Accounting principles chapter 14

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...  Stated v

Accounting Principles

Second Canadian Edition

Prepared by:

Carole Bowman, Sheridan College

Weygandt · Kieso · Kimmel ·

Trenholm

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.

 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

Transferable ownership rights

Ability to acquire capital

Continuous life

Corporation management - ownership separated from management

Increased costs and complexity

to adhere to government regulation

Potential for additional income taxes

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

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

 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?

SHARE ISSUE CONSIDERATION

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 value – assigned value to no-par value shares

 Par value – assigned legal capital value

STATED AND PAR SHARE VALUES

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

Account Titles and Explanation Debit Credit Cash

Common Shares

To record issue of 1,000 shares.

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.

1,000

1,000

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 Retained earnings

Total shareholders’ equity

$800,000 130,000

$930,000

ISSUING STATED VALUE

COMMON SHARES FOR CASH

Account Titles and Explanation Debit Credit

Cash

Common Shares

Contributed Capital in Excess of Stated Value

To record issue of 1,000 shares.

5,000

1,000 4,000

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.

SHAREHOLDERS’ EQUITY - CONTRIBUTED CAPITAL IN EXCESS

Total contributed capital

Retained earnings

Total shareholders’ equity

$ 2,000 4,000 6,000 27,000

$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

– If authorized share limit reached, may need

additional shares for use in bonus or

compensation plans or acquisitions

 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 SHARES

 Liquidation preference

 Cumulative (dividends in arrears)

 Convertible (book value)

 Redeemable/callable (company option)

 Retractable (shareholder option)

PREFERRED SHARE

PREFERENCES

DIVIDEND PREFERENCES CUMULATIVE DIVIDEND

 A cumulative dividend requires that preferred

shareholders be paid both current and prior year

dividends before common shareholders receive any

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

preferred shares except that the shareholder can redeem shares at their option instead of the corporation’s.

similarities.

redemption of the shares they both offer a repayment of the principal investment.

liability section of the balance sheet rather than in the equity section because it has more of the features of debt than equity.

STATEMENT PRESENTATION OF

REMINDER-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

Common shares, $5 stated value, unlimited shares

authorized, 400,000 shares issued Total share capital

Contributed capital in excess of stated value - common shares

Total contributed capital

Total shareholders’ equity

$ 770,000

2,000,000 2,770,000

860,000 3,630,000 1,058,000

$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.

Net Income

Average Shareholders Equity

Return on 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:

Book Value per Share

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.

CALCULATION OF BOOK VALUE

WITH PREFERRED SHARES

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.

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