Chapter 10 Notes

Chapter 10

Shareholders’ Equity

Learning Objective 1Explain the features of a corporation

2Copyright ©2014 Pearson Education.

Corporate CharacteristicsADVANTAGES DISADVANTAGES• Can raise more

capital• Continuous life• Ease of transferring

ownership• Limited liability of

shareholders

• Separation of ownership and management

• Corporate taxation• Government

regulation


Organizing a Corporation•Corporate organizers (incorporators)

obtain a charter from the government▫Charter includes authorization to issue

shares•Incorporators:

▫Pay fees▫Sign the charter▫File documents with the state▫Agree to set of bylaws

•In Hong Kong, see www.cr.gov.hk4Copyright ©2014 Pearson Education.

Copyright ©2014 Pearson Education. 5

Shareholders (Owners)

Chief Executive Officer (CEO)

Board of Directors (elected by SH)

Chief Operating Officer (COO)

Director, Sales

Chief Financial Officer

Company Secretary

Controller Treasurer

Director, Personnel

Director, Manufacturi

ng

Shareholder Rights

Vote Dividends

Liquidation

Preemption



Shareholder Rights• 1. Vote.

▫ The right to participate in management by voting on matters that come before the shareholders. This is the shareholder’s sole voice in the management of the corporation.

• 2. Dividends. ▫ The right to receive a proportionate part of any dividend, if declared by

the board. Each share in a particular class receives an equal dividend.• 3. Liquidation.

▫ The right to receive a proportionate share of any assets remaining after the corporation pays its liabilities in liquidation. Liquidation means to go out of business, sell the assets, pay all liabilities, and distribute any remaining cash to the owners.

• 4. Preemption. ▫ The right to maintain one’s proportionate ownership in the corporation.

Sometimes required by law, sometimes company grant this right.

Shareholders’ EquityPaid-in capital

• Amount shareholders have contributed

Retained earnings

• Amount earned by profitable operations


Classes of SharesORDINARY PREFERENCE• Basic form of share

capital• Has four basic rights• Shareholders benefit

most if corporation succeeds▫ Take more risk

• Has advantages over common▫ Receive dividends first▫ Receive assets first in

liquidation• Shareholders earn a fixed

dividend• Very few corporations

(7%) issue • Disadvantage

▫ Sometimes does not have voting right


Comparison of Issuing Shares and Debt


Ordinary share

Preference share

Long-term debt

Obligation to repay principal

No No Yes

Dividends/interest Dividends are not tax deductible

Dividends are not tax deductible

Interest expense is tax deductible

Obligation to pay dividends/interest

Only after declaration

Only after declaration

At fixed rates and date

Par Value•________ amount assigned to a share•Usually set low to avoid legal issues•No-par shares

▫May have a stated value


Learning Objective TwoAccount for the issuance of shares


Ordinary Shares at Par•DR Cash • CR Ordinary Shares•Ex: Issue 6,200,000 shares of $10 par

stock for $10 each.


JOURNALDate Accounts and explanation Debit Credit

Cash (__________) ________ Ordinary shares ________To issue ordinary shares.

Ordinary Shares above Par•DR Cash (shares * sale price)

• CR Ordinary Shares (shares * par value)

• CR Additional Paid-in Capital (shares*(sale price – par))

•Ex: Issue 6,200,000 shares of $0.01 par stock for $10 each.


JOURNALDate

Accounts and explanation Debit Credit

Cash 62,0000,000 Ordinary shares 62,000 Paid-in capital in excess of par

61,938,000

To issue ordinary shares above par

Ordinary Shares with No-Par Values•Dr Cash (shares * price)• Cr Share capital (shares * price)•Ex: Sell X shares for $2,893,154


JOURNALDate


Cash 2,893,154 Share capital 2,893,154To record issuance of no-par shares.

Shares Issued for Non-Cash Assets•Asset received is recorded at current

market value•Ex: Exchange 15,000 shares of $1 par for

equipment worth 4,000 and building worth 120,000


JOURNALDate


Equipment ______Building ______ Ordinary Shares ______ Paid-in capital in excess of par ______To issue $1 par shares in exchange for equipment and a building

Shares Issued for Services•Asset received is recorded at current

market value•Ex: Company hires lawyer to represent

the company. The services are for $25,000. In return, the lawyer accepts 2,500 shares of $1 par common stock with $10/share market value.


JOURNALDate


Legal expense ______ Ordinary Shares ______ Paid-in capital in excess of par ______

Preference Shares•Follows same pattern as accounting for

ordinary shares•May have separate accounts for paid-in

capital in excess of par for preferred shares

•Can be issued with conversion feature▫Allows preferred shareholders to exchange

preferred shares for ordinary shares


Number of Shares

Authorized Issued

Outstanding



Number of Shares•Authorized

▫Total number of shares the company is permitted to offer (registered with government)

•Issued▫Number of shares sold to shareholders

•Outstanding▫Number of shares sold and not redeemed

or cancelled

Learning Objective ThreeDescribe how treasury shares affects a company


Treasury Share•Issued shares __________by the company•Reasons:

▫Make shares available for employee share purchase plans

▫Plan to “buy low” and “sell high”▫Avoid takeover▫Increase earnings per share

•In this class, we will not cover Treasury Shares in detail


Retained EarningsCumulativ

e Net income

Net losses

Dividends declared


Retained Earnings Balance


Credit balance

Lifetime earnings

Lifetime losses & dividends>

Debit balance

Lifetime earnings

Lifetime losses & dividends

<

Learning Objective FourAccount for dividends


Cash Dividends• Company must have both:

▫Enough Retained earnings to declare the dividend

▫Enough Cash to pay the dividend▫DR_______________▫ CR ________________

• Two types of dividends:▫Final dividend

Declared after the end of financial year and company’s AGM

Recommended by board of directors and require approval by shareholders

▫Interim dividends Declared during the year Declared by board of directors 26Copyright ©2014 Pearson Education.

Learning Objective FiveUse share values in decision making


Share Values•Price of a share in the marketMarket value

•Price a company agrees to pay on redemption of the share

Redemption value

•Amount paid to a preference shareholder during liquidation

Liquidation value

•Amount of owner’s equity on the company’s booksBook value


Learning Objective SixCompute earnings per share and return on equity


Earnings Per Share


Net income – Preference Dividends

Average number of shares

(Beginning total shares + Ending total shares)/2

Return on Equity


Net income – Preference dividends

Average ordinary shareholders’ equity

(Beginning ordinary shareholder equity+ Ending ordinary shareholder s’equity)/2

Learning Objective SevenReport equity transactions on the statement of cash flows


Equity Transactions on the Cash Flow Statement


Consolidated Cash Flow StatementCash flows from operating activities $XXX Cash flows from investing activities XXXCash flows from financing activities Payment for share issuance costs (XXX) Payment for repurchase of shares (XXX) Proceeds from issuance of shares

XXX

Dividends paid (XXX)XXX

Net cash flows XXX

Documents

Chapter 10 Notes