Chapter 12: Equity
Characteristics of corporation:
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Advantages:
o Separate legal existence
o Limited Liability of Shareholders
o Transferable Ownership Rights
o Ability to Acquire capital
o Continuous Life
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Disadvantages:
o Corporate Management
o Government Regulations
§
Financial Reporting Regulations
o Additional Taxes
Share Issue Considerations:
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Questions for corporation which decide to issue shares:
o How many shares should it authorize for sale?
o How should it issue the shares?
o What value should the corporation assign to the shares?
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Authorized shares:
o Charter indicates the number of shares that a corporation is authorized to sell
o Number of authorized shares often exceed the number of shares sold
o Number of authorized shares is often reported in equity section
o No formal accounting entry
Par value versus non-par value shares:
- Note that the charter may assign a par value to ordinary shares:
o Par value used to determine the legal capital per share
o Company required to retain the legal capital in the firm
o Governments required corporations to sell shares for price at or above par
value
- Practically, par value is mostly immaterial relative to market price:
o Governments no longer require it
o No-par value shares are common today
o But board may assign a stated value to no-par shares
- Does matter for accounting
How to Account for Issuance of Shares:
Accounting for Ordinary Shares
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Corporations can sell (=issue) ordinary shares at or above par value
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Ordinary Shares can be issued…:
o
o
o
…to raise cash
…to pay for expenses
…against non-cash assets
Accounting for Preference Shares
- Preference shares are different from ordinary shares
- Preference shares entitle shareholders to a…:
o Better dividend rights
§ Benefit for us investors
o No voting rights
§ Main difference to ordinary shares
o Priority regarding assets in event of liquidation (bankruptcy)
- Practically very relevant still nowadays
How to Account for Repurchase of Own Shares:
Accounting for Treasury Shares
- Corporations can purchase their own shares on the stock market:
o They are “kept” in a contra-equity account called “treasury shares”
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Corporations acquire treasury shares for various reasons:
o To reissue the shares to officers and employees under bonus and share
compensation plans
o To signal that the stock is undervalued
o To increase earnings per share
Purchase of Treasury Shares
- Companies generally use cost method
- Debit “Treasury Shares” for price paid to reacquire shares
- Treasury Shares is a Contra Equity Account
- Reduces Equity