Chapter 15 Shareholders’ Equity

Name: Chapter 15 Shareholders’ Equity
Uploaded: 2017-08-27T11:14:27+00:00
Duration: PTM27S33
Channel: Esther Woods
Description: Chapter 15 Shareholders’ Equity

Chapter 15 Shareholders’ Equity
Prepared by: Dragan Stojanovic, CA Rotman School of Management, University of Toronto

Shareholders’ Equity The Corporate Form Share capital
Corporate law Share capital system Share capital Types of shares Limited liability of shareholders Issuance of shares Reacquisition of shares Retirement of reacquired shares Retained Earnings Formality of profit distribution Types of dividends Stock splits Other Components of Shareholders’ Equity Contributed surplus Accumulated other comprehensive income Presentation and Disclosure Special presentation issues Perspectives Analysis IFRS / Private Entity GAAP Comparison Looking ahead Comparison

Components of Shareholders’ Equity
Share Capital: Common And/or Preferred shares Contributed Surplus Contributed Capital Retained Earnings Accumulated other Comprehensive Income Earned Capital

Primary Forms of Business Organization
Proprietorship Partnership Corporation Profit-oriented Engaged in making financial returns for their owners Shares publicly traded Shares privately held Private Sector Public Sector Not-for-profit No shares issued; created to provide services for members or society Crown Created by government statute to provide public services Municipalities, Cities, Etc.

Corporate Accounting Special characteristics that impact on accounting: Corporate law Share capital system Limited Liability

Corporate Law Articles of Incorporation Corporation Charter Issued
Corporation Recognized as Legal Entity

Corporate Law Canada Business Corporation Act (CBCA)
Articles of incorporation prepared and submitted Company name Location of registered office Classes and authorized shares Share transfer restrictions (if any) Directors Business restrictions CBCA regulations required financial statements be prepared in accordance with GAAP

Share Capital System Shares grouped by “class” (e.g. Class A Common)
Within each class, each share equal Each share contains certain rights and privileges Ease of transfer of ownership Advantage to both issuing corporation and investor Share becomes more attractive investment

Share Capital System As a minimum each share has these basic or inherent rights To share proportionately in profits and losses The right to vote for directors To share proportionately in assets upon liquidation Preemptive right for any new share issues can also be assigned under CBCA

Share Capital Common shares Represent basic ownership interest
Represents residual ownership interest - have ultimate risk of loss and benefit from success Dividends, or assets on dissolution, not guaranteed True advantage is in the right of Common Shares to ultimately control by way of voting

Share Capital Preferred Shares
Certain inherent rights given up or exchanged for other special rights or privileges Preference given on Dividends (usually at a stated rate) Claim to assets on dissolution Preferred shares features (some or all may be attached to a preferred share) Cumulative  Callable/redeemable Convertible  Retractable Participating

Share Capital Preferred Shares Features
Cumulative: Dividends in arrears must be paid before any profits can be distributed to common shareholders Convertible: The company or holder can exchange the shares for common shares at a predetermined ratio Callable/Redeemable: The issuing company can “call” at its option the preferred shares at specified future dates at stipulated prices Retractable: The holders can “put” (or sell) their shares to the company Participating: Holders can participate with common shareholders in any profit distributions higher than the prescribed rate

Limited Liability Limited Liability of Shareholders
Unlike partnership or proprietorship form of business Shareholders not generally liable for the obligations of the corporation Shareholders losses restricted to Amount invested in the corporate shares

Accounting for the Issuance of Shares
Shares basic Shares sold on a subscription basis Defaulted Subscription accounts Shares issued in combination with other securities

Shares Issue - Basic Full amount of proceeds received is credited to the respective share capital account (preferred/common/class type) 500 common shares are sold for $10.00 each (issuance costs not included in this transaction). The journal entry is: Cash 5,000 Common Shares 5,000

Shares Sold by Subscription
Shares are sold, with “instalment” payments Shares are not issued, and any rights are not given (e.g., voting, dividends) until the full subscription price is received Dividends may be attached to some subscription shares, once the initial payment is received

Accounts in share subscription transaction Common Shares Subscribed Set up a separate one for each type/class of share An equity account, reported below the respective share capital account on the Balance Sheet Subscription Receivable Normally considered a current asset May be reported as a contra account to the Shares Subscribed account in equity section of the Balance Sheet Share Capital Credited only when the subscription is paid in full, or settled in some other manner, in the case of default

500 shares are sold on subscription for $20 each. 50% is due as initial payment. The initial journal entries would be: Subscription Receivable 10,000 Common Shares Subscribed 10,000 Cash ,000 Subscription Receivable ,000

If all payments are made as scheduled, the entries would be: Cash ,000 Subscription Receivable 5,000 Shares Subscribed 10,000 Share Capital 10,000 If the subscriber defaults, one of the following may happen (depending on the contract terms and applicable legislation).

If a subscription contract is defaulted there are generally three possible consequences: Funds paid to date are refunded, often with a deduction for expenses, and the balance of the contract is cancelled Funds paid to date are forfeited transferring it to the Contributed Surplus account, with no refund or shares being issued; balance of the contract is cancelled Shares are issued for the amount paid to date, with the balance of the contract cancelled

Default after first payment – funds refunded with no penalty. Shares Subscribed 10,000 Accounts Payable (or Cash) 5,000 Subscription Receivable 5,000 Default after first payment – shares issued for amount paid. Shares Subscribed 10,000 Share Capital 5,000 Subscription Receivable 5,000

Default after first payment – funds held by corporation. Shares Subscribed 10,000 Subscription Receivable 5,000 Contributed Surplus 5,000

Shares Issued With Other Securities
When two or more classes of shares are sold for a lump sum Accounting problem is the allocation of the funds received to the respective share classes Two methods available Proportional method (relative market value method) Incremental method

Accounting for Share Issue Costs
Direct incremental costs incurred to sell shares include legal fees, accounting fees, underwriter fees & commissions, printing and mailing costs, taxes, etc. These amounts are considered to be capital transactions (rather than operating transactions) and therefore should not be included in net income calculation Accounting treatment—debit to Share Capital

Accounting for Share Issue Costs
Reduction of the amount paid in 1,000 shares sold for $10.00 each, with $500 in issue costs Cash 9,500 Share Capital Share Capital 10,000

Share Repurchase Major reasons for the reacquisition of a corporation’s own shares Reduce the shares outstanding to increase EPS Have enough shares on hand to meet employee share compensation contracts Buy out a particular ownership interest Meet the needs of a potential merger Stop (or slow down) takeover attempts Reduce number of shareholders Make a market in the company’s shares Return cash to shareholders

Reacquisition of Shares
Shares may be retired when reacquired May also (in limited circumstances and jurisdictions) become Treasury Stock (held in treasury for reissue) In Canada, the CBCA requires repurchased shares be cancelled and restored to status of authorized but unissued, if a limit to authorized shares exists

Reacquisition of Shares
Share capital debited with the original issue or assigned value only The difference then allocated to equity accounts: Contributed Surplus Retained earnings

Reacquisition of Shares - Retired
In January 2011, Cooke Corp. purchased and cancelled 500 Class A shares at $4 per share. There are 10,500 shares issued and outstanding, with total share capital of $63,000 Common Shares (500 [$63,000/10,500] ) 3,000 Cash (500 $4.00) 2,000 Contributed Surplus 1,000 Assigned share value = $63,000/10,500 = $ 6.00 Acquisition cost = per share price/cost Value over assigned value $2.00

Items Affecting Retained Earnings
DEBITS Net loss Prior period adjustments, accounting principle changes Cash, property, stock dividends Treasury stock CREDITS Net Income Prior period adjustments, accounting principle changes Adjustments from financial reorganization

Formality of Profit Distribution
No amounts may be distributed unless corporate capital is maintained intact Under the CBCA: There needs to be sufficient capital after the dividend to pay liabilities as they are due The realizable value of the corporate assets does not fall below the total of the liabilities and the stated and legal capital for all classes of shares Formal approval of the Board of Directors required Dividends are in full agreement with share capital contracts Before declaration of a dividend, management should consider availability of funds to pay the dividend

Dividend Distributions
Types of dividends Return on capital Cash dividend Stock dividend Return of capital Liquidating dividends Important dates Date of declaration Date of record Date of payment

Cash Dividends First journal entry is on Date of Declaration
Dividend becomes legal obligation of the corporation Equity account is debited, liability account is credited Cash Dividends Declared (or Retained Earnings) xxx Dividends Payable xxx On Date of Payment liability is reduced

Cash Dividends Before the dividend is paid, a current list of shareholders needs to be prepared (as at the date of record) If a Cash Dividends Declared account is used rather than Retained Earnings at the date of declaration, this account is closed to Retained Earnings at year end

Dividends in Kind Dividends payable in corporation assets other than cash These dividends are normally measured at the “fair value” of the asset given up Fair value is determined by referring to: estimated realizable value of same or similar assets, quoted market prices, independent appraisals

Stock Dividends No assets distributed (unlike cash dividends)
Unlike with cash dividends or dividends in kind, total shareholders equity does not change Amounts are “re-arranged” as a result of the stock dividend The transaction is measured at the fair value of the shares at declaration date Each shareholder has the exact same proportionate interest in the corporation However, book value per share decreases

Stock Dividends 1,000 common shares outstanding
Retained earnings = $50,000 10% stock dividend declared Fair (market) value of share = $130 per share Stock Dividends Declared 13,000 Common Shares ,000 1,000 x 10% = Fair value $ Total $13,000

Dividend Preferences Example Data $50,000 total declared as dividends
Common share capital = $400,000 Preferred shares: 1,000 $6 outstanding (issued at $100,000)

Non-cumulative If shares are non-cumulative and non-participating
Dividends are distributed only when declared, up to the stated amount of the share No amount is paid for years where dividends were not declared Referring to previous data: Preferred Shareholders are paid $6,000 ($6 x 1000) and Common Shareholders are paid the remaining amount of $44,000

Cumulative If the preferred shares are cumulative and non-participating, and dividends not paid to the preferred shareholders in previous 2 years: Preferred Shareholders are paid $18,000 ( ($6 x 1000 x 2) + $6,000) Common Shareholders are paid the remaining $32,000 ($50,000 - $18,000)

Participating If no specific participation agreement exists, participation generally follows these guidelines Following assignment to preferred shares of current year dividends (any cumulative dividends have been allocated first); common shares receive an amount to give them the same return rate as the preferred Any remaining dividend amount is shared by both preferred and common in proportion to the carrying value of each share class

Participating If preferred shares are non-cumulative and fully participating, using the previous data: Preferred Common Current year’s: Preferred ($6 x 1000) $6,000 Common (6% x $400,000) $24,000 Remaining $20,000 at a rate of $20,000/$500,000 (i.e. 4%): Preferred (4% x $100,000) $4,000 Common (4% x $400,000) $16,000 TOTAL $10, $40,000

Stock Dividends vs. Stock Splits
As form of dividend must follow the requirements of a dividend Both the number of shares, and the amount of share capital generally affected Shares are not exchanged Stock Split Increases the number of shares outstanding Amount of share capital is not affected Results in a market price manipulation

Contributed Surplus transactions Par value share issue and/or retirement Treasury share transactions Liquidating dividends Financial reorganization Stock options and warrants Issue of convertible debt Share subscriptions forfeited Donated shares Redemption or conversion of shares

Accumulated Other Comprehensive Income Cumulative change in equity from non- shareholder transactions which are excluded from net income Considered to be earned income

Disclosure of Share Capital
Following basic disclosure is required: Authorized share capital Issued share capital Changes in share capital since last balance sheet date

Disclosure of Share Capital
Additional disclosures include: Authorized number of shares (if no limit, then so stated) The existence of unique rights Number of shares issued, and the amount received Whether the shares are par-value or no-par value Amount of any dividends in arrears for cumulative preferred shares Changes during the year, including new issuances and redemptions (under IFRS, presented in statement of changes in equity) Restrictions on retained earnings

Shareholders’ Equity Ratios
Rate of return on common shareholders’ equity Net income – Preferred dividends Average common shareholders’ equity Payout ratio Cash Dividends Net income – Preferred dividends Price earnings ratio Market price per share Earnings per share Book value per share Common shareholders’ equity Number of outstanding shares

Looking Ahead There are several projects being undertaken by IASB and FASB that may impact accounting for shareholders’ equity These include financial statement project, and project on liabilities and equity

COPYRIGHT Copyright © 2010 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.

Chapter 15 Shareholders’ Equity

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