Financial Accounting:
Tools for Business Decision Making
Kimmel, Weygandt, Kieso, Trenholm
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Chapter 11
Reporting and Analysing
Shareholders’ Equity
1.
2.
3.
4.
After studying Chapter 11, you should
be able to:
Identify and discuss the major characteristics
of a corporation.
Record the issuance of common shares.
Differentiate preferred shares from common
shares.
Prepare the entries for cash dividends and
stock dividends.
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Chapter 11
Reporting and Analysing
Shareholders’ Equity
After studying Chapter 11, you should
be able to:
5. Identify the items that affect retained
earnings.
6. Prepare a comprehensive shareholders' equity
section.
7. Evaluate a corporation's dividend and
earnings performance from a shareholder's
perspective.
3
Corporation
 Separate legal entity
 Has most of the rights and privileges
of a person
 Classified by purpose and ownership
 Purpose - profit or nonprofit
 Ownership - public or private
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Characteristics








Separate legal existence
Limited liability of shareholders
Transferable ownership rights
Ability to acquire capital
Continuous life
Corporation management
Government regulations
Additional taxes
5
Advantages and
Disadvantages
 Advantages
 Disadvantages
 Corporate managementprofessional managers
 Separate legal existence
 Limited liability of
shareholders
 Deferred or reduced taxes
 Transferable ownership
rights
 Ability to acquire capital
 Continuous life
 Corporation
management –
ownership separated
from management
 Increased costs and
complexity to
adhere to
government
regulation
 Additional taxes
6
Shareholder Rights
 To raise capital, the corporation sells
shares
 If only one class of shares-common
shares
 Ownership rights specified in articles
of incorporation or by-laws
7
Illustration 11-2
Share Terminology
 Authorized shares – maximum
amount of shares a corporation is
allowed to sell as authorized by
corporate charter
 Issued shares – number of shares
sold
 Outstanding shares – number of
shares held by shareholders
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Share Issue Consideration
 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?
10
Stock Market Price
 Shares of publicly held companies
are traded on organized exchanges
at dollar prices per share established
by the interaction between buyers
and sellers
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Stated and Par Share
Values
 Stated value – assigned value to nopar value shares
 Par value – assigned legal capital
value
Must retain legal capital.
Stated and par values have NO
relationship to market value
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No-Par Share Values
 No assigned legal capital value
 Legal capital equals issue price
(proceeds)
Must retain legal capital.
No-par value has NO
relationship to market value once issued.
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Issuing No-Par Value
Common Shares for Cash
When no-par shares do not have a
stated value, the entire proceeds
from the issue are credited to
Common Shares
Account Titles and Explanation
Cash
Common Shares
(To record issuance of 1,000 no-par
common shares)
Debit
Credit
8,000
8,000
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Issuing Common Shares for
Non-Cash
 When common shares are issued
for non-cash assets or services,
cost is the fair market value of the
consideration given up. If this is
not identifiable, than the
consideration received, is used
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Corporate Capital
 Shareholders’ equity (owner’s
equity)
 The shareholders’ equity section of a
corporation’s balance sheet consists
of:
1. Share capital
2. Retained earnings
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Shareholders’ Equity
Section
Shareholders’ equity
Share capital
Common shares, 100,000
no-par value shares authorized,
50,000 issued and outstanding $800,000
Retained earnings
Total shareholders’ equity
130,000
$930,000
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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
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Preferred Share
Preferences
Liquidation preference
Cumulative (dividends in arrears)
Convertible (book value)
Redeemable/callable (company
option)
 Retractable (shareholder option)




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Reacquisition of Shares
 Reacquired shares are a corporation’s own
shares (either common or preferred) that
have been issued, fully paid for, and
reacquired by the corporation
 Reacquired shares are normally retired
and cancelled
 In certain restricted circumstances, these
shares are held as treasury shares for
later reissue
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Reacquisition of Shares
 Why would a company choose to
reacquire its shares?
 Reduce quantity/raise share price
 Increase EPS
 If authorized share limit reached, may
need additional shares for use in bonus
or compensation plans or acquisitions
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Dividends
 Distribution by a corporation to its
shareholders on a pro rata (equal)
basis
 Dividends may be in the form of
 Cash
 Property
 Scrip (promissory note to pay cash)
 Stock (common shares)
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Cash Dividends
 For a cash dividend to occur, a
corporation must have
1. Retained earnings,
2. Adequate cash, and
3. Declared dividends
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Entries for Cash Dividends
Three dates are
important in
connection with
dividends:
1. Declaration date
2. Record date
3. Payment date
Month and ye ar
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Monday
Tue sday
Wedne sday
Thursday
Friday
Saturday
Sunday
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Declaration Date
 Date the Board of Directors declares
cash dividend
 Commits the corporation to a binding
legal obligation that cannot be
rescinded
On December 1, 2002 the directors of Media General declare a
$.50 per share cash dividend on 100,000 shares of no-par value
common shares (100,000 x $.50=$50,000)
12/1 Cash Dividends (or Retained Earnings)
Dividends Payable
50,000
50,000
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Record Date
 Date ownership of the outstanding
shares is determined for dividend
purposes
12/1
No entry necessary
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Payment Date
 Date dividend cheques are mailed.
January 20 is the payment date for
Media General
1/20 Dividends Payable 50,000
Cash
50,000
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Allocating Cash Dividends Between
Preferred and Common Shares
 Cumulative
 Dividends in arrears must be paid to
preferred shareholders before
allocating dividends to common
shareholders
 Non-cumulative
 Only the current year’s dividend must
be paid to preferred shareholders
before paying dividends to common
shareholders
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Stock Dividends
 Distributed (paid) in shares
 Decreases retained earnings; increases
contributed capital
 In most cases, fair market value is
assigned to the stock dividend shares
 Total shareholders’ equity and the legal
capital per share remain the same
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Purposes and Benefits of
Stock Dividends
 For company
 To satisfy shareholders' dividend
expectations without spending cash
 To increase marketability of its shares by
increasing number of shares outstanding
and decreasing market price per share
 To reinvest and restrict a portion of
shareholders' equity
30
Purposes and Benefits of
Stock Dividends
 For shareholder
 More shares with which to earn
additional dividend income
 More shares for future profitable resale,
as share price climbs again
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Stock Dividends
 Assume 2% ownership interest in
Cetus Inc., owning 200 of its 10,000
shares of common shares
 In a 10% stock dividend, 1,000
common shares (10,000 x 10%)
would be issued. You would receive
20 shares (2% x 1,000), but your
ownership interest would remain at
2% (220 /11,000)
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Stock Dividends
Cetus Inc. would journalize the stock dividend as
follows, assuming FMV $25 (1,000 x $25 = $25,000):
Declaration Date
Stock Dividends (or Retained Earnings)
Common Stock Dividends Distrib.
Record Date
25,000
25,000
No Entry
Distribution Date
Common Stock Dividends Distrib.
Common Shares
25,000
25,000
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Stock Dividend Effects
Shareholders’ equity
Common shares
Retained earnings
Total shareholders’ equity
Outstanding shares
Shareholder
Number of shares
Percentage ownership
Before
Stock Dividend
$500,000
300,000
$800,000
10,000
200
2%
After
Stock Dividend
$525,000
275,000
$800,000
11,000
220
2%
34
Stock Splits
 A stock split involves the
issuance of additional shares
to shareholders according to
their percentage ownership
 Number of shares is
increased in the same
proportion that legal capital
per share is decreased. No
change to dollar amount in
share capital account
35
Stock Splits
 A stock split has no effect on
total share capital, retained
earnings, and total shareholders’
equity
 Market value of the shares will
decrease roughly proportionately to
the split
 It is not necessary to formally
journalize a stock split
36
Stock Split Effects
Medland Corporation splits its 50,000 no-par
value common shares on a 2-for-1 basis. This
means that one no-par share is exchanged for
two no-par shares
Shareholders’ equity
Common shares
Retained earnings
Total shareholders’ equity
Outstanding shares
Before
Stock Split
After
Stock Split
$500,000
300,000
$800,000
50,000
$500,000
300,000
$800,000
100,000
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Effects of Stock Splits, Stock
Dividends and Cash Dividends
Total assets
Total liabilities
Total shareholders’ equity
Total share capital
Total retained earnings
Legal capital per share
Number of shares
% of shareholder ownership
NE = No effect
Stock
Split
Stock
Dividend
Cash
Dividend
NE
NE
NE
NE
NE


NE
NE
NE
NE


NE

NE

NE

NE

NE
NE
NE
 = Increase
 = Decrease
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Retained Earnings
 Retained earnings is the cumulative net
earnings (less losses) that is retained in
the business (i.e., not distributed to
shareholders)
Retained earnings, opening balance
+ Net earnings (or - net loss)
- Dividends
= Retained earnings, ending balance
39
Deficit
Shareholders’ equity
Share capital
Common shares
Retained earnings (deficit)
Total shareholders’ equity
$800,000
(50,000)
$750,000
A debit balance in retained earnings is identified
as a DEFICIT and is reported as a deduction in
the shareholders’ equity section
40
Retained Earnings
Restrictions
 In some cases there may be retained
earnings restrictions that make a
portion of the balance currently
unavailable for dividends
 Restrictions result from one or more
of the following causes
 Legal
 Contractual
 Voluntary
41
Measuring Corporate
Performance
 Dividend record
 Payout ratio
 Dividend yield
 Earnings performance
 EPS
 P/E ratio
 Return on common shareholders’ equity
42
Payout Ratio
 Measures the percentage of earnings
distributed in the form of cash
dividends to common shareholders
Payout ratio =
Total common cash dividends
Net earnings
43
Dividend Yield
 Reports the rate of return an
investor earns from dividends
Dividend yield =
Cash dividends per common share
Year end share price
44
Earnings Per Share
 Measures the net earnings per
common share
Earnings per share =
Net earnings – Preferred share dividends
Average common shares outstanding
45
Price-Earnings Ratio
 In order to make a meaningful comparison
of earnings across firms, use the priceearnings ratio
 The price-earnings ratio reflects the
investors' assessment of a company's
future earnings
Price-earnings ratio =
Market price per share
Earnings per share
46
Return on Common
Shareholders’ Equity
 Measures the profitability from the
shareholders’ point of view
Return on common shareholders’ equity ratio =
Net earnings – Preferred share dividends
Average common shareholders’ equity
47
Decision Checkpoints
 Should the
company
incorporate?
 What portion of
earnings does the
company pay out
in dividends?
 What level of
return can be
earned on the
company’s
dividends?
 Payout ratio
 Dividend yield
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Decision Checkpoints
(continued)
 How does the company’s  Earnings per share
earnings performance
compare with that of
previous years?
 Price-earnings ratio
 How does the market
perceive the company’s
prospects for future
earnings?
 Return on common
 What is the company’s
shareholders’ equity
return on common
shareholders’
investment?
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Copyright
Copyright © 2001 John Wiley & Sons Canada, Ltd. All
rights reserved. Reproduction or translation of this
work beyond that permitted by CANCOPY (Canadian
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further information should be addressed to the
Permissions Department, John Wiley & Sons Canada,
Ltd. The purchaser may make back-up copies for his /
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author and the publisher assume no responsibility for
errors, omissions, or damages, caused by the use of
these programs or from the use of the information
contained herein.
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