INTERMEDIATE ACCOUNTING
TENTH CANADIAN EDITION
Kieso • Weygandt • Warfield • Young • Wiecek • McConomy
CHAPTER 15
Shareholders’ Equity
Prepared by:
Lisa Harvey, CPA, CA
Rotman School of Management,
University of Toronto
CHAPTER 15
SHAREHOLDERS’ EQUITY
After studying this chapter, you should be able to:
• Discuss the characteristics of the corporate form of organization,
rights of shareholders, and different types of shares.
• Explain how to account for the issuance, reacquisition, and
retirement of shares, stock splits, and dividend distribution.
• Understand the components of shareholders’ equity and how they
are presented.
• Understand capital disclosure requirements.
• Calculate and interpret key ratios relating to equity.
• Identify the major differences in accounting between ASPE and
IFRS, and what changes are expected in the near future.
Copyright © John Wiley & Sons Canada, Ltd.
2
Shareholders’ Equity
Understanding the
Corporate Form,
Share Capital and
Profit Distribution
Recognition,
Derecognition,
and
Measurement
•Corporate law and the
share capital system
•Issuance of shares
•Types of shares
•Reacquisition and
retirement of shares
•Limited liability of
shareholders
•Dividends
Presentation,
Disclosure,
and Analysis
•Components of
shareholders’
equity
IFRS/ASPE
Comparison
•Comparison of
IFRS and
ASPE
•Looking Ahead
•Capital
disclosures
•Analysis
•Formality of profit
distribution
Copyright © John Wiley & Sons Canada, Ltd.
3
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
Copyright © John Wiley & Sons Canada, Ltd.
4
Corporate Law
Articles of Incorporation
Corporation Charter Issued
Corporation Recognized
as Legal Entity
Copyright © John Wiley & Sons Canada, Ltd.
5
Corporate Law
• The Canada Business Corporation Act (CBCA)
is a relevant business corporation act
– Provincial business corporation acts also exist but
vary from province to province
• Articles of incorporation prepared and submitted
–
–
–
–
–
–
Company name
Location of registered office
Classes and authorized shares
Share transfer restrictions (if any)
Directors
Business restrictions
Copyright © John Wiley & Sons Canada, Ltd.
6
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
Copyright © John Wiley & Sons Canada, Ltd.
7
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
Copyright © John Wiley & Sons Canada, Ltd.
8
Types of Shares
Common Shares
• Represent basic ownership interest
• Represents residual ownership interest have ultimate risk of loss and benefit from
success
• Dividends or assets on dissolution are not
guaranteed
• True advantage is in the right of Common
Shares to ultimately control by way of voting
Copyright © John Wiley & Sons Canada, Ltd.
9
Types of Shares
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
– Convertible
– Participating
 Callable/redeemable
 Retractable
Copyright © John Wiley & Sons Canada, Ltd.
10
Types of Shares
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 the
prescribed rate
Copyright © John Wiley & Sons Canada, Ltd.
11
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 the
amount invested in the corporate shares
Copyright © John Wiley & Sons Canada, Ltd.
12
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 must be in full agreement with share capital
contracts
• Before declaration of a dividend, management should
consider availability of funds to pay the dividend
Copyright © John Wiley & Sons Canada, Ltd.
13
Shareholders’ Equity
Understanding the
Corporate Form,
Share Capital and
Profit Distribution
Recognition,
Derecognition,
and
Measurement
•Corporate law and the
share capital system
•Issuance of shares
•Types of shares
•Reacquisition and
retirement of shares
•Limited liability of
shareholders
•Dividends
Presentation,
Disclosure,
and Analysis
•Components of
shareholders’
equity
IFRS/ASPE
Comparison
•Comparison of
IFRS and
ASPE
•Looking Ahead
•Capital
disclosures
•Analysis
•Formality of profit
distribution
Copyright © John Wiley & Sons Canada, Ltd.
14
Share 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
Copyright © John Wiley & Sons Canada, Ltd.
5,000
15
Shares Sold on a Subscription Basis
• 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
Copyright © John Wiley & Sons Canada, Ltd.
16
Shares Sold on a Subscription Basis
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
– Subscriptions Receivable
•
•
Normally considered a current asset
May be reported as a contra account to the Shares
Subscribed account in equity section
– Share Capital
•
Credited only when the subscription is paid in full, or settled in
some other manner in the case of default
Copyright © John Wiley & Sons Canada, Ltd.
17
Shares Sold on a Subscription Basis
500 shares are sold on subscription for $20
each. 50% is due as initial payment.
The initial journal entries would be:
Subscriptions Receivable
10,000
Common Shares Subscribed
Cash
10,000
5,000
Subscription Receivable
Copyright © John Wiley & Sons Canada, Ltd.
5,000
18
Shares Sold on a Subscription Basis
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
Copyright © John Wiley & Sons Canada, Ltd.
19
Shares Sold on a Subscription Basis
• 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
Copyright © John Wiley & Sons Canada, Ltd.
20
Shares Sold on a Subscription Basis
• 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
Copyright © John Wiley & Sons Canada, Ltd.
21
Shares Sold on a Subscription Basis
• Default after first payment – funds held by
corporation
Shares Subscribed
10,000
Subscription Receivable
5,000
Contributed Surplus
5,000
Copyright © John Wiley & Sons Canada, Ltd.
22
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
Copyright © John Wiley & Sons Canada, Ltd.
23
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
Copyright © John Wiley & Sons Canada, Ltd.
24
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
500
Share Capital
Copyright © John Wiley & Sons Canada, Ltd.
10,000
25
Reacquisition and Retirement of
Shares
• 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
Copyright © John Wiley & Sons Canada, Ltd.
26
Reacquisition and Retirement 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
Copyright © John Wiley & Sons Canada, Ltd.
27
Reacquisition and Retirement of
Shares
• Share capital debited with the original
issue or assigned value only
• The difference then allocated to equity
accounts:
– Contributed Surplus
– Retained Earnings
Copyright © John Wiley & Sons Canada, Ltd.
28
Reacquisition and Retirement of
Shares - Example
In January 2013, 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)
Contributed Surplus (500 @$2.00)
2,000
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
Copyright © John Wiley & Sons Canada, Ltd.
29
Dividends
• Two basic classes of dividends:
1. Return on capital
2. Return of capital
• Important dates:
– Date of declaration
– Date of record
– Date of payment
Copyright © John Wiley & Sons Canada, Ltd.
30
Cash Dividends
• First journal entry is on Date of Declaration
– Dividend becomes legal obligation of the
corporation
Dividends (or Retained Earnings)
Dividends Payable
xxx
xxx
– On Date of Payment, the liability is reduced
Copyright © John Wiley & Sons Canada, Ltd.
31
Cash Dividends
• Before the dividend is paid, a current list of
shareholders needs to be prepared (as at
the date of record)
• If a Dividends account is used rather than
Retained Earnings at the date of
declaration, this account is closed to
Retained Earnings at year end
Copyright © John Wiley & Sons Canada, Ltd.
32
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 can be determined by referring
to estimated realizable value of same or
similar assets, quoted market prices,
independent appraisals etc.
Copyright © John Wiley & Sons Canada, Ltd.
33
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 same proportionate interest
in the corporation
– However, book value per share decreases
Copyright © John Wiley & Sons Canada, Ltd.
34
Stock Dividends - Example
•
•
•
•
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
$13,000
Total
$13,000
13,000
13,000
Copyright © John Wiley & Sons Canada, Ltd.
35
Liquidating Dividends
• Any dividends paid in excess of the
accumulated income of the company
represents a liquidating dividend
– Results in a return of the shareholders’
investment
Copyright © John Wiley & Sons Canada, Ltd.
36
Dividend Preferences
Given:
•
•
•
•
$50,000 total declared as dividends
Common share capital: $400,000
1,000 $6 Preferred shares: $100,000
Preferred share dividends have been paid for
the past 2 years
Calculate the dividend distribution to common
and preferred shareholders based on the
different types of dividend preferences
Copyright © John Wiley & Sons Canada, Ltd.
37
Non-cumulative
• 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
• The dividend distribution is therefore:
– Preferred Shareholders are paid $6,000 ($6 x 1000)
– Common Shareholders are paid the remaining
amount of $44,000
Copyright © John Wiley & Sons Canada, Ltd.
38
Cumulative
• If the preferred shares are cumulative and
non-participating:
– The dividends that were not paid to preferred
shareholders in the previous 2 years must
also be paid
• The dividend distribution is therefore:
– 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)
Copyright © John Wiley & Sons Canada, Ltd.
39
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
$4,000
$10,000
Copyright © John Wiley & Sons Canada, Ltd.
$16,000
$40,000
40
Stock Dividends vs. Stock Splits
Stock Dividend
• A 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
Copyright © John Wiley & Sons Canada, Ltd.
41
Shareholders’ Equity
Understanding the
Corporate Form,
Share Capital and
Profit Distribution
Recognition,
Derecognition,
and
Measurement
•Corporate law and the
share capital system
•Issuance of shares
•Types of shares
•Reacquisition and
retirement of shares
•Limited liability of
shareholders
•Dividends
Presentation,
Disclosure,
and Analysis
•Components of
shareholders’
equity
IFRS/ASPE
Comparison
•Comparison of
IFRS and
ASPE
•Looking Ahead
•Capital
disclosures
•Analysis
•Formality of profit
distribution
Copyright © John Wiley & Sons Canada, Ltd.
42
Components of Shareholders’ Equity
Share Capital:
Common
And/or
Preferred shares
Contributed
Capital
Contributed
Surplus
Retained Earnings
Accumulated other
Comprehensive
Income
Earned
Capital
Copyright © John Wiley & Sons Canada, Ltd.
43
Contributed Surplus
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 assets by a shareholder
Redemption or conversion of shares
Copyright © John Wiley & Sons Canada, Ltd.
44
Retained Earnings
1.
2.
3.
4.
DEBITS
Net loss
Prior period
adjustments,
accounting principle
changes
Cash, property, stock
dividends
Some treasury share
transactions
CREDITS
1. Net Income
2. Prior period
adjustments,
accounting principle
changes
3. Adjustments from
financial reorganization
Copyright © John Wiley & Sons Canada, Ltd.
45
Accumulated Other Comprehensive
Income (AOCI)
• Cumulative change in equity from nonshareholder transactions which are
excluded from net income
• Considered to be earned income
• Note that the concept of comprehensive
income is not applicable under ASPE
Copyright © John Wiley & Sons Canada, Ltd.
46
Disclosure of Share Capital
• Following basic disclosure is required:
– Authorized share capital
– Issued share capital
– Changes in share capital since the last
statement of financial position date
Copyright © John Wiley & Sons Canada, Ltd.
47
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
Copyright © John Wiley & Sons Canada, Ltd.
48
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 © John Wiley & Sons Canada, Ltd.
49
Shareholders’ Equity
Understanding the
Corporate Form,
Share Capital and
Profit Distribution
Recognition,
Derecognition,
and
Measurement
•Corporate law and the
share capital system
•Issuance of shares
•Types of shares
•Reacquisition and
retirement of shares
•Limited liability of
shareholders
•Dividends
Presentation,
Disclosure,
and Analysis
•Components of
shareholders’
equity
IFRS/ASPE
Comparison
•Comparison of
IFRS and
ASPE
•Looking Ahead
•Capital
disclosures
•Analysis
•Formality of profit
distribution
Copyright © John Wiley & Sons Canada, Ltd.
50
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
Copyright © John Wiley & Sons Canada, Ltd.
51
COPYRIGHT
•
Copyright © 2013 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.
Copyright © John Wiley & Sons Canada, Ltd.
52