Chapter 15
Shareholders’ Equity
Prepared by:
Dragan Stojanovic, CA
Rotman School of Management, University of Toronto
Shareholders’ Equity
The
Share
Corporate capital
Form
•Types of
•Corporate
law
•Share
capital
system
shares
•Limited
liability of
shareholders
•Issuance of
shares
•Reacquisition
of shares
Retained
Earnings
•Formality of
profit
distribution
Other
Components
of
Shareholders’
Equity
•Types of
dividends
•Contributed
surplus
•Stock splits
•Accumulated
other
comprehensive
income
Presentation Perspectives IFRS /
and
Private Entity
•Analysis
Disclosure
GAAP
Comparison
•Special
presentation
issues
•Looking ahead
•Comparison
•Retirement of
reacquired
shares
2
Components of Shareholders’
Equity
Share Capital:
Common
And/or
Preferred shares
Contributed
Surplus
Retained
Earnings
Accumulated
other
Comprehensive
Income
Contributed
Capital
Earned
Capital
3
Shareholders’ Equity
The
Share
Corporate capital
Form
•Types of
•Corporate
law
•Share
capital
system
shares
•Limited
liability of
shareholders
•Issuance of
shares
•Reacquisition
of shares
Retained
Earnings
•Formality of
profit
distribution
Other
Components
of
Shareholders’
Equity
•Types of
dividends
•Contributed
surplus
•Stock splits
•Accumulated
other
comprehensive
income
Presentation Perspectives IFRS /
and
Private Entity
•Analysis
Disclosure
GAAP
Comparison
•Special
presentation
issues
•Looking ahead
•Comparison
•Retirement of
reacquired
shares
4
Primary Forms of
Business Organization
Proprietorship
Engaged in making
financial returns for their
owners
Partnership
Corporation
Profit-oriented
Shares
privately held
Not-for-profit
No shares issued; created to
provide services for members or
society
Private
Sector
Public
Sector
Shares
publicly traded
Municipalities, Cities, Etc.
Crown
Created by government statute
to provide public services
5
Corporate Accounting
Special characteristics that impact on
accounting:
1. Corporate law
2. Share capital system
3. Limited Liability
6
Corporate Law
Articles of Incorporation
Corporation Charter Issued
Corporation Recognized
as Legal Entity
7
Corporate Law
• Canada Business Corporation Act (CBCA)
• Articles of incorporation prepared and submitted
– Company name
– Location of registered office
– Classes and authorized shares
– Share transfer restrictions (if any)
– Directors
– Business restrictions
• CBCA regulations required financial statements be
prepared in accordance with GAAP
8
Share Capital System
•
Shares grouped by “class” (e.g. Class A
Common)
– Within each class, each share equal
• Each share contains certain rights and
privileges
• Ease of transfer of ownership
– Advantage to both issuing corporation and
investor
– Share becomes more attractive investment
9
Share Capital System
•
As a minimum each share has these basic
or inherent rights
1. To share proportionately in profits and
losses
2. The right to vote for directors
3. To share proportionately in assets upon
liquidation
•
Preemptive right for any new share
issues can also be assigned under CBCA
10
Shareholders’ Equity
The
Share
Corporate capital
Form
•Types of
•Corporate
law
•Share
capital
system
shares
•Limited
liability of
shareholders
•Issuance of
shares
•Reacquisition
of shares
Retained
Earnings
•Formality of
profit
distribution
Other
Components
of
Shareholders’
Equity
•Types of
dividends
•Contributed
surplus
•Stock splits
•Accumulated
other
comprehensive
income
Presentation Perspectives IFRS /
and
Private Entity
•Analysis
Disclosure
GAAP
Comparison
•Special
presentation
issues
•Looking ahead
•Comparison
•Retirement of
reacquired
shares
11
Share Capital
Common shares
• Represent basic ownership interest
• Represents residual ownership interest have ultimate risk of loss and benefit from
success
• Dividends, or assets on dissolution, not
guaranteed
• True advantage is in the right of Common
Shares to ultimately control by way of voting
12
Share Capital
Preferred Shares
• Certain inherent rights given up or exchanged
for other special rights or privileges
• Preference given on
– Dividends (usually at a stated rate)
– Claim to assets on dissolution
• Preferred shares features (some or all may be
attached to a preferred share)
– Cumulative  Callable/redeemable
– Convertible  Retractable
– Participating
13
Share Capital
Preferred Shares Features
• Cumulative: Dividends in arrears must be paid
before any profits can be distributed to common
shareholders
• Convertible: The company or holder can exchange
the shares for common shares at a predetermined
ratio
• Callable/Redeemable: The issuing company can
“call” at its option the preferred shares at specified
future dates at stipulated prices
• Retractable: The holders can “put” (or sell) their
shares to the company
• Participating: Holders can participate with common
shareholders in any profit distributions higher than
14
the prescribed rate
Limited Liability
• Limited Liability of Shareholders
– Unlike partnership or proprietorship form of
business
– Shareholders not generally liable for the
obligations of the corporation
• Shareholders losses restricted to
– Amount invested in the corporate shares
15
Accounting for the
Issuance of Shares
•
•
•
•
Shares basic
Shares sold on a subscription basis
Defaulted Subscription accounts
Shares issued in combination with other
securities
16
Shares Issue - Basic
Full amount of proceeds received is credited to the
respective share capital account
(preferred/common/class type)
500 common shares are sold for $10.00 each
(issuance costs not included in this transaction).
The journal entry is:
Cash
5,000
Common Shares
5,000
17
Shares Sold by Subscription
• Shares are sold, with “instalment” payments
• Shares are not issued, and any rights are not
given (e.g., voting, dividends) until the full
subscription price is received
• Dividends may be attached to some
subscription shares, once the initial payment is
received
18
Shares Sold by Subscription
Accounts in share subscription transaction
– Common Shares Subscribed
• Set up a separate one for each type/class of share
• An equity account, reported below the respective share
capital account on the Balance Sheet
– Subscription Receivable
• Normally considered a current asset
• May be reported as a contra account to the Shares
Subscribed account in equity section of the Balance
Sheet
– Share Capital
• Credited only when the subscription is paid in full, or
settled in some other manner, in the case of default
19
Shares Sold by Subscription
500 shares are sold on subscription for $20
each. 50% is due as initial payment.
The initial journal entries would be:
Subscription Receivable
10,000
Common Shares Subscribed
Cash
10,000
5,000
Subscription Receivable
5,000
20
Shares Sold by Subscription
If all payments are made as scheduled, the
entries would be:
Cash
5,000
Subscription Receivable
Shares Subscribed
Share Capital
5,000
10,000
10,000
If the subscriber defaults, one of the following
may happen (depending on the contract terms
and applicable legislation).
21
Shares Sold by Subscription
• If a subscription contract is defaulted there are
generally three possible consequences:
– Funds paid to date are refunded, often with a
deduction for expenses, and the balance of the
contract is cancelled
– Funds paid to date are forfeited transferring it to the
Contributed Surplus account, with no refund or
shares being issued; balance of the contract is
cancelled
– Shares are issued for the amount paid to date, with
the balance of the contract cancelled
22
Shares Sold by Subscription
Default after first payment – funds refunded with no
penalty.
Shares Subscribed
10,000
Accounts Payable (or Cash)
5,000
Subscription Receivable
5,000
Default after first payment – shares issued for amount paid.
Shares Subscribed
10,000
Share Capital
5,000
Subscription Receivable
5,000
23
Shares Sold by Subscription
Default after first payment – funds held by
corporation.
Shares Subscribed
10,000
Subscription Receivable
5,000
Contributed Surplus
5,000
24
Shares Issued
With Other Securities
• When two or more classes of shares are sold for
a lump sum
• Accounting problem is the allocation of the funds
received to the respective share classes
• Two methods available
– Proportional method (relative market value
method)
– Incremental method
25
Accounting for Share Issue Costs
• Direct incremental costs incurred to sell shares
include legal fees, accounting fees, underwriter
fees & commissions, printing and mailing costs,
taxes, etc.
• These amounts are considered to be capital
transactions (rather than operating transactions)
and therefore should not be included in net
income calculation
• Accounting treatment—debit to Share Capital
26
Accounting for Share Issue Costs
Reduction of the amount paid in
1,000 shares sold for $10.00 each, with $500 in
issue costs
Cash
9,500
Share Capital
Share Capital
500
10,000
27
Share Repurchase
• Major reasons for the reacquisition of a
corporation’s own shares
– Reduce the shares outstanding to increase EPS
– Have enough shares on hand to meet employee
share compensation contracts
– Buy out a particular ownership interest
– Meet the needs of a potential merger
– Stop (or slow down) takeover attempts
– Reduce number of shareholders
– Make a market in the company’s shares
– Return cash to shareholders
28
Reacquisition of Shares
• Shares may be retired when reacquired
• May also (in limited circumstances and jurisdictions)
become Treasury Stock (held in treasury for
reissue)
• In Canada, the CBCA requires repurchased shares
be cancelled and restored to status of authorized
but unissued, if a limit to authorized shares exists
29
Reacquisition of Shares
• Share capital debited with the original issue or
assigned value only
• The difference then allocated to equity accounts:
– Contributed Surplus
– Retained earnings
30
Reacquisition of Shares - Retired
In January 2011, Cooke Corp. purchased and
cancelled 500 Class A shares at $4 per share.
There are 10,500 shares issued and outstanding,
with total share capital of $63,000
Common Shares (500 [$63,000/10,500] ) 3,000
Cash (500 shares@ $4.00)
2,000
Contributed Surplus (500 @$2.00)
1,000
Assigned share value = $63,000/10,500 = $ 6.00
Acquisition cost = per share price/cost
4.00
Value over assigned value
$2.00
31
Shareholders’ Equity
The
Share
Corporate capital
Form
•Types of
•Corporate
law
•Share
capital
system
shares
•Limited
liability of
shareholders
•Issuance of
shares
•Reacquisition
of shares
Retained
Earnings
•Formality of
profit
distribution
Other
Components
of
Shareholders’
Equity
•Types of
dividends
•Contributed
surplus
•Stock splits
•Accumulated
other
comprehensive
income
Presentation Perspectives IFRS /
and
Private Entity
•Analysis
Disclosure
GAAP
Comparison
•Special
presentation
issues
•Looking ahead
•Comparison
•Retirement of
reacquired
shares
32
Items Affecting Retained
Earnings
1.
2.
3.
4.
DEBITS
Net loss
Prior period
adjustments,
accounting principle
changes
Cash, property, stock
dividends
Treasury stock
CREDITS
1. Net Income
2. Prior period
adjustments,
accounting principle
changes
3. Adjustments from
financial
reorganization
33
Formality of Profit Distribution
•
•
No amounts may be distributed unless corporate capital is
maintained intact
Under the CBCA:
1. There needs to be sufficient capital after the
dividend to pay liabilities as they are due
2. The realizable value of the corporate assets does
not fall below the total of the liabilities and the
stated and legal capital for all classes of shares
•
•
•
Formal approval of the Board of Directors required
Dividends are in full agreement with share capital contracts
Before declaration of a dividend, management should
consider availability of funds to pay the dividend
34
Dividend Distributions
•
•
Types of dividends
1. Return on capital
– Cash dividend
– Stock dividend
2. Return of capital
– Liquidating dividends
Important dates
– Date of declaration
– Date of record
– Date of payment
35
Cash Dividends
• First journal entry is on Date of Declaration
– Dividend becomes legal obligation of the
corporation
– Equity account is debited, liability account
is credited
Cash Dividends Declared
(or Retained Earnings) xxx
Dividends Payable
xxx
– On Date of Payment liability is reduced
36
Cash Dividends
• Before the dividend is paid, a current list of
shareholders needs to be prepared (as at the
date of record)
• If a Cash Dividends Declared account is used
rather than Retained Earnings at the date of
declaration, this account is closed to
Retained Earnings at year end
37
Dividends in Kind
• Dividends payable in corporation assets other
than cash
• These dividends are normally measured at
the “fair value” of the asset given up
• Fair value is determined by referring to:
estimated realizable value of same or similar
assets, quoted market prices, independent
appraisals
38
Stock Dividends
• No assets distributed (unlike cash dividends)
• Unlike with cash dividends or dividends in
kind, total shareholders equity does not
change
– Amounts are “re-arranged” as a result of
the stock dividend
– The transaction is measured at the fair
value of the shares at declaration date
– Each shareholder has the exact same
proportionate interest in the corporation
– However, book value per share decreases
39
Stock Dividends
•
•
•
•
1,000 common shares outstanding
Retained earnings = $50,000
10% stock dividend declared
Fair (market) value of share = $130 per share
Stock Dividends Declared
Common Shares
1,000 x 10% =
100
Fair value $ 130
Total
$13,000
13,000
13,000
40
Dividend Preferences
Example Data
• $50,000 total declared as dividends
• Common share capital = $400,000
• Preferred shares: 1,000 $6 outstanding
(issued at $100,000)
41
Non-cumulative
• If shares are non-cumulative and non-participating
– Dividends are distributed only when declared, up
to the stated amount of the share
– No amount is paid for years where dividends
were not declared
• Referring to previous data:
– Preferred Shareholders are paid $6,000
($6 x 1000) and
– Common Shareholders are paid the remaining
amount of $44,000
42
Cumulative
• If the preferred shares are cumulative and
non-participating, and dividends not paid to
the preferred shareholders in previous 2
years:
• Preferred Shareholders are paid $18,000
( ($6 x 1000 x 2) + $6,000)
• Common Shareholders are paid the remaining
$32,000 ($50,000 - $18,000)
43
Participating
•
If no specific participation agreement exists,
participation generally follows these
guidelines
a. Following assignment to preferred shares of
current year dividends (any cumulative
dividends have been allocated first);
common shares receive an amount to give
them the same return rate as the preferred
b. Any remaining dividend amount is shared by
both preferred and common in proportion to
the carrying value of each share class
44
Participating
•
If preferred shares are non-cumulative and fully
participating, using the previous data:
Preferred Common
1. Current year’s:
– Preferred ($6 x 1000)
– Common (6% x $400,000)
$6,000
$24,000
2. Remaining $20,000 at a
rate of $20,000/$500,000 (i.e. 4%):
– Preferred (4% x $100,000)
– Common (4% x $400,000)
TOTAL
$10,000
$4,000
$16,000
$40,000
45
Stock Dividends vs. Stock Splits
Stock Dividend
• As form of dividend must follow the
requirements of a dividend
• Both the number of shares, and the amount
of share capital generally affected
• Shares are not exchanged
Stock Split
• Increases the number of shares outstanding
• Amount of share capital is not affected
• Results in a market price manipulation
46
Shareholders’ Equity
The
Share
Corporate capital
Form
•Types of
•Corporate
law
•Share
capital
system
shares
•Limited
liability of
shareholders
•Issuance of
shares
•Reacquisition
of shares
Retained
Earnings
•Formality of
profit
distribution
Other
Components
of
Shareholders’
Equity
•Types of
dividends
•Contributed
surplus
•Stock splits
•Accumulated
other
comprehensive
income
Presentation Perspectives IFRS /
and
Private Entity
•Analysis
Disclosure
GAAP
Comparison
•Special
presentation
issues
•Looking ahead
•Comparison
•Retirement of
reacquired
shares
47
Components of Shareholders’
Equity
Contributed Surplus transactions
• Par value share issue and/or retirement
• Treasury share transactions
• Liquidating dividends
• Financial reorganization
• Stock options and warrants
• Issue of convertible debt
• Share subscriptions forfeited
• Donated shares
• Redemption or conversion of shares
48
Components of Shareholders’
Equity
Accumulated Other Comprehensive Income
• Cumulative change in equity from nonshareholder transactions which are excluded
from net income
• Considered to be earned income
49
Shareholders’ Equity
The
Share
Corporate capital
Form
•Types of
•Corporate
law
•Share
capital
system
shares
•Limited
liability of
shareholders
•Issuance of
shares
•Reacquisition
of shares
Retained
Earnings
•Formality of
profit
distribution
Other
Components
of
Shareholders’
Equity
•Types of
dividends
•Contributed
surplus
•Stock splits
•Accumulated
other
comprehensive
income
Presentation Perspectives IFRS /
and
Private Entity
•Analysis
Disclosure
GAAP
Comparison
•Special
presentation
issues
•Looking ahead
•Comparison
•Retirement of
reacquired
shares
50
Disclosure of Share Capital
• Following basic disclosure is required:
– Authorized share capital
– Issued share capital
– Changes in share capital since last
balance sheet date
51
Disclosure of Share Capital
• Additional disclosures include:
– Authorized number of shares (if no limit, then so
stated)
– The existence of unique rights
– Number of shares issued, and the amount received
– Whether the shares are par-value or no-par value
– Amount of any dividends in arrears for cumulative
preferred shares
– Changes during the year, including new issuances and
redemptions (under IFRS, presented in statement of
changes in equity)
– Restrictions on retained earnings
52
Shareholders’ Equity
The
Share
Corporate capital
Form
•Types of
•Corporate
law
•Share
capital
system
shares
•Limited
liability of
shareholders
•Issuance of
shares
•Reacquisition
of shares
Retained
Earnings
•Formality of
profit
distribution
Other
Components
of
Shareholders’
Equity
•Types of
dividends
•Contributed
surplus
•Stock splits
•Accumulated
other
comprehensive
income
Presentation Perspectives IFRS /
and
Private Entity
•Analysis
Disclosure
GAAP
Comparison
•Special
presentation
issues
•Looking ahead
•Comparison
•Retirement of
reacquired
shares
53
Shareholders’ Equity Ratios
1.
Rate of return on common shareholders’ equity
2.
Payout ratio
Net income – Preferred dividends
Average common shareholders’ equity
Cash Dividends
Net income – Preferred dividends
3.
Price earnings ratio
Market price per share
Earnings per share
4.
Book value per share
Common shareholders’ equity
Number of outstanding shares
54
Shareholders’ Equity
The
Share
Corporate capital
Form
•Types of
•Corporate
law
•Share
capital
system
shares
•Limited
liability of
shareholders
•Issuance of
shares
•Reacquisition
of shares
Retained
Earnings
•Formality of
profit
distribution
Other
Components
of
Shareholders’
Equity
•Types of
dividends
•Contributed
surplus
•Stock splits
•Accumulated
other
comprehensive
income
Presentation Perspectives IFRS /
and
Private Entity
•Analysis
Disclosure
GAAP
Comparison
•Special
presentation
issues
•Looking ahead
•Comparison
•Retirement of
reacquired
shares
55
Looking Ahead
• There are several projects being undertaken
by IASB and FASB that may impact
accounting for shareholders’ equity
• These include financial statement project,
and project on liabilities and equity
56
COPYRIGHT
Copyright © 2010 John Wiley & Sons Canada, Ltd.
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57