Lecture Principles of financial accouting - Chapter 13: Accounting for corporations

After completing this chapter you should be able to: Identify characteristics of corporations and their organization; explain characteristics of, and distribute dividends between, common and preferred stock; explain the items reported in retained earnings; compute earnings per share and describe its use; compute price-earnings ratio and describe its use in analysis.

PowerPoint Authors:

Susan Coomer Galbreath, Ph.D., CPA Charles W Caldwell, D.B.A., CMA Jon A Booker, Ph.D., CPA, CIA Cynthia J Rooney, Ph.D., CPA Winston Kwok, Ph.D., CPA

McGraw­Hill/Irwin         Copyright © 2011 by The McGraw­Hill Companies, Inc. All rights reserved.

Accounting for Corporations

Privately Held

Publicly Held

Ownership can be

Corporate Form of Organization

An entity created by law

Has rights and

privileges

Has rights and

privileges

C 1

Characteristics of Corporations

Advantages

 Separate legal entity

 Limited liability of shareholders

 Transferable ownership rights

 Continuous life

 Lack of mutual agency for shareholders

 Ease of capital accumulation

Disadvantages

 Corporate taxation

C 1

Board of Directors

President, Vice-President,

and Other Officers

Employees of the Corporation

Corporate Organization and

Management

C 1

C 1

Basics of Share Capital

Total number of shares that a corporation

is authorized to sell or issue.

Total number of shares that has been

sold or issued to shareholders.

C 1

Par Value Share

On September 1, Matrix, Inc issued 100,000 shares of $2 par value for $25 per share Let’s

record this transaction

Issuing Par Value Share

Issuing Par Value Shares

P 1

Issuing Shares for Noncash Assets

Par Value Shares

On September 1, Matrix, Inc issued 100,000 shares of $2 par value for land valued at

$2,500,000 Let’s record this transaction

Dividends Shareholders

Cash Dividends

Corporation

To pay a cash dividend, the

corporation must have:

1 A sufficient balance in

retained earnings; and

2 The cash necessary to

pay the dividend

Accounting for Cash Dividends

Three important dates

Date of Payment Record payment of cash to shareholders.

P 2

Date of Declaration

Record liability for dividend.

Div ide

nds

Dr Cr Jan 19 Retained Earnings 10,000

Ordinary Dividend Payable 10,000

Declared $1 per share cash dividend.

Accounting for Cash Dividends

On January 19, a $1 per share cash dividend is declared

on Dana, Inc.’s 10,000 ordinary shares outstanding The dividend will be paid on March 19 to shareholders of

record on February 19.

P 2

No entry required on February 19, the date of record.

Accounting for Cash Dividends

On January 19, a $1 per share cash dividend is declared

on Dana, Inc.’s 10,000 ordinary shares outstanding The dividend will be paid on March 19 to shareholders of

record on February 19.

P 2

Share Dividends or Bonus Issue

Why a share dividend?

 Can be used to keep the market price on the shares affordable.

 Can provide evidence of management’s confidence that

the company is doing well.

A distribution of a corporation’s own shares to its shareholders

without receiving any cash payment in return.

Capitalization: Transferring a portion of equity from retained earnings to contributed capital

P 2

Ordinary Shares

$10 par value

100 shares

OldShares

A distribution of additional shares to shareholders

according to their percent ownership.

P 2

Preference Shares

A separate class of shares, typically having

priority over ordinary shares in

Usually has a stated

dividend rate

Normally has no voting rights

C 2

vs Noncumulative

Cumulative

Dividends in arrears must

be paid before dividends

may be paid on ordinary

shares (Normal case)

Undeclared dividends from current and prior years do not have to be paid in

future years.

Preference Shares

Consider the following Shareholders’ Equity section of

the Balance Sheet The Board of Directors did not

declare or pay dividends in 2010 In 2011, the Board

declared and paid cash dividends of $42,000

C2

If Preference Shares Are Noncumulative : Preference Ordinary

Year 2010: No dividends paid $ - $ Year 2011:

-1 Pay 2011 preference dividend $ 9,000

2 Remainder goes to ordinary $ 33,000

If Preference Share Are Cumulative: Preference Ordinary

Year 2010: No dividends paid $ - $ Year 2011:

-1 Pay 2010 preference dividend in arrears $ 9,000

2 Pay 2011 preference dividend 9,000

3 Remainder goes to ordinary $ 24,000 Totals $ 18,000 $ 24,000

preference shares

C2

vs Nonparticipating

Participating Dividends may exceed a

stated amount once

common shareholders

receive a dividend equal to

the preferred stated rate.

Dividends are limited to a maximum amount each year The maximum is usually the

stated dividend rate.

(Normal case)

Preference Shares

Reasons for Issuing Preference Shares

 To raise capital without sacrificing control

 To boost the return earned by ordinary shareholders

through financial leverage

 To appeal to investors who may believe the ordinary

shares are too risky or that the expected return on

common stock is too low

C2

Treasury Shares

Treasury shares are a company’s own shares

that have been acquired Corporations might

acquire its own shares to:

1 Use their shares to buy other companies.

2 Avoid a hostile takeover.

3 Reissue to employees as compensation.

4 Support the market price.

P 3

Purchasing Treasury Shares

Treasury shares are shown as a reduction in total

shareholders’ equity on the balance sheet.

Treasury shares are shown as a reduction in total

shareholders’ equity on the balance sheet.

On May 8, Whitt, Inc purchased 2,000 of its own

shares in the open market for $4 per share

P 3

Selling Treasury Shares at Cost

Sold 100 treasury shares

for $4 per share

On June 30, Whitt sold 100 shares of its treasury shares for $4 per share.

P 3

Selling Treasury Shares

Above Cost

Dr Cr July 19 Cash 4,000

Treasury Shares-Ordinary 2,000 Share Premium-Treasury Shares 2,000

Sold 500 treasury shares for $8 per share.

On July 19, Whitt, Inc sold an additional 500

treasury shares for $8 per share.

P 3

Selling Treasury Shares

Below Cost

Dr Cr Aug 27 Cash 600

1,000

Treasury Shares-Ordinary 1,600

Sold 500 treasury shares for $1.50 per share.

Share Premium-Treasury Shares

On August 27, Whitt sold an additional 400

treasury shares for $1.50 per share.

P 3

Statement of Comprehensive Income

C3

Statement of Changes in Equity

C3

Most reserves result from accounting standards

to reflect certain measurement changes in equity

rather than the income statement, e.g asset

revaluation reserve, foreign currency translation

reserve and other statutory reserves.

Retained earnings also called revenue reserves.

Ending Retained Earnings = Beginning Retained Earnings + Net Income – Dividends

A company’s cumulative net income less any net losses and

dividends declared since its inception

C3

Earnings Per Share

Basic

earnings

per share = Net income - Preference dividends

Weighted-average ordinary shares outstanding

Earnings per share is one of the most widely

cited accounting statistics.

A 1

PRICE–EARNINGS RATIO

Price–

Earnings

Ratio

=    Market value per share    

Earnings per share

This ratio reveals information about the stock market’s expectations for a company’s future growth

in earnings, dividends, and opportunities.

A 2

Dividend Yield

Dividend

Market value per share

Tells us the annual amount of cash dividends distributed to ordinary shareholders relative to

the share’s market price.

A 3

BOOK VALUE PER ORDINARY SHARE

Book value per

ordinary share

ordinary share =

Shareholders’ equity applicable

to ordinary shares Number of ordinary shares outstanding

Reflects the amount of shareholders’ equity applicable to ordinary shares on a per share basis.

End of Chapter 13