1. University of New Brunswick Memorial University of Newfoundland
Financial Accounting: Tools for Business Decision-Making
Second Canadian Edition
Prepared by:
Barbara Trenholm
University of New Brunswick
&
Peggy Coady
Memorial University of Newfoundland

2. Reporting and Analysing Shareholders’ Equity
CHAPTER 11
Reporting and Analysing Shareholders’ Equity

3. Corporation Separate legal entity
Has most of the rights and privileges of a person
Classified by purpose and ownership
Purpose: profit or nonprofit
Ownership: public or private

4. Characteristics of a Corporation
Separate legal existence
Limited liability of shareholders
Transferable ownership rights
Ability to acquire capital
Continuous life
Corporation management
Government regulations
Income taxes

5. Advantages and Disadvantages of a Corporation
Corporate management
professional managers
Separate legal existence
Limited liability of shareholders
Deferred or reduced taxes
Transferable ownership rights
Ability to acquire capital
Continuous life
Disadvantages
Corporation management
ownership separated from management
Increased costs and complexity in order to adhere to government regulation
Additional taxes

6. Shareholder Rights To raise capital, the corporation sells shares
If there is only one class of shares, these are referred to as common shares
Ownership rights are specified in articles of incorporation or in by-laws

7. Share Terminology Authorized shares Issued shares
maximum amount of shares a corporation is allowed to sell as authorized by corporate charter
Issued shares
number of shares sold

8. 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

9. Must retain legal capital. relationship to market value once issued.
No Par Value Shares
Par and stated value shares seldom used
Par value has 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.

10. Reacquisition of Shares
Reacquired shares are a corporation’s own shares (either common or preferred) that have been issued and reacquired by the corporation
Reacquired shares are normally retired and cancelled

11. Shareholders’ Equity Legal capital
The shareholders’ equity section of a corporation’s balance sheet consists of:
1. Share capital (contributed capital)
2. Retained earnings
Legal capital

12. Shareholders’ Equity Shareholders’ equity Share capital
Common shares, 100,000 no par value shares authorized, 50, issued
$800,000
Retained earnings
130,000
Total shareholders’ equity
$930,000

13. Preferred Shares
Preferred shares have priority over common shares with regards to:
1. Dividends
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

14. Preferred Share Preferences
Liquidation preference
Cumulative (dividends in arrears)
Convertible
Redeemable/callable (company option)
Retractable (shareholder option)

15. Dividends
Dividends are distributed by a corporation to its shareholders on a pro rata (equal) basis
They are normally in the form of:
Cash
Stock (common shares)

16. Cash Dividends For a cash dividend to occur, a corporation must have:
1. Retained earnings
2. Adequate cash
3. Declared dividends

17. Entries for Cash Dividends
Three dates are important in connection with dividends:
1. Declaration date
2. Record date
3. Payment date

18. Declaration Date Date the Board of Directors declares cash dividend
Commits the corporation to a binding legal obligation that cannot be rescinded
On December 1, 2004, the directors of Media General declare a $0.50 per share cash dividend on 100,000 common shares (100,000 x $0.50 = $50,000).
Dec. 1 Cash Dividends ,000
Dividends Payable ,000

19. Record Date
Date ownership of shares is determined for dividend purposes
Dec No entry necessary

20. Payment Date Date dividend cheques are mailed
The payment date for Media General is January 20.
Jan. 20 Dividends Payable 50,000 Cash 50,000

21. Stock Dividends Distributed (paid) in shares
In most cases, fair market value is assigned to the stock dividend shares
Decreases retained earnings, increases common shares, total shareholder’s equity remains the same
Before Stock Dividend
After Stock Dividend
Common shares
$500,000
$575,000
Retained earnings
300,000
225,000
Total shareholders’ equity
$800,000

22. Purposes and Benefits of Stock Dividends
For company
To satisfy shareholders' dividend expectations without spending cash
To increase marketability of its shares by increasing number of shares and decreasing market price per share
To reinvest and restrict a portion of shareholders' equity

23. Purposes and Benefits of Stock Dividends
For shareholder
More shares with which to earn additional dividend income
More shares for future profitable resale, as share price increases

24. Stock Dividends
Assume 2% ownership interest in Cetus Inc., owning 200 of its 10,000 common shares
In a 10% stock dividend, 1,000 common shares (10,000 x 10%) would be issued
You would receive 20 shares (2% x 1,000), but your ownership interest would remain at 2% (220 /11,000)

25. Common Stock Dividends Distributable
Cetus Inc. would journalize the stock dividend as follows, assuming $25 FMV (1,000 x $25 = $25,000):
Declaration Date
Stock Dividends
Common Stock Dividends Distributable
25,000
Record Date No Entry
Distribution Date
Common Shares

26. Stock Splits
A stock split involves the issue of additional shares to shareholders according to their percentage ownership
Number of shares is increased
No change to dollar amount in share capital account

27. Stock Splits
A stock split has no effect on total share capital, retained earnings, or total shareholders’ equity
Market value of the shares will decrease roughly proportionately to the split
It is not necessary to formally journalize a stock split

28. Effects of Stock Splits, Stock Dividends, and Cash Dividends
Total assets NE 
Total liabilities
Total shareholders’ equity
Total share capital 
Total retained earnings
Number of shares
% of shareholder ownership
NE = No effect  = Increase  = Decrease

29. Retained Earnings
Retained earnings is the cumulative net earnings (less losses) that is retained in the business (i.e., not distributed to shareholders)
Retained earnings, opening balance
+ Net earnings (or - net loss)
- Dividends
= Retained earnings, ending balance

30. Deficit
A debit balance in retained earnings is identified as a deficit and is reported as a deduction in the shareholders’ equity section
Shareholders’ equity
Common shares
Retained earnings (deficit)
Total shareholders’ equity
$800,000
(50,000)
$750,000

31. Retained Earnings Restrictions
In some cases there may be retained earnings restrictions that make a portion of the balance currently unavailable for dividends
Restrictions result from one or more of the following causes:
Legal
Contractual
Voluntary

32. Measuring Corporate Performance
Dividend record
Payout ratio
Earnings performance
Return on common shareholders’ equity

33. Payout Ratio Cash Dividends Payout Ratio =
Measures the percentage of earnings distributed in the form of cash dividends to common shareholders
Payout Ratio =
Cash Dividends
Net Earnings

34. Return on Common Shareholders’ Equity
Measures the company’s profitability from the shareholders’ point of view
Return on Common Shareholders’ Equity =
Net Earnings – Preferred Share Dividends
Average Common Shareholders’ Equity

35. Components of ROE

36. Debt vs. Equity Decision
Companies must decide between issuing bonds or selling shares to raise long-term capital
Bonds
Do not affect shareholder control
Offer tax savings
Have the potential for a higher return on common shareholders’ equity
However, bonds do require a fixed payment which may be difficult for a company to meet

37. Copyright
Copyright © 2004 John Wiley & Sons Canada, Ltd. All rights reserved. Reproduction or translation of this work beyond that permitted by Access Copyright (The Canadian Copyright Licensing Agency) is unlawful. Requests for further information should be addressed to the Permissions Department, John Wiley & Sons Canada, Ltd. The purchaser may make back-up copies for his or 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.