ACCOUNTING
PRINCIPLES
SIXTH CANADIAN EDITION
Chapter 13
Introduction to Corporations
Prepared by:
Debbie Musil
Kwantlen Polytechnic University
Introduction to Corporations
• The corporate form of organization
– Characteristics
– Operating a corporation
• Share capital
– Issuing shares
– Preferred shares
• Retained earnings
– Corporate income statements
– Cash dividends
– Reporting retained earnings
• Statement presentation and analysis
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CHAPTER 13:
Introduction to Corporations
STUDY OBJECTIVES:
1. Identify and discuss characteristics of the
corporate form of organization.
2. Account for the issuance of common and
preferred shares.
3. Prepare a corporate income statement.
4. Account for cash dividends.
5. Prepare a statement of retained earnings and
closing entries for a corporation.
6. Prepare the shareholders’ section of the balance
sheet and calculate return on equity.
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The Corporate Form of
Organization
• A legal entity separate from its owners
(known as shareholders)
• Classified by purpose and ownership:
– Purpose: for profit or not-for-profit
– Ownership:
• Public corporation: shares are available for
purchase on an organized securities market
• Private corporation: shares are held by a few
individuals and are not traded
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Characteristics of a
Corporation
• Separate legal existence from its owners
– Acts under its own name
– Owners do not bind the corporation
• Limited liability of shareholders
– Limited to the amount of their investment
• Transferable ownership rights
– Shares may be bought and sold
– No effect on operating activities of corporation
• Ability to acquire capital
– Can raise capital by issuing shares
– May be difficult for closely-held corporations
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Characteristics of a Corporation 2
• Continuous and unlimited life
– Unaffected by change in ownership
• Government regulations
– Specific laws that govern operations of
corporations
• Income tax
– Taxed as a separate entity
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Forming a Corporation
• Can incorporate federally or provincially
• Done by filing articles of incorporation (the
company’s “constitution”):
– Provide information such as :
• Name and purpose of company
• Number of shares and kinds of shares
• Location of corporation’s head office
• By-laws: internal rules and policies
• Organization costs:
– Costs of forming a corporation
– Must be expensed when incurred
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Ownership Rights of
Shareholders
• Ownership rights are in the form of
shares
– Can be divided into different classes
• As stated in the articles of incorporation
• Each class has rights and privileges
• Usually referred to as common and preferred
shares
• Shareholders have rights:
– To vote on certain matters
– To dividends: the distribution of profit
– To remaining assets in a liquidation
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Corporation Management
• Shareholders manage the corporation
through the Board of Directors that
they elect
• The board:
– Decides on the corporation’s operating
policies
– Selects officers (such as the Chief
Executive Officer or CEO) to perform
daily management functions
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CHAPTER 13:
Introduction to Corporations
STUDY OBJECTIVES:
1. Identify and discuss characteristics of the
corporate form of organization.
2. Account for the issuance of common and
preferred shares.
3. Prepare a corporate income statement.
4. Account for cash dividends.
5. Prepare a statement of retained earnings and
closing entries for a corporation.
6. Prepare the shareholders’ section of the balance
sheet and calculate return on equity.
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10
Share Issue Considerations
• Authorized share capital
– Number of shares company is allowed to
sell
– Many companies have unlimited number
of shares
• Issue of shares
– Issued directly to investors or through an
investment dealer
– First public sale is called an initial public
offering (IPO)
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Share Issue Considerations 2
• Market value of shares
– Once issued, shares trade on a
secondary market
– Prices determined by buyers and sellers
and other external factors
• Legal capital
– Share capital is legal capital and cannot
be distributed to shareholders
– Retained earnings are earned capital
and can be distributed as dividends
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Common Shares:
Issuing Shares
• Shares are usually issued for cash:
Dr. Cash
Cr. Common shares
• Shares can be issued in exchange for
services or noncash assets
– Recorded at fair value of goods/services
received:
Dr. Service or asset (e.g. Legal Fees Expense)
Cr. Common shares
– Under IFRS, if fair value of goods/services not
measurable, use fair value of shares given up
– Under ASPE, can use either of the above
valuation methods
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Preferred Shares
• Priority over common shares for
dividends and assets in the event of
liquidation of the company
• Entries to record issue and
reacquisition of preferred shares
similar to entries for common shares
• Transactions for each class of share
is recorded in a separate account
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Dividend Preference
• Preferred shareholders have a right to
dividends before common shareholders
• Cumulative preferred shares have a right to
current year’s dividends and any prior
years’ dividends owing before dividends
are paid on common shares
• Any unpaid dividends (in arrears) are not
considered a liability
– No obligation to pay unless dividend is declared
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Convertible Preferred Shares
• Provide option to exchange preferred shares to
common shares at a specified ratio
• Conversion is recorded by transferring cost from
Preferred Shares to Common Shares account
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Redeemable and Retractable
Preferred Shares
• Corporation (redeemable) or the
shareholder (retractable) can redeem the
shares at specified future dates and prices
• Similar to debt: offers a repayment of the
principal
• Considered a financial instrument
• These preferred shares usually reported in
the liabilities section of the balance sheet
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CHAPTER 13:
Introduction to Corporations
STUDY OBJECTIVES:
1. Identify and discuss characteristics of the
corporate form of organization.
2. Account for the issuance of common and
preferred shares.
3. Prepare a corporate income statement.
4. Account for cash dividends.
5. Prepare a statement of retained earnings and
closing entries for a corporation.
6. Prepare the shareholders’ section of the balance
sheet and calculate return on equity.
Copyright John Wiley & Sons Canada, Ltd.
18
Retained Earnings
• The cumulative total of profit less losses and less
declared dividends since incorporation
• Represents part of shareholder’s claim on total
assets of a corporation
– Not a claim on any specific asset (including cash)
• Two major components:
– Profit
– Dividends: cash distributions to owners
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Corporate Income
Statements
• Income statement for corporations are
similar to proprietorship or partnership
statements
• One major difference is income taxes
– Since corporation is a separate legal entity
– Affects income statement (income tax expense)
and balance sheet (income tax payable or
receivable)
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Corporate Income Statements 2
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CHAPTER 13:
Introduction to Corporations
STUDY OBJECTIVES:
1. Identify and discuss characteristics of the
corporate form of organization.
2. Account for the issuance of common and
preferred shares.
3. Prepare a corporate income statement.
4. Account for cash dividends.
5. Prepare a statement of retained earnings and
closing entries for a corporation.
6. Prepare the shareholders’ section of the balance
sheet and calculate return on equity.
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22
Dividends
• Pro-rata distribution of a portion of
corporation’s retained earnings to
shareholders
– Pro-rata: based on the proportion of
shares owned
• Common types of dividends
• Cash dividends
• Stock dividends (normally common shares)
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Cash Dividends
• To pay dividends, a corporation must:
– Have enough retained earnings and cash
– Declare a dividend payable
• Declaration date:
– Board of directors formally declares dividend
– Commits company to a legal obligation
– Declaration is recorded:
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Cash Dividends 2
• Record date:
– Ownership of shares is determined
– Shareholders of record on this date will receive
dividend
– No journal entry required
• Payment date:
– Dividend is paid to shareholders and recorded:
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CHAPTER 13:
Introduction to Corporations
STUDY OBJECTIVES:
1. Identify and discuss characteristics of the
corporate form of organization.
2. Account for the issuance of common and
preferred shares.
3. Prepare a corporate income statement.
4. Account for cash dividends.
5. Prepare a statement of retained earnings and
closing entries for a corporation.
6. Prepare the shareholders’ section of the balance
sheet and calculate return on equity.
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26
Statement of Retained
Earnings
• Shows the changes in retained
earnings during the year
• Required under ASPE
• Transactions that affect retained
earnings:
– Earning a profit (incurring a loss)
– Declaring cash and stock dividends
– Other transactions
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Sample Statement of Retained
Earnings
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CHAPTER 13:
Introduction to Corporations
STUDY OBJECTIVES:
1. Identify and discuss characteristics of the
corporate form of organization.
2. Account for the issuance of common and
preferred shares.
3. Prepare a corporate income statement.
4. Account for cash dividends.
5. Prepare a statement of retained earnings and
closing entries for a corporation.
6. Prepare the shareholders’ section of the balance
sheet and calculate return on equity.
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29
Shareholders’ Equity on the
Balance Sheet
• Contributed Capital
– Share capital: preferred and common shares
– Contributed surplus: amounts contributed from
acquiring and retiring shares
• Retained Earnings
– Cumulative profit (loss) since incorporation
– Annual profit (loss) is added (deducted);
dividends are deducted
• Accumulated Other Comprehensive
Income
– Used by companies that follow IFRS (not
ASPE)
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Sample Shareholders’ Equity Section
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Return on Equity
• Also called return on investment
• Considered to be the most important
measure of a firm’s profitability
• It evaluates how many dollars are earned
for each dollar invested by shareholders
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Copyright
Copyright © 2013 John Wiley & Sons Canada, Ltd. All rights
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caused by the use of these files or programs or from the use
of the information contained herein.
Prepared by:
A. Davis, MSc, BComm, CA, CFE
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