Chapter 15
Shareholders’ Equity
Prepared by:
Patricia Zima, CA
Mohawk College of Applied Arts and Technology
Shareholders’ Equity
Corporate Share Capital
Form
Retained
Earnings
Other
Components
Corporate Types of
Law
shares
Formality
of profit
distribution
Contributed
surplus
Share
capital
system
Limited
liability of
shareholders
Types of
dividends
Issuance
Stock splits
Accumulated
Other
comprehensive
income
Presentation
and
Perspectives
Disclosure
Analysis
Special
presentation
issues
Reacquisition
Retirement
Appendix 15B Financial
Reorganization
Comprehensive revaluation
Appendix 15A – Par Value and Treasury
Shares
Par value shares
Treasury shares
2
Components of Shareholders’
Equity
Share Capital:
Common
And/or
Preferred shares
Contributed
Surplus
Retained
Earnings
Accumulated
other
Comprehensive
Income
Contributed
Capital
Earned
Capital
3
Major Sources of Changes in
Shareholders’ Equity
All Transactions and Events That Cause
Changes in Shareholders’ Equity
Net Income
Revenues
&
Expenses
Gains
and
Losses
Transfers Between Entity and
Owners
Investments
by Owners
Distributions
to Owners
4
Defining Capital
• Legal capital (stated capital)
– the full price received for shares issued
• If par value shares are issued, then legal/stated
capital = par value
– Par value shares are not permitted under CBCA
– Permitted under some provincial jurisdictions
(see Appendix)
5
Defining Capital
Accounting definition of capital
• Shareholders’ equity which includes:
– Share capital
• the legal/stated capital
– Contributed surplus
• equity transactions not specifically included
elsewhere
– Retained earnings
• all undistributed income that remains invested in
the business
– Accumulated other comprehensive income
• Cumulative change in equity due to revenues
and expenses, and gains and losses from
transactions not included in net income
6
Primary Forms of
Business Organization
Proprietorship
Engaged in making
financial returns for their
owners
Partnership
Corporation
Profit-oriented
Shares
privately held
Not-for-profit
No shares issued; created to
provide services for members or
society
Private
Sector
Public
Sector
Shares
publicly traded
Municipalities, Cities, Etc.
Crown
Created by government statute
to provide public services
7
Corporate Accounting
Special characteristics that impact on
accounting:
1. Corporate law
2. Share capital system
3. Limited Liability
8
Corporate Law
Articles of
Incorporation
Corporation
Recognized as
Legal Entity
Corporation
Charter
Issued
9
Corporate Law
• Canada Business Corporation Act (CBCA)
• Articles of incorporation prepared and submitted
– Company name
– Location of registered office
– Classes and authorized shares
– Share transfer restrictions (if any)
– Directors
– Business restrictions
• CBCA regulations required financial statements be
prepared in accordance with GAAP
10
Share Capital System
•
Shares grouped by “class” (e.g. Class A
Common)
– Within each class, each share equal
• Each share contains certain rights and
privileges
• Ease of transfer of ownership
– Advantage to both issuing corporation and
investor
– Share becomes more attractive investment
11
Share Capital System
•
As a minimum each share has these basic
or inherent rights
1. To share proportionately in profits and
losses
2. The right to vote for directors
3. To share proportionately in assets upon
liquidation
4. Preemptive right for any new share issues
12
Share Capital
Common shares
• Represent basic ownership interest
• Represents residual ownership interest have ultimate risk of loss and benefit from
success
• Dividends, or assets on dissolution, not
guaranteed
• True advantage is in the right of Common
Shares to ultimately control by way of voting
13
Share Capital
Preferred Shares
• Certain inherent rights given up or exchanged
for other special rights or privileges
• Preference given on
– Dividends (usually at a stated rate)
– Claim to assets on dissolution
• Preferred shares features (some or all may be
attached to a preferred share
– Cumulative  Callable/redeemable
– Convertible  Retractable
– Participating
14
Share Capital
Preferred Shares Features
• Cumulative: Dividends in arrears must be paid
before any profits can be distributed to common
shareholders
• Convertible: The company or holder can
exchange the shares for common shares at a
predetermined ratio
• Callable/Redeemable: The issuing company can
“call” at its option the preferred shares at
specified future dates at stipulated prices
• Retractable: The holders can “put” (or sell) their
shares to the company
• Participating: Holders can participate with
common shareholders in any profit distributions
15
higher than the prescribed rate
Limited Liability
• Limited Liability of Shareholders
– Unlike partnership or proprietorship form of
business
– Shareholders not generally liable for the
obligations of the corporation
• Shareholders losses restricted to
– Amount invested in the corporate shares
16
Accounting for the
Issuance of Shares
•
•
•
•
Shares basic
Shares sold on a subscription basis
Defaulted Subscription accounts
Shares issued in combination with other
securities
17
Shares Issue - Basic
Full amount of proceeds received is credited to the
respective share capital account
(preferred/common/class type)
500 common shares are sold for $10.00 each
(issuance costs not included in this transaction).
The journal entry is:
Cash
5,000
Common Shares
5,000
18
Shares Sold by Subscription
• Shares are sold, with “instalment” payments
• Shares are not issued, and any rights are not
given (e.g., voting, dividends) until the full
subscription price is received
• Dividends may be attached to some
subscription shares, once the initial payment is
received
19
Shares Sold by Subscription
Accounts in share subscription transaction
– Shares Subscribed
• Set up a separate one for each type/class of share
• An equity account, reported below the respective share
capital account on the Balance Sheet
– Subscription Receivable
• Normally considered a current asset
• May be reported as a contra account to the Shares
Subscribed account in equity section of the Balance
Sheet
– Share Capital
• Credited only when the subscription is paid in full, or
settled in some other manner, in the case of default
20
Shares Sold by Subscription
• If a subscription contract is defaulted there are
generally three possible consequences:
– Funds paid to date are refunded, often with a
deduction for expenses, and the balance of the
contract is cancelled
– Funds paid to date are forfeited transferring it to the
Contributed Surplus account, with no refund or
shares being issued; balance of the contract is
cancelled
– Shares are issued for the amount paid to date, with
the balance of the contract cancelled
21
Shares Sold by Subscription
500 shares are sold on subscription for $20.00
each. 50% is due as initial payment.
The initial journal entries would be:
Subscription Receivable
10,000
Shares Subscribed
Cash
10,000
5,000
Subscription Receivable
5,000
22
Shares Sold by Subscription
If all payments are made as scheduled, the
entries would be:
Cash
5,000
Subscription Receivable
Shares Subscribed
Share Capital
5,000
10,000
10,000
If the subscriber defaults, one of the following
may happen (depending on the contract terms
and applicable legislation).
23
Shares Sold by Subscription
Default after first payment – funds refunded with no
penalty.
Shares Subscribed
10,000
Accounts Payable (or Cash)
5,000
Subscription Receivable
5,000
Default after first payment – shares issued for amount paid.
Shares Subscribed
10,000
Share Capital
5,000
Subscription Receivable
5,000
24
Shares Sold by Subscription
Default after first payment – funds held by
corporation.
Shares Subscribed
10,000
Subscription Receivable
5,000
Contributed Surplus
5,000
25
Shares Issued
With Other Securities
• When two or more classes of shares are sold for
a lump sum
• Accounting problem is the allocation of the funds
received to the respective share classes
• Two methods available
– Proportional method (relative market value
method)
– Incremental method
26
Accounting for Share Issue Costs
• Include legal fees, accounting fees, underwriter
fees & commissions, printing and mailing costs,
advertising and administrative expenses of
preparation
• CICA Handbook (Section 3610) deems these
amounts to be capital transactions (rather than
operating transactions) and therefore should not
be included in net income calculation
• Accounting treatment—debit to Share Capital
27
Accounting for Share Issue Costs
Reduction of the amount paid in
1,000 shares sold for $10.00 each, with $500 in
issue costs
Cash
9,500
Share Capital
Share Capital
500
10,000
28
Share Repurchase
• Major reasons for the reacquisition of a
corporation’s own shares
– Reduce the shares outstanding to increase EPS
– Have enough shares on hand to meet employee
share compensation contracts
– Buy out a particular ownership interest
– Meet the needs of a potential merger
– Stop (or slow down) takeover attempts
– Reduce number of shareholders
– Make a market in the company’s shares
– Return cash to shareholders
29
Share Repurchase
• Other reasons may include:
–
–
–
–
Reduce the operations of the business
Change the debt-to-equity ratio
Settle a debt
Provide a boost to shareholders (remaining
shareholders end up with a larger portion of
the entity)
– Fulfill the terms of a contract
– Satisfy a claim from a shareholder
– Change from a public to a private corporation
30
Reacquisition of Shares
• Shares may be retired when reacquired
• May also (in limited circumstances and jurisdictions)
become Treasury Stock (see Appendix)
• In Canada, the CBCA requires repurchased shares
be cancelled and restored to status of authorized
but unissued, if a limit to authorized shares exists
• In either case, the accounts affected are:
–
–
–
–
Share Capital
Contributed Surplus
Retained Earnings
Treasury Stock (for Treasury Stock only)
31
Reacquisition of Shares
• Share capital debited with the original issue or
assigned value only
• The difference then allocated to equity accounts:
– Contributed Surplus
– Retained earnings
Contributed Surplus NEVER goes to a debit balance
32
Reacquisition of Shares - Retired
In January 2007, Cooke Corp. purchased and
cancelled 500 Class A shares at $4 per share.
There are 10,500 shares issued and outstanding,
with total share capital of $63,000
Common Shares (500 [$63,000/10,500] ) 3,000
Cash (500 shares@ $4.00)
2,000
Contributed Surplus (500 @$2.00)
1,000
Assigned share value = $63,000/10,500 = $ 6.00
Acquisition cost = per share price/cost
4.00
Value over assigned value
$2.00
33
Items Affecting Retained
Earnings
1.
2.
3.
4.
DEBITS
Net loss
Prior period
adjustments,
accounting principle
changes
Cash, property, stock
dividends
Treasury stock
CREDITS
1. Net Income
2. Prior period
adjustments,
accounting principle
changes
3. Adjustments from
financial
reorganization
34
Formality of Profit Distribution
•
•
No amounts may be distributed unless corporate capital is
maintained intact
Under the CBCA:
1. There needs to be sufficient capital after the
dividend to pay liabilities as they are due
2. The realizable value of the corporate assets does
not fall below the total of the liabilities and the
stated and legal capital for all classes of shares
•
•
•
Formal approval of the Board of Directors required
Dividends are in full agreement with share capital
contracts
Before declaration of a dividend, management should
consider availability of funds to pay the dividend
35
Dividend Distributions
•
Types of dividends
1. Return on capital
– Cash dividend
– Stock dividend
2. Return of capital
– Liquidating dividends
3. Important dates
– Date of declaration
– Date of record
– Date of payment
36
Cash Dividends
• First journal entry is on Date of Declaration
– Dividend becomes legal obligation of the
corporation
– Equity account is debited, liability account
is credited
Cash Dividends Declared
(or Retained Earnings)
xxx
Dividends Payable
xxx
– On Date of Payment liability is reduced
37
Cash Dividends
• Before the dividend is paid, a current list of
shareholders needs to be prepared (as at the
date of record)
• If a Cash Dividends Declared account is used
rather than Retained Earnings at the date of
declaration, this account is closed to
Retained Earnings at year end
38
Dividends in Kind
• Dividends payable in corporation assets other
than cash
• These dividends are normally measured at
the “fair value” of the asset given up
• Fair value is determined by referring to:
estimated realizable value of same or similar
assets, quoted market prices, independent
appraisals
39
Stock Dividends
• No assets distributed (unlike cash dividends)
• Unlike with cash dividends or dividends in
kind, total shareholders equity does not
change
– Amounts are “re-arranged” as a result of
the stock dividend
– The transaction is measured at the fair
value of the shares at declaration date
– Each shareholder has the exact same
proportionate interest in the corporation
– However, book value per share decreases
40
Stock Dividends
•
•
•
•
1,000 common shares outstanding
Retained earnings = $50,000
10% stock dividend declared
Fair (market) value of share = $130 per share
Stock Dividends Declared
Common Shares
1,000 x 10% =
100
Fair value
$ 130
Total
$13,000
13,000
13,000
41
Dividend Preferences
Example Data
• $50,000 total declared as dividends
• Common share capital = $400,000
• Preferred shares:
1,000 $6 outstanding
(issued at $100,000)
42
Non-cumulative
• If shares are non-cumulative and non-participating
– Dividends are distributed only when declared,
up to the stated amount of the share
– No amount is paid for years where dividends
were not declared
• Referring to previous data:
– Preferred Shareholders are paid $6,000
($6 x 1000) and
– Common Shareholders are paid the remaining
amount of $44,000
43
Cumulative
• If the preferred shares are cumulative and
non-participating, and dividends not paid to
the preferred shareholders in previous 2
years:
• Preferred Shareholders are paid $18,000
( ($6 x 1000 x 2) + $6,000)
• Common Shareholders are paid the remaining
$32,000 ($50,000 - $18,000)
44
Participating
•
If no specific participation agreement exists,
participation generally follows these
guidelines
a. Following assignment to preferred shares of
current year dividends (any cumulative
dividends have been allocated first);
common shares receive an amount to give
them the same return rate as the preferred
b. Any remaining dividend amount is shared by
both preferred and common in proportion to
the carrying value of each share class
45
Participating
•
If preferred shares are non-cumulative and fully
participating, using the previous data:
Preferred Common
1. Current year’s:
– Preferred ($6 x 1000)
– Common (6% x $400,000)
$6,000
$24,000
2. Remaining $20,000 at a
rate of $20,000/$500,000 (i.e. 4%):
– Preferred (4% x $100,000) $4,000
– Common (4% x $400,000)
TOTAL
$10,000
$16,000
$40,000
46
Stock Dividends vs. Stock Splits
Stock Dividend
• As form of dividend must follow the
requirements of a dividend
• Both the number of shares, and the amount
of share capital are affected
• Shares are not exchanged
Stock Split
• Increases the number of shares outstanding
• Amount of share capital is not affected
• Results in a market price manipulation
47
Components of Shareholders’
Equity
Contributed Surplus transactions
• Par value share issue and/or retirement
• Liquidating dividends
• Financial reorganization
• Stock options and warrants
• Issue of convertible debt
• Share subscriptions forfeited
• Donated shares
• Redemption or conversion of shares
48
Components of Shareholders’
Equity
Accumulated Other Comprehensive Income
• Cumulative change in equity from nonshareholder transactions which are excluded
from net income
• Considered to be earned income
49
Disclosure of Share Capital
• Per CICA Handbook, Section 3240, the
following disclosure is required:
– Authorized share capital
– Issued share capital
– Changes in share capital since last
balance sheet date
• May be disclosed in the notes to the
financial statements, or in the body of the
Balance Sheet
50
Disclosure of Share Capital
• Note disclosure will contain the following information:
– Authorized number of shares (if no limit, then so
stated)
– The existence of unique rights
– Number of shares issued, and the amount
received
– Whether the shares are par-value or no-par value
– Amount of any dividends in arrears for cumulative
preferred shares
– Changes during the year, including new issuances
and redemptions
– Restrictions on retained earnings
51
Shareholders’ Equity Ratios
1.
Rate of return on common shareholders’ equity
2.
Payout ratio
Net income – Preferred dividends
Average common shareholders’ equity
Cash Dividends
Net income – Preferred dividends
3.
Price earnings ratio
Market price per share
Earnings per share
4.
Book value per share
Common shareholders’ equity
Number of outstanding shares
52
International
• IAS requires a separate statement for
changes in all equity accounts
• Canadian GAAP only requires separate
retained earnings statement
53
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Copyright © 2007 John Wiley & Sons Canada, Ltd.
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54