Shareholders’ Equity. Chapter 14. The primary advantages are: limited liability capital accumulation ease of ownership transfer potential for an expanded equity base. The Corporate Form of Organization Advantages and Disadvantages. The disadvantages include: increased taxation - PowerPoint PPT Presentation
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Public companies: companies whose securities, either debt or equity, are traded on stock exchanges
Private placement: issuing financial instruments to a single buyer or a syndicate of buyers; not made available to the public; benefits include the ability to modify terms to address specific investor needs and to avoid requirements imposed by securities regulators (OSC, SEC, etc.)
Share Capital Share capital, represented by share certificates,
represent ownership in a corporation Shares may be bought, sold, or otherwise transferred
by the shareholders without the consent of the corporation unless there is an enforceable agreement to the contrary
At least one class of shares has the right to vote, and that class receives the residual interest (if any) in the assets if the company is liquidated or dissolved
This class of shares normally is described as the common shares
While the CBCA and most provincial business corporations acts prohibit the use of par value shares, one or two provincial jurisdictions do allow their issuance
Par value shares: have a designated dollar amount per share, as stated in the articles of incorporation and as printed on the face of the share certificates
Premiums and discounts are recognized and recorded in separate equity accounts
Fundamental Share Equity Concepts and Distinctions
The fundamental concepts that underlie the accounting and reporting of shareholders’ equity may be summarized as follows:separate legal entitysources of shareholders' equitycost-base accountingno impact on income
Fundamental Share Equity Concepts and Distinctions (cont.)
Authorized share capital: the maximum number of shares that can be legally issued
Issued share capital: the number of shares that have been issued to shareholders to date
Unissued share capital: the number of shares of authorized share capital that have not been issued when there is a limit on the number of authorized shares, that is, the difference between authorized and issued shares
Authorization: the articles of incorporation will authorize an unlimited (or, less frequently, a limited) number of shares
This authorization may be recorded as a memo entry in the general journal and in the ledger account by the following notation:common shares – no-par value
No-par Value Shares Issued for Cash: when shares are issued, a share certificate, specifying the number of shares represented, is prepared for each shareholder
An entry reflecting the number of shares held by each shareholder is made in the shareholder ledger, a subsidiary ledger to the share capital account
The issuance of 10,000 common shares, no-par, for cash of $10.20 per shareCash 102,000 Common shares, no par value (10,000 shares) 102,000
Default on Subscriptions: When a subscriber defaults after partial fulfilment of the subscription contract, certain complexities arise
In case of default, the corporation may decide to (1) return all payments received to the subscriber (2) issue shares equivalent to the number paid for
in full, rather than the total number subscribed (3) keep the moneys received.
Non-Cash Sale of Share Capital: Corporations sometimes issue share capital for non-cash assets
When a corporation issues its shares for non-cash assets or services or to settle debt, the transaction should be recorded at the fair value–but there are two fair values present the fair value of the asset received, and the fair value of the shares issued
To illustrate, assume that Bronex Corp. issued 136,000 Class A shares inexchange for land. The land was appraised at $420,000, while the shares,based on the one prior transaction in the shares, were valued at $450,000.The board of directors passed a motion approving the issuance of sharesto be valued at the average of these two prices, $435,000.
Land 435,000Class A share capital (136,000 shares) 435,000
the incremental method, in which the market value of one security is used as a basis for that security and the remainder of the lump sum is allocated to the other class of security
Share Issue Costs: costs corporations incur when they issue shares in a public offering, e.g., registration fees, underwriter commissions, legal and accounting fees, printing costs, clerical costs, and promotional costs
When shares are purchased and immediately retired, all capital items relating to the specific shares are removed from the accounts
If cumulative preferred shares are retired, and there are dividends in arrears, such dividends are paid and charged to retained earnings in the normal manner
Retirement of Shares (cont.) Where the reacquisition cost of the acquired shares is
different from the average original issuance price, the CICA Handbook recommends that the cost be allocated as follows for no-par shares:
Reacquisition cost is higher than the average price per share issued to date, the cost should be charged in this sequence: to share capital at the average price per issued
share to any contributed capital that was created by
earlier treasury stock transactions in the same class of shares
Reacquisition cost is lower than the average price per share issued to date, the cost should be charged: to share capital at the average price per issued
shareany remaining amount to contributed capital
The effect of these rules is to ensure that a corporation records no income effect (i.e., no gain or loss on the income statement) on buying back its own shares
A firm may also buy its own shares and hold them for eventual resale
Such shares may not vote at shareholder meetings or receive dividends
The Canada Business Corporations Act (and provincial legislation modelled after the act) provides that corporations that reacquire their own shares must immediately retire those shares
Retained earnings represent accumulated net income or net loss (including all gains and losses), error corrections, and retroactive changes in accounting policy, if any, less accumulated cash dividends, property dividends, stock dividends, and other amounts transferred to contributed capital accounts
Increases (credits):net income (including extraordinary items) removal of deficit in a financial reorganizationunrealized appreciation of investments valued at
Appropriations and Restrictions of Retained Earnings
Appropriated retained earnings are the result of discretionary management action
Restricted retained earnings are the result of a legal contract or corporate law
The following are examples of some of the ways in which appropriations and restrictions may arise: to fulfil a contractual agreement, as in the case of
a debt covenant restricting the use of retained earnings for dividends that would result in the disbursement of assets
Appropriations and Restrictions of Retained Earnings (cont.)
to fulfil a contractual agreement, as in the case of a debt covenant restricting the use of retained earnings for dividends that would result in the disbursement of assets
to report a discretionary appropriation made to constrain a specified portion of retained earnings as an aspect of financial planning
to report a discretionary appropriation of a specified portion of retained earnings in anticipation of possible future losses
A dividend is a distribution of earnings to shareholders in the form of assets or shares
A dividend typically results in a credit to the account that represents the item distributed (cash, non-cash asset, or share capital) and a debit to retained earnings
Under the Canada Business Corporations Act, a liquidity test must also be met
Dividends may not be declared or paid if the result would be that the corporation became unable to meet its liabilities as they came due, or if the dividend resulted in the realizable value of assets being less than liabilities plus stated capital
Cumulative Dividend Preferences on Preferred Shares (cont.)
If cumulative preference dividends are not declared in a given year, they are said to have been passed and are called dividends in arrears on the cumulative preferred shares
The CICA Handbook requires that arrears of dividends for cumulative preference shares be disclosed, usually in the notes to the financial statements
Participating preferred shares provide that the preferred shareholders participate above the stated preferential rate on a pro rata basis in dividend declarations with the common shareholders first, preferred shareholders receive their
preference ratesecond, the common shareholders receive a
specified matching dividend then, if the total declared dividend is larger than
these two amounts, the excess is divided on a pro rata basis between the two share classes
Property dividends or dividends in kind: payment of a dividend with non cash assets
The property may be investments in the securities of other companies held by the corporation, real estate, merchandise, or any other non-cash asset designated by the board of directors
A property dividend is recorded at the current market value of the assets transferred
A corporation that has a temporary cash shortage might declare a dividend to maintain a continuing dividend policy by issuing a scrip dividend
A scrip dividend (also called a liability dividend) occurs when the board of directors declares a dividend and issues promissory notes, called scrip, to the shareholders
This declaration means that a relatively long time (e.g., six months or one year) will elapse between the declaration and payment dates
Ordinary stock dividend: a stock dividend is of the same class as that held by the recipients
Special stock dividend: a stock dividend is of a class of share capital other than the one already held by the recipients is issued (e.g., preferred shares issued to the owners of common)
A special stock dividend: a dividend in a share class different from the class held by the recipients, e.g., such as a stock dividend consisting of preferred shares issued to common shareholders
In this case, the market value of the dividend (the preferred shares) should be capitalized
Stock Splits A stock split: change in the number of shares
outstanding with no change in the recorded capital accounts
A stock split usually increases the number of shares outstanding by a significant amount, such as doubling or tripling the number of outstanding shares
The primary purpose of a stock split is to increase the number of shares outstanding and decrease the market price per share, increase the market activity of the shares, reduce earnings per share
A reverse stock split results in a proportional reduction in the number of shares issued and outstanding and an increase in the average book value per share
Reverse splits may be used to increase the market price of so-called penny stocks, often in preparation for a new public offering of shares
Comprehensive revaluation of assets and liabilities from cost to market value is only permitted when there is:a change in control such that the controlling
shareholder has 90% or more of equity interests
a financial reorganization signalling a fresh start for the entity following receivership or bankruptcy or following a voluntary restructuring agreement with the corporation’s creditors and shareholders
Cumulative foreign currency translation account: unrealized gains and losses that arise from a certain type of foreign currency exposure
Life insurance and mutual fund companies, which are required to carry their investment assets at market values, will report an unrealized capital increment that represents the difference between the cost and the market value of their investments