INTERMEDIATE
ACCOUNTING
Seventh Canadian Edition
KIESO, WEYGANDT, WARFIELD, YOUNG, WIECEK
Prepared by:
Gabriela H. Schneider, CMA
Northern Alberta Institute of Technology
CHAPTER
16
Shareholders’ Equity
Learning Objectives
1. Discuss the characteristics of the corporate form
of organization.
2. Identify the rights of shareholders.
3. Describe the major features of preferred shares.
4. Explain the accounting procedures for issuing
shares.
5. Identify the major reasons for repurchasing
shares.
Learning Objectives
6. Explain the accounting for reacquisition and
retirement of shares.
7. Explain the accounting for various forms of
dividend distributions.
8. Explain the effect of different types of dividend
preferences.
9. Distinguish between stock dividends and stock
splits.
Learning Objectives
10. Understand the nature of other components of
shareholders’ equity.
11. Indicate how shareholders’ equity is presented.
12. Analyse shareholders’ equity.
13. Explain accounting for par value shares
(Appendix 16A).
14. Explain accounting for treasury shares
(Appendix 16A).
15. Describe the accounting for a financial
reorganization (Appendix 16B).
Shareholders’ Equity
Corporate Share Capital
Form
Retained
Earnings
Other
Components
Corporate Types of
Law
shares
Formality
of profit
distribution
Contributed
surplus
Share
capital
system
Limited
liability of
shareholders
Types of
dividends
Issuance
Stock splits
Other
comprehensiv
e income
Presentation
and
Perspectives
Disclosure
Analysis
Special
presentation
issues
Statement of
shareholders’
equity
Reacquisition
Retirement
Appendix 16B Reorganizations
Appendix 16A – Par Value and Treasury
Shares
Comprehensive revaluation
Par value shares
Treasury shares
Components of Shareholders’
Equity
Share Capital
Common
And/or
Preferred shares
Contributed
Capital
Contributed
Surplus
Retained
Earnings
Earned
Capital
Major Sources of Changes in
Shareholders’ Equity
All Transactions and Events That Cause
Changes in Shareholders’ Equity
Net Income
Revenues
&
Expenses
Gains
and
Losses
Transfers Between Entity and
Owners
Investments
by Owners
Distributions
to Owners
Defining Capital
• Legal capital (stated capital)
– the full price received for shares issued
• If par value shares are issued, then legal/stated
capital = par value
– Par value shares are not permitted under CBCA
– Permitted under some provincial jurisdictions
(see Appendix)
Defining Capital
Accounting definition of capital
• Shareholders’ equity which includes:
– Share capital
• the legal/stated capital
– Contributed surplus
• equity transactions not specifically included
elsewhere
– Retained earnings
• all undistributed income that remains invested
in the business
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
Corporate Accounting
Special characteristics that impact on
accounting:
1. Corporate law
2. Share capital system
3. Limited Liability
Corporate Law
Articles of
Incorporation
Corporation
Recognized as
Legal Entity
Corporation
Charter
Issued
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
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
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
4.Preemptive right for any new share issues
Share Capital
Common shares
• Represent basic 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
Share Capital
Preferred Shares
• Certain inherent rights given up or exchanged for
other rights
• Preference given on
– Dividends
– Claim to assets on dissolution
• Preferred shares features (some or all may be
attached to a preferred share
– Cumulative  Callable/redeemable
– Convertible  Retractable
– Participating
Disclosure of Share Capital
• Note disclosure will contain the following
information:
– Authorized number of shares (if no limit then so
stated)
– If any unique rights attached to share class, which
rights and to which shares
– Number of shares issued, and the amount received
– Whether the shares are par-value or no-par value
– Amount of any dividends in arrears
– Changes during the year, including new issuances,
redemptions and resale of treasury shares
Limited Liability
• Limited Liability of Shareholders
– Unlike partnership or proprietorship form of
business
– Shareholders not generally liable for the
obligations of the corporation
• Shareholders gains (“profit”) restricted to
– Gain on the market price of their share
– Dividends declared by the Board of Directors
• Shareholders losses restricted to
– Amount invested in the corporate shares
Accounting for the
Issuance of Shares
• Shares basic
• Shares sold on a subscription basis
• Shares issued in combination with other
securities
Shares Issue - Basic
Full amount of proceeds received is credited to the
respective share capital account
(preferred/common/class type)
500 shares are sold for $10.00 each (issuance
costs not included in this transaction). The
journal entry is:
Cash
5,000
Share Capital
5,000
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 price
is paid and the contract is settled
• Dividends may be attached to some
subscription shares, once the initial payment is
received
Shares Sold by Subscription
Accounts in share subscription transaction
– 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
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, and the balance of the contract is
cancelled
– Funds paid to date are forfeited, 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
Shares Sold by Subscription
500 shares are sold on subscription for $20.00
each. 50% is due as initial payment.
The initial journal entries would be:
Subscription Receivable
10,000
Shares Subscribed
Cash
10,000
5,000
Subscription Receivable
5,000
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).
Shares Sold by Subscription
Default after first payment – funds refunded with no
penalty.
Shares Subscribed
10,000
Accounts Payable (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
Shares Sold by Subscription
Default after first payment – funds held by
corporation.
Shares Subscribed
10,000
Subscription Receivable
5,000
Contributed Surplus
5,000
Share Subscription Exercise:
E16-2
30,000 shares @ $20.00
Subscription terms:
30% down; balance in six (6) months
Journal entries?
Share Subscription Exercise:
E16-2
Share Subscription Receivable
420,000
Cash
180,000
Shares Subscribed
600,000
(30,000 x $20.00) = $600,000
600,000 x 30% = $180,000
Record initial subscriptions and down payment
received
Share Subscription Exercise:
E16-2
Cash
420,000
Share Subscription Receivable 420,000
Record receipt of the balance due on the
subscription
Shares Subscribed
600,000
Share Capital
600,000
Record issuance of shares from subscription sale
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
Accounting for Share Issue Costs
• Include legal fees, accounting fees, underwriter
fees & commissions, printing and mailing costs,
advertising and administrative expenses of
preparation
• CICA Handbook (Section 3610) deems these
amounts to be capital transactions and therefore
should not be included in net income calculation
• Accounting treatment—debit to Share Capital
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
stock option 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
Share Repurchase
• Other reasons may include:
–
–
–
–
Reduce the operations of the business
Change the debt-to-equity ratio
Settle a debt
Provide a kind of boost to shareholders
(remaining shareholders end up with a larger
portion of the entity)
– Fulfill the terms of a contract
– Satisfy a claim from a shareholder
– Change from a public to a private corporation
Reacquisition of Shares
• Shares may be retired when reacquired
• May also (in limited circumstances and jurisdictions)
become Treasury Stock (see Appendix)
• In either case, the accounts affected are:
–
–
–
–
Share Capital
Contributed Surplus
Retained Earnings
Treasury Stock (for Treasury Stock only)
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
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
Contributed Surplus NEVER goes to a debit balance
Reacquisition of Shares - Retired
In January 2005, Cooke Corp. repurchased and
retired 500 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
Disclosure of Share Capital
• Per CICA Handbook, Section 3240, the following
disclosure is required:
– Authorized share capital
– Issued share capital
– Changes in share capital since last balance sheet
date
• May be disclosed in the notes to the financial
statements, or in the body of the Balance Sheet
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
Formality of Profit Distribution
• No amounts may be distributed unless corporate
capital is maintained intact
– Sufficient capital remains after the dividend to pay
liabilities as they are due
– The realizable value of the corporate assets does
fall below the total of the liabilities
• Formal approval of the Board of Directors required
• Dividends are in full agreement with share provisions
Dividend Distributions
•
Types of dividends
1. Return on capital
– Cash dividend
– Stock dividend
2. Return of capital
– Liquidating dividends
3. Important dates
– Date of declaration
– Date of record
– Date of payment
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
Dividends Declared
xxx
Dividends Payable
xxx
– On Date of Payment liability is reduced
Stock Dividends
• No assets distributed (unlike cash dividends)
• Unlike with cash, or other asset, dividends,
total shareholders equity does not change
– Amounts are “re-arranged” as a result of the
stock dividend
– Amount transferred generally equal to the fair
value at declaration date
Stock Dividend
•
•
•
•
1,000 shares outstanding
Retained earnings = $50,000
10% stock dividend declared
Fair (market) value of share = $130 per share
Stock Dividend Declared
Common Stock
1,000 x 10% =
100
Fair value
$ 130
Total
$13,000
13,000
13,000
Dividend Preferences
Example Data
• $50,000 total declared as dividends
• Common share capital = $400,000
• Preferred shares:
1,000 outstanding
6%
Share capital - $100,000
Non-Participating
• If shares are non-cumulative and nonparticipating
– 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
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
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 are affected
• Shares are not exchanged
Stock Split
• Done to exact a market price manipulation
• Amount of share capital is not affected
Components of Shareholders’
Equity
Contributed Surplus transactions
•
•
•
•
•
•
•
Par value share issue, retirement
No-par value share repurchase/retirement
Liquidating dividends
Financial reorganization
Stock rights and warrants
Issue of convertible debt
Share subscriptions forfeited
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
COPYRIGHT
Copyright © 2005 John Wiley & Sons Canada, Ltd.
All rights reserved. Reproduction or translation of
this work beyond that permitted by Access Copyright
(The Canadian Copyright Licensing Agency) is
unlawful. Requests for further information should be
addressed to the Permissions Department, John
Wiley & Sons Canada, Ltd. The purchaser may make
back-up copies for his or her own use only and not
for distribution or resale. The 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.