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FINANCING:FINANCING:
Part 3A: EquityPart 3A: Equity
CHAPTERSCHAPTERS
13-1613-16
CORPORATIONSCORPORATIONSKindsKinds
Profit or non-profit
Publicly-held, or privately held
Sole Proprietorship
Partnership Corporation
Service
Merchandise
Manufacturing
CORPORATIONSCORPORATIONSFrom Grade 11From Grade 11
A corporation is a personIt is a legal entity that is separate and
distinct from its ownersThe shareholders own the corporation;
the corporation owns the assets.
OwnThe Legal
Entity of the Corporation
The Legal Entity of the Corporation
Owns
Remits wealthThe Legal
Entity of the Corporation
The Legal Entity of the Corporation
Make profit
CORPORATIONSCORPORATIONSFrom Grade 11From Grade 11
Likewise, as separate legal entities, corporations and their owners are taxed
separately.
TA
X
TA
X
(Dividends)
CORPORATIONSCORPORATIONSCharacteristics – From Grade 11Characteristics – From Grade 11
Separate legal entity Have shares which represent ownership Common shares come with voting rights Limited liability of shareholders Transferable ownership rights Ability to acquire capital more easily Continuous life Management can be separate from owners Government regulations (lots) Possibility of double taxation
Advantages Disadvantages
• Corporate management - professional managers
• Separate legal existence
• Limited liability of shareholders
• Deferred or reduced income taxes
• Transferable ownership rights
• Ability to acquire capital
• Continuous life
• Corporation management - ownership separated from management
• Increased costs and complexity to adhere to government regulation
• Potential for additional income taxes
CORPORATIONSCORPORATIONSCharacteristics – From Grade 11Characteristics – From Grade 11
CORPORATIONSCORPORATIONSOrganization CostsOrganization Costs
Costs incurred in forming a corporation are called organization costs.
Organization costs are normally expensed in the year the organization cost is incurred.
CORPORATIONSCORPORATIONSShares – The BasicsShares – The Basics
To raise capital, a corporation sells shares
Several types, but always common (voting) shares
Authorized shares– Total number of shares allowed to be sold (as authorized by corporate
charter).
Issued shares– Total number of shares actually sold and outstanding.
CORPORATIONSCORPORATIONSShares – Stock Market PriceShares – Stock Market Price
Shares of publicly held companies are traded on stock exchanges
According to Capital Market Theory, just like bonds, share prices are determined by two factors:
1. The NPV of expected future cash flows from business operations (discounted to the present)
2. Supply and demand for the stock.
Shares Legal Capital per Share
CORPORATIONSCORPORATIONSShares - Par, No Par And Stated ValueShares - Par, No Par And Stated Value
Par value Par value
No par value
Entire proceeds
Stated value
Stated value
A Corporation must retain legal capital.Note: Legal capital has NO
relationship to market value once issued.
CORPORATIONSCORPORATIONSShares - Par, No Par And Stated ValueShares - Par, No Par And Stated Value
What goes into the Equity Accounts
Par value and Stated value – are assigned values given to issued shares.
Originally they were required to ensure shares would always have some value. Their significance is now next to meaningless
For No-par shares, legal capital equals the proceeds from issuing the stock to the public.
CORPORATIONSCORPORATIONS Shares – Par Value, Stated Value, and No-Par ValueShares – Par Value, Stated Value, and No-Par Value
CORPORATIONSCORPORATIONSStatement of Shareholder’s EquityStatement of Shareholder’s Equity
The shareholders’ equity section of a corporation’s balance sheet consists of:
1. Contributed capital (from proceeds from issue of shares)
– Share capital (par or stated value)
– Additional contributed capital (beyond par or stated value)
2. Retained earnings (profit retained in the business)
CORPORATIONSCORPORATIONSStatement of Shareholder’s EquityStatement of Shareholder’s Equity
Shareholder’s EquityContributed Capital
Common shares: 2,000 $1 stated value shares, (50,000 authorized).
Contributed capital in excess of stated value
Total Contributed Capital
Retained EarningsRetained Earnings, January 1st
Add: Net IncomeLess: Cash DividendsChange in Retained Earnings for the period.
Retained Earnings, December 31st
Total Shareholder’s Equity
2,000
18,000
$30,000
$30,000$150,000
(80,000)70,000
100,000
$130,000
Share Capital
Additional Contributed Capital
Note: when common shares have No-par value, the entire proceeds are legal capital, and are credited to
Common Shares. Observe...
Date Particulars Debit CreditJuly 31 Cash 20,000
Common Shares 20,000
Issued 2,000 no-par shares for $10 per share.
When common shares have par value or stated value, this value is credited to “Common Shares” as you see here.
Any proceeds beyond the stated value are credited to “Contributed Capital in Excess of Stated Value.”
Observe…
Date Particulars Debit Credit
Sept 30 Cash 20,000Common Shares (stated value only) 2,000Contributed Capital in Excess of Stated Value 18,000
Issued 2,000 shares with a stated value of $1 per share for $10 each.
Preferred Shares,$5 no par, cumulative (1,000 issued, 10,000 authorized). $10,000
Preferred shares have priority over common shares with regards to:
1. Dividends and 2. Any payments in the event of
liquidation All dividends must be paid to preferred
shareholders before common shareholders can receive anything (including past owed dividends)
They can often be redeemable/callable/or convertible
They usually don’t have voting rights
CORPORATIONSCORPORATIONSPreferred Shares - BasicsPreferred Shares - Basics
RETURN ON EQUITYRETURN ON EQUITYRETURN ON EQUITYRETURN ON EQUITY
Return on equity (or return on investment) is considered to be the most important measure of a firm’s profitability and efficiency.
Evaluates how many dollars were earned for each dollar invested by the owners.
=Net IncomeAverage
Shareholders Equity
Return on Equity
BOOK VALUE PER SHARE BOOK VALUE PER SHARE
Book value per share represents the equity a common shareholder has in the net assets of the corporation from owning one share.
The formula for calculating book value per share when a corporation has only one class of shares is:
=Total
Shareholders’ Equity
Number of Common
Shares
Book Value per Share
When a company has both preferred and common shares, the calculation of book value is more complex.
Steps required are:1. Calculate the preferred shareholders’ equity (the sum of
redemption price of preferred shares plus any cumulative dividends in arrears).
2. Determine the common shareholders’ equity (total shareholders’ equity less preferred shareholders’ equity).
3. Divide common shareholders’ equity by the number of common shares to determine book value per share.
CALCULATION OF BOOK VALUE CALCULATION OF BOOK VALUE WITH PREFERRED SHARESWITH PREFERRED SHARES
Do Problems:
BE14-1 and BE14-10
E14-7 (no memo required)
P14-4A (use T-accounts to post)
P14-5A (you’ll have to read the text learn how to calculate this ratio when you have preferred
shares)