary share

24. 14 - 23 Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia Issuing Shares Example The application money is now ours, so it can be transferred from the trust account to our account. Cash 50,000 Cash Trust 50,000 Transfer application money to company’s bank account

25. 14 - 24 Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia Issuing Shares Example Received allotment money Cash 30,000 Allotment 30,000 Collected amount due on allotment

26. 14 - 25 Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia Issuing Shares Example Made the call and then received the money Call 20,000 Ordinary Share Capital 20,000 Called up balance outstanding on partly paid shares Cash20,000 Call 20,000 Collected call on ordinary shares

27. 14 - 26 Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia Issuing Shares Example Oversubscription l Investors may apply for more shares than are available to be issues. l If there is an oversubscription management may: ä Refund the money or ä Apply it to later amounts payable; allotment and or call. l Assume Huang received applications for 12,000 shares (12,000 x $5)

28. 14 - 27 Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia Issuing Shares Example Or Application 10,000 Allotment 10,000 Apply excess application money to amount due on allotment Application 10,000 Cash Trust 10,000 Refund excess application money

29. 14 - 28 Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia Issuing Shares Example Forfeiture l Investors who do not pay the allotment or call may forfeit their shares. l Assume the holder of 100 Huang shares did not pay the call l The “Call” account was originally debited $20,000 l But only $19,800 cash was received

30. 14 - 29 Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia Issuing Shares Example Ordinary Share Capital (100 x $10) 300 Call (100 x $2) 300 Forfeited Share Account 700 Record forfeiture of 100 shares To forfeit the shares

31. 14 - 30 Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia Issuing Shares Example Cash950 Forfeited Share Account 50 Ordinary Share Capital 1,000 Reissued 100 forfeited shares The forfeited shares were reissued for $9.50 each

32. 14 - 31 Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia Issuing Preference share l Accounting for preference share follows the pattern illustrated for ordinary share. l Shareholders’ equity on the statement of financial position lists, ordinary share, preference share, and retained profit – in that order.

33. 14 - 32 Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia Objective 3 Prepare the shareholders’ equity section of a company’s statement of financial position.

34. 14 - 33 Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia Contributed equity: 400 ordinary shares, fully paid4,000 100 preference shares (70c per share annual dividend) fully paid 2,000 Retained profits3,000 Total equity9,000 Review of Accounting for Paid-up Capital Shareholders’ Equity

35. 14 - 34 Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia Review of Accounting for Paid-up Capital l Contributed equity and retained profits represent the shareholders’ equity (ownership) in the assets of the company. l Contributed equity comes from the company’s shareholders who invested in the company. l Retained profits come from the company’s customers – but has become the shareholders’.

36. 14 - 35 Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia Objective 4 Account for cash dividends.

37. 14 - 36 Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia Dividend Dates l A company must declare a dividend before paying it. l The board of directors alone has the authority to declare a dividend.

38. 14 - 37 Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia Dividend Dates Declaration date Date of record Payment date Three relevant dates for dividends are:

39. 14 - 38 Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia Cash Dividends Example l On April 1, the board declares a dividend of $1 per share payable June 15 to shareholders of record on May 15. l There are 60,000 shares outstanding.

40. 14 - 39 Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia Cash Dividends Example June 15 Dividends Payable60,000 Cash60,000 Paid a cash dividend April 1 Retained Profits60,000 Dividends Payable60,000 Declared a cash dividend

41. 14 - 40 Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia Cash Dividends Example 1,000 Preference shares $6 annual dividend per share 25,000 Ordinary shares $50,000 dividends declared

42. 14 - 41 Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia Cash Dividends Example Preference dividend $6 × 1,000 = $6,000 Ordinary dividend $50,000 – $6,000 = $44,000

43. 14 - 42 Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia Preference dividend $6 × 10,000 = $60,000 (The full $50,000 goes to preference shares) Suppose there were 10,000 preference shares, $6 annual dividend per share Ordinary shareholders receive nothing. Cash Dividends Example

44. 14 - 43 Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia Cumulative and Non-cumulative Preference Shares l If the preference is cumulative, the $10,000 shortage must be paid before any dividend is paid to ordinary shareholders. l If noncumulative, a passed dividend not paid or not fully paid is simply lost.

45. 14 - 44 Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia Objective 5 Use different share values in decision-making.

46. 14 - 45 Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia Share Values l The business community refers to different share values in addition to the original issue price. – market value – liquidation value – book value

47. 14 - 46 Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia Share Values Example Book value preference = (Liquidation value + Dividends in arrears) ÷ Number of shares outstanding Book value per share = Total shareholders’ equity ÷ Total shares outstanding Book value ordinary = (Shareholders’ equity – Amount allocated to preference) ÷ Number of shares outstanding

48. 14 - 47 Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia Share Values Example Contributed Equity: Ordinary share, 10,000 shares, fully paid$300,000 Retained profits 100,000 Total shareholders’ equity$400,000 Book value per share: $400,000 ÷ 10,000 = $40 Shareholders’ Equity

49. 14 - 48 Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia Share Values Example Book value per share preference: ($210,000 + $12,000) ÷ 2,000 = $111.00 liquidation + cumulative ÷ number = book value dividends shares value Book value per share ordinary: ($606,000 – 222,000) ÷ 10,000 = $38.40 (total equity – preference ÷ number = book book value) shares value

50. 14 - 49 Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia Objective 6 Evaluate a company’s return on assets and return on shareholders’ equity.

51. 14 - 50 Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia Return on Assets Rate of return on total assets = Earnings before (interest + tax) ÷ Average total assets It is a measure of a company’s ability to generate profits from the use of its assets.

52. 14 - 51 Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia Return on Equity Rate of return on ordinary shareholders’ equity = (Net profit – Preference dividends) ÷ Average ordinary shareholders’ equity It is a measure of the profits earned from the ordinary shareholders’ investment in the company.

53. 14 - 52 Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia Objective 7 Account for the income tax of a company.

54. 14 - 53 Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia Accounting for Income Taxes by Company’s Income tax expense = Profits before income tax (from the statement of financial performance.) × Income tax rate Income tax payable = Taxable income (from the tax return filed with the ATO) × Income tax rate

55. 14 - 54 Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia Accounting for Income Taxes by Company’s l Deferred tax liability is the difference between income tax expense and income tax payable for any one year. l Revenues and expenses may be reported in different periods for statements of financial performance and tax return purposes. l Alternative depreciation methods may be used for book and tax purposes.

56. 14 - 55 Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia End of Chapter 14