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Accounting Accounting PrinciplesPrinciplesSecond Canadian EditionSecond Canadian Edition
Prepared by: Carole Bowman, Sheridan College
Weygandt · Kieso · Kimmel · Trenholm
CORPORATIONS: CORPORATIONS: ORGANIZATION AND SHARE ORGANIZATION AND SHARE
CAPITAL TRANSACTIONSCAPITAL TRANSACTIONS
CHAPTERCHAPTER
1414
CORPORATE FORM OF CORPORATE FORM OF ORGANIZATIONORGANIZATION
A corporation is a legal entity created by law that is separate and distinct from its owners
CLASSIFICATION OF CLASSIFICATION OF CORPORATIONSCORPORATIONS
A corporation’s purpose may be to earn a profit, or it may be organized as non-profit.
Classification by ownership distinguishes between publicly-held corporations and privately-held corporations.
CHARACTERISTICSCHARACTERISTICS
Separate legal existence Limited liability of shareholders Transferable ownership rights Ability to acquire capital Continuous life Corporation management Government regulations Additional taxes
ILLUSTRATIONILLUSTRATION 14-114-1ADVANTAGES AND DISADVANTAGES ADVANTAGES AND DISADVANTAGES
OF A CORPORATION OF A CORPORATION
Advantages Disadvantages
Corporate management - professional managersSeparate legal existenceLimited liability of shareholdersDeferred or reduced income taxesTransferable ownership rightsAbility 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
ORGANIZATION COSTSORGANIZATION COSTS
Costs incurred in forming a corporation are called organization costs.
These costs include fees to underwriters, legal fees, incorporation fees, and promotional expenditures.
Organization costs are normally expensed in the year the organization cost is incurred.
SHAREHOLDER RIGHTSSHAREHOLDER RIGHTS
To raise capital, the corporation sells shares
If only one class of shares-common shares
Ownership rights specified in articles of incorporation or by-laws– Voting…owners
SHARE TERMINOLOGYSHARE TERMINOLOGY
Authorized shares – maximum amount of shares a corporation is allowed to sell as authorized by corporate charter
Issued shares – number of shares sold
How many shares should be authorized for sale?
How should the shares be issued? At what price should the shares be issued? What value should be assigned to the
shares?
SHARE ISSUE CONSIDERATIONSHARE ISSUE CONSIDERATION
STOCK MARKET PRICESTOCK MARKET PRICE
Shares of publicly held companies are traded on organized exchanges at dollar prices per share established by the interaction between buyers and sellers
Stated value – assigned value to no-par value shares
Par value – assigned legal capital value
STATED AND PAR SHARE VALUESSTATED AND PAR SHARE VALUES
Must retain legal capital.Stated and par values have NO relationship to market value
NO PAR SHARE VALUESNO PAR SHARE VALUES
No assigned legal capital valueLegal capital equals issue price
(proceeds)
Must retain legal capital.No-par value has NO
relationship to market value once issued.
ILLUSTRATIONILLUSTRATION 14-5 14-5RELATIONSHIP OF PAR, NO PAR AND RELATIONSHIP OF PAR, NO PAR AND
STATED VALUE SHARES TO LEGAL STATED VALUE SHARES TO LEGAL CAPITALCAPITAL
Shares Legal Capital per Share Par value Par value No par value Entire proceeds Stated value Stated value
Account Titles and Explanation Debit CreditCash Common Shares
To record issue of 1,000 shares.
ISSUING NO PAR VALUE ISSUING NO PAR VALUE COMMON SHARES FOR CASHCOMMON SHARES FOR CASH
Shares are most commonly issued for cash. When no par value common shares are issued, the entire proceeds from the issue becomes legal capital.
1,000 1,000
CORPORATE CAPITALCORPORATE CAPITAL
Shareholders’ equity (owner’s equity) The shareholders’ equity section of a
corporation’s balance sheet consists of: – Contributed capital
• Share capital• Additional contributed capital
– Retained earnings
ILLUSTRATIONILLUSTRATION 14-6 14-6SHAREHOLDERS’ EQUITY SECTIONSHAREHOLDERS’ EQUITY SECTION
Shareholders’ equity
Contributed capital Common shares, 100,000 no par value
shares authorized, 50,000 issued
Retained earnings
Total shareholders’ equity
$800,000
130,000
$930,000
ISSUING STATED VALUE ISSUING STATED VALUE COMMON SHARES FOR CASHCOMMON SHARES FOR CASH
Account Titles and Explanation Debit CreditCash Common Shares
Contributed Capital in Excess of Stated ValueTo record issue of 1,000 shares.
5,000 1,000 4,000
When common shares have a stated value, the stated value is credited to Common Shares. When the selling price exceeds the stated value, the excess is credited to Contributed Capital in Excess of Stated Value.
SHAREHOLDERS’ EQUITY - SHAREHOLDERS’ EQUITY - CONTRIBUTED CAPITAL IN EXCESS CONTRIBUTED CAPITAL IN EXCESS
OF STATED VALUEOF STATED VALUE
Shareholders’ equity Contributed capital Common shares, 10,000 shares of $1 stated value authorized,
2,000 shares issued Contributed capital in excess of stated value Total contributed capital Retained earnings Total shareholders’ equity
$ 2,0004,0006,000
27,000$33,000
ISSUING COMMON SHARES FOR ISSUING COMMON SHARES FOR SERVICES OR NON-CASH ASSETSSERVICES OR NON-CASH ASSETS
Shares may be issued for services, such as compensation to lawyers, or for non-cash assets, such as land.
When common shares are issued for services or non-cash assets, cost is either the fair market value of the consideration given up or the consideration received, whichever is more clearly determinable.
REACQUIRED SHARESREACQUIRED SHARES
Reacquired shares are a corporation’s own shares that have been issued, fully paid for, and then reacquired by the corporation.
Reacquired shares are generally retired and cancelled.
In certain restricted circumstances, these shares are not retired, but are held as treasury shares for later reissue.
REACQUISITION OF SHARESREACQUISITION OF SHARES
Why would a company choose to reacquire its shares?– Reduce quantity/raise share price– Increase EPS– If authorized share limit reached, may need
additional shares for use in bonus or compensation plans or acquisitions
Preferred shares have priority over common shares with regards to:1. Dividends and 2. Assets in the event of liquidation
Preferred shareholders usually do not have voting rights
Preferred shares are shown first in the share capital section of shareholders' equity
PREFERRED SHARESPREFERRED SHARES
Liquidation preferenceCumulative (dividends in arrears)Convertible (book value)Redeemable/callable (company option)Retractable (shareholder option)
PREFERRED SHARE PREFERRED SHARE PREFERENCESPREFERENCES
DIVIDEND PREFERENCESDIVIDEND PREFERENCESCUMULATIVE DIVIDENDCUMULATIVE DIVIDEND
A cumulative dividend requires that preferred shareholders be paid both current and prior year dividends before common shareholders receive any dividends.
Preferred dividends not declared in a given period are called dividends in arrears.
Dividends in arrears are not considered a liability, but the amount of the dividends in arrears should be disclosed in the notes to the financial statements.
CONVERTIBLE PREFERRED CONVERTIBLE PREFERRED SHARESSHARES
Convertible preferred shares allow the exchange of preferred shares into common shares at a specified ratio.
This kind of share is purchased by investors who want the greater security of a preferred share, but who also desire the added option of conversion.
In recording the conversion, the book value of the preferred shares is used.
The conversion of preferred shares does not result in either gain or loss to the corporation.
The market value of the shares is not considered.
REDEEMABLE PREFERREDREDEEMABLE PREFERRED Redeemable (callable) preferred shares grant the issuing
corporation the right to purchase the shares from shareholders at specified future dates and prices.
This call feature allows some flexibility to a corporation by enabling it to eliminate this type of equity when it is advantageous to do so.
While convertible shares are for the benefit of the shareholder, redeemable shares are for the benefit of the corporation.
RETRACTABLE PREFERREDRETRACTABLE PREFERRED Retractable preferred shares are similar to redeemable
preferred shares except that the shareholder can redeem shares at their option instead of the corporation’s.
Retractable preferred shares and debt have many similarities.
Both offer a rate of return to the investor, and with the redemption of the shares they both offer a repayment of the principal investment.
Retractable preferred shares are presented in the liability section of the balance sheet rather than in the equity section because it has more of the features of debt than equity.
REMINDER-REMINDER-STATEMENT PRESENTATION OF STATEMENT PRESENTATION OF
SHAREHOLDERS’ EQUITYSHAREHOLDERS’ EQUITY In the shareholders’ equity section of the balance
sheet, contributed capital and retained earnings are reported and the specific sources of contributed capital are identified.
Within contributed capital, two classifications are recognized:1. Share capital2. Additional contributed capital
ILLUSTRATIONILLUSTRATION 14-10 14-10SHAREHOLDERS’ EQUITY SHAREHOLDERS’ EQUITY
PRESENTATIONPRESENTATION
ZABOSCHUK INC.Partial Balance Sheet
Shareholders’ equity Contributed capital Share capital
$9 preferred shares, no-par value, cumulative, 10,000 shares authorized, 6,000 shares issuedCommon shares, $5 stated value, unlimited shares
authorized, 400,000 shares issuedTotal share capital
Additional contributed capital Contributed capital in excess of stated value - common shares Total contributed capital Retained earnings Total shareholders’ equity
$ 770,000
2,000,0002,770,000
860,0003,630,0001,058,000
$4,688,000
RETURN 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
BOOK VALUE VS. MARKET VALUEBOOK VALUE VS. MARKET VALUE
Book value per share seldom equals market value. Book value is based on historical costs; market
value reflects the subjective judgement of thousands of shareholders and prospective investors about the company’s potential for future earnings and dividends.
Market value per share may exceed book value per share, but that fact does not necessarily mean that the shares are overpriced.
COPYRIGHTCOPYRIGHT
Copyright © 2002 John Wiley & Sons Canada, Ltd. All rights reserved. Reproduction or translation of this work beyond that permitted by CANCOPY (Canadian Reprography Collective) is unlawful. Request for further information should be addressed to the Permissions Department, John Wiley & Sons Canada, Ltd. The purchaser may make back-up copies for his / 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.