1 Prepared by: Carole Bowman, Sheridan College Accounting PrinciplesSecond Canadian EditionWeygandt · Kieso · Kimmel · TrenholmPrepared by: Carole Bowman, Sheridan College
2 CORPORATIONS: ORGANIZATION AND SHARE CAPITAL TRANSACTIONS CHAPTER14CORPORATIONS: 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
4 CLASSIFICATION OF CORPORATIONS 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.
5 CHARACTERISTICS Separate legal existence Limited liability of shareholdersTransferable ownership rightsAbility to acquire capitalContinuous lifeCorporation managementGovernment regulationsAdditional taxes
6 ILLUSTRATION 14-1 ADVANTAGES AND DISADVANTAGES OF A CORPORATION Advantages DisadvantagesCorporate management - professional managersSeparate legal existenceLimited liability of shareholdersDeferred or reduced income taxesTransferable ownership rightsAbility to acquire capitalContinuous lifeCorporation management - ownership separated from managementIncreased costs and complexity to adhere to government regulationPotential for additional income taxes
7 ORGANIZATION COSTSCosts 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.
8 SHAREHOLDER RIGHTS To raise capital, the corporation sells shares If only one class of shares-common sharesOwnership rights specified in articles of incorporation or by-lawsVoting…owners
9 SHARE TERMINOLOGYAuthorized shares – maximum amount of shares a corporation is allowed to sell as authorized by corporate charterIssued shares – number of shares sold
10 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?
11 STOCK MARKET PRICEShares of publicly held companies are traded on organized exchanges at dollar prices per share established by the interaction between buyers and sellers
12 STATED AND PAR SHARE VALUES Stated value – assigned value to no-par value sharesPar value – assigned legal capital valueSeldom UsedMust retain legal capital.Stated and par values have NOrelationship to market value
13 Must retain legal capital. relationship to market value once issued. NO PAR SHARE VALUESNo assigned legal capital valueLegal capital equals issue price (proceeds)Must retain legal capital.No-par value has NOrelationship to market value once issued.
14 ILLUSTRATION 14-5 RELATIONSHIP OF PAR, NO PAR AND STATED VALUE SHARES TO LEGAL CAPITAL
15 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 ExplanationDebitCreditCash1, ,000Common SharesTo record issue of 1,000 shares.
16 CORPORATE CAPITAL Shareholders’ equity (owner’s equity) The shareholders’ equity section of a corporation’s balance sheet consists of:Contributed capitalShare capitalAdditional contributed capitalRetained earnings
17 ILLUSTRATION 14-6 SHAREHOLDERS’ EQUITY SECTION Contributed capitalCommon shares, 100,000 no par value shares authorized, 50,000 issuedRetained earningsTotal shareholders’ equity$800,000130,000$930,000
18 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 ExplanationDebitCreditCash5, , ,000Common SharesContributed Capital in Excess of Stated ValueTo record issue of 1,000 shares.
19 SHAREHOLDERS’ EQUITY - CONTRIBUTED CAPITAL IN EXCESS OF STATED VALUE Common shares, 10,000 shares of $1 stated value authorized,2,000 shares issuedContributed capital in excess of stated valueTotal contributed capitalRetained earningsTotal shareholders’ equity$ 2,0004,0006,00027,000$33,000
20 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.
21 REACQUIRED SHARESReacquired 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.
22 REACQUISITION OF SHARES Why would a company choose to reacquire its shares?Reduce quantity/raise share priceIncrease EPSIf authorized share limit reached, may need additional shares for use in bonus or compensation plans or acquisitions
23 PREFERRED SHARESPreferred shares have priority over common shares with regards to:1. Dividends and2. Assets in the event of liquidationPreferred shareholders usually do not have voting rightsPreferred shares are shown first in the share capital section of shareholders' equity
25 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.
26 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.
27 REDEEMABLE PREFERREDRedeemable (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.
28 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.
29 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 capital2. Additional contributed capital
31 Average Shareholders Equity RETURN ON EQUITYReturn 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 EquityReturn on Equity
32 Total Shareholders’ Equity Number of Common Shares BOOK VALUE PER SHAREBook 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’ EquityNumber of Common SharesBook Value per Share
33 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.
34 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.