You are on page 1of 35

Accounting

Principles
Second Canadian Edition
Weygandt · Kieso · Kimmel · Trenholm

Prepared by:
Carole Bowman, Sheridan College
CHAPTER

14

CORPORATIONS:
ORGANIZATION AND SHARE
CAPITAL TRANSACTIONS
CORPORATE FORM OF
ORGANIZATION

 A corporation is a legal entity created by


law that is separate and distinct from its
owners
CLASSIFICATION OF
CORPORATIONS

 A corporation’s purpose may be to earn


a profit, or it may be organized as non-
profit.
 Classification by ownership distinguishes
between publicly-held corporations and
privately-held corporations.
CHARACTERISTICS

 Separate legal existence


 Limited liability of shareholders
 Transferable ownership rights
 Ability to acquire capital
 Continuous life
 Corporation management
 Government regulations
 Additional taxes
ILLUSTRATION 14-1
ADVANTAGES AND DISADVANTAGES
OF A CORPORATION

Advantages Disadvantages

Corporate management - Corporation management -


professional managers ownership separated from
Separate legal existence management
Limited liability of
shareholders Increased costs and complexity
to adhere to government
Deferred or reduced income regulation
taxes
Transferable ownership rights
Potential for additional income
Ability to acquire capital taxes
Continuous life
ORGANIZATION COSTS

 Costs incurred in forming a corporation are


called organization costs.
 These costs include fees to underwriters,
legal fees, incorporation fees, and
promotional expenditures.
 Organization costs are normally expensed in
the year the organization cost is incurred.
SHAREHOLDER RIGHTS

 To raise capital, the corporation sells


shares
 If only one class of shares-common
shares
 Ownership rights specified in articles of
incorporation or by-laws
– Voting…owners
SHARE TERMINOLOGY

 Authorized shares – maximum amount


of shares a corporation is allowed to sell
as authorized by corporate charter
 Issued shares – number of shares sold
SHARE ISSUE CONSIDERATION

 How many shares should be authorized for


sale?
 How should the shares be issued?
 At what price should the shares be issued?
 What value should be assigned to the
shares?
STOCK MARKET PRICE

 Shares of publicly held companies are


traded on organized exchanges at dollar
prices per share established by the
interaction between buyers and sellers
STATED AND PAR SHARE VALUES

 Stated value – assigned value to no-par


value shares
 Par value – assigned legal capital value

Must retain legal capital.


Stated and par values have NO
relationship to market value
NO PAR SHARE VALUES

 No assigned legal capital value


 Legal capital equals issue price
(proceeds)

Must retain legal capital.


No-par value has NO
relationship to market value once issued.
ILLUSTRATION 14-5
RELATIONSHIP OF PAR, NO PAR AND
STATED VALUE SHARES TO LEGAL
CAPITAL

Shares Legal Capital per Share


Par value Par value
No par value Entire proceeds
Stated value Stated value
ISSUING NO PAR VALUE
COMMON SHARES FOR CASH

Shares are most commonly issued for cash. When


no par value common shares are issued, the entire
proceeds from the issue becomes legal capital.

Account Titles and Explanation Debit Credit


Cash 1,000
Common Shares 1,000
To record issue of 1,000 shares.
CORPORATE CAPITAL

 Shareholders’ equity (owner’s equity)


 The shareholders’ equity section of a
corporation’s balance sheet consists of:
– Contributed capital
• Share capital
• Additional contributed capital
– Retained earnings
ILLUSTRATION 14-6
SHAREHOLDERS’ EQUITY SECTION

Shareholders’ equity

Contributed capital
Common shares, 100,000 no par value
shares authorized, 50,000 issued $800,000

Retained earnings 130,000


Total shareholders’ equity
$930,000
ISSUING STATED VALUE
COMMON SHARES FOR CASH
When common shares have a stated value, the stated
value is credited to Common Shares. When the selling
price exceeds the stated value, the excess is credited to
Contributed Capital in Excess of Stated Value.

Account Titles and Explanation Debit Credit


Cash 5,000
Common Shares 1,000
Contributed Capital in Excess of Stated Value 4,000
To record issue of 1,000 shares.
SHAREHOLDERS’ EQUITY -
CONTRIBUTED CAPITAL IN EXCESS
OF STATED VALUE

Shareholders’ equity
Contributed capital
Common shares, 10,000 shares of $1 stated value authorized,
2,000 shares issued $ 2,000
Contributed capital in excess of stated value 4,000
Total contributed capital 6,000
Retained earnings 27,000
Total shareholders’ equity $33,000
ISSUING COMMON SHARES FOR
SERVICES OR NON-CASH ASSETS
 Shares may be issued for services, such as
compensation to lawyers, or for non-cash assets,
such as land.
 When common shares are issued for services or
non-cash assets, cost is either the fair market
value of the consideration given up or the
consideration received, whichever is more clearly
determinable.
REACQUIRED SHARES

 Reacquired shares are a corporation’s own


shares that have been issued, fully paid for,
and then reacquired by the corporation.
 Reacquired shares are generally retired
and cancelled.
 In certain restricted circumstances, these
shares are not retired, but are held as
treasury shares for later reissue.
REACQUISITION OF SHARES

 Why would a company choose to


reacquire its shares?
– Reduce quantity/raise share price
– Increase EPS
– If authorized share limit reached, may need
additional shares for use in bonus or
compensation plans or acquisitions
PREFERRED SHARES

 Preferred shares have priority over common


shares with regards to:
1. Dividends and
2. Assets in the event of liquidation
 Preferred shareholders usually do not have
voting rights
 Preferred shares are shown first in the share
capital section of shareholders' equity
PREFERRED SHARE
PREFERENCES

 Liquidation preference
 Cumulative (dividends in arrears)
 Convertible (book value)
 Redeemable/callable (company option)
 Retractable (shareholder option)
DIVIDEND PREFERENCES
CUMULATIVE DIVIDEND
 A cumulative dividend requires that preferred
shareholders be paid both current and prior year
dividends before common shareholders receive any
dividends.
 Preferred dividends not declared in a given period are
called dividends in arrears.
 Dividends in arrears are not considered a liability, but
the amount of the dividends in arrears should be
disclosed in the notes to the financial statements.
CONVERTIBLE PREFERRED
SHARES
 Convertible preferred shares allow the exchange
of preferred shares into common shares at a
specified ratio.
 This kind of share is purchased by investors who
want the greater security of a preferred share, but
who also desire the added option of conversion.
 In recording the conversion, the book value of the
preferred shares is used.
 The conversion of preferred shares does not result
in either gain or loss to the corporation.
 The market value of the shares is not considered.
REDEEMABLE PREFERRED
 Redeemable (callable) preferred shares grant the issuing
corporation the right to purchase the shares from
shareholders at specified future dates and prices.
 This call feature allows some flexibility to a corporation
by enabling it to eliminate this type of equity when
it is advantageous to do so.
 While convertible shares are for the
benefit of the shareholder, redeemable
shares are for the benefit of the
corporation.
RETRACTABLE PREFERRED
 Retractable preferred shares are similar to
redeemable preferred shares except that the
shareholder can redeem shares at their option instead
of the corporation’s.
 Retractable preferred shares and debt have many
similarities.
 Both offer a rate of return to the investor, and with
the redemption of the shares they both offer a
repayment of the principal investment.
 Retractable preferred shares are presented in the
liability section of the balance sheet rather than in the
equity section because it has more of the features of
debt than equity.
REMINDER-
STATEMENT PRESENTATION OF
SHAREHOLDERS’ EQUITY
 In the shareholders’ equity section of the balance
sheet, contributed capital and retained earnings
are reported and the specific sources of
contributed capital are identified.
 Within contributed capital, two classifications are
recognized:
1. Share capital
2. Additional contributed capital
ILLUSTRATION 14-10
SHAREHOLDERS’ EQUITY
PRESENTATION
ZABOSCHUK INC.
Partial Balance Sheet
Shareholders’ equity
Contributed capital
Share capital
$9 preferred shares, no-par value,
cumulative, 10,000 shares authorized,
6,000 shares issued
$ 770,000
Common shares, $5 stated value, unlimited shares
authorized, 400,000 shares issued
2,000,000
Total share capital
2,770,000
Additional contributed capital
Contributed capital in excess of stated value - common shares
860,000
Total contributed capital
3,630,000
Retained earnings
1,058,000
Total shareholders’ equity
$4,688,000
RETURN ON EQUITY

 Return on equity (or return on


investment) is considered to be the most
important measure of a firm’s
profitability and efficiency.
 Evaluates how many dollars were earned
for each dollar invested by the owners.


Average
Return on
Net Income Shareholders
Equity
= Equity
BOOK VALUE PER SHARE
 Book value per share represents the equity a
common shareholder has in the net assets of
the corporation from owning one share.
 The formula for calculating book value per
share when a corporation has only one class of
shares is:

Total Number of
Shareholders’
Equity
 Common
Shares
= Book Value
per Share
CALCULATION OF BOOK VALUE
WITH PREFERRED SHARES
When a company has both preferred and common
shares, the calculation of book value is more complex.
Steps required are:
1. Calculate the preferred shareholders’ equity (the sum of
redemption price of preferred shares plus any
cumulative dividends in arrears).
2. Determine the common shareholders’ equity (total
shareholders’ equity less preferred shareholders’
equity).
3. Divide common shareholders’ equity by the number of
common shares to determine book value per share.
BOOK VALUE VS. MARKET VALUE

 Book value per share seldom equals market value.


 Book value is based on historical costs; market
value reflects the subjective judgement of
thousands of shareholders and prospective
investors about the company’s potential for future
earnings and dividends.
 Market value per share may exceed book value per
share, but that fact does not necessarily mean that
the shares are overpriced.
COPYRIGHT

Copyright © 2002 John Wiley & Sons Canada, Ltd. All rights reserved.
Reproduction or translation of this work beyond that permitted by
CANCOPY (Canadian Reprography Collective) is unlawful. Request for
further information should be addressed to the Permissions Department,
John Wiley & Sons Canada, Ltd. The purchaser may make back-up copies
for his / 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.

You might also like