1. Prepared by: Carole Bowman, Sheridan College
Accounting Principles
Second Canadian Edition
Weygandt · Kieso · Kimmel · Trenholm
Prepared by: Carole Bowman, Sheridan College

2. CORPORATIONS: ORGANIZATION AND SHARE CAPITAL TRANSACTIONS
CHAPTER 14
CORPORATIONS: ORGANIZATION AND SHARE CAPITAL TRANSACTIONS

3. CORPORATE FORM OF ORGANIZATION
A corporation is a legal entity created by law that is separate and distinct from its owners
As a legal entity, may enter into contracts, responsible for its own debts, and pays income taxes on its earnings.
A corporation may sue and be sued as if it were a person.

4. CLASSIFICATION OF CORPORATIONS
A corporation’s purpose may be
to earn a profit
to be non-profit.
Classification by ownership distinguishes between publicly-held corporations and privately-held corporations.

5. CHARACTERISTICS OF A CORPORATION
Separate legal existence
May act like a person, sue and be sued
Enter into contracts
Continuous life
Ability to acquire capital (e.g. $ and property)
Corporation management
Government regulations
Additional taxes
Limited liability of shareholders
Transferable ownership rights

6. ADVANTAGES AND DISADVANTAGES OF A CORPORATION
Advantages Disadvantages
Corporate management - professional managers
Separate legal existence
Limited liability of shareholders
Deferred or reduced income taxes
Transferable ownership rights
Ease of acquiring capital
Continuous life
Corporation management - ownership separated from management
Increased costs and complexity to adhere to government regulation
Potential for additional income taxes
More complex to set up

7. FORMATION OF A CORPORATION
Need a Certificate of Incorporation (Federal or Provincial) or a corporate charter.
Articles of incorporation application must be completed and submitted to the government to obtain a certificate of incorporation.
Once the certificate or charter is obtained, shareholders in the new corporation hold a meeting to elect Directors and pass By-laws as a guide to the company's affairs.

8. ORGANIZATION COSTS
Costs incurred in forming a corporation are called organization costs. Include:
Incorporation fees (Federal or Provincial)
Legal fees
Underwriter fees
Promotional expenditures
Organization costs are normally expensed in the year the organization cost is incurred.
However, may be capitalized as "Other Assets” and amortized over a maximum of 40 years

9. CORPORATE CAPITAL Shareholders’ equity (owner’s equity)
The shareholders’ equity section of a corporation’s balance sheet consists of:
Contributed capital
Capital stock
Amount invested by the owners of the business
When owners invest cash or other assets in the business, the corporation issues capital stock as evidence of the investors' ownership equity
Additional contributed capital
Retained earnings
From profitable operations

10. CLOSING ENTRIES For a net income
Income Summary xx
Retained Earnings xx
To close the Income Summary account by transferring the year's net income into the Retained Earnings account.
For a net loss
To close the Income Summary account to transferring the year's net loss into the Retained Earnings account.

11. SHAREHOLDERS’ EQUITY SECTION
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

12. DIVIDENDS
If a corporation has sufficient cash, a distribution of income or earnings may be made to shareholders.
This distribution of earnings is termed "Dividends" and decrease both total assets and total shareholder's equity

13. CASH DIVIDENDS
Dividends are only paid through action by the Board of Directors. Once a dividend is declared the following transactions occur.
Declaration date:
Retained Earnings xx
Dividends Payable xx
To record declaration by the board of directors of a cash dividend of $1 per share on the 100,000 shares of capital stock outstanding.
Date dividend actually paid:
Cash xx
To record payment of dividend declared on "Date".

14. SHAREHOLDER RIGHTS To raise capital, the corporation
Sells shares
Issues debt securities (to be discussed later)
If it only has one class of shares:
common shares
Ownership rights are specified in articles of incorporation or by-laws
Voting…owners

15. SHARE ISSUE CONSIDERATION
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?

16. SHARE TERMINOLOGY
Authorized shares – maximum amount of shares a corporation is allowed to sell as authorized by the corporate charter
Issued shares – number of shares sold

17. Must retain legal capital. relationship to market value once issued.
NO PAR SHARE VALUES
No assigned legal capital value
Legal capital equals issue price (proceeds)
Must retain legal capital.
No-par value has NO
relationship to market value once issued.

18. ISSUING NO PAR VALUE COMMON 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.
Account Titles and Explanation
Debit
Credit
Cash
600, ,000
Common Shares
To record issue of 60,000 $10/share.

19. SHAREHOLDERS’ EQUITY - CONTRIBUTED CAPITAL AT NO-PAR VALUATION
Capital Stock, no-par value, authorized, an unlimited number
of shares, issued and outstanding, 60,000 shares
Retained earnings
Total shareholders’ equity
$ 600,000
280,000
$880,000

20. ISSUING CAPITAL STOCK – The role of an Underwriter
When a large amount of capital stock is to be issued, most corporations use the services of an investment dealer (i.e. underwriter).
The underwriter guarantees the issuing corporation a specific price for the stock and makes a profit by selling the shares to the investing public at a slightly higher price.

21. SETTING THE ASKING PRICE
The price that a corporation will ask for a new issue of capital stock is based on
Expected future earnings and dividends
The financial strength of the company
The current state of the investment markets
If a corporation asks too much, it will not find an underwriter or other buyers willing to purchase the shares.

22. STATED AND PAR SHARE VALUES
Stated value – assigned value to no-par value shares
Par value – arbitrary amount assigned by a corporation as its legal capital value per share. E.g. $1, $2, $5 per share – any amount
Seldom Used
Must retain legal capital.
Stated and par values have NO
relationship to market value.

23. ISSUING STATED VALUE COMMON SHARES FOR CASH
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.
Account Titles and Explanation
Debit
Credit
Cash
5, , ,000
Common Shares
Contributed Capital in Excess of Stated Value
To record issue of 1,000 shares.

24. SHAREHOLDERS’ EQUITY - CONTRIBUTED CAPITAL IN EXCESS OF STATED VALUE
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
$ 2,000
4,000
6,000
27,000
$33,000

25. RELATIONSHIP OF PAR, NO PAR AND STATED VALUE SHARES TO LEGAL CAPITAL

26. COMMON STOCK RIGHTS
Common stock is the basic, residual element of ownership in a corporation.
To vote at any meeting of shareholders of the corporation.
To receive any dividend declared by the corporation
To receive the remaining property of the corporation on dissolution.

27. PREFERRED STOCK
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

28. PREFERRED SHARE PREFERENCES
Liquidation preference
Cumulative (dividends in arrears)
Convertible (book value)
Redeemable/callable (company option)
Retractable (shareholder option)

29. DIVIDEND PREFERENCES CUMULATIVE 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.

30. CONVERTIBLE PREFERRED SHARES
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.

31. REDEEMABLE 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.

32. RETRACTABLE 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.

33. REMINDER- STATEMENT PRESENTATION OF SHAREHOLDERS’ 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 capital
2. Additional contributed capital

34. SHAREHOLDERS’ EQUITY PRESENTATION
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 issued
Common shares, $5 stated value, unlimited shares authorized, 400,000 shares issued
Total share capital
Additional contributed capital
Contributed capital in excess of stated value - common shares
Total contributed capital
Retained earnings
Total shareholders’ equity
$ ,000
2,000,000
2,770,000
860,000
3,630,000
1,058,000
$4,688,000

35. STOCK 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
Investors’ expectations as to the profitability of future operations greatly affect the market value of common shares.
Bear Market = stock prices are falling
Bull Market = stock prices are rising

36. STOCK MARKET PRICE
Once shares are issued they belong to the shareholders, not to the corporation. Therefore, changes in the market price of the shares do not affect the financial statements of the corporation, and these changes are not recorded in the corporation’s accounting records.
The contributed capital shown in the corporate balance sheet represents the amount received when the stock was issued, not the current market value of shares.

37. ISSUING COMMON SHARES FOR SERVICES 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.

38. SUBSCRIPTIONS TO CAPITAL STOCK
Small, newly formed corporations sometimes offer investors an opportunity to subscribe to shares of the company’s capital stock.
Under a subscription plan, the investors agree to purchase specified numbers of shares at a stated price at a future date, often by making a series of installment payments.
The stock is issued after the entire subscription price has been collected.

39. DONATED CAPITAL
On occasion, a corporation my receive assets as a gift. (e.g. land given by the city to build a factory)
Both total assets and total shareholders’ equity increase by the market value of the assets received.
DR Asset
CR Donated capital
No income is recognized when a gift is received.

40. REACQUIRED 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.

41. REACQUISITION OF SHARES
Why would a company choose to reacquire its shares?
Reduce quantity/raise share price
Increase EPS (earnings per share)
If authorized share limit is reached, may need additional shares for use in bonus or compensation plans or acquisitions

42. Total Shareholders’ Equity Number of Common Shares
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

43. CALCULATION OF BOOK VALUE WITH PREFERRED SHARES
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.

44. BOOK 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.

45. Average Shareholders Equity
RETURN 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 Income
Average Shareholders Equity
Return on Equity

46. COPYRIGHT
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.