Topic 10 equity PDF(1)

Prepare the entries for cash dividends and share dividends and describe the impact on equity and assets... Share Capital 20,000 record issue of 20,000 shares at $1 each Accounting for a

TOPIC 10 EQUITY

PART 1: THE CORPORATION, SHARES, AND DIVIDENDS

Topic 10 Learning

Objectives (Part 1)

On completion of this topic, you should be able to:

1 Explain the business context and the importance of decision

making relating to equity.

2 Identify and discuss the main characteristics of a corporation

(company).

3 Record the issue of ordinary shares.

4 Prepare the entries for cash dividends and share dividends and

describe the impact on equity and assets.

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CHARACTERISTICS OF A

CORPORATION

• Companies most common form of a

corporation – private and public

(listed and unlisted)

• Company is a separate legal entity

(unlike sole trader and partnership)

where owners are referred to as

shareholders and because of this…

• Shareholders have limited liability

• Companies have transferability of

life

• government regulation

Forming a Company

• The process of creating a company begins when the organisers (promoters) obtain

a certificate of registration from ASIC.

• The Corporations Act includes

a number of basic rules for managing companies.

• The company can accept these rules or replace them with

their own company constitution.

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SHAREHOLDER RIGHTS

Three essential characteristics:

• Shareholders elect the board of

directors

• The board sets policy, appoints the

officers, and elects a chairperson

• The board also designates the

managing director, who is often known

as the chief executive officer (CEO)

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ISSUE OF SHARES

• A company may issue shares by private

placement

• Public companies may also issue shares

publicly

• This requires a prospectus , which is a

document reporting on the company’s

financial position, performance and plans

Share Capital 20,000

(record issue of 20,000 shares at $1 each)

Accounting for a private placement

KCeT P/L needs capital to expand her

business and Kelly Cook’s uncle buys 20,000

shares at $1 each.

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ISSUE OF SHARES

Accounting for a public issue

On 15 July, Flight Central Ltd A public company

needs capital to expand and invites the public to

subscribe for 1,000 ordinary shares at $20 each:

• $12 payable on application

• $5 on allotment

• $3 on call

Applications close on 1 September and directors

will allot shares on 20 Sep and payment for

allotment due by 30 September 2018

1/9/2018

20/9/2018

20/9/2018

30/9/2018

Cash Trust (1,000 x $12) Application

Application Allotment

Cash Trust Cash at Bank

Allotment Cash at Bank

Ordinary Share Capital (Record issue of shares)

(Record transfer of application money to company’s bank account)

(Record receipt of application funds at $12 per share)

(Record collection of amount due on allotment - $5 x 1,000)

12,000

12,000

12,000 5,000

17,000

12,000

12,000 5,000

5,000

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DIVIDENDS

A dividend is a distribution of profit by a company to its

shareholders on a pro rata basis Forms of dividends:

 cash

 Shares

 property

Public companies often pay 2 dividends:

• Final dividend determined at end of year

• Interim dividend paid during the year

On 1 Dec 2018 Flight Central Ltd declares a cash dividend of $5 per share payable Dec 15 to shareholders of record on Dec 8 There are 5,000 shares outstanding.

1/12/2018

15/12/2018

Retained Earnings Dividends Payable

Dividends Payable Cash at Bank (Record payment of cash dividend)

(Record declared dividend)

25,000

25,000

25,000

25,000

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SHARE DIVIDENDS

 Sometimes called bonus issues they are a

distribution of own shares to shareholders

 No assets are relinquished and they do not

change total shareholders’ equity

 A share dividend is a transfer of retained

earnings to share capital (contributed

equity)

 Same process & recording procedure as

cash dividends (declare, record & pay)

The current market price of Flight Central Ltd is $20 and on 1 Jan 2018 the directors declare a bonus issue of 1,500 shares for shareholders of record on Jan 8 for Jan 15.

EQUITY

Before Bonus Issue

After Bonus Issue

Share Capital

5000 Ordinary shares fully paid 100,000 100000

1500 Ordinary shares fully paid 30000

1/1/2019

15/1/2019

Retained Earnings Dividends Payable (Record declared ordinary share dividend from retained earnings)

Dividends Payable Share Capital (Record issue of 1,500 ordinary shares in a share dividend)

30,000

30,000

30,000

30,000

Topic 10 Learning

Objectives (Part 1)

On completion of this topic, you should be able to:

1 Explain the business context and the importance of decision

making relating to equity.

2 Identify and discuss the main characteristics of a corporation

(company).

3 Record the issue of ordinary shares.

4 Prepare the entries for cash dividends and share dividends and

describe the impact on equity and assets.

Topic 10 Learning

On completion of this topic, you should be able to:

1 Identify components of comprehensive income and changes in

equity including items that affect retained earnings.

2 Evaluate a company’s dividend and earnings performance from

a shareholder’s perspective.

3 Evaluate debt and equity as alternative sources of finance.

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EQUITY - REPORTING

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EQUITY - REPORTING

Equity section includes:

equity (paid and any outstanding amounts).

kept within company and not distributed as dividends.

created through transactions with owners.

Statement of Changes in equity

• Reflects the net changes in equity accounts for the period.

• Must show for each equity account a reconciliation between opening and closing balances.

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ANALYSING FINANCIAL

STATEMENTS FOR

DECISION MAKING

DIVIDEND PAYOUT measures the percentage of profit

distributed in the form of cash dividends to ordinary

shareholders RETURN ON ORDINARY SHAREHOLDERS

EQUITY measures profitability from the shareholders’

perspective

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DEBT vs EQUITY FINANCING

DECISION MAKING

Advantages & Disadvantages of

DEBT

• Finances profitable investment

opportunities.

• Does not dilute ownership interests.

• Interest is tax deduction (a tax shield).

• “Leverage” is the use of debt to increase

return on investment for stockholders.

• Interest payments must be made before

dividends

• Increases financial risk (bankruptcy risk).

Financing through EQUITY on the other hand……

• Is less risky

• Creates no liabilities

• Has no interest burden

• But may dilute ownership interest

Businesses can increase the return to their shareholders (ROE) by using debt, provided that the return they receive on their assets exceeds the

amount paid to service the debt.

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DEBT vs EQUITY FINANCING

DECISION MAKING

• Sista Limited, an internet retailer of raunchy women’s surf clothing has

$1,000,000 in share capital and wants to expand into men’s surf wear and needs $500,000 to purchase Brosta

• Sista’s CFO believes this acquisition will increase profits to $300,000 (before interest and income tax at a rate of 30%)

• Sista Limited can either:

• Borrow the required capital of $500,000 at 10% interest p.a

OR

• Issue 50,000 ordinary shares for $10 each to raise $500,000

Should Sista borrow the money or issue additional

ordinary shares?

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DEBT vs EQUITY FINANCING

DECISION MAKING

• Share capital before capital raising $1 million

• Purchase of Brosta estimated to increase profits

before interest and tax to $300,000

• Cost of debt finance 10% pa

• Tax payable at 30%

Share Capital before capital raising Sell shares to finance investment in Brosta Expected EBIT with Brosta

Less Income Tax Expense @ 30%

Less Interest Expense (500,000 x 10%)

Total Equity

Profit before tax Projected net profit

Total Equity

$300,000

-$90,000

$250,000

-$75,000

$175,000

$210,000

$1,500,000 $1,000,000

$300,000

$0

$300,000

-$50,000

Topic 10 Learning

On completion of this topic, you should be able to:

1 Identify components of comprehensive income and changes in

equity including items that affect retained earnings.

2 Evaluate a company’s dividend and earnings performance from

a shareholder’s perspective.

3 Evaluate debt and equity as alternative sources of finance.