Accounting
Principles
Second Canadian Edition
Weygandt · Kieso · Kimmel · Trenholm
Prepared by:
Carole Bowman, Sheridan College
Julia Banks, Cairine Wilson
CHAPTER
13
CORPORATIONS:
ORGANIZATION AND SHARE
CAPITAL TRANSACTIONS
CORPORATE FORM OF
ORGANIZATION

A corporation is a legal entity created by
law that is separate and distinct from its
owners

Has most of the rights and privileges of a
person
CLASSIFICATION OF
CORPORATIONS

A corporation’s purpose may be to earn
a profit, or it may be organized as notfor-profit or more commonly referred to
as non-profit.

Classification by ownership distinguishes
between publicly-held corporations and
privately-held corporations.
Publicly Held Corportaion

Examples inlcude BCE Inc., Sears
Canada, Nortel

May have 1000’s of shareholders

Shares usually traded in an organized
securities market such as the Toronto
Stock Exchange (TSE)
Privately Held Corporations

Sometimes referred to as a “closely held
corporation”

Usually has only a few shareholders

Usually does not offer its shares for sale to the
general public

Research in Motion (RIM) used to be a
privately held corportation.
Crown Corporation

Owned by the government

Canada Post, Ontario Hydro, BC Ferries
etc….Petro Canada used to be a long
time ago.
CHARACTERISTICS

Separate legal existence
- may buy, own, and sell property; may borrow money,
enter into legally binding contracts, sue and be sued

Limited liability of shareholders
- shareholders liability is limited to their
investment; creditors have no legal claim on s/h
personal assets unless fraud has been
committed.

Transferable ownership rights
- s/h can buy and sell shares as they wish
Characteristics Con’t

Ability to acquire capital
- company can raise capital/money by issuing
shares to the public

Continuous life
- As a separate legal entity, the death of a
shareholder (owner, employee etc, does not
interfere with the company’s buisness.

Corporation management – s/h’s elect board
members who select executives to run the
business and to execute company policy

Additional taxes
Characteristics Con’t

Government Regulations
– Incorporated federally under the terms of the
Canada Business Corporations Act or
– Provincially under the terms of a provincial
business corporations or company act.
– Provincially corporation must obtain a
separate licence to do business in other
provinces.
Characteristics Con’t

Government Regulations con’t…
– Laws specify requirements for issuing shares, the
permitted distribution of earnings to shareholders,
etc.
– Securities laws govern the sale of share capital and
the disclosure of financial information to the general
public.
– Respecting federal, provincial, and securities
regulations increases costs and complexity of
corporations.
– Regulations are designed to protect
shareholders/owners of the corporation.
Characteristics…

Additional Taxes
- Pay federal and provincial income
taxes

Up to as much as 50% of taxable
income but there are lots of deductions and tax incentives which
often reduce it to about 20 – 25%)

Corporate tax rate is often lower for the same income earned by an
individual

Shareholders pay tax on cash dividends

Sole proprietorships and partnerships report income from their
organizations on the personal income tax return

Some sole proprietorhsips or parnterships may be better off
incorporating as a privately held corporation to reduce the amount of
income tax they may have to pay on their income.
ADVANTAGES AND DISADVANTAGES
OF A CORPORATION
Advantages
Corporate management professional managers
Separate legal existence
Limited liability of
shareholders
Deferred or reduced income
taxes
Transferable ownership rights
Ability to acquire capital
Continuous life
Disadvantages
Corporation management ownership separated from
management
Increased costs and complexity
to adhere to government
regulation
Potential for additional income
taxes
Forming a Corporation

Usually, “Articles of Incorporation” are filed to incorporate
a company.

Initial step is to file an application as required by the Act.

Application contains info such as:
- name and purpose of organization
- amounts and kinds of share capital to be
authorized and number of shares.
- names and addresses of the incorporators
- the location of the corporation’s head office

Anyone can apply – 18+, of sound mind, and not bankrupt
Forming A Corporation
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

When chartered (incorporated) to raise capital, the
corporation sells shares

Different classes of shares – Class A, Class B, etc.

Rights and privileges assigned to each class area
outlined in the articles of incorporation

Different classes are usually identified by the generic
terms Common Shares and Preferred Shares.

If only one class of shares-common shares

A share certificate proves the s/h owns shares.
Common Share Holders Rights:

Vote in the election of the board of directors at an
annual meeting

Vote on actions that require s/h approval

Share the corporate income by receiving dividends

Keep the same percentage ownership when new
shares are issued (called pre-emptive right - though
not all corporations follow this

Share in assets upon liquidation in proportion to their
holdings (residual claim) – after all creditors have
been paid.
Share Issue Considerations
1.
2.
3.
4.
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 Considerations
Authorized Share Capital
 maximum amount of shares a corporation is allowed to sell as authorized by
corporate charter (articles of incorporation)
 ¾ of Canadian companies have unlimited amount of authorized shares
 If a number is specified, the company has anticipated its current and future
financial needs
 To later increase number of authorized shares if they were limited, the
company must obtain legislative approval to amend its articles of incorporation
before it can issue more shares
Issued Shares
 Number of shares from the authorized total that have been sold
Accounting for Authorized Share Capital
 No accounting entry for authorization of shares since it has no effect on assets
or shareholder’s equity as of yet.
 BUT, disclosure (mention) of the number of authorized and issued shares is
required in the shareholder’s equity section of the balance sheet. See pg. 658
Issue of Shares

Issued directly or indirectly

Directly issues shares done more by
closely/privately held corporations

Indirectly issued through an investment
dealer (brokerage house).
(i.e. RBC Dominion Securities)
IPO – Initial Public Offering

The first time a corporation’s shares are offered to
the public (IPO)

The company receives the cash less any issuance fees
and the company’s Cash account increases as well as
its Shareholder’s Equity account.

Once initially issued, those shares continue trading on
the secondary market (stock market) where investors
buy and sell from each other and determine the price
of the share.

There is no impact on the buying and selling of shares
in the secondary market on the company’s financial
position except for the name of its shareholders.
STOCK MARKET PRICE

Shares of publicly held companies are
traded using organized securities
exchanges such as the Toronto Stock
Exchange (TSE), the Montreal Stock
Exchange (MSE), at dollar prices per
share established by the interaction
between buyers and sellers
Market Value of Shares

Established by interaction of seller and buyer

Market price usually follows the trend of a company’s
earnings and dividends.

Other market influences include embargo on oil,
changes in interest rates, the outcome of an election,
terrorist attacks etc.

150 million shares traded on average a day on the
TSE

The business section of the paper reports daily
statistics on the trading of individual company shares
on the exchange
Types of Shares
Par, No Par and Stated Values
Par Value Shares
 Shares have a specific value as stated in the corporate charter
 Usually quite low due to filing fees that may vary with
amount of legal capital. (stated value of business as
determined by the amount of shares)
 Set low to try to avoid possibility of market prices falling
below par value

DOES NOT INDICATE WORTH OR MARKET VALUE OF
THE SHARES

It represents the legal capital ($) that must be kept in the
business for the protection of corporate creditors. Amount can
not be withdrawn by shareholders. Thus, corporations must
sell shares at par or above.
Drawbacks of Par Value Shares


Potentially creates an inadequate cushion of
protection for creditors if corporation only
retains assets equal to its minimum legal
capital.
If market prices fall below par value,
corporations are restricted as they can not sell
more shares for less than par value.
NOTE:
 These drawbacks have caused many
jurisdictions such as the Province of Ontario
and the federal government to abolish par
value shares in favour of no par value shares.
No Par Value Shares
Share capital that has not been assigned
a value in the Charter
 Most common type of shares today
 90% of Canadian public companies issue
no par value shares
 All proceeds from initial IPO become
legal capital

Stated Value Shares

Many provinces permit BOD to assign a
stated value to no par value shares

This value becomes the legal capital per
share = minimum amount of capital the
corporation must keep to protect its
creditors

May be changed at any time by directors

Only a few companies have stated values –
i.e. Sears Canada
RELATIONSHIP OF PAR, NO PAR AND
STATED VALUE SHARES TO LEGAL
CAPITAL
Shares
Legal Capital per Share
Par value
No par value
Par value
Entire proceeds
Stated value
Stated value
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.
Account Titles and Explanation
Cash
Common Shares
To record issue of 1,000 shares.
Debit
Credit
1,000
1,000
CORPORATE CAPITAL
Shareholder’s Equity
The shareholders’ equity section of a
corporation’s balance sheet consists of:

1. Contributed capital
•
•
Share capital – may consist of different classes of shares; if
only one class, they are common shares.
Additional contributed capital
2. Retained earnings
•
•
•
accumulation of companies net income and losses over its
lifetime.
retained earning are distributed to shareholder’s through
dividends
Dividends account is used similar to a drawings account for a
sole propietorship
SHAREHOLDERS’ EQUITY SECTION
This company has authorized share capital of a
maximum of 100,000 shares of which only 50,000 have
been issued.
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
Closing Accounts
1.
2.
3.
Close your revenue accounts to
Retained Earnings
Close your expense accounts and Cost
of Goods Sold section accounts to
Retained Earnings
Close your Dividends account to
Retained Earnings
Accounting For Common Share Issues
1. Issuing No Par Value Shares For Cash
Hydro Slide Inc. is authorized to issue 10,000
no par value common shares. It issues 1,000
for $1 per share on January 12, 2003.
Jan 12
Cash
1,000
Common Shares
1,000
To record issue of 1,000 no par value
common shares.
Accounting For Common Shares
Share price climbs on the market, so HydroSlide issues another 1,000 shares at $5 per share
on March 18
March 18
Cash
5,000
Common Shares
5,000
To record issue of 1,000 no
par value shares
Total amount of legal capital after these two
transactions is 6,000 (1,000+5,000)
Accounting For Common Shares
2. Issuing Stated Value Shares For Cash
• When common shares have a stated value, the stated
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.
Account Titles and Explanation
Cash
Common Shares
Contributed Capital in Excess of Stated Value
To record issue of 1,000 shares.
Debit
Credit
5,000
1,000
4,000
Other Account Names used instead of
Contributed Capital in Excess of Stated
Value
1.
2.
3.
4.
5.
Premium
Contributed Surplus
Paid-In Capital
Additonal Paid-In Capital
Capital Surplus
Example of Journal Entries For Stated Value Shares
Banks Co. authorized to issue 10,000 common shares with a stated value of $1. It issues 1,000
shares for csh at its stated value on Jan. 12.
Jan 12
Cash
1,000
Common Shares
To record issue of 1,000 common shares at its
stated value
1,000
Banks Co. issues for cash an additional 1,000 of the $1 stated value common shares on March 18
for $5 per share
March 18
Cash
Common Shares
Contributed Capital in Excess of Stated Value
To record issue of 1,000 common shares.
5,000
1,000
4,000
NOTE: Entries for Par Value Common Shares are similar to those for stated value shares where
the par value represents the legal capital and when the selling price is above the par value, the
excess amount is credited to the Contributed Capital account. Again Par Value is seldomly
used.
SHAREHOLDERS’ EQUITY
Based on Stated Value Transactions
Shareholders’ equity
Contributed capital
Common shares, 10,000 shares of $1 stated value authorized,
2,000 shares issued
Contributed capital in excess of stated value
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.
Services Received



Lawyers have billed Banks Co. $5000 for their services. On Sept. 18,
Lawyers have agreed to accept 4,000 no par value common shares in
payment of their bill.
No established market price of the shares has been established, thus value
of common shares will be equal to the bill if $5,000.
The market value of the consideration received is the only measure of the
asset.
Sept. 18
Legal Fees Expense
5,000
Common Shares
5,000
To record issue of 4,000 no par value shares to lawyer.
Consideration Given
Banks Corporation’s shares are actively trading at $8 per share. The company issues
10,000 shares on Oct. 1 to acquire land recently advertised for sale at $90,000.
The best market value is the market price of the consideration given $80,000
(10,000 x $8.00)
Oct. 1
Land
80,000
Common Shares
80,000
To record issue of 10,000 no par value shares for land.
NOTE: Value of land will be equal to the given market value per share issued.
If there was a stated value of say $5 per share, then the journal entry would be:
Oct. 1
Land
80,000
Common Shares
50,000
Contributed Capital in Excess of Stated Value
30,000
To record issue of 10,000 of stated value $5 per shares selling for
$8 per share
NOTE: Stated value does not represent economic value.
REACQUIRED SHARES

Reacquired shares are a corporation’s own shares that have been
issued, fully paid for, and then reacquired on the market by the
corporation.

Reacquired shares are generally retired and cancelled. Shares are
restored to the status of authorized but unissued.

In certain restricted circumstances, these shares are not retired, but
are held as treasury shares for later reissue.
Issued Shares: Shares that have been sold
Outstanding Shares: Shares sold and are held/owned by people outside
the company.
Note: Treasury Shares will result in a difference between the number of
shares issued and the outstanding shares
REACQUISITION OF SHARES

Why would a company choose to reacquire its
shares?
 Reduce quantity/raise share price (supply and
demand)
 Increase EPS (Earnings per share)  Less shares to
distribute total dividend amount to
 If authorized share limit reached, may need
additional shares for use in bonus or compensation
plans or acquisitions\
 To limit foreign ownership
 May want to eliminate a hostile shareholder and buy
them out
PREFERRED SHARES

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

Move toward companies eliminating the two types of
classes so that all shareholder’s have voting rights
Preferred Shares

Transaction entries for preferred shares (no
par value, stated value) are similar to those for
common shares, only a Preferred Shares
account is used rather than a Common Shares
account.

Excess proceeds of stated value shares also
appears in a Contributed Capital in Excess of
Stated Value – Preferred Shares account.

Preferred Shares account appears before the
Common Shares account in the Shareholder
Equity section of the balance sheet.
PREFERRED SHARE PREFERENCES
Liquidation preference
 In the event a corporation fails and assets are sold
off (liquidation), preferred shareholders receive any
monies left over only after the creditors of a
company have been paid back.
Dividend Preference
 If dividends are declared, (either a stated $amount
or percentage of stated value of the preferred
shares), common s/h will only receive dividends if
money is available after preferred s/h have been
paid.
NOTE: Preferred s/h only receive dividends if the BOD
declares them. It depends on adequate retained
earnings and availability of cash.
Variations of Types/Features of
Preferred Shares
1.
2.
3.
4.
Cumulative versus Noncumulative
Preferred Shares
Convertible Preferred shares
Redeemable Preferred Shares
Retractable Preferred Shares
PREFERRED SHARE PREFERENCES Cont’
1. Cumulative Dividend Feature (Dividends in arrears)
 Preferred s/h’s must be paid both current year dividends
declared and any unpaid prior year dividends before
common shareholders receive dividends.

When preferred shares are noncumulative, any unpaid
dividends in any year is lost forever.

Dividends in arrears are not considered a liability. There
is no payment obligation until a dividend is declared by
the BOD.

Amount of dividends in arrears should be disclosed in the
notes to financial statements. Why do you think this is so?
PREFERRED SHARE PREFERENCES Cont’
2. Convertible Preferred Shares

Conversion priviglege gives s/h’s option of exchanging preferred shares for common shares at
a specified ratio.

May want to convert if the market value of common shares increases significantly.
Example 1:

1,000 shares of no par value convertible preferred shares at $100 per share.

One preferred share is convertible into 10 shares of no par value common stock which has a
current market value of $9 per share.

Would a preferred shareholder want to convert?
Value of Preferred Shares to Shareholder
1,000 preferred shares at $100 = $100, 000
shares
Value of shares if converted to Shareholder
1,000 X 10 common shares = 10,000 common
10,000 common shares X $9 = $90,000
Value of preferred shares is greater than value if preferred shares were converted to common
shares. No, it would not be advantageous to convert ones shares.
Example 2:

1,000 convertible no par value preferred shares at $101 per share

One preferred share is convertible into 10 shares

Market value of common shares is $12
Value of Preferred Shares
1,000 at $101 = $101,000
Value of shares if converted
1,000 x 10 common shares = 10,000
10,000 common shares x $12 = $120,000
Value of preferred shares is less than when converted into common shares. Yes, it would be good
to convert to common shares.
Journal Entries for Corporation to Record Conversion

The original amount paid for the preferred share or its book value is transferred to the
appropriate common share account. The market value of the shares at the time of conversion
are not considered in recording the conversion transaction. The increase in value to the
shareholder has no effect on the valuation of the shares to the corporation.
Example 1: No Par Value Share conversion:
On June 10th, 1,000 convertible preferred shares purchased for $100 a share are converted to
common shares at a ratio of 10 common per 1 preferred share. The market value of the
preferred share is $102 and the common share is $14.00
June 10
Preferred Shares
100,000
Common Shares
100,000
To record conversion of 1,000 preferred shares of no par value
into 10,000 common shares of no par value.
Example 2: Stated Value Share conversion:
If preferred shares had a stated value of $75, but were purchased for $100 the entry would be as
follows:
June 10
Preferred Shares
75,000
Contributed Capital in Excess of Stated Value
25,000
Common Shares
100,000
To record conversion of 1,000 perferred shares of $75 stated value into
10,000 common shares.
Preferred Share Preference Con’t…
3. Redeemable or Callable Preferred Share
 The corporation has the right to purchase the shares
from s/h’s at specified future dates and prices.

Allows a corporation to eliminate preferred shares
when it is advantageous for them to do so.

Often redeemable shares are also convertible to
encourage investors to convert their shares to
common rather than have them called back.
Preferred Share Preference Con’t…
4. Retractable Preferred Shares (shareholder option)
 Shareholders have the option of redeeming their
preferred shares to the corporation.
 Usually at an arranged price and date
Both Redeemable and Retractable shares offer a rate of
return to the investor including repayment of the
principal investment. – Known as FINANCIAL
INSTRUMENTS arrangements.
Thus, these shares are considered to be treated as a
liability to the corporation and are presented in the
liability section of the balance sheet rather than the
equity section because it has more of the features of
debt than equity.
STATEMENT PRESENTATION OF SHAREHOLDERS’ EQUITY
Shareholder’s Equity
A. Contributed Capital

Within contributed capital, two classifications are
recognized:
1. Share capital
– Preferred Shares comes before Common Shares.
2. Additional contributed capital
– Contributed Capital in Excess of Stated Value –
Preferred Shares
– Contributed Capital in Excess of Stated Value –
Common Shares
B. Retained Earnings
SHAREHOLDERS’ EQUITY
PRESENTATION
ZABOSCHUK INC.
Partial Balance Sheet
Shareholders’ equity
Contributed capital
Share capital
$9 preferred shares, no-par value,
cumulative, 10,000 shares authorized,
6,000 shares issued
$ 770,000
Common shares, $5 stated value, unlimited shares
authorized, 400,000 shares issued
2,000,000
Total share capital
2,770,000
Additional contributed capital
Contributed capital in excess of stated value - common shares
860,000
Total contributed capital
3,630,000
Retained earnings
1,058,000
Total shareholders’ equity
$4,688,000
Useful Ratios from the
Shareholder’s Equity section
Two most important:
1.
2.
Return on Equity
Book Value Per Share
Useful Shareholder Ratios Con’t…
1. Return on equity (Return on Investment - ROI)
 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.
 Used to compare investment opportunities in the
marketplace
 Published figure in company financial reports and
other media mediums.
Net Income

Average
Shareholders
Equity
=
Return on
Equity
Useful Shareholder Ratios Con’t…
2.


Book value per share
represents the equity a common shareholder
has in the net assets (Total Assets – Total
Liabilities) 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:
Total
Shareholders’
Equity

Number of
Common
Shares
=
Book Value
per Share
CALCULATION OF BOOK VALUE WITH
PREFERRED SHARES
When a company has both preferred and common shares, the
calculation of book value is more complex.
Preferred s/h’s equity must be deducted from total s/h’s equity
because they have prior claim on net assets.
Steps required are:
1.
Calculate the preferred shareholders’ equity

the sum of redemption price of preferred shares (Legal Capital)
+ any cumulative dividends in arrears).
2. Determine the common shareholders’ equity

Total Shareholders’ Equity - preferred shareholders’ equity).
3. Divide common Shareholders’ Equity by the number of
common shares to determine book value per share.
Calculating Book Value- example (pg. 667)
Preferred shares are cumulative; Dividends on Zaboschuk’s preferred shares are
one year in arrears, for a total of 54,000 (6,000 x $9.00)
Step 1: Calculation of Preferred Shareholder’s Equity
Legal Capital
$770,000
Dividends in arrears (6,000 x $9)
54,000
Preferred Shareholder’s Equity
$ 824,000
Step 2 and 3 – Book Value per common share
Total Shareholder’s Equity
$4,688,000
Less: Preferred Shareholder’s Equity
824,000
Common Shareholder’s Equity
$ 3,864,000
Common Shares Issues
Book Value per common share ($3,864,000 / 400,000 =
400,000
$9.66
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
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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