Intermediate Accounting
Thomas H. Beechy
Schulich School of
Business,
York University
Joan E. D. Conrod
Faculty of Management
Dalhousie University
Powerpoint slides by:
Michael L. Hockenstein  Commerce Department • Vanier College
Copyright © 2003 McGraw-Hill Ryerson Limited, Canada
Shareholders’ Equity
Chapter 14
14-2
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Copyright © 2003 McGraw-Hill Ryerson Limited, Canada

The Corporate Form of Organization
Advantages and Disadvantages
 The primary advantages are:
limited liability
capital accumulation
ease of ownership transfer
potential for an expanded equity base
14-3
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
The Corporate Form Of Organization
Advantages and Disadvantages (cont.)
 The disadvantages include:
increased taxation
difficulties of control
limited power of minority shareholders
cost to operate
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Copyright © 2003 McGraw-Hill Ryerson Limited, Canada

Private vs. Public Corporations
 Federal and provincial legislation governs


the formation and operation of corporations
A corporation may be formed either
provincially or federally
About half of the 200 Canadian public
companies surveyed by Financial Reporting
in Canada 2000 are incorporated federally
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
Private vs. Public Corporations (cont.)
 Private companies have a limited number of


shareholders (maximum of 50 by the provincial
securities acts) and the shares cannot be
publicly traded
Private corporations generally have a
shareholders’ agreement that describes the
way in which shares can be transferred
Approximately 50% of the corporations on the
Financial Post list of the 500 largest Canadian
corporations are private
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
Private vs. Public Corporations (cont.)
 Public companies: companies whose
securities, either debt or equity, are traded on stock
exchanges
 Private placement: issuing financial instruments
to a single buyer or a syndicate of buyers; not made
available to the public; benefits include the ability to
modify terms to address specific investor needs and
to avoid requirements imposed by securities
regulators (OSC, SEC, etc.)
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
Share Capital




Share capital, represented by share certificates,
represent ownership in a corporation
Shares may be bought, sold, or otherwise transferred
by the shareholders without the consent of the
corporation unless there is an enforceable agreement
to the contrary
At least one class of shares has the right to vote, and
that class receives the residual interest (if any) in the
assets if the company is liquidated or dissolved
This class of shares normally is described as the
common shares
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
Share Capital (cont.)
 Preferred shares are so designated because they

confer certain preferences, or differences, over
common shares
Preference may involve one of the following:
 voting rights
 dividends
- cumulative
- participating
 assets upon liquidation
 convertibility to other securities
 guarantee
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Par Value versus No-Par Value Shares

While the CBCA and most provincial business
corporations acts prohibit the use of par value shares,
one or two provincial jurisdictions do allow their
issuance
 Par value shares: have a designated dollar

amount per share, as stated in the articles of
incorporation and as printed on the face of the share
certificates
Premiums and discounts are recognized
and recorded in separate equity
accounts
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Par Value versus No-Par Value
Shares (cont.)
 No-par shares do not carry a designated or

assigned value per share
The entire amount of proceeds received by
the company is credited to share capital
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
Fundamental Share Equity Concepts
and Distinctions
 The fundamental concepts that underlie the
accounting and reporting of shareholders’
equity may be summarized as follows:
separate legal entity
sources of shareholders' equity
cost-base accounting
no impact on income
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
Fundamental Share Equity
Concepts and Distinctions (cont.)
 Authorized share capital: the maximum
number of shares that can be legally issued
 Issued share capital: the number of shares
that have been issued to shareholders to date
 Unissued share capital: the number of shares
of authorized share capital that have not been issued
when there is a limit on the number of authorized
shares, that is, the difference between authorized
and issued shares
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
Fundamental Share Equity
Concepts and Distinctions (cont.)
 Outstanding share capital: issued and
currently owned by shareholders
 Treasury shares: outstanding shares
reacquired
 Subscribed shares: unissued shares set
aside to meet subscription contracts
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
Exhibit 14-1
14-15
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
Accounting for Share Capital at
Issuance
 Authorization: the articles of incorporation will

authorize an unlimited (or, less frequently, a
limited) number of shares
This authorization may be recorded as a memo
entry in the general journal and in the ledger
account by the following notation:
 common shares – no-par value
(authorized: unlimited shares)
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
Accounting for Share Capital at
Issuance (cont.)


No-par Value Shares Issued for Cash: when
shares are issued, a share certificate, specifying the
number of shares represented, is prepared for each
shareholder
An entry reflecting the number of shares held by
each shareholder is made in the shareholder ledger,
a subsidiary ledger to the share capital account
The issuance of 10,000 common shares, no-par, for cash of $10.20 per share
Cash
102,000
Common shares, no par value (10,000 shares)
102,000
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Accounting for Share Capital at
Issuance (cont.)
 Shares Sold on a Subscription Basis: Prospective
shareholders may sign a contract to purchase a specified
number of shares on credit, with payment due at one or
more specified future dates
120 no-par common shares of BT Corporation are subscribed for at $12 by J. Doe.
The total is payable in three instalments of $480 each.
Stock subscriptions receivable – common shares (Doe)
1,440*
Common shares subscribed, no-par (120 shares)
1,440
To record the collection:
Cash
Stock subscriptions receivable – common shares (Doe)
To record issuance of shares:
Common shares subscribed, no-par (120 shares)
Common shares, no-par (120 shares)
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480
480
1,440
1,440
Accounting for Share Capital at
Issuance (cont.)


Default on Subscriptions: When a subscriber
defaults after partial fulfilment of the subscription
contract, certain complexities arise
In case of default, the corporation may decide to
 (1) return all payments received to the subscriber
 (2) issue shares equivalent to the number paid for
in full, rather than the total number subscribed
 (3) keep the moneys received.
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
Accounting for Share Capital at
Issuance (cont.)


Non-Cash Sale of Share Capital: Corporations
sometimes issue share capital for non-cash assets
When a corporation issues its shares for non-cash
assets or services or to settle debt, the transaction
should be recorded at the fair value–but there are two
fair values present
 the fair value of the asset received, and
 the fair value of the shares issued
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Accounting for Share Capital at
Issuance (cont.)
To illustrate, assume that Bronex Corp. issued 136,000 Class A shares in
exchange for land. The land was appraised at $420,000, while the shares,
based on the one prior transaction in the shares, were valued at $450,000.
The board of directors passed a motion approving the issuance of shares
to be valued at the average of these two prices, $435,000.
Land
435,000
Class A share capital (136,000 shares)
435,000
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
Accounting for Share Capital at
Issuance (cont.)
 Basket Sales of Share Capital: a corporation
sells two or more classes for one lump-sum amount
(often referred to as a basket sale)
 Two methods used in such situations are:
the proportional method, in which the lump
sum received is allocated proportionately
among the classes of shares on the basis of
the relative market value of each security
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
Accounting For Share Capital At
Issuance (cont.)
the incremental method, in which the
market value of one security is used as a
basis for that security and the remainder of
the lump sum is allocated to the other
class of security
-
when there is no market value for any
of the issued securities, proceeds may
be allocated arbitrarily
14-23
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
Accounting For Share Capital At
Issuance (cont.)
 Share Issue Costs: costs corporations incur
when they issue shares in a public offering,
e.g., registration fees, underwriter
commissions, legal and accounting fees,
printing costs, clerical costs, and promotional
costs
14-24
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Copyright © 2003 McGraw-Hill Ryerson Limited, Canada

Accounting For Share Capital At
Issuance (cont.)
 Two methods of accounting for share issue
costs are found in practice:
 offset method: share issue costs are treated as
a reduction of the amount received from the sale
of the related share capital
 retained earnings method: share issue costs
are charged directly to retained earnings in a
variation of the offset method
14-25
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
Retirement of Shares
 Some preferred shared are retractable, which



means that, at the option of the shareholder, and
at a contractually arranged price, a company is
required to buy back its shares.
Other preferred shares are callable, or
redeemable, which means that there are
specific buy-back provisions, at the option of the
company
A company can buy back any of its shares,
preferred or common, at any time, if they are
offered for sale
Such a sale can be a private transaction, or a
public (stock market) transaction
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
Retirement of Shares (cont.)
 A company may retire shares for the following
reasons:
 to increase earnings per share
 to provide cash flow to shareholders in lieu of
dividends
 to acquire shares when they appear to be
undervalued
 to buy out one or more particular shareholders
and to thwart take-over bids
 to reduce future dividend payments by reducing
the shares outstanding
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Retirement of Shares (cont.)


When shares are purchased and immediately
retired, all capital items relating to the specific
shares are removed from the accounts
If cumulative preferred shares are retired, and
there are dividends in arrears, such dividends
are paid and charged to retained earnings in the
normal manner
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
Retirement of Shares (cont.)
 Where the reacquisition cost of the acquired shares is
different from the average original issuance price, the
CICA Handbook recommends that the cost be
allocated as follows for no-par shares:
 Reacquisition cost is higher than the average
price per share issued to date, the cost should be
charged in this sequence:
 to share capital at the average price per issued
share
 to any contributed capital that was created by
earlier treasury stock transactions in the same
class of shares
 any remaining amount to retained earnings
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
Retirement of Shares (cont.)
 Reacquisition cost is lower than the average
price per share issued to date, the cost should
be charged:
 to share capital at the average price per issued
share
 any remaining amount to contributed capital
 The effect of these rules is to ensure that a
corporation records no income effect (i.e., no
gain or loss on the income statement) on buying
back its own shares
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Treasury Stock
 A firm may also buy its own shares and hold


them for eventual resale
Such shares may not vote at shareholder
meetings or receive dividends
The Canada Business Corporations Act (and
provincial legislation modelled after the act)
provides that corporations that reacquire their
own shares must immediately retire those
shares
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
Retained Earnings
 Retained earnings represent accumulated
net income or net loss (including all gains and
losses), error corrections, and retroactive
changes in accounting policy, if any, less
accumulated cash dividends, property
dividends, stock dividends, and other amounts
transferred to contributed capital accounts
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
Retained Earnings (cont.)
The following items affect retained earnings:
 Decreases (debits):
 net loss (including extraordinary items)
 error correction (may also be a credit)
 affect a change in accounting policy applied
retroactively (may also be a credit)
 cash and other dividends
 stock dividends
 share retirement and treasury stock transactions
 share issue costs
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
Retained Earnings (cont.)
 Increases (credits):
 net income (including extraordinary items)
 removal of deficit in a financial reorganization
 unrealized appreciation of investments valued at
market (such as by an investment fund)
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
Appropriations and Restrictions of
Retained Earnings
 Appropriated retained earnings are the result of


discretionary management action
Restricted retained earnings are the result of a
legal contract or corporate law
The following are examples of some of the ways
in which appropriations and restrictions may
arise:
 to fulfil a contractual agreement, as in the case of
a debt covenant restricting the use of retained
earnings for dividends that would result in the
disbursement of assets
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
Appropriations and Restrictions of
Retained Earnings (cont.)
 to fulfil a contractual agreement, as in the case of
a debt covenant restricting the use of retained
earnings for dividends that would result in the
disbursement of assets
 to report a discretionary appropriation made to
constrain a specified portion of retained earnings
as an aspect of financial planning
 to report a discretionary appropriation of a
specified portion of retained earnings in
anticipation of possible future losses
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
Reporting Retained Earnings
 The statement of retained earnings may
include the following:
beginning balance of retained earnings
restatement of beginning balance for error
corrections
restatement of beginning balance for
retroactively applied accounting changes
net income or loss for the period
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
Reporting Retained Earnings (cont.)
dividends declared for the period
appropriations and restrictions of retained
earnings (may alternatively be disclosed in the
notes)
adjustments made pursuant to a financial
reorganization
adjustments resulting from some share
retirements
ending balance of retained earnings
14-38
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
Exhibit 14-2
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
Exhibit 14-2 (cont.)
14-40
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
Dividends
 A dividend is a distribution of earnings to

shareholders in the form of assets or shares
A dividend typically results in a credit to the
account that represents the item distributed
(cash, non-cash asset, or share capital) and
a debit to retained earnings
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
Relevant Dividend Dates
 Date of Declaration: the date the corporation's
board of directors formally announces the dividend
declaration
 Date of Record:
the date on which the list of
shareholders of record is prepared
 individuals holding shares at this date, as shown
in the corporation's shareholders' record, receive
the dividend, regardless of sales or purchases of
shares after this date
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
Relevant Dividend Dates (cont.)
 Ex-Dividend Date: the day following the date
of record
 Date of Payment: the actual day of the
payment of the dividend
 the date of payment typically follows the
declaration date by four to six weeks
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Copyright © 2003 McGraw-Hill Ryerson Limited, Canada

Legality of Dividends
 The following two provisions must be present
for dividends to be declared:
 dividends may not be paid from legal capital
(usually represented in the share capital
accounts) without permission from creditors
 retained earnings are available for dividends
unless there is a contractual or statutory
restriction
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
Legality of Dividends (cont.)
 Under the Canada Business Corporations Act,

a liquidity test must also be met
Dividends may not be declared or paid if the
result would be that the corporation became
unable to meet its liabilities as they came due,
or if the dividend resulted in the realizable
value of assets being less than liabilities plus
stated capital
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
Cumulative Dividend Preferences
on Preferred Shares
 Cumulative preferred shares provide that

dividends not declared in a given year
accumulate at the specified rate on such
shares
This accumulated amount must be paid in full
if and when dividends are declared in a later
year before any dividends can be paid on the
common
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
Cumulative Dividend Preferences
on Preferred Shares (cont.)
 If cumulative preference dividends are not

declared in a given year, they are said to
have been passed and are called dividends in
arrears on the cumulative preferred shares
The CICA Handbook requires that arrears of
dividends for cumulative preference shares
be disclosed, usually in the notes to the
financial statements
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
Participating Dividends

Participating preferred shares provide that the
preferred shareholders participate above the
stated preferential rate on a pro rata basis in
dividend declarations with the common
shareholders
 first, preferred shareholders receive their
preference rate
 second, the common shareholders receive a
specified matching dividend
 then, if the total declared dividend is larger than
these two amounts, the excess is divided on a pro
rata basis between the two share classes
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
Property Dividends and Spin-Offs
 Property dividends or dividends in
kind: payment of a dividend with non cash


assets
The property may be investments in the securities
of other companies held by the corporation, real
estate, merchandise, or any other non-cash asset
designated by the board of directors
A property dividend is recorded at the current
market value of the assets transferred
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
Property Dividends and Spin-Offs
(cont.)
 Spin-off: the shares of a wholly or substantially


owned subsidiary are distributed to the parent
company's shareholders
The parent company's shareholders now directly
own the subsidiary rather than exercise control
indirectly through the corporation
Since a spin-off is a splitting up of a reporting
entity, the spin-off is usually valued at the book
value of the spun off shares, not at market value
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
Liquidating Dividends
 Liquidating dividends: distributions that are a


return of the amount received when shares were
issued, rather than assets acquired through
earnings
Liquidating dividends are appropriate when there is
no intention or opportunity to conserve resources
for asset replacement
A mining company might pay such a liquidating
dividend when it is exploiting a non-replaceable
asset
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
Scrip Dividends



A corporation that has a temporary cash shortage
might declare a dividend to maintain a continuing
dividend policy by issuing a scrip dividend
A scrip dividend (also called a liability dividend)
occurs when the board of directors declares a
dividend and issues promissory notes, called scrip,
to the shareholders
This declaration means that a relatively long time
(e.g., six months or one year) will elapse between
the declaration and payment dates
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
Stock Dividends
 Ordinary stock dividend: a stock dividend
is of the same class as that held by the recipients
 Special stock dividend: a stock dividend is
of a class of share capital other than the one
already held by the recipients is issued (e.g.,
preferred shares issued to the owners of
common)
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
Stock Dividends (cont.)
 A stock dividend: a proportional distribution
to shareholders of additional common or preferred
shares of the corporation
 A stock dividend does not change the assets,


liabilities, or total shareholders' equity of the
issuing corporation
It does not change the proportionate
ownership of any shareholder
It simply increases the number of shares
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
Stock Dividends (cont.)
 Numerous reasons exist for a company to
issue a stock dividend:
 to reveal that the firm plans to permanently
retain a portion of earnings in the business
 to increase the number of shares outstanding,
which reduces the market price per share and
which, in turn, tends to increase trading of
shares in the market
 to continue dividend distributions without
disbursing assets (usually cash) that may be
needed for operations
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
Stock Dividends (cont.)
 stock dividends do not subject the shareholders
to income tax
 shareholders may actually prefer to receive
stock dividends because they can sell these
additional shares only if they choose to do so
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
Accounting Issues Related to
Stock Dividends
 The two primary issues in accounting for


stock dividends are the value that should be
recognized and the timing of accounting
recognition.
Accountants disagree about the value that
should be used in recognizing stock
dividends
The shares issued for the dividend could be
recorded at market value, at stated (or par)
value, or at some other value
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
Accounting Issues Related to
Stock Dividends (cont.)
 The AcSB has made no recommendation on


the matter
The Canada Business Corporations Act
requires shares to be issued at fair market
value
In Ontario, legislation permits the board of
directors to capitalize any amount it desires
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
Special Stock Dividends
 A special stock dividend:

a dividend in a
share class different from the class held by the
recipients, e.g., such as a stock dividend consisting
of preferred shares issued to common
shareholders
In this case, the market value of the dividend (the
preferred shares) should be capitalized
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
Stock Splits
 A stock split: change in the number of shares


outstanding with no change in the recorded
capital accounts
A stock split usually increases the number of
shares outstanding by a significant amount, such
as doubling or tripling the number of outstanding
shares
The primary purpose of a stock split is to
increase the number of shares outstanding and
decrease the market price per share, increase
the market activity of the shares, reduce
earnings per share
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
Stock Splits (cont.)
 A reverse stock split results in a

proportional reduction in the number of
shares issued and outstanding and an
increase in the average book value per
share
Reverse splits may be used to increase the
market price of so-called penny stocks, often
in preparation for a new public offering of
shares
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
Exhibit 14-4
14-62
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
Other Components of Shareholders’
Equity

Comprehensive revaluation of assets and
liabilities from cost to market value is only
permitted when there is:
 a change in control such that the controlling
shareholder has 90% or more of equity
interests
 a financial reorganization signalling a fresh
start for the entity following receivership or
bankruptcy or following a voluntary
restructuring agreement with the corporation’s
creditors and shareholders
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
Other Components of Shareholders’
Equity (cont.)
 Cumulative foreign currency translation
account: unrealized gains and losses that arise

from a certain type of foreign currency exposure
Life insurance and mutual fund companies, which
are required to carry their investment assets at
market values, will report an unrealized capital
increment that represents the difference between
the cost and the market value of their investments
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
Shareholders’ Equity Disclosure
 Corporations must disclose the items and


conditions of all class shares
Companies must disclose the changes in
share capital accounts in terms of the
number of shares issued, repurchased, and
retired and the dollar amount assigned to
the transactions
Corporations must disclose the changes in
their equity accounts that take place during
the year
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
Shareholders’ Equity Disclosure (cont.)
 Changes in contributed capital must be

clearly disclosed
Some companies do this in a disclosure
note, but many present a schedule or
statement to demonstrate continuity from
one year to the next
14-66

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada

Exhibit 14-5
14-67

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada

Exhibit 14-5 (cont.)
14-68

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada
