1. FINANCIAL ACCOUNTING a user perspective Sixth Canadian Edition Prepared by: Lynn de Grace C.A. Chapter 11 Shareholders’ Equity

2. Forms of Organization John Wiley & Sons Canada, Ltd. ©2011  Sole Proprietorship  Partnership  Corporation 2

3. Sole Proprietorship John Wiley & Sons Canada, Ltd. ©2011  Single-owner business  Business and owner are same legal entity  Unlimited liability  Less concern with reporting to shareholders  Profits are taxed as owner’s income  Owner’s capital and withdrawal accounts 3

4. Partnership John Wiley & Sons Canada, Ltd. ©2011  A general partnership - two or more owners  Partnership agreement  Profits are taxed as partner’s income  General partners have unlimited liability  Partner’s capital and withdrawal (drawing) accounts 4

5. Partnership John Wiley & Sons Canada, Ltd. ©2011  Limited partnership A partnership with two types of partners: General partners Limited partners Have limited involvement in the partnership Invest in the partnership but do not make day-to-day decisions about its operations They share in profits and losses but creditors cannot normally sue them if the partnership runs into financial difficulty 5

6. Corporation John Wiley & Sons Canada, Ltd. ©2011  Organization is legally separate from the owners (shareholders)  Limited liability  Subject to corporate taxation  Incorporation means additional filing requirements and fees.  Additional administrative requirements – bookkeeping, financial statements, minute book.  Additional accounting and legal fees. 6

7. Corporations John Wiley & Sons Canada, Ltd. ©2011  Companies may be incorporated under federal or provincial law  A separate legal entity is created by issuing articles of incorporation. Includes information on type of business, organization, management, and kinds of shares to be issued 7

8. Shares John Wiley & Sons Canada, Ltd. ©2011  Authorized shares: The maximum number of shares that a company can issue, as specified in the articles of incorporation Many companies establish an unlimited number.  Issued shares: Shares that have been sold by the company 8

9. Shares John Wiley & Sons Canada, Ltd. ©2011  Par value A specified dollar amount attached to each share Used in the past, no longer permitted under CBCA. When shares are sold, par value is credited to the share capital account and any excess is credited to an account called contributed surplus in excess of par.  No par value shares Commonly used today Total amount received for the shares is credited to the share capital account. 9

10. Shares John Wiley & Sons Canada, Ltd. ©2011  Legal capital Total amount received for shares when issued Must be kept intact Cannot be paid out as dividends 10

11. Shares John Wiley & Sons Canada, Ltd. ©2011  Major classes of shares Common shares Preferred shares  Differ in the rights that accrue to their holders 11 Le Chateau Inc. Capital Stock Note

12. Common Shares John Wiley & Sons Canada, Ltd. ©2011  Represent the basic voting ownership rights of the company  Basic set of rights that allow the owner to share proportionately in: Profits and losses The selection of corporate management Assets upon liquidation Subsequent issues of shares (preemptive right) (although not all jurisdictions in Canada provide for this basic right)  Generally issued through underwriters Details and features are outlined in a prospectus 12

13. Common Shares John Wiley & Sons Canada, Ltd. ©2011  Common shares carry the right to vote – standard rule: one vote for each share.  Different classes of shares may be entitled to different portions of the earnings  Dividends are restricted for preferred shares  Dividends are not restricted for common shares  Dividends are shared proportionately within each class of shares. 13

14. Preferred Shares John Wiley & Sons Canada, Ltd. ©2011  Have preference over common shares with regard to dividends;  Preferred shareholders are not guaranteed a dividend;  If a dividend is declared, preferred shareholders will receive dividends before common shareholders  Preferred dividend Amount is usually stated as a dollar amount per share 14

15. Preferred Shares John Wiley & Sons Canada, Ltd. ©2011  Cumulative preferred shares If a dividend is not declared in one year, the dividends carry over to the next year Dividends in arrears Dividends from prior years that have not been declared; Dividends in arrears, as well as current preferred share dividends, must always be paid prior to paying dividends to common shareholders 15

16. Preferred Shares John Wiley & Sons Canada, Ltd. ©2011  Convertible preferred shares Convertible at the option of the shareholder Can be converted into common shares based on a preset ratio Usually contingent on the occurrence of a specific event, such as the price of the shares, or a change in the interest rates. 16

17. Preferred Shares John Wiley & Sons Canada, Ltd. ©2011  Redeemable preferred shares Can be bought back by the company (retired) Price and time is specified  Retractable preferred shares Can be sold back to the company (retired) at the option of the shareholder  Most shares are both redeemable and retractable. 17

18. Preferred Shares John Wiley & Sons Canada, Ltd. ©2011  Participating preferred shares Shareholders can share dividends in excess of those specified; Most preferred shares are nonparticipating. 18

19. Preferred Shares John Wiley & Sons Canada, Ltd. ©2011 19

20. Accounting for the Issuance of Common Shares John Wiley & Sons Canada, Ltd. ©2011  For no par value shares Cash (A) 15,000 Common shares (SE)15,000  For par value shares Cash (A) 15,000 Common shares (SE) 10,000 Contributed capital (SE) 5,000* *Amount in excess of par value 20

21. Repurchased Shares John Wiley & Sons Canada, Ltd. ©2011  Treasury Shares: Shares that have been repurchased by the issuing company; Usually cancelled immediately upon purchase; Treasury shares are considered issued but not outstanding  The repurchase reduces the share capital account by the amount the shares were originally issued for.  If the cost of repurchase differs from the original amount received, the excess or shortfall would be recorded in the retained earnings or the contributed surplus account. It is not a gain or loss reported in income. 21

22. Cash Dividends John Wiley & Sons Canada, Ltd. ©2011  Payments to be made to shareholders from the total net income retained in the company’s Retained Earnings account  Payment in return for the company’s use of the shareholders’ money 22

23. Cash Dividends John Wiley & Sons Canada, Ltd. ©2011  Paid only if the board of directors has voted to declare a dividend  Declaration results in a legal liability  Not paid on treasury shares  Paid only on outstanding shares 23

24. Dividends John Wiley & Sons Canada, Ltd. ©2011 Three Important Dates in the process: 1. Date of declaration Date of the board of directors vote Dividends declared (SE) XXX Dividends payable (L) XXX 24

25. Dividends John Wiley & Sons Canada, Ltd. ©2011 2. Date of record Date on which a shareholder must own the shares in order to receive the dividend No journal entry is made 25

26. Dividends John Wiley & Sons Canada, Ltd. ©2011 3.Date of payment Date on which the payment is made Dividends payable (L) XXX Cash (A) XXX 26

27. Property Dividends John Wiley & Sons Canada, Ltd. ©2011  Dividend declared that will be settled with some resource other than cash – ie. inventory, land, a vehicle.  Also known as dividends in kind  Recorded at fair market value on the declaration date 27

28. Stock Dividends John Wiley & Sons Canada, Ltd. ©2011  Additional shares of the company are issued instead of cash or property  Can satisfy shareholders when cash flows are limited.  Stock dividends reduce retained earnings and increase share capital by the same amount – no change in shareholders’ equity. 28

29. Stock Dividends John Wiley & Sons Canada, Ltd. ©2011  Example Company has 100,000 shares outstanding, owned equally by 10 people A 20% stock dividend is issued Each shareholder receives 2000 new shares, resulting in 120,000 shares outstanding 29

30. Stock Dividends John Wiley & Sons Canada, Ltd. ©2011  Why issue stock dividends ? Shareholder may be better off: Per share book value lower, but market value may not fully reflect the reduction; Company is able to capitalize its retained earnings 30

31. Accounting for Stock Dividends John Wiley & Sons Canada, Ltd. ©2011  Valuation is market value on the date of declaration  Declaration Dividends declared (SE) 150,000 Stock dividend issuable (SE) 150,000  Issuance Stock dividends issuable (SE) 150,000 Share capital (SE) 150,000 31

32. Stock Splits John Wiley & Sons Canada, Ltd. ©2011  Usually stated as a ratio Example: A two-for-one stock split Each share currently held is exchanged for two new shares Number of shares outstanding is adjusted  No change to the shareholders’ equity account 32

33. Employee Stock Options John Wiley & Sons Canada, Ltd. ©2011  An agreement between two parties to either buy or sell a share at a fixed price at some future date Exercise price (or strike price): the fixed price for the shares Expiration date: date after which the options can no longer be exercised Service period: the length of time the employee must work before he can exercise the option  Are used as form of compensation  Generally not traded – options pricing models are used to estimate fair value at grant date  Compensation expense is recorded at fair value 33

34. Employee Stock Options  Example: Maple Co. issues 5,000 options to its CEO on Jan 1, 2010 On that date: Share price = $25Exercise price $30 Options can only be exercised after three years of service Using Black-Scholes model, the fair value of the options is determined to be $6,000 Compensation expense is debited for $2,000 per year for three years The offsetting account is Contributed Surplus, since the shares are not issued yet. John Wiley & Sons Canada, Ltd. ©2011 34

35. Employee Stock Options  Example (cont’d): On July 31, 2013 CEO exercises the options when the shares are trading for $38. CEO pays $150,000 [$30x5000] and receives shares valued at $190,000 [$38x5000] Maple Co. would make the following journal entry: Contributed Surplus6,000 Cash150,000 Capital Stock156,000 John Wiley & Sons Canada, Ltd. ©2011 35

36. Statement of Retained Earnings  Changes in retained earnings can be summarized in a separate statement or shown as an extension of the statement of earnings  Items that affect retained earnings include: Net income Dividends Excess of share repurchase price over amount originally paid Some changes in accounting policy that directly affect retained earnings Corrections of errors John Wiley & Sons Canada, Ltd. ©2011 36

37. Statement of Retained Earnings Standard format: Retained earnings at the end of the preceding period XX Net earnings (or net loss) for the current periodXX Dividends declared in the current period(XX) Retained earnings at the end of the current periodXX John Wiley & Sons Canada, Ltd. ©2011 37

38. Statement of Retained Earnings John Wiley & Sons Canada, Ltd. ©2011 38 Le Chateau Inc. 2009 Annual Report

39. Statement of Changes in Equity  Summarizes the changes in all the equity accounts  Usually presented in columnar format  Includes all items affecting shareholders’ equity: Common and preferred shares Retained earnings Contributed surplus Accumulated other comprehensive income John Wiley & Sons Canada, Ltd. ©2011 39

40. Statement of Changes in Equity Accumulated Other Comprehensive Income:  Includes: Gains and losses on some types of investments Some foreign currency translation adjustments Gains and losses on complex financial instruments to hedge events.  Reported either in a separate statement or at the bottom of the statement of earnings directly below net earnings  Other comprehensive income is added to net earnings to determine the total comprehensive income for the year.  These other comprehensive gains and losses affect shareholders’ wealth but are not included in retained earnings. John Wiley & Sons Canada, Ltd. ©2011 40

41. John Wiley & Sons Canada, Ltd. ©2011 ROGERS COMMUNICATIONS INC. 2009 ANNUAL REPORT

42. Financial Statement Analysis  Book Value of a company = Assets – Liabilities It is the value of the shareholders’ investment in the company according to the accounting records.  Market Value = the value in the open market  Sometimes book value approximates market value, because many of the company’s assets are recorded at market values – ie financial institutions  Sometimes a large difference – ie. Industrial manufacturer. John Wiley & Sons Canada, Ltd. ©2011 42

43. Price/Earnings Ratio John Wiley & Sons Canada, Ltd. ©2011  A higher valuation usually indicates a market perception of higher earnings potential, lower risk, or a positive assessment of future market share. Price/Earnings = Market price per share RatioEarnings per share 43

44. Price/Earnings Ratio January 29, 2010 $13.82 ÷ $1.23 = 11.24 January 30, 2009 $8.30 ÷ $1.56 = 5.32 John Wiley & Sons Canada, Ltd. ©2011 44 Le Chateau Inc. CLASS A non-voting shares

45. Return on Shareholders’ Equity  Measures the return to common shareholders only. John Wiley & Sons Canada, Ltd. ©2011 ROE= Net income - Preferred dividends Average common shareholders’ equity 45 Le Chateau Inc. Financial Statements

46. Return on Shareholders’ Equity John Wiley & Sons Canada, Ltd. ©2011 46 * * From 2008 balance sheet

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